Tuesday, September 30, 2014

Accounting Principles : Accounting Basics Day 5

Introduction

The accounting principles are accounting rules used to prepare, present, and report financial statements for a wide variety of entities, including publicly-traded and privately-held companies, non-profit organizations, and governments. In this chapter we are going to learn about these accounting procedures which form the guidelines to prepare the financial statements.


Learning Objectives

By the time you finish Day 3 you would have learnt about

  • Basic accounting conventions. 
  • Concepts. 
  • Assumption

Why Accounting Principles?


Imagine that you are a business owner, and you take copies of your financial records to six different accountants. You ask each one to calculate your profit for the year. A fortnight later they each provide you with their answers. There are six different profit figures, with very wide variations between them. What impression do you now have of the accounting profession?
To avoid this kind of situation arising various rules, or accepted ways of going about things have evolved. These rules are known as 'concepts' and 'conventions' To support the application of the "true and fair view", accounting has adopted certain concepts and conventions which help to ensure that accounting information is presented accurately and consistently.


Assumptions

The basic assumptions of accounting are like the foundation pillars on which the structure of accounting is based. The four basic assumptions are as follows:

Business Entity Assumption

The concept of business entity assumes that business has a distinct and separate entity from its owners. It means that for the purposes of accounting, the business and its owners are to be treated as two separate entities. Keeping this in view, when a person brings in some money as capital into his business, in accounting records, it is treated as liability of the business to the owner. Here, one separate entity (owner) is assumed to be giving money to another distinct entity (business unit). Similarly, when the owner withdraws any money from the business for his personal expenses (drawings), it is treated as reduction of the owner’s capital and consequently a reduction in the liabilities of the business.

Money Measurement Assumption

The concept of money measurement states that only those transactions and happenings in an organization which can be expressed in terms of money such as sale of goods or payment of expenses or receipt of income, etc. are to be recorded in the book of accounts. All such transactions or happenings which cannot be expressed in monetary terms, for example, the appointment of a manager, capabilities of its human resources or creativity of its research department or image of the organization among people in general do not find a place in the accounting records of a firm.

Accounting Period Assumption

The users of financial statements need periodical reports to know the operational result and the financial position of the business concern. Hence it becomes necessary to close the accounts at regular intervals. Usually a period 52 weeks or 1 year is considered as the accounting period.

Going Concern Assumption

As per this assumption, the business is assumed to continue for a never ending period and therefore transactions are recorded from this point of view. There is neither the intention nor the necessity to wind up the business in the foreseeable future.

Basic Concepts of Accounting

These concepts guide how business transactions are reported. On the basis of the above four assumptions the following concepts (principles) of accounting have been developed.

Dual Aspect Concept

Dual aspect is the foundation or basic principle of accounting. It provides the very basis for recording business transactions into the book of accounts. This concept states that every transaction has a dual or two-fold effect and should therefore be recorded at two places. In other words, at least two accounts will be involved in recording a transaction. This can be explained with the help of an example. Ram started business by investing in a sum of Rs. 50, 00,000 the amount of money brought in by Ram will result in an increase in the assets (cash) of business by Rs. 50, 00,000. At the same time, the owner’s equity or capital will also increase by an equal amount. It may be seen that the two items that got affected by this transaction are cash and capital account.All business transactions recorded in accounts have two aspects - receiving benefit and giving benefit. For example, when a business acquires an asset (receiving of benefit) it must pay cash (giving of benefit).

Realization Concept

The concept of revenue recognition requires that the revenue for a business transaction should be included in the accounting records only when it is realized. Here arise two questions in mind. First, is termed as revenue and the other, when the revenue is realized. Let us take the first one first. Revenue is the gross inflow of cash arising from (i) the sale of goods and services by an enterprise; and (ii) use by others of the enterprise’s resources yielding interest, royalties and dividends. Secondly, revenue is assumed to be realized when a legal right to receive it arises, i.e. the point of time when goods have been sold or service has been rendered. Thus, credit sales are treated as revenue on the day sales are made and not when money is received from the buyer. As for the income such as rent, commission, interest, etc. these are recognized on a time basis. For example, rent for the month of March 2005, even if received in April 2005, will be taken into the profit and loss account of the financial year ending March 31, 2005 and not into financial year beginning with April 2005. Similarly, if interest for April 2005 is received in advance in March 2005, it will be taken to the profit and loss account of the financial year ending March 2006.

Historical Cost Concept

Under this concept, assets are recorded at the price paid to acquire them, which includes cost of acquisition, transportation, installation and making the asset ready to use . For example, if a piece of land is purchased for Rs.50,00,000 and its market value is Rs.70,00,000 at the time of preparing final accounts the land value is recorded only for Rs.50,00,000. Thus, the balance sheet does not indicate the price at which the asset could be sold for.

Matching Concept

The earnings and expenses shown in an income statement must both refer to the same goods transferred or services rendered during the accounting period. The matching concept requires that expenses should be matched to the revenues of the appropriate accounting period.
Profit is an excess of revenue over expenditure therefore it becomes necessary to bring together all revenues and expenses relating to the period under review so we must determine the revenue earned during a particular accounting period and the expenses incurred to earn these revenues

Verifiable and Objective Evidence Concept

The concept of objectivity requires that accounting transaction should be recorded in an objective manner, free from the bias of accountants and others. This can be possible when each of the transaction is supported by verifiable documents or vouchers. For example, the transaction for the purchase of materials may be supported by the cash receipt for the money paid, if the same is purchased on cash or copy of invoice and delivery challan, if the same is purchased on credit. Similarly, receipt for the amount paid for purchase of a machine becomes the documentary evidence for the cost of machine and provides an objective basis for verifying this transaction.

Conventions

To make the accounting information useful to various interested parties, the basic assumptions and concepts discussed earlier have been modified. These modifying principles are as under.

Convention of Full Disclosure

The principle of full disclosure requires that all material and relevant facts concerning financial performance of an enterprise must be fully and completely disclosed in the financial statements and their accompanying footnotes. This is to enable the users to make correct assessment about the profitability and financial soundness of the enterprise and help them to take informed decisions.

Convention of Materiality

The materiality principle requires all relatively relevant information should be disclosed in the financial statements. Unimportant and immaterial information are either left out or merged with other items.
For example, money spent on creation of additional capacity of a theatre would be a material fact as it is going to increase the future earning capacity of the enterprise. Similarly, information about any change in the method of depreciation adopted or any liability which is likely to arise in the near future would be significant information. All such information about material facts should be disclosed through the financial statements and the accompanying notes so that users can take informed decisions.

Convention of Consistency

The aim of consistency principle is to preserve the comparability of financial statements. The rules, practices, concepts and principles used in accounting should be continuously observed and applied year after year. Comparisons of financial results of the business among different accounting period can be significant and meaningful only when consistent practices were followed in ascertaining them.
To illustrate, an investor wants to know the financial performance of an enterprise in the current year as compared to that in the previous year. He may compare this year’s net profit with that in the last year. But, if the accounting policies adopted, say with respect to depreciation in the two years are different, the profit figures will not be comparable. Because the method adopted for the valuation of stock in the past two years is inconsistent. It is, therefore, important that the concept of consistency is followed in preparation of financial statements so that the results of two accounting periods are comparable.

Convention of Conservatism

The concept of conservatism requires that profits should not to be recorded until realized but all losses, even those which may have a remote possibility, are to be provided for in the books of account. This principle takes into consideration all prospective losses but leaves all prospective profits. The essence of this principle is “anticipate no profit and provide for all possible losses”. For example, while valuing stock in trade, market price or cost price whichever is less is considered.


Go Back to Accounting Basics Day 4

Monday, September 29, 2014

Bills Payable Book

Bills payable book is used to record bill accepted by us. When a bill drawn by our creditor is accepted particulars of the same are recorded in this book.

Posting:

In the ledger, the account of each person whose bill has been accepted is debited with the amount of the bill. The monthly total of the bills accepted is credited to the bills payable account ledger.

Format of Bills Receivable Book:

The following is the ruling and format of bills payable book:

Dr
Bills Payable Book
Cr
No. of BillsDateTo whom GivenDrawerPayeeP/ble AtTermDue DateL.F.AmtRemarks

2)

Dr
Bills Payable Book
Cr
DateTo whom givenTermDue DateL.F.Amount


From the following transactions of a trader let us prepare the bills receivable book and post it into ledger

Date
January 5,2009Accepted a bill at 3 m/d for $200 drawn by Rahmat & Co
" 20gave acceptance at 2 m/d for $500 to Kamal.
" 30Acceptance at 1 m/d for $ 500 given to Feroz & Co.

Solution

DateFrom whom receivedTermDue DateL.F.Amount
Jan 5,2009Rahmat & Co.3 m/dApril 8200
Jan 20Kamal3 m/dMarch 23500
Jan 30Feroz & Co.1 m/dMarch 30500
Total : 1200

Now the individual entries are posted in their respective Ledgers as shown below:

Dr
Purchases Return Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount



January 31,2005By Sundry as per Bills Payable Book1200


Dr
Rahmat & Co. Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
January 8,2005By Bills Payables200



Dr
Kamal Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
January 20,2005By Bills Payables500



Dr
Feroz and Co. Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
January31,2005By Bills Payables500



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Sunday, September 28, 2014

Bills Receivable book

This book is used to record the bills received from debtors. When a bill is received, details of it are recorded in the bills receivable book.

Posting:

In the ledger the account of the person from whom each bill is received is credited with the amount of that bill and the periodical total of the book is posted to the debit of bills receivable account.
The bills receivable book is ruled according to the requirements of a particular account. The following is the format of bills receivable book:

1)


Dr
Bills Receivable Book
Cr
No. of BillsDateR/ved FromDrawerAceptorP/ble AtTermDue DateL.F.AmtRemarks

2)

Dr
Bills Receivable Book
Cr
DateFrom whom receivedTermDue DateL.F.Amount


From the following transactions of a trader let us prepare the bills receivable book and post it into ledger

Date
January 5,2009Drew a bill on Abishek & Co. at 2 m/d for $600
" 10Acceptance received from Ravi at 3 m/d for $ 900.
" 20A. Riaz gives his acceptance at 3 m/d for $700.
" 30Bill at 2 m/d for $100 is drawn on Basker

Solution


DateFrom whom receivedTermDue DateL.F.Amount
Jan 5,2009Abishek & Co2 m/dMarch 8600
Jan 10Ravi3 m/dApril 13900
Jan 20A. Riaz3 m/dApril 21700
Jan 30Basker2 m/dMarch 30100
/td>Total : 2300

Dr
Bills Receivables Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
Jan 30,2009 By Sundry as per B/R Book2300



Dr
Abishek & Co. Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 5,2014By Bills Receivables600


Dr
Ravi Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 10,2014By Bills Receivables900

Dr
A. Riaz Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 20,2014By Bills Receivables700

Dr
Abishek & Co. Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 30,2014By Bills Receivables100


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Saturday, September 27, 2014

Cash Book

Cash book is a book in which all transactions relating to cash receipts and cash payments are recorded. It starts with the cash or bank balances at the beginning of the period. Generally, it is made on monthly basis. This is a very popular book and is maintained by all organizations, big or small, profit or not-for-profit. It serves the purpose of both journal as well as the ledger (cash) account. It is also called the book of original entry. When a cashbook is maintained, transactions of cash are not recorded in the journal, and no separate account for cash or bank is required in the ledger.

Single Column Cash Book 

It records all cash transactions of the business in a chronological order, i.e., it is a complete record of cash receipts and cash payments. When all receipts and payments are made in cash by a business organization only, the cash book contains only one amount column on each (debit and credit) side. The format of single column cash book


Double Column Cash Book

In this type of cash book, there are two columns of amount on each side of the cash book. In fact, now-a-days bank transactions are very large in number. In many organizations, as far as possible, all receipts and payments are affected through bank. A businessman generally opens a current account with a bank. Bank, do not allow any interest on the balance in current account but charge a small amount, called incidental charges, for the services rendered.
When the number of bank transactions is large; it is convenient to have a separate amount column for bank transactions in the cash book itself instead of recording them in the journal. This helps in getting information about the position of the bank account from time to time. Just like cash transactions, all payments into the bank are recorded on the left side and all withdrawals/ payments through the bank are recorded on the right side. When cash is deposited in the bank or cash is withdrawn from the bank, both the entries are recorded in the cash book. This is so because both aspects of the transaction appear in the cash book itself. When cash is paid into the bank, the amount deposited is written on the left side in the bank column and at the same time the same amount is entered on the right side in the cash column. The reverse entries are recorded when cash is withdrawn from the bank for use in the office. Against such entries the word C, which stands for contra is written in the L.F. column indicating that these entries are not to be posted to the ledger




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Friday, September 26, 2014

Journal Proper

A book maintained to record transactions, which do not find place in special journals, is known as Journal Proper or Journal Residual. Following transactions are recorded in this journal:

  1. Opening Entry: In order to open new set of books in the beginning of new accounting year and record therein opening balances of assets, liabilities and capital, the opening entry is made in the journal.
  2. Adjustment Entries: In order to update ledger account on accrual basis, such entries are made at the end of the accounting period. Such as Rent outstanding, Prepaid insurance, Depreciation and Commission received in advance
  3. Rectification entries: To rectify errors in recording transactions in the books of original entry and their posting to ledger accounts this journal is used.
  4. Transfer entries: Drawing account is transferred to capital account at the end of the accounting year. Expenses accounts and revenue accounts which are not balanced at the time of balancing are opened to record specific transactions. Accounts relating to operation of business such as Sales, Purchases, Opening Stock, Income, Gains and Expenses etc and drawing are closed at the end of the year and their Total/balances are transferred to Trading and Profit and Loss account by recording the journal entries. These are also called closing entries.
  5. Other entries: In addition to the above mentioned entries in the points number 1 to 4, recording of the following transaction is done in the journal proper:
At the time of a dishonour of a cheque the entry for cancellation for discount received or discount allowed earlier.

  • Purchase/sale of items on credit other than goods.
  • Goods withdrawn by the owner for personal use.
  • Goods distributed as samples for sales promotion.
  • Endorsement and dishonor of bills of exchange.
  • Transaction in respect of consignment and joint venture, etc.
  • Loss of goods by fire/theft/spoilage.

Thursday, September 25, 2014

Sales Return Book

Sales return book is used to record all returns of goods by the customers to the business. The entries in the sales return book are usually on the basis of debit notes issued by the customers or credit notes issued to the customers.




From the following transactions of a trader Let us prepare the sales returns book and post it into ledger

DateAmount
January 8,2005Goods returned by Parker & Co.60
" 20Goods returned by Ideal Traders 72
" 31Allowance granted to Ramesh & Co., for short delivery110



Sales Return Book
DateParticularsD/NL.F.Amount $
January 8,2005Parker & Co.60
January 20Ideal Traders.72
January 31Allowance granted to Ramesh & Co., for short delivery110
Total : 242

Now the individual entries are posted in their respective Ledgers as shown below:

Dr
Sales Return Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
January 31,2005By Sundries as per S.R.B242


Dr
Parker & Co's Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount



January 8,2005By Sales returns60


Dr
 Ideal Traders's Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount



January 20,2005By Sales returns72


Dr
Ramesh & Co's Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount



January 31,2005By Sales returns110


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Wednesday, September 24, 2014

Purchases Return Book

This book is used to record all returns of goods by the business to the suppliers. The entries in the Purchases Returns Book are usually made on the basis of debit note issued to the suppliers or credit note received from the suppliers. We call it a debit note because the party’s (supplier) account is debited with the amount written in this note. The same note is termed as credit note from the receiving party’s point of view because he will credit the account of the party from whom he has received the note together with goods. The flow of notes is as follows.


From the following transactions of a trader let us now prepare the purchases returns day book and post it into ledger

DateAmount
January 8,2005Karim & Sons.135
" 20varun & Co.150
" 31patil Bros.250



Purchases Return Book
DateParticularsD/NL.F.Amount $
January 8,2005Karim & Sons.135
January 20varun & Co.150
January 31patil  Bros250
Total : 535

Now the individual entries are posted in their respective Ledgers as shown below:

Dr
Purchases Return Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount



January 31,2005By Purchases as per P.R.B535


Dr
Karim & Sons Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
January 8,2005To Purchases returns135



Dr
Varun & Co's Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
January 20,2005To Purchases returns150



Dr
Patil Bros Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
January31,2005To Purchases returns250


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Tuesday, September 23, 2014

Sales Book

The sales book is used to record all credit sales of goods dealt in business. Cash sales, cash and credit sales of assets are not entered in this book. The entries in the sales book are on the basis of the invoices issued to the customers with the net amount of sale. The format of sales book is shown below

  • Date Column – shows the date on which the transaction took place.
  • Particulars Column – This column includes the name of purchasers and the particulars of goods sold.
  • Outward Invoice No. Column – Reveals the serial number of the outward invoice.
  • L.F. Column – The page number of the customer’s accounts in the Ledger is recorded.
  • Details Column – Contains the amount of goods sold and the amount of trade discount if any
  • Total Column – This column shows the net amount which is receivable from the customers.
  • Remarks Column – Any other extra information will be recorded


Now Let us understand the Sales Book and post it in ledger with the help of the following illustration
Given the following are the transactions, let us prepare the sales day book of M. Amin and post it into ledger

DateAmount
January 5,2014Sold goods to Idea college200
" 10Sold goods to Ankith & Co.100
" 20Credit sales to Karthik400
" 31Sold goods to cheap stores100



Sales Day Book
DateParticularsInv.No.L.F.Amount $
January 5,2014 Sold goods to Idea college200
January 10,2014Sold goods to Ankith & Co.100
January 20,2014Credit sales to Karthik400
January 30,2014Sold goods to cheap stores100
Total : 800


Now the individual entries are posted in their respective Ledgers as shown below:
Dr
Sales Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 5,2014By Sundry as per Sales Book800


Dr
Idea College Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
Jan 5,2014To Sales200


Dr
Ankith & Co Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
Jan 102014To Sales100


Dr
Idea College Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
Jan 20,2014To Sales400


Dr
Idea College Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
Jan 30,2014To Sales100



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Monday, September 22, 2014

Purchase Books

Purchases book also known as Bought Day Book is used to record all credit purchases of goods which are meant for resale in the business. Cash purchases of goods, cash and credit purchases of assets are not entered in this book.



Date Column – shows the date on which the transaction took place.
Particulars Column – This column includes the name of the seller and the particulars of goods purchased.
Inward Invoice No. Column – Reveals the serial number of the inward invoice.
LF. Column – This column shows the page number of the suppliers account in the ledger accounts.
Details Column – Reveals the amount of goods purchased and the amount of trade discount.
Total Column – This column represents the net price of the goods, i.e., the amount which is payable to the creditors after adjusting discount and expenses if any.
Remarks Column – Contains any extra information.
At the end of each month, the purchase book is totaled. The total shows the total amount of goods or materials purchased on credit.

Now Let us understand the Purchases Day book and post it in ledger with the help of the following illustration
Given below are the transactions of a firm

DateAmount
January 5,2014Purchased goods from Ravi & Co.3400
" 15Purchased goods from Ishan Bros.7000
" 25Purchased goods from More & Co.2500
" 30Purchased goods from Madhu & Co.4000



Purchase Day Book
DateParticularsInv.No.L.F.Amount $
January 5,2014 Ravi & Co.3400
January 15,2014Ishan Bros7000
January 25,2014More & Co.2500
January 30,2014Madhu & Co.4000
Total : 16900


Now the individual entries are posted in their respective Ledgers as shown below:
Dr
Purchases Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
Jan 5,2014 To Sundry as per Purchase Book16900



Dr
Ravi &Co. Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 5,2014By Purchases3400


Dr
Ishan Bros Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 15,2014By Purchases7000


Dr
More & Co's Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 25,2014By Purchases2500


Dr
Madhu & Co's Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount

Jan 5,2014By Purchases4000

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Sunday, September 21, 2014

Subsidiary Books : Accounting Basics Day 4

Businesses do not record a their transactions in one journal. The reason is that, journal can not give periodical data about some important business transactions viz. monthly sales, or purchases. Moreover having only one journal does not facilitate internal check system, since only one person handles journal.
Transactions can be classified and grouped according to their nature when they are repetitive in nature. Transactions are of two types: Cash and Credit. These can be grouped in two different categories viz. cash and credit. Thus journal is divided into separate sub-books for each category of transaction, which are repetitive and sufficiently large in number. Following are the subsidiary books which are special journals.

  • Day Books- Purchase book, sales book, purchase return book, sales return book
  • Bill books- Bills receivable and bills payable book
  • Cash book
  • Journal paper

Purpose

  1. Purchases Book records only credit purchases of goods by the trader.
  2. Sales Book is meant for entering only credit sales of goods by the trader.
  3. Purchases Return Book records the goods returned by the trader to suppliers.
  4. Sales Return Book deals with goods returned (out of previous sales) by the customers.
  5. Bills Receivable Book records the receipts of bills (Bills Receivable).
  6. Bills Payable Book records the issue of bills (Bills Payable).
  7. Cash Book is used for recording only cash transactions i.e., receipts and payments of cash.
  8. Journal Proper is the journal which records the entries which cannot be entered in any of the above listed subsidiary books.


Kinds of Subsidiary Books
The number of subsidiary books may vary according to the requirements of each business. The following are the special purpose subsidiary books.




  • Purchases Book records only credit purchases of goods by the trader.
  • Sales Book is meant for entering only credit sales of goods by the trader.
  • Purchases Return Book records the goods returned by the trader to suppliers.
  • Sales Return Book deals with goods returned (out of previous sales) by the Customers.
  • Bills Receivable Book records the receipts of bills (Bills Receivable).
  • Bills Payable Book records the issue of bills (Bills Payable).
  • Cash Book is used for recording only cash transactions i.e., receipts and payments of cash.
  • Journal Proper is the journal which records the entries which cannot be entered in any of the above listed subsidiary books

Go Back to Accounting Basics Day 3
Go To Accounting Basics Day 5

Saturday, September 20, 2014

Balancing General Ledger Accounts

Balancing an Account

The difference between total debits and the total credits of an account is balance. As shown above many accounts have entries on their debit as well as credit side. The net result of such debits and credits in an account is the balance.
The writing of the difference between the amount columns of the two sides in the lighter (smaller total) side, so that the grand totals of the two sides become equal is called balancing.
While balancing an account three things may happen depending upon the debit total and the credit total.

  • It may be a debit balance or
  • A credit balance or
  • A nil balance

Debit balance results, when debit total is in excess of credit total. It is first recorded on credit side above the total and then entered on the debit side below the total as first item for next period. It is first recorded on the credit side, above the total. Then it is entered on the debit side, below the total, as the first item for the next period.


Dr
Cash Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
Mar 1,2009To Sales A/c10000Mar 5, 2009By Purchase A/c 5000
Mar 10,2009To Kumar's A/c4000Mar 19, 2009By Salary A/c4000


Total : 14000April 1, 2010By Balance c/d 5000

To Balance b/d5000
Total : 14000

Conversely excess of credit total over the debit total is called the credit balance. It is first written in the debit side, as the last item, above the total. Then it is recorded on the credit side, below the total, as the first item for the next period.
Dr
Capital Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
Mar 31,2009To Balance c/d 100000Apr 5, 2008By Cash 100000

Total : 100000
Total : 100000



April 1, 2009By Balance c/d 100000

Balancing is done periodically, i.e., weekly, monthly, quarterly, half-yearly, or yearly. i. Personal accounts are generally balanced regularly to know the amounts due to the persons (creditors) or due from the persons (debtors). Real accounts are balanced at the end of the financial year, when final accounts are being prepared. Cash account however is frequently balanced to know the cash on hand. Assets accounts always show debit balances and it is the value of the asset owned by business.

Nominal Accounts, not to be balanced as they are to be closed by transfer to final accounts. A debit balance in a nominal account indicates that it is an expense or loss. A credit balance in a nominal account indicates that it is an income or gain. Balances in personal and real accounts are shown in the Balance Sheet and the balances in nominal accounts are taken to the Profit and Loss Account.

Lets understand procedure to balance the accounts.

  • Find difference between total amount of debit column and credit column.
  • If the debit exceeds credit, enter this difference in the amount column of the credit side, alongwith date of balancing and words “By Balance c/d” (c/d means carried down) in the particulars column. If the credit exceeds the debit , enter this difference in the amount column of the debit side, alongwith date of balancing and words “To Balance c/d” in the particulars column.
  • Sum up both the amount columns, and put the total on both the sides
  • Enter the date of the beginning of the next period and bring down the debit balance on the debit side along with the words “To Balance b/d” (b/d means brought down) in the particulars column and the credit balance on the credit side along with the words “By balance b/d” in the particulars column.

In place of c/d and b/d, the words c/f or c/o (carried forward or carried over) and b/f or b/o (brought forward or brought over) may also be used.

When the balance is carried down in the same page, the words c/d and b/d are used, while balance is carried over to the next page, the term c/o and b/o are used. When balance is carried forward to some other page either in same book or some other book, the abbreviations c/f (carried forward) and b/f (brought forward) are used.

How would you balance following account in the ledger on March 31,2009?

Dr
Shrikant's Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
Mar 10,2009To Sales A/c100000Mar 5, 2009By Sales Return A/c 10000
Mar 10,2009To Sales A/c50000Mar 19, 2009By Cash A/c25000


Total : 150000April 1, 2010By Bank A/C 50000

To Balance b/d65000By Balance c/d65000



Total : 165000

Next Page :  Subsidiary Books
Go Back to : General Ledger Concepts

Friday, September 19, 2014

General Ledger Concepts : Accounting Basics Day 3

All types of accounts we learnt in the last chapter viz. personal, real, and nominal are summarized in Ledger. Ledger is a book which contains a classified and permanent record of all the transactions of a business. Ledgers are bound book or loose leaf with each account starting on new page, and each page numbered. Loose-leaf ledger allows addition of pages, removal of completed accounts, and rearrangement of accounts.
Ledger is principal book containing all the accounts also called “Book of Final Entry” or “Book of secondary entry” because transactions are recorded here finally.
Ledger offers following benefits

  • Ledger gives snapshot of an account, all at one place. For example all cash transactions at one place.
  • Trial balance can be prepared to check arithmetical accuracy of the accounts in ledger.
  • It facilitates preparation of final accounts for ascertaining operating result and financial position of the firm.
Ledger Book

DrCr
DateParticularsJ.FAmountDateParticularsJ.FAmount
Year Month DateTo (Name of Credit Account in Journal)Year Month DateBy (Name of Debit account in Journal)

As shown above each ledger account is divided into two parts: left hand side is known as debit side and right hand side credit side. Debit and credit is abbreviated as ‘Dr.’ and ‘Cr.’ Account name is mentioned in the middle and at the top of the account. ‘To’ is used on the debit side in the particulars column. Similarly, the word ‘By’ is used on the credit side. The name of the account affected is written in debit or credit side in particulars column. Journal page number is entered in J.F column. For amount a separate column is also provided.
Posting of Transactions
Posting is the process of transferring entries from journal to the respective accounts in the ledger. All transactions relating to a particular account are grouped in ledger. It is necessary to know the net effect of various transactions during a given period on particular account.
Now we shall see the procedure of posting entries from journal to ledger. Let us assume a scenario of posting for an account which has been debited in the journal entry.

  1. First locate account to be debited. Enter date of the transaction in date column.
  2. Record the name of the account credited in the Journal in the particulars column on the debit side as “To..... (Name of the account credited)”.
  3. Record the page number of the Journal in the J.F column on the debit side and in the Journal, write the page number of the ledger on which a particular account appears in the L.F. column.
  4. Enter the relevant amount in the amount column on the debit side.For scenario of posting for an account which has been credited in the journal entry, procedure is same, except at step 1 and 2. These steps would be as follows
  5. First locate account to be credited. Enter date of the transaction in date column.
  6. Record the name of the account debited in the Journal in the particulars column on the credit side as “By..... (Name of the account debited)”.

For example
If you have started business with cash Rs. 5000 on 1st June 2009. The above transaction will appear in Journal and Ledger as under.

DateParticularsL.FDebit RsCredit Rs
Jun 1,Cash A/c Dr.105000-
2009To Capital A/c23-5000
(Business started)

Here two accounts are involved, Cash Account and your capital account, so ledger shall have page for each account.

Dr
Cash Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
June 1, 2009To Capital A/C5000


Dr
Cash Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount



June 1, 2009Cash A/c5000

Posting of Opening Entries
We learnt about opening entries which are passed at the beginning of new financial year which is nothing but the debit or credit balance of an account at the end of accounting period. Let us see the procedure.
An account with debit balance is recorded with words “TO BALANCE B/D” on debit side and with credit balance “BY BALANCE B/D” on credit side. We can not say this process as “posting” but merely incorporating in the ledger.
Let us take one example of posting the opening entry into the ledger of PHPL as on 1st April 2010, cash in hand Rs. 10,000; Loan Rs. 1,00,000.

Dr
Cash Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount
April 1, 2010To Balance A/c100000


Dr
Loan Account
Cr
DateParticularsJ.FAmountDateParticularsJ.FAmount



April 1, 2010By Balance b/d 1000000

Next Page:



Thursday, September 18, 2014

Special Cases of Journalling


A business concern has bank relationship and takes up bank transactions such as cash paid into bank, payment of cheques for expenses and cheques issued to suppliers or creditors, cheques and bills received from customers paid into bank for collection. Any cheque received is treated as cash.
Consider a sample transaction,
July 18, 2009 – Opened a current account with Indian Bank Rs.10,000.

Step 1Determine the two accounts involved in the transactionBank AccountCash Account
Step 2Classify the account under Real, Personal, NominalPersonal AccountReal Account
Step 3Find out the rules of debit creditDebit the receiverCredit what goes out
Step 4Identify which account is to be debited and creditedBank A/C is to be debitedCash Account is to be credited

DateParticularsL.FDebit RsCredit Rs
July 18,Indian Bank A/c Dr.3410000-
2009To Cash A/c10-10000
(Opened Cash Account)

September 3, 2009 – Rent paid by cheque Rs. 5,000.

Step 1Determine the two accounts involved in the transactionReal AccountBank Account
Step 2Classify the account under Real, Personal, NominalNominal AccountPersonal Account
Step 3Find out the rules of debit creditDebit all expenses and losesCredit the giver
Step 4Identify which account is to be debited and creditedRent A/C is to be debitedBank Account is to be credited

DateParticularsL.FDebit RsCredit Rs
Sep 3,Rent A/c Dr.565000-
2009To Bank A/c34-5000
(Rent Paid by Cheque No.)

As per principles of accounting business is a separate entity from business owners. Hence all transactions have to be analysed from business point of view and not from proprietor’s point of view. The initial amount with which a business is started is known as Capital. The owner may withdraw certain amounts from the business to meet personal expense or goods for personal use. It is called Drawings. Following table shows treatment of this transaction.
Drawing from businessGoodsValue of purchases decreasesDebit drawings A/c
Credit Purchases a/c
ChequeBank-the giverDebit drawings A/c
Credit Bank a/c
CashCash goes outDebit drawings A/c
Credit bank a/c

Lets consider one such transaction.

 July 31, 2009 – Shrikant withdrew for personal use Rs. 20,000.

Step 1Determine the two accounts involved in the transactionDrawings AccountCash Account
Step 2Classify the account under Real, Personal, NominalPersonal AccountReal Account
Step 3Find out the rules of debit creditDebit the receiverCredit what goes out
Step 4Identify which account is to be debited and creditedDebit Drawing AccountCredit Cash Account


DateParticularsL.FDebit RsCredit Rs
Jul 31,Drawing A/c Dr.9920000-
2009To Cash A/c10-20000
(Cash withdrawn for personal use)


Compund journal entry is made when transactions of same nature occur on the same day. Similar transactions are entered as combined journal entry. The total debit should be equal to credit.

Lets try to understand this by an example.
July 23, 2009 – Shrikant contributed capital Rs. 50,000
                          Arun contributed capital Rs. 50,000

DateParticularsL.FDebit RsCredit Rs
Jul 23,Cash A/c Dr.10100000-
2009To Shrikant's A/c91-50000

To Arun's A/c92-50000
(Cash withdrawn for personal use)

Sometime the goods are sold to a customer on credit and if the amount becomes irrecoverable due to buyer’s insolvency or for some other reason, then that amount becomes bad debts. For recording this transaction, the bad debts account is debited because the unrealised amount is a loss to the business and the customer’s account is credited.

Let’s see this transaction in the journal.
Camlin Ltd which owed us Rs.10,000 is declared insolvent and 25 paise in a rupee is received from her on 15th July, 2009.
DateParticularsL.FDebit RsCredit Rs
Jul 15,Cash A/c Dr.102500-
2009Bad Debt's A/c1007500-

To Camlin Ltd's A/c92-10000
(25 paise in a rupee received)

If bad debt written off previously is recovered then cash account is debited and bad debts recovered account is credited because the amount so received is a gain to the business.
Received cash for a Bad debt written off on July15, 2009, Rs.7,500 on 15th decemeber, 2009.
DateParticularsL.FDebit RsCredit Rs
Dec 15,Cash A/c Dr.107500-
2009Bad Debt's Recovered A/c Dr45-7500

(Bad Debt Recovered)



In the beginning of each year “opening entry” is passed to record closing balance of assets and liabilities of the previous year. While doing this, asset account is debited and ‘capital and liabilities” account is credited. (Capital=Assets-liability)
Lets see an example. Following balances appeared in the books of Tata motors ltd
1st January 2009 – Cash Rs. 7,000, Bank Rs.70,000, Stock Rs.80,000, Furniture Rs.10,000, Computer Rs.50,000, Debtors Rs.33,000 and Creditors Rs.90,000.
DateParticularsL.FDebit RsCredit Rs
Jan1,Cash A/c Dr.107000-

Bank A/c Dr4570000-

Stock A/c Dr
80000-

Debtor A/c Dr
33000-

Furniture A/c Dr
10000-

Computer A/c Dr
50000-

To Creditors A/c
-90000

To Capital's A/C
-160000

(assets and liabilities brought forward)



Recap

In this section, we shall review what we learnt in paragraphs above and some new concepts. We learnt that every business transaction affects at least two accounts, and hence our accounting system is known as a double entry system.
  • For example, when a your company borrows Rs1,000 crores from a bank, the transaction affects the company's Cash account and Notes Payable account. When the company repays bank loan, the Cash account and the Notes Payable account are also involved.
  • If a company buys supplies in exchange for cash, its Supplies account and Cash account will be affected. If supplies are bought on credit, the accounts involved are Supplies and Accounts Payable.
  • If a company pays rent for the current month, Rent Expense and Cash are the two accounts involved.
  • If a company provides service on credit and gives client 30 days for payment, the company's Service Revenues account and Accounts Receivable are affected.
Though the system is referred to as double entry, a transaction may involve more than two accounts. In case of loan payment by company to the bank, three accounts are involved: Cash, Notes Payable, and Interest Expense.
Generally following types of accounts are increased with a debit:
  1. Dividends (Draws)
  2. Expenses
  3. Assets
  4. Losses 
Remember D – E – A – L

Generally following types of accounts are increased with a credit:
  1. Gains 
  2. Income 
  3. Revenues 
  4. Liabilities 
  5. Stockholders' (Owner's)
Equity Remember G – I – R – L – S.

To decrease an account we shall do the opposite of what was done to increase the account.
We also learnt about real and nominal account. Asset, liability, and most owner/stockholder equity accounts (capital) are referred to as " real accounts " (or " permanent accounts"). These accounts are not closed at the end of the accounting year; their balances are automatically carried forward to the next accounting year.

Nominal accounts (or "Temporary accounts ") include all of the revenue accounts, expense accounts, the owner drawing account, and the income summary account. The balances in temporary accounts increase throughout the accounting year and are "zeroed out" and closed at the end of the accounting year. “Zeroing out” in case of revenue and expense account is done by closing/transferring/clearing balances to the income summary account. The net amount is then closed/transferred/cleared to owner’s equity account (capital) or Retained earnings (in case of corporations). The Drawing A/c of the owner is also temporary account which is closed directly without going through an income summary account. This is means new accounting year starts with no revenue or expense or drawing amount.

Previous Page :  Journalling

Journalling

The accounting books in which transaction is recorded for first time from any of above source document are known as books of prime entry or journal because “journal” is one such book where business transactions are recorded in chronological order by following double entry system. It is shown below.


DateParticularsLedger folioDebit RsCredit Rs

Date: Year and month written first and only once till it changes followed by dates in that month. Sequence matters.
Particulars: For each transaction two accounts are affected, one account is debited and the other is credited. Account to be debited is written first followed by word “Dr”. Account to be credited is written in the next line which starts with word ‘To’, a few spaces away from the margin.
Narration: The transaction is explained briefly in brackets after entering particulars.
Ledger Folio (L.F): Entries from this journal are posted to the ledger account sometime later in the day. The folio (page) number of the ledger, where the posting has been made from the Journal is recorded in the L.F column of the Journal. Till such time, this column remains blank.
Debit Amount: In this column, the amount of the account being debited is written.
Credit Amount: In this column, the amount of the account being credited is written. If you are given a task of making entry (journal entry) into the journal to you, how will you do it? Follow following steps for ‘journalling”.
  • First analyse business transaction 
  • Determine which two accounts are involved in the transaction. 
  • Classify the above two accounts under Personal, Real or Nominal or asset, capital, liability, income, expenses etc 
  • Determine which rules are applicable for debit and credit for the above two accounts. 
  • Identify which account is to be debited and which account is to be credited. 
  • Record the transaction as per convention for date, particular, narration etc.
Illustrations for Journalling
Consider following transactions to be recorded in the journal.
1. August 1, 2009 – Shrikant started business with Rs. 1,00,000.
2. August 3, 2009 : Received cash from Vijay Rs. 25,000
3. September 7, 2009 – Paid cash to Tushar Rs.37,000.
4. October 7, 2009 – Bought goods for cash Rs. 80,000.
5. december10, 2004 – Cash sales Rs.90,000.
6. January 15, 2004 – Sold goods to Sudeep on credit Rs.1,00,000.
7. January 18, 2009 – Purchased goods from Simrat on credit Rs.1,50,000.
8. February 20, 2009 – Returned goods from Sudeep Rs.5,000.
9. February 25, 2009 – Goods returned to Simrat Rs.7,000.
10. February 27, 2009 – Paid salaries in cash Rs.6,000.
11. March 14, 2009 – Commission received Rs.5,000.

Journal Entry for first Transaction

Step 1Determine the two accounts involved in the transactionCash AccountCapital Account
Step 2Classify the account under Real, Personal, NominalReal AccountPersonal Account
Step 3Find out the rules of debit creditDebit what comes in Credit the giver
Step 4Identify which account is to be debited and creditedCash A/C is to be debitedCapital Account is to be credited


DateParticularsL.FDebit RsCredit Rs
August 1,Cash A/c Dr.1010000000
2009To Capital A/c2301000000
(Initial capital for business)

Journal Entry for Second Transaction

Step 1Determine the two accounts involved in the transactionCash AccountVijay's Account
Step 2Classify the account under Real, Personal, NominalReal AccountPersonal Account
Step 3Find out the rules of debit creditDebit what comes in Credit the giver
Step 4Identify which account is to be debited and creditedCash A/C is to be debitedVijay's Account is to be credited


DateParticularsL.FDebit RsCredit Rs
August 1,Cash A/c Dr.1025000-
2009To Vijay's A/c30-25000
(Cash received from Vijay)

The Ledger Folio column indicates 10 against Cash Account which means that Cash Account is found in page 10 in the ledger and this debit of Rs.1, 00,000 to Cash A/c can be seen on that page. Similarly 23 and 24 against Capital A/c and Vijay’s a/c respectively indicates the page number in which these accounts may be found.

 TRY IT OUT : Record remaining transactions in the above format.

Next Page: Special Cases of Journalling

Wednesday, September 17, 2014

Debit and Credit Rules : Accounting Basics Day 2

Debit and Credit
In the preceding session we learnt about “Account”. Account is a place to record transactions of similar nature where all debit and credit happen which is an account. All transactions relating to any asset or liability or expense or income are recorded in an account.

An account is a record of all business transactions relating to a particular person or asset or liability or expense or income. The place where such a record is maintained is termed as an ‘Account’.

Visually an account has two sides viz. the left hand side is for Debit and the right hand side for Credit. Debit is abbreviated as Dr. and Credit Cr.

Now let’s see when to fill debit column and when credit column. There are two ways as we have seen in the previous session. 1) Accounting Equation Approach, 2) Traditional Approach.

As per accounting equation approach rules for debit and credit depend on the nature of an account. Account may be classified as follows
1. Assets Accounts
2. Liabilities Accounts
3. Capital Account
4. Incomes (Revenues) Accounts
5. Expenses (Losses)

Accounts Whenever there is increase or decrease in one account, there will be equal decrease or increase in another account.

Rules for Debit and Credit

Nature of AccountIncreaseDecrease
AssetDebitCredit
LiabilityCreditDebit
CapitalCreditDebit
IncomeCreditDebit
ExpensesDebitCredit


According to traditional approach, accounts are classified as
1.Personal
2. Real
3.Nominal.
As per this approach rules for debit and credit are

Nature of AccountDebitCredit
Personal AccountsReceiverGiver
Real AccountsWhat comes inWhat goes out
Nominal AccountsAll expenses and lossesAll incomes and gains

Read More : Illustration of Accounting Equations

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Illustrations of Accounting Equation with Examples

The starting point for accounting process is accounting equation. We have seen before that accounting equation is based on dual aspect concept (debit and credit) that each transaction has Two effects, one on asset and another on claims on the assets (liability).
Total claims i.e. of the owners and outsiders are equal to the total assets of the firm. These claims on asset are also known as equities 1. Owner’s equity (capital) 2.Outsider’s equity (liability).
Assets = Capital + Liabilities (A = C+L)
where asset=equity

Now it is time to learn effect of transaction on accounting equation. If you started a business with Rs. 10,000 as capital and the firm received Rs. 10,000 in the form of cash, then transaction equation can be written as
Assets = Capital + Liabilities
Cash = Capital + Liabilities  Rs. 10,000 = Rs. 10,000 + 0

Now if you buy some basic furniture for Rs. 1000 then your “cash” asset decreases and “furniture” asset increases by same amount. Total asset remain same.

Assets = Capital + Liabilities
Cash + Furniture = Capital + Liabilities
First transaction 10,000 + 0 = 10,000 + 0
Second transaction (–) 1,000 + 1,000 = 0 + 0
----------------------------------------------
Equation 9,000 + 1,000 = 10,000 + 0

Now suppose you buy goods worth Rs. 1500, then cash will be utilized at the same time, leaving asset unchanged. The equation will look like as given

Cash + Furniture + Stock = Capital +Liabilities
1st and 2nd transaction 9000 + 1000 + 0 = 10,000 + 0
3rd (–) 1500 + 0 + 1500 = 0 + 0
----------------------------------------------
Equation 7500 + 1000 + 1500 = 10000 + 0

Now suppose you buy goods on credit for Rs. 500. This transaction will create liability with increase in assets.
Cash + Furniture + Stock = Capital +Creditors
Transaction 1-3 7500 + 1000 + 1500 = 10,000 + 500
Transaction 4 0 + 0 + 500 = 0 + 500
----------------------------------------------
Equation 7500 + 1000 + 2000 = 10,000 + 500


Next lets assume that you sold goods costing Rs.1500 for Rs. 2000 on credit then “Debtors” account will go up by Rs.2000 and “cost of goods sold” would come down by Rs.1500. The increase of Rs. 500 would be your “Revenue” which would be added to the capital.

Cash + Furniture + Stock + Debtors = Capital + Creditors+Revenue
Transaction 1-4 7500 + 1000 + 2000 + 0 = 10,000 + 500
Transaction 5 0 + 0 +(-)1500 + 2000 = 500 + 0
-------------------------------------------------------------
Equation 7500 + 1000 + 500 + 2000 = 10500 + 500

Lets assume now that you paid wages to the pizza delivery boys of Rs. 1300. It is an expense (loss to the company) and reduces capital.
Cash + Furniture + Stock + Debtors = Capital + Creditors
Transaction 1-5 7500 + 1000 + 500 + 2000 = 10500 + 500
Transaction 6 – 1300 + 0 + 0 + 0 = –1300 + 0
-------------------------------------------------------------
Equation 6200 + 1000 + 500 + 2000 = 9200 + 500

What is evident from above series of transactions? The accounting equation holds good in all cases. Thus one thing to note is that when one asset increases, other asset decreases or liability increases or capital increases. Similarly when asset decreases , another asset increases and liability or capital decreases.

Above transaction may be put in presentable format as given below.

Your balancesheet as on___________


LiabilitiesRs.AssetsRs.
Capital9200Cash200
Creditors500Stock500
Debtors2000
Furniture1000
97009700



Now we shall see for some sample transactions how accounts are affected.

S.NoBusiness TransactionWhich account and how it is effected
AssetsLiabilities
1Capital injection in businessCash increasesCapital creation
2Cash used to purchase stocksStock increases and cash decreasesNo effect
3Purchases on creditStock increasesCreditors increases
4Any expense (e.g. rent,salaries)Cash decreasesCapital decreases
5Sale on cashstock decreases and cash increasesNo effect
6Payment to creditorsCash decreasesCapital decreases
7Credit saleStock decreases/Debtors increasesNo effect