[Financial Accounting] ABF 103 [ACeL] In business, however, it is a more serious matter. The student may not be questioned by his parents or the housewife may just meet her expenses as and when they come without bothering to find out how much she spent, but in business it is a must. You cannot run a business unless you know how much you owe outsiders and how much outsiders owe you. And when you invest money in a business, wouldn‟t you like to know whether you‟ve recovered it, increased it or lost it? [Amity University]
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
[Financial Accounting]
ABF 103
[ACeL] In business, however, it is a more serious matter. The student may not
be questioned by his parents or the housewife may just meet her
expenses as and when they come without bothering to find out how
much she spent, but in business it is a must. You cannot run a
business unless you know how much you owe outsiders and how
much outsiders owe you. And when you invest money in a business,
wouldn‟t you like to know whether you‟ve recovered it, increased it
or lost it?
[Amity University]
PREFACE
This Financial Accounting module seeks to discuss the concept of
accounting & their application in the organization. The principle concern
of the book is to show how financial accounting theory can be applied to
solve the problems in practice. An attempt has been made to relate
theory to practice to make it understandable easily for all kind of
students i.e. from accounts or non-accounts background.
Each chapter is having various illustrations relating to each topic
covered and followed by numerous questions and multiple choice
questions also, which are designed to reinforce concepts & procedure
presented in the body of chapter.
I wish to express my sincere thanks to many of the authors who have
received due acknowledgements, without whom, this module would not
have been completed.
I have taken every possible effort to remove the errors either of principle
or of printing. Even then, if the reader comes across any error, he/she is
requested to point out the same to me.
I hope that many students will find this module interesting & helpful.
Further suggestion for the improvement of the module is solicited.
By- Tanu Agrawal
Table of Contents PREFACE ........................................................................................................................................................ 2
CHAPTER-1 MEANING & SCOPE OF ACCOUNTING ...................................................................................... 6
1.1 MEANING OF ACCOUNTING.................................................................................................................... 6
1.2 The Accounting Process/Accounting Cycle: ............................................................................................ 7
End Chapter Quizzes ................................................................................................................................... 18
3.1 MEANING OF ACCOUNTING STANDARDS ............................................................................................. 20
3.2 INTERNATIONAL ACCOUNTING STANDARDS ........................................................................................ 20
3.3 The list of accounting standards issued by the IASC is given below: .................................................... 21
3.4 AUDITOR’S DUTIES IN RELATION TO ACCOUNTING STANDARDS ......................................................... 23
3.5 ACCOUNTING STANDARDS ISSUED BY ASB OF THE INSTITUTE OF CHARTERED ACCOUNTANTS OF
INDIA ........................................................................................................................................................... 23
End Chapter Quizzes ................................................................................................................................... 25
CHAPTER 4 SYSTEMS OF BOOK-KEEPING & ACCOUNTING ...................................................................... 27
4.1 SINGLE ENTRY SYSTEM:- ....................................................................................................................... 27
End Term Quizzes ........................................................................................................................................ 32
CHAPTER 5 RECORDING OF ACCOUNTING TRANSACTIONS ..................................................................... 35
5.1 TYPES OF ACCOUNTS: ........................................................................................................................... 35
5.9 BALANCING OF LEDGER ........................................................................................................................ 45
End Term Quizzes ........................................................................................................................................ 49
CHAPTER 6 SUBSIDIARY BOOKS I- CASH BOOK ......................................................................................... 51
6.1 MEANING OF SPECIAL JOURNALS OR SUNSIDIARY BOOKS: ................................................................. 51
6.2 ADVANTAGES OF SPECIAL JOURNALS (SUBSIDIARY BOOKS) ................................................................ 51
6.3 CASH BOOK ........................................................................................................................................... 52
6.4 TYPES OF CASH BOOK ........................................................................................................................... 53
6.5 CONTRA ENTRIES .................................................................................................................................. 57
CHAPTER 7 SUBSIDIARY BOOK II- OTHER BOOKS ..................................................................................... 62
7.1 MEANING .............................................................................................................................................. 62
7.2 PURCHASE BOOK ................................................................................................................................... 62
End Chapter Quizzes ................................................................................................................................... 69
CHAPTER 8- BANK RECONCILIATION STATEMENT .................................................................................. 71
8.2 REASONS FOR DIFFERENCE BETWEEN BANK BALANCES AS PER CASHBOOK AND PASSBOOK: ............ 71
8.3 Advantages of Bank Reconciliation Statement ..................................................................................... 72
8.4 Steps in Preparation of BRS .................................................................................................................. 72
End Chapter Quizzes ................................................................................................................................... 76
CHAPTER 9 DEPRECIATION & ITS METHODS ............................................................................................. 78
9.1 Meaning of Depreciation: ..................................................................................................................... 78
9.5 CHANGE IN THE METHOD OF DEPRECIATION ....................................................................................... 87
End Chapter Quizzes ................................................................................................................................... 91
CHAPTER 10 FINAL ACCOUNTS & ADJUSTMENTS .............................................................................. 93
End Chapter Quizzes ................................................................................................................................. 114
CHAPTER- 11 BILLS OF EXCHANGE .................................................................................................. 116
11.2 ACCOUNTING FOR BILLS OF EXCHANGE ........................................................................................... 116
11.3 Dishonor of Bills ................................................................................................................................ 121
End Chapter Quizzes ................................................................................................................................. 134
Q1 Which of the following statements is/are true? i. Cash book records all cash receipts and cash
payments. ii. Cash book records all sale and purchase transactions of goods both in cash and on
credit. iii.Cash book records discount on cash payments.
(a) Only (i)
(b) Only (ii)
(c) Only (iii)
(d) Both (i) & (iii)
Q2 The periodical total of discount column on receipts side of a triple column cash book is
recorded to the:
(a) Credit side of discount column
(b) Credit side of provision of discount column
(c) Debit side of discount column
(d) Credit side of debtor‟s account
Q3 Which of the following statements is false?
(a) Credit side of total of discount column is an income
(b) Debit balance of bank column is a liability
(c) Debit balance of cash column is an asset
(d) None of the above
Q4 Cash book is used to record
(a) All receipts only
(b) All payment only
(c) All cash & credit sale
(d) All receipts & payments of cash
Q5 Single column cash book may show:
(a) Only debit balance
(b) Only credit balance
(c) Either debit or credit balance
(d) None of the above
Q6 When a cheque is received on a particular dale is not deposited into bank on the same dale, it
is entered in:
(a) Cash column on the debit side
(b) Bank column on debit side
(c) Cash column on credit side
(d) Bank column on credit side
Q7 When a cheque is returned dishonored, it is recorded in:
(a) Cash column on credit side
(b) Cash column on debit side
(c) Bank column on credit side
(d) Bank column on debit side
Q8 If the debit as well as credit aspects of a transaction are recorded in the cash book itself, it is
called:
(a) An opening entry
(b) A compound entry
(c) A transfer entry
(d) A contra entry
Q9 Which is not a contra entry:
(a) Cash deposited into bank
(b) Cash withdrew from bank
(c) Cash withdrew from bank for personal use
(d) None of above
Q 10 Bank column may show:
(a) Only a debit balance
(b) Only a credit balance
(c) Either debit balance or credit balance
(d) None of above
CHAPTER 7 SUBSIDIARY BOOK II- OTHER BOOKS
At the end of this chapter you will be conversant with:
7.1 Meaning
7.2 Purchase Book
7.3 Purchases Returns Book
7.4 Sales book
7,5 Sales return book
7.6 Bills receivable Book
7.7 Bills payable book
7.8 Journal Proper
7.1 MEANING
The Books of Accounts maintained by an organization other than the Cashbook may be
classified into Journals and Ledgers. The Journal is used as the book of first entry for all
transactions which cannot be recorded in the Cashbook. In other words, all non-cash
transactions should be recorded in the journal. The journal is inadequate as the single
book of the original entry when the transactions are voluminous in number. The journal is
divided into divisions and they are commonly termed as subsidiary books. Some of the
subsidiary books are:
i.Purchase Book
ii.Purchase Returns Book
iii.Sales Book
iv.Sales Returns Book
v.Bills Receivable Book
vi.Bills Payable Book
vii.Journal Proper.
7.2 PURCHASE BOOK Also known as the Purchases Journal, this book is used to record credit purchases of goods only.
The term „goods‟ covers only those items procured by the business for resale.
A simple format of purchase book is given below:
Purchase book of XYS Ltd Date Particulars
(Name of Supplier, etc.) Ledger Folio
Inward Invoice
No.
Amount Rs.
2001
April 2
12
20
Y Limited
Sharp Enterprises
Best and Company
3354
401
5542
10,950
2,700
3,900
Total
17,550
7.3 PURCHASES RETURNS BOOK:
This subsidiary book is used to record the goods purchased on credit and sent back to
suppliers as not conforming to specifications or for any other reason.
simple format of purchase return book is given below:
Purchase return book of XYZ Ltd Date Name of Supplier Ledger
Folio Debit
Note No.* Amount
Rs.
2001
April,
15
25
Sharp Enterprises
Best and Company
80
81
1,000
900
Total
1,900
* Debit note is document prepared by the purchaser to inform the supplier that his
account has been debited with the amount mentioned & for reason stated therin. Debit
note contains the date of return, name of supplier to whom the goods has been
returned, details of goods. Each debit note is serially numbered.
7.4 SALES BOOK:
Also known as the Sales Journal, this subsidiary book is used to record the sale of goods
on credit.
simple format of sales book is given below:
SALES BOOK OF XYZ Ltd
Date Name of Customer Ledg
er
Folio
Outwar
d
Invoice
No.
Amount
Rs.
2001
April,3
5
6
15
25
Beta Corporation
Zeta Company
Quality Dealers
Sooraj Traders
Star Enterprises
1001
1002
1003
1004
2,410
3,940
4,900
1,800
1005 19,500
Total 32,550
7.5 SALES RETURNS BOOK :
This book is used to record the transactions relating to goods sold on credit and received
back from the customers as not conforming to the specifications or for any other reason.
Simple format of sales return book is given below
SALES RETURN BOOK OF XYZ LTD
Date Name of Customer Ledger
Folio Credit
Note
No.*
Amount
Rs.
2001
April,1
0
27
Zeta Company
Star Enterprises
10
11
540
2,000
Total 2,540
* A credit note is a document prepared by the seller to inform the buyer that his
account has been credited with the amount mentioned & for he reason stated
therein.
7.6 BILLS RECEIVABLE BOOK The Bills Receivable of an enterprise consists of all Promissory Notes given or Bills of
Exchange accepted by customers in respect of amounts due from them. The bills receivable
book is used to record all promissory notes given or Bills of Exchange accepted by
customers
Simple format of Bill Receivable Book is given below:
BIILS RECEIVABLE BOOK OF XYZ LTD
S.
No
.
Date From
whom
receive
d
Acceptor Date of
Bill Ter
m Date of
Maturity L
F Where
Payable Amount
Rs. How
Disposed
1
2
2001
April 12
April 18
Quality
Dealer
s
Sooraj
Trader
s
Quality
Dealers
Sooraj
Traders
8.4.01
16.4 X 1
90
days
60
days
10.7.01
10.6.01
Bank of
India,
Mumbai
Union
Bank,
Mumbai
4,900
1,800
6,700
Discounted
on
20.4.01
7.7 BILLS PAYABLE BOOK
The Bills Payable consists of all Promissory Notes given or Bills of Exchange accepted by
the business in respect of amounts owing to its suppliers. The Bills Payable Book is used to
record all such Promissory Notes given or Bills of Exchange accepted by the business.
Simple format of Bill Payable Book is given below:
BIILS PAYABLE BOOK OF XYZ LTD
S.
No
.
Date
Accepte
d
Name
of the
drawer
Payee Date of
Bill Ter
m Date of
Maturity L
F Where
Payable Amount
Rs. Remarks
1
2001
April 25
Best &
Co.
Best &
Co.
25.04.01
90
days
27.07.01
Bank of
India,
Mumbai
4,900
7.8 JOURNAL PROPER This book is used to record all transactions which cannot be included in the Cashbook or any
of the other six subsidiary books discussed so far. The transactions that will be recorded in
journal proper are, purchase or sale of fixed assets and investments on credit, adjusting
entries, rectification entries, etc. Format Given below:
JPURNAL PROPER OF XYZ LTD
Date Particulars Doc. Ref. Ledger Debit Credit
Folio Rs. Rs.
2001 Furniture and Fittings a/c Dr. 4,000
April,10 To Furniture Marta/c 4,000
(being the purchase of furniture on credit)
April,30 Repairs to Machinery a/c Dr. 500
To Machinery a/c 500
(being the rectification of a wrong posting
of a repair expense to asset a/c) We will now take up the transactions of a business during a month and study how they will
be recorded in the various subsidiary books of accounts:
ILLUSTRATION:
During January 2001, Narayan transacted the following business:
Dat
e Rs.
1.
2.
3.
4.
Commenced business with cash
Purchased goods on credit from Shyam
Purchased goods for cash
Paid Gopalan an advance for goods ordered
40,000
30,000
1,000
2,000
Dat
e Rs.
5.
6.
7.
8.
9.
10.
11.
13.
15.
18.
20.
22.
25.
28.
31.
Received cash from Murthy as advance for goods
ordered by him
Purchased furniture for office use for cash
Paid wages
Received commission (in cash)
Goods returned to Shyam
Goods sold to Kamal
Paid for postage and telegrams
Goods returned by Kamal
Paid for stationery
Paid into bank
Goods sold for cash
Bought goods for cash
Paid salaries
Paid rent
Drew cash for personal use
3,000
2,000
500
600
200
10,000
200
500
200
500
750
1,000
700
500
1,000
SOLUTION:
Cashbook
Dr. Cr.
Date Receipts Le
dg
er
Fol
io
Cash
Rs.
Bank
Rs.
Date Payments Le
dg
er
Fol
io
Cash
Rs.
Bank
Rs.
2001
Jan. 1
Jan. 5
Jan. 8
Jan.18
Jan.20
To Capital a/c
To Murthy a/c
To Commission
a/c
To Cash a/c
To Sales a/c
C
40,000
3,000
600
750
500
2001
Jan. 3
Jan. 4
Jan. 6
Jan. 7
Jan.12
Jan.15
Jan,18
Jan.22
Jan,25
Jan.28
Jan.31
Jan.31
By Purchases a/c
By Gopalan a/c
By Furniture a/c
By Wages a/c
By Postage &
Telegrams a/c
By Stationery a/c
By Bank a/c
By Purchases a/c
By Salaries a/c
By Rent a/c
By Drawings a/c
By Balance c/d
C
1,000
2,000
2,000
500
200
200
500
1,000
700
500
1,000
34,750
500
Date Receipts Le
dg
er
Fol
io
Cash
Rs.
Bank
Rs.
Date Payments Le
dg
er
Fol
io
Cash
Rs.
Bank
Rs.
44,350 500 44,350 500 Note: The letter „C‟ in the Ledger Folio column denotes a „contra entry‟. That is an entry for which the debit and credit aspects are found in the Cashbook itself
Purchases Book
Date Name of Supplier Ledger
Folio Inward
Invoice
No.
Amount
Rs.
2001
Jan.2
Shyam
Total
30,000
330,000
Purchases Returns Book
Date Name of
Supplier Ledger
Folio Debit
Note
No.
Amount
Rs.
2001
Jan.
9
Shyam
Total
200
200
Sales Book
Name of
Customer Ledger
Folio Outward
Invoice
No.
Amo
unt
Rs.
200
1
Jan.
10
Kamal
Total
10,0
00
10,0
00 Sales Returns Book
Name of
Customer Ledger
Folio Credit
Note No. Amoun
t
Rs.
2001 Jan.
13
Kamal
Total
500
500
End Chapter Quizzes
Choose the most appropriate answer:
Q (1) Purchase book is maintained to record:
(a) Purchase of goods
(b) All cash purchases
(c) All credit purchases
(d) All credit purchases of goods
Q (2) The periodical total of purchase book is posted to the:
(a) Debit of purchase a/c
(b) Debit of sales a/c
(c) Credit of purchase a/c
(d) Credit of cash a/c
Q3 sales book is mainained to record:
(a) Credit sales of goods only
(b) Cash sales of goods only
(c) All credit sales
(d) Both (a) & (c)
Q4 the periodical total of the sales book is posted to the:
(a) Debit of sales a/c
(b) Credit of sales a/c
(c) Credit of cash a/c
(d) Credit of customer‟s a/c
Q5 Return inward book is maintained to record:
(a) Return of goods purchased
(b) Return of goods sold
(c) Return of anything purchased
(d) Return of anything sold
Q6 Return inward book‟s periodical total is posted to:
(a) Credit of return inward a/c
(b) Debit of return outward book
(c) Debit of return inward a/c
(d) Credit of supplier
Q7 The debit notes are used to prepare:
(a) Sales book
(b) Sales return book
(c) Purchase return book
(d) Purchase book
Q8 Closing entries are recorded in:
(a) Cash book
(b) Ledger
(c) Journal proper
(d) Balance sheet
Q9 Cash book is:
(a) Ledger a/c
(b) A book of original entry
(c) Journal as well as ledger
(d) None of these
Q10 When a customer returns the goods:
(a) An invoice is sent to him
(b) A debit note is sent to him
(c) A credit note is sent to him
(d) Both (a) & (b) above
CHAPTER 8- BANK RECONCILIATION STATEMENT
At the end of this chapter you will be conversant with:
8.1 Meaning of BRS
8.2 Reasons for difference between Bank Balances as per Cashbook and Passbook
8.3 Advantages of Bank Reconciliation Statement
8.4 Steps in Preparation of BRS
8.1 MEANING: The Bank Reconciliation Statement is an aid used to ensure the accuracy of transactions
appearing in the bank columns of the Cashbook. Such transactions can be verified through
an external record, namely, the bank statement received periodically from the banker. While
the business keeps a record of its transactions through the bank columns in the Cashbook,
the banker in turn maintains the bank‟s transactions with the business in his ledger. An
extract from this ledger showing details of the transactions during a specified period is sent
at frequent intervals by the bank to the business and this extract is referred to as a bank
statement.
8.2 REASONS FOR DIFFERENCE BETWEEN BANK BALANCES AS PER CASHBOOK AND
PASSBOOK:
The relationship between the customer and the banker is that of a creditor and a debtor.
So, if the bank column of the Cashbook shows a debit balance as on a specified date the
bank statement should show an equal amount of credit balance as on that date and vice
versa. However, the balances shown by the two independent records may not always agree
due to the following:
1. Cheques issued by the business to its suppliers or other parties may not have
been presented for payment.
2. Cheques received from customers and deposited may not have been collected
by the banker.
3. Deposits may have been directly made by the customers into the bank account
of the enterprise.
4. Collection charges, service charges and interest on overdraft are charged by the
banker. The business can ascertain the exact amount of charges and record
them in the Cashbook only after the receipt of the bank statement.
5. Interest credited by bank for the balance maintained with it and any other
income such as interest on securities, dividend, etc. collected by the bank on
behalf of the business can be ascertained only from the bank statement.
6. Wrong entries made by the business in the Cashbook or errors committed by
the bank in its ledger.
7. Omission of entries in the two sets of books.
8. Dishonor of customer‟s cheques deposited in the bank account
8.3 Advantages of Bank Reconciliation Statement
(1) Error Detection:
It helps in detection of errors of omission of transactions or wrong recording of
transactions either by the bank or the business enterprises. Errors identified in the
books by preparing BRS can be rectified.
(ii) Delay in Collection Revealed:
The delay in the collection of cheques, bills, etc., if any, is revealed, when BRS is
prepared. The matter can be pursued to avoid unnecessary delays in collection. It also
helps the management to keep track of the cheques and bills sent for collection.
(iii) Completion of Cashbook:
Business enterprises get information about bank charges, cheques dishonored, direct
payments, direct deposits, etc. from the bank statement only. Entries of the same are
made in the Cashbook on the basis of bank statement. Thus to complete the
Cashbook, comparison and reconciliation of Cashbook and bank book is essential.
(iv) Chances of Embezzlements are Reduced:
Periodical comparison of Cashbook and passbook keeps a check on the office staff. For
example, entry for cash deposit is appearing in the Cashbook but not in the passbook,
indicates fraud being committed by the staff. This type of frauds come to light when
Bank Reconciliation Statement is prepared.
8.4 Steps in Preparation of BRS
(1) Take the Cashbook or passbook balance as starting point. The following points
have to be noted while taking the opening balance.
1. Dr. balance as per Cashbook indicates favorable balance.
2. Cr. balance as per Cashbook means overdraft or unfavorable balance.
3. Dr. balance as per passbook means overdraft or unfavorable balance.
4. Cr. Balance as per passbook means favorable balance.
If the starting point denotes a favorable balance as per Cashbook or passbook, take it
as a positive figure. However, if the starting point denotes negative unfavorable
balance, take it as a negative figure.
(2) Adjust the starting point amount as per the information given and analyze its
impact on the other balances.
(3) After adjusting all the differences or errors, the balance as per the other book is
obtained. If the final balance is positive, it denotes favorable balance (Dr. balance as
per Cashbook or credit balance as per the passbook). However, if the final balance is
negative, it denotes the unfavorable balance or overdraft. (Cr. balance as per
Cashbook or debit balance as per passbook).
The following table summarizes the impact of various differences and errors on the
starting balance.
Bank Reconciliation Statement (BRS)
Items Rs Rs
Bank Balance as per Cashbook
Or
Overdraft balance as per Passbook
xxxx
1
2
3
4
5
Add:
Cheques issued but not presented for payment
Direct payments made by customers
Amount collected by bank (rent, dividends, interest on investments, etc.)
Cheques deposited but omitted to be recorded in
Cashbook
Wrong credit on the credit side of Passbook
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
1
2
3
4
5
6
Less:
Cheques deposited but not collected
Cheques paid into the bank but dishonored
Bank charges and interest charges
Payments made by the banker on behalf of the trader
Cheques issued but not recorded in the Cashbook
Wrong entry on the debit side of the passbook
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Xxxx
Balance as per other book xxxx
Illustration:
On March 31, 2001, the bank column of Cashbook of Prithvi Limited showed a bank
balance (debit) of Rs.48,500. However, the bank statement showed a credit balance of
Rs.53,900 as on the same date. A detailed comparison of entries revealed the following:
1. Customers‟ cheques amounting to Rs.8,450 had not been collected by the
bank as on 31.3.2001.
2. Certain cheques amounting to Rs.8,850 had not been presented for
payment as on 31.3.2001.
3. Bank charges of Rs.1,000 and interest on investments of Rs.2,500 collected
by the banker appear only in the bank statement.
4. On 30.3.2001, there was a wrong credit of Rs.2,500 in the bank statement.
5. Swaroop Limited, a customer, had paid into the bank directly a sum of
Rs.3,000 on March 29, 2001. This has not been recorded in the Cashbook.
6. A cheque for Rs.2,000 received from Excel Limited, a customer, which was
deposited had been returned unpaid. The dishonor of this cheque has not
been entered in the Cashbook.
Solution: Prithvi Limited will first pass the necessary rectification entries in the Cashbook and then
prepare a reconciliation statement
Cashbook of Prithvi Limited (Bank Columns only)
Date Receipts Bank
Rs.
Date Payments Bank
Rs.
2001
March,31
March,31
March,31
To Balance b/d
To InterestReceived
To SwaroopLimited
48,500
2,500
3,000
2001
March,31
March,31
March,31
By Bank Charges
By Excel Limited
By Balance c/d
1,000
2,000
51,000
54,000 54,000
Bank Reconciliation Statement as on March 31, 2001
Particulars Rs. Rs.
Bank balance as per Cashbook
Add: Cheques issued but not presented for payment 8,850
Wrong credit in the bank statement 2,500
Less: Cheques deposited and remained uncollected
Bank balance as per bank statement
51,000
11,350
62,350
8,450
53,900
Test Questions:
Problem 1. From the following particulars, prepare a Bank Reconciliation Statement as on 31st
December, 2007:
Balance as per Cash book Rs 5,800.
Cheques issued but not presented for payment RS 2,000.
Cheques sent for collection but not collected up to 31st December,2007 rs 1500.
The bank had wrongly debited the account of the firm by Rs200, which was rectified by them
after 31st December.
Balance as per Pass book is Rs 6,100.
Problem 2: Prepare a Bank reconciliation Statement from the following particulars. You are required to
ascertain the bank balance as it would appear in the cash book of Shri Gobind as on 31st December, 1995.
(a) The bank pass book showed an overdraft of Rs 9500 on 31st December, 1995.
(b) Interest of Rs 250 on overdraft for six month ending 31st December, 1995 is debited in the pass
book, but is not entered in the bank column of cash book.
(c) Cheques issued but not cashed, prior to 31st December, 1995 amounted to Rs 1500.
(d) Club bill for Rs 2700 was directly debited to his bank account and not yet reflected in the cash
book.
(e) Cheques paid into bank, but not cleared and credited before 31st December, 1995 amounted to Rs
2500.
(f) Interest on investments collected by the Bankers and credited in the pass book amounted to Rs
1800.
Shri Govind issued a cheque of Rs 900 for his LIC premium, which was returned as the amount
mentioned in figure and in words did not tally. Shri Govind, therefore paid the premium by cash but this
was not reflected in his books of account.
Problem 3: on 30th
November 1997, the cash book of Mrs P Ali showed an overdrawn position of
Rs 3630 although her bank statement showed different balance. Detailed examination of the two
records revealed the following:
1. The debit side of the cash book had been undercast by Rs 300.
2. (A cheque for Rs 1560 in favour of X suppliers Ltd had been omitted by the bank from its
statement, the cheque having been debited to another customers‟s account.
3. A cheque fro Rs 182 drawn for payemnet of telephone bill had been enetered in the cash
book at Rs 128 but was shown correctly in the bank st.
4. A cheque of Rs 210 from A banerjee having been paid into bank was dishonoured and
shown as such on the bank st, although no entry relating to the dishpnoted chqque had
been made in the cash book
5. The bank had debited a cheque for Rs 126 to Mrs Ali‟s account in error; it should have
been debited by them to Mr Kali‟s account
6. A dividend of RS 90 had been collcted ny the bank, but not recorded in the cash book
7. Cheques totaling Rs 1260 drawn on Nov, had not been presented for payment.
8. Cheque of Rs 1080 deposited on 30th
Nov, had not been credited by the bank.
9. Int amounting to Rs 228, had been debited by the bank, but noy entered in the cash book.
You are required to prepare a BRS on 30th
Nov 1997
End Chapter Quizzes
Choose the most appropriate answer:
Q1 The Bank Reconciliation Statement is prepared :
(a) To rectify the mistakes of the cash book
(b) To rectify the mistakes of the bank statement
(c) To arrive at its bank balance
(d) To bring out the reasons for the differences between the balance as per cash book &
balance as per bank statement
Q2 A bank pass book is a copy of:
(a) A customer‟s account in the bank‟s books.
(b) Cash book relating to bank column.
(c) Cash book relating to cash column
(d) None of the above
Q3 A bank reconciliation statement is prepared to know the causes for the difference between:
(a) Balance as per cash column of cash book & balance as per pass book
(b) Balance as per bank column of cash book & balance as per pass book
(c) Balance as per cash column of cash book & balance as per bank column of cash book
(d) Neither of above
Q4 A BRS is:
(a) Part of cash book
(b) Part of bank account
(c) Both of above
(d) None of above
Q5 A BRS is prepared with the help of:
(a) Bank pass book & bank column of cash book
(b) Bank pass book & cash column of cash book
(c) Cash column of cash book & bank column of cash book
(d) None of the above
Q6 The balance shown on the bank statement is Rs.3,093 but this does not agree with the cash
book. The differences are found to be a cheque written by the firm for Rs.30 not yet presented; a
standing order of the firm to bank for payment of Rs.21 recorded in cash book only; a dividend
of Rs.84 paid direct to the bank.
(a) 2958
(b) 2988
(c) 3000
(d) 3126
Q7 If a cheque has been issued for payment to the supplier, but the same is not presented into the
bank for payment till date, this would:
(a) Increase the balance of bank column as per cash book
(b) Increase the balance of cash column as per cash book
(c) Increase the balance as per pass book
(d) None of the above
Q8 If a cheque has been collected for payment from the customer, but the same is not presented
into the bank for payment till date, this would:
(a) Decrease the balance of bank column as per cash book
(b) Increase the balance of cash column as per cash book
(c) Decrease the balance as per pass book
(d) None of the above
Q9 Bank has credited interest of Rs 500 directly in customer‟s account, but the same has not
been entered in the cash book. Due to this:
(a) Cash book balance will be more than pass book balance by Rs 500
(b) Cash book balance will be less than pass book balance by Rs 500
(c) It will not affect both the balances.
(d) None of the above
Q10 When cash is withdrawn from the bank, the bank ____ the customer‟s account:
(a) Debit
(b) Credit
(c) Does not touch
(d) None of the above
CHAPTER 9 DEPRECIATION & ITS METHODS
After reading this chapter, you will be conversant with:
9.1 Concept of Depreciation
9.2 Methods of Charging Depreciation
9.3 Comparison between SLM & WDV methods of depreciation
9.4 Recording Depreciation in the books of accounts
9.5 Change in the method of depreciation
9.1 Meaning of Depreciation: Provision is created in a company‟s account towards depreciation to account for the wear
and tear of its assets caused by usage, passage of time, technological obsolescence, etc.
while depreciation does not involve payment of money to any third party, it is nevertheless
an accounting entry in the books.
Depreciation is the acquisition cost of an asset (less the expected salvage value) spread
over the economic life of that asset. The purpose of charging depreciation over the
economic life of the asset is to match the cost of the asset over the period for which
revenue is earned by using the asset.
9.2 DEPRECIATION METHODS
The two methods which are basically used for charging depreciation are
1.Straight Line Method
Under the straight-line method, the net acquisition cost or construction cost is charged off
in equal proportion during the useful economic life and the quantum of the depreciation is
arrived at by dividing the net acquisition or construction cost by the number of years of
useful economic life. The net acquisition or construction cost is calculated by deducting
salvage value from the acquisition or construction cost.
Depreciation =
For example, if the cost of an asset is Rs.1,00,000, the expected salvage value is
Rs.20,000 and the estimated useful life is 8 years, the annual depreciation would be =
Rs.10,000 or 10% per annum.
This method has the following advantages:
1. the amount of depreciation and the rate does not change over the useful economic
life of the asset;
2. the calculation is relatively simple; and
3. it realistically matches cost and revenue.
2. The Written Down Value Method/Diminishing Balance Method
Under this method the depreciation charged in the various years will not be equal over the
useful life of the asset. This is because the depreciation charge every year is calculated as a
percentage of the outstanding balance of the asset as at the beginning of that particular
year and not on the original cost of the asset.
While preparing final accounts, if depreciation is shown as an item under adjustments,
calculate the amount of depreciation and charge it off to profit and loss account by debiting P
& L account and crediting depreciation; show depreciation as a deduction from the asset value
on the assets side of Balance Sheet.
If depreciation is shown in the trial balance, then, the amount of depreciation should be
charged to only P & L account. The percentage of depreciation to be charged under the declining balance method can be
determined as under
r = 1 – (or) 1 – (s/c)1/n
where,
r = rate of depreciation under the written down value method
n = estimated useful life of the asset in years
s = residual value or scrap value of the asset
c = original cost of the asset.
Please note that if the residual or scrap value of an asset is zero, the rate of depreciation cannot
be determined using the above formula.
Illustration 1
Original Cost of the Machine- Rs.1,00,000
Estimated Scrap Value - Rs.30,000
Useful Life - 6 years
The calculation of depreciation for each of the years would be as follows:
r = 1 – (30,000/1,00,000)1/6 = 18%
At the end of the 1st year, the depreciation is calculated by applying the rate to the original cost.
Then the written down value is arrived at by deducting the depreciation so arrived at from the
original cost. At the end of the 2nd year, the depreciation rate is applied to the written down
value at the end of the 1st year. This depreciation amount is again deducted to arrive at the
written down value at the end of the 2nd year. In the above
mentioned asset the depreciation calculations will be as follows:
Year Calculation of
depn. Depreciation Written down value
1 1,00,000 x 18% 18,000 82,000
2 82,000 x 18% 14,760 67,240 3 67,240 x 18% 12,103 55,137
4 55,137 x 18% 9,925 45,212
5 45,212 x 18% 8,138 37,074
6 37,074 x 18% 6,673 30,401
(The small difference between the estimated scrap value and the written down value at the end of
the sixth year is due to approximation of the depreciation rate)
The following are the advantages of Diminishing Balance Method.
1. It matches the service of the asset in the sense that higher depreciation is charged in the
initial years, when the machine is most efficient compared to later years.
2. It recognizes the risk of obsolescence by concentrating the major part of the depreciation
in the early years of the life of the asset.
3. It equalizes the expenses of depreciation and repair charges taken together. It is assumed
that repairs are the lowest in the initial years and higher in the later years while the
depreciation under this method is higher in the initial years and lower in the later years.
4. It results in a better cash flow through tax deferral as under this method the net income to
be taxed is lower in the initial years and higher in the subsequent years.
The disadvantages of declining balance method are:
1. It requires elaborate bookkeeping.
2. As the amount of the depreciation varies from year to year, intra-enterprise
comparability is lost and that income is understated in early years and overstated in
subsequent years.
9.3 COMPARISON BETWEEN SLM & WDV METHODS OF DEPRECIATION
Explanation: In the above diagram we see that irrespective of the time period the amount of
depreciation charged is same under the straight line method. But in case of written down value
method, the amount of depreciation charged falls down as the time period increases. The
depreciation charged under this method is more in the initial years and keeps on falling as the
number of years of usage increase.
We can draw the following differences between the diminishing balance method and straight line
method. They are:
Straight Line Diminishing Balance
1 A fixed amount of depreciation is charged A fixed rate of depreciation is charged
2 The rate of depreciation is the reciprocal
of the life of the asset
The rate of depreciation is ascertained
by applying the formula
3 The asset may or may not have scrap
value
The asset must have a significant
scrap value
4 The amount of depreciation per year is
same
The amount of depreciation goes on
reducing with each passing year.
5 In the first year, the depreciation is
charged on the cost of the asset, less scrap
value, if any
In the first year, the depreciation is
charged on the asset
6 At the end of its life, the book value of the
asset becomes zero
The book value of the asset never
reduces to zero.
9.4 RECORDING DEPRECIATION There are two methods of recording depreciation.
When no provision for depreciation account is maintained
When Provision for depreciation account is maintained
When no provision for depreciation account is maintained Under the first method, the asset account is directly credited for the depreciation and the written
down value is readily ascertained. The journal entry to record depreciation under the method is
Depreciation a/c Dr
To Asset a/c
For transferring depreciation to Profit and Loss Account
Profit and Loss Account Dr.
To Depreciation account
When Provision for depreciation account is maintained Under the second method, the depreciation charged is credited to a depreciation provision and
the written down value of the asset is shown in the balance sheet by deducting the provision from
the original cost of the asset. The journal entry recorded under this method is:
Depreciation a/c Dr
To Depreciation Provision a/c
(Being the depreciation provided for the
accounting period)
After the expiry of useful life of the asset, these two accounts are closed by debiting accumulated
depreciation account and crediting asset account and – any balance in asset account is transferred
to the Profit and Loss account.
P&L a/c Dr
To Depreciation a/c
Illustration 2
An enterprise whose accounting period ends on 31st March, purchased three cars for Rs.90,000
each on 1st April, 1998. Depreciation is charged @ 10% on cost of the Machinery. On 1st
January, 2000 one car was damaged in an accident and was sold for Rs.60,000. Another car was
sold for Rs.80,000 on 30th September, 2000.
You are required to prepare necessary accounts on the basis of straight line method while: (a)
charging to the Asset Account (b) maintaining Provision for Depreciation Account.
Solution:
a. Direct Charge to the Asset Account
Cars Account
Dr. Cr.
Rs. Rs.
1998
Apr. 1
1999
Apr. 1
2000
Apr. 1
2001
To Cash/Bank a/c
(purchase of cars)
To Balance b/d
To Balance b/d
-
To Balance b/d
2,70,000
2,70,000
2,43,000
2,43,000
1,44,000
1,44,000
1999
Mar. 31
Mar. 31
2000
Jan. 1
Mar. 31
Mar. 31
2000
Sept. 1
2001
Mar. 31
By Depreciation a/c
By Balance c/d
By Car disposal a/c (2)
By Depreciation (1)
By Balance c/d
By Car disposal a/c (4)
By Depreciation a/c (3)
By Balance c/d
27,000
2,43,000
2,70,000
74,250
24,750
1,44,000
2,43,000
67,500
13,500
63,000
1,44,000
April 1 63,000
Car Disposal Account*
Dr. Cr.
Particulars Rs. Particulars Rs.
2000 To Cars a/c 74,250
Jan. 1
2000 By Cash/Bank a/c 60,000 Jan. 1 Mar. 31 By Profit & Loss a/c 14,250 (Loss)
74,250 74,250
Car Disposal Account*
Dr. Cr.
Date Particulars Amount Rs.
Date Particulars Amount Rs.
2000 Sept.1 2001 Mar.31
To Cars a/c To Profit & Loss a/c (Profit)
67,500 12,500
2000 Sept 1
By Cash/Bank a/c
80,000
80,00
0 80,00
0
* As two cars have been disposed off on two different dates ‘Car Disposal Account’ has
been opened twice.
Depreciation account
Date Particulars Amount Rs.
Date Particulars Amount Rs.
1999 Mar. 31 2000 Mar. 31 2001 Mar. 31
To Cars a/c To Cars a/c To Cars a/c
27,000
27,000
24,750
24,750
13,500
1999 Mar. 31 2000 Mar. 31 2001 Mar. 31
By Profit & Loss a/c By Profit & Loss a/c By Profit & Loss a/c
27,000
27,000
24,750
24,750
13,500
13,500 13,500
Working Notes:
1. Depreciation for 1999-00 Rs.
For two cars 9,000 x 2 18,000
For the third car for 9 months 9,000 x 9/12 6,750
24,750
2. Determination of book value of car:
Cost 90,000
Less: Depreciation provided up to the date of disposal (9,000
+ 6,750) 15,750
74,250
3. Depreciation for 2000-01
For one car for one year 9,000
Another car for 6 months 4,500
13,500
4. Determination of book value of the car sold in September,
2000:
Cost of the car 90,000
Less: Depreciation provided up to the date of disposal
(9,000 + 9,000 + 4,500) 22,500
67,500
b. If Provision for Depreciation Account is maintained
Cars Account
Dr. Cr. Particulars Rs. Particulars Rs.
1998 Apr. 1
1999 Apr. 1
2000 Apr. 1
To Cash/Bank a/c
To Balance b/d
To Balance b/d
2,70,000
2,70,000
2,70,000
2,70,000
1,80,000
1999 Mar.31
2000 Jan.1 Mar.31
2000 Sep. 1
By Balance c/d
By Sale of Cars a/c
By Balance c/d
By Sale of Cars a/c
2,70,000
2,70,000
90,000
1,80,000
2,70,000
90,000
2001 Apr. 1
To Balance b/d
1,80,000
90,000
2001 Mar.31
By Balance c/d
90,000
1,80,000
Provision for Depreciation Account
Dr. Cr. Rs. Rs.
1999 Mar.31
2000 Mar. 31
2000 Sep. 1 2001 Mar.31
To Balance c/d
To Sale of Cars a/c
To Balance c/d
To Sale of Cars a/c (4)
To Balance c/d
27,000
27,000
15,750
36,000
51,750
22,500
27,000
49,500
1999 Mar.31
1999 Apr. 1 2000 Jan. 1 Mar. 31
2000 Apr. 1 Sep. 1
2001 Apr. 1
By Profit & Loss a/c
By Balance b/d
By Profit & Loss a/c
By Profit & Loss a/c
By Balance b/d
By Profit & Loss a/c
By Profit & Loss a/c
By Balance b/d
27,000
27,000
27,00
0
6,750
18,000
51,750
36,00
0
4,500
9,000
49,500
27,000
Sale of Cars Account Dr. Cr.
Date Particulars Rs. Date Particulars Rs. 2000 Jan. 1
To Cars a/c 90,000 2000 Jan. 1
By Provision for 15,750
2000 Sep. 1
2001 Mar.31
To Cars a/c
To Profit & Loss a/c (Profit)
90,000
90,000
12,500
1,02,500
Mar. 31
2000
Sep. 1
Depreciation a/c
By Cash a/c
By Profit & Loss a/c
(loss)
By Provision for
Depreciation a/c
By Cash a/c.
60,000
14,250
90,000
22,500
80,000
1,02,500
Illustration 2.
On 1st January 1999, the Supreme Manufacturers purchased a machine for Rs.2,50,000.
Depreciation is provided annually according to the straight line method. The estimated useful life
of the machine is 10 years and the scrap value is Rs.10,000. You are required to find out the rate
of depreciation and also show the machine account as on 31st December, 2001.
Determination of amount of depreciation:
Depreciation =
= = 2,40,000/10 = Rs.24,000
Determination of rate of depreciation:
r = (Amount of Depreciation/Cost of the Machine) x 100
= (24000/250000) * 100= 9.6%
Machinery Account
Dr. Cr.
9.5 CHANGE IN THE METHOD OF DEPRECIATION
The depreciation that is charged under the straight line method remains the same every year.
Under the WDV method it reduces gradually. This gives rise to variations in the depreciation
charge calculated as per the two different methods. For instance, let us assume that the following
particulars relate to an asset X:
Original Cost = Rs.12,000
Salvage Value = Rs.2,000
Useful Life = 5 years
Depreciation as per straight line method
=
= Rs.2,000 per annum
Rate of depreciation = (2000/12000) x 100
= 16.67%
Depreciation percentage as per WDV method
Date Particulars Rs. Date Particulars Rs. 1999 Jan. 1
2000
Jan. 1
2001 Jan. 1
2002
Jan. 1
To Cash/Bank a/c
(Purchase of
Machinery)
To Balance b/d
To Balance b/d
To Balance b/d
2,50,000
2,50,000
2,26,000
2,26,000
2,02,000
2,02,000
1,78,000
1999 Dec.31
2000
Dec. 31
Dec. 31
2001
Dec. 31 Dec. 31
By Depreciation a/c By Balance c/d
By Depreciation a/c By Balance c/d
By Depreciation a/c By
Balance c/d
24,000 2,26,000
2,50,000
24,000
2,02,000
2,26,000
24,000
1,78,000
2,02,000
r =
= 1–
The depreciation each year will be as follows:
Year Depn. as per SLM Depn. as per WDV
method
1 2,000 3,600
2 2,000 2,520
3 2,000 1,764
4 2,000 1,235
5 2,000 864
We see that the depreciation in the initial years is higher under the written down value method
and is higher under the straight line method in the latter years of the life of the asset. A company
may use this to manipulate its profits by switching over from one method to another.
Procedure for recording a change in the Method of depreciation
Step 1 – Calculate the total depreciation already provided on assets existing as at the end of
previous accounting year (i.e. assets other than sold/discarded/destroyed up to the end of
previous year) under the existing method up to the end of previous accounting year.
Step 2- Calculate the total depreciation on asset existing as at the end of previous accounting
year by adopting the new method.
Step 3- Calculate the difference between the total depreciation under existing method (as per
step 1) & under new method (as per step 2)
Step 4- Adjust the short depreciation (excess of step 2 over step 1) by debiting Profit & Loss A/c
& crediting the Asset Account/Provision for depreciation a/c
OR
Adjust the excess depreciation (excess of step 1 over step 2) by debiting Asset A/c/Provision for
Depreciation A/c & crediting Profit & Loss A/c.
Step 5- Charge depreciation from current accounting year & onwards by adopting new method.
The following illustration shows the effect of change in the method of depreciation on the
profits of a company:
Illustration:
On 1st January 2001 Bharat Steel Ltd purchased two machines I & II costing Rs 50,000 each &
provided depreciation @10% p.a. on straight line method basis. At the end of 2004, the company
decided to change the method of depreciation from staraight line to written down value method,
the rate remaining the same. Prepare the Machinery Account upto 2004.
Solution:
Step 1- Calculation of depreciation as per old method (SLM) for 3 years = 1,00,000 *10% * 3 =
Rs 30,000
Step 2- Calculation of depreciation as per new method (WDV) =
Rs
A. Cost as on 1.1.2001 1,00,000
B. Less: Depreciation for 2001 10,000
C. Book value as on 1.1.2002 90,000
D. Less: Depreciation for 2002 9000
E. Book Value as on 1.1.2003 81000
F . Less: Depreciation for 2003 8100
E. Book Value as on 1.1.2004 72900
Total Depreciation under new method:
= Rs 10,000 + Rs 9000 + Rs 8100= Rs 27,100
Step 3- Calculate the difference between the total depreciation as per Step 1 & Step 2:
A Total depreciation under old method Rs 30,000
B Total depreciation under new method Rs 27100
C Difference being excess Depreciation Rs 2900s
Step 4-Journal Entry to adjust excess depreciation
Machinery A/c Dr. Rs 2,900
To Profit & Loss A/c Rs 2,900
Step 5- Depreciation for the current accounting year = 10% of Rs 72,900 = Rs 7,290
Step 6- MACHINERY ACCOUNT
Dr. Cr.
Date Particulars Rs Date Particulars Rs 1.01.2001 To Bank A/c 1,00,000 31.12.2001 By Depreciation A/c
By Balance c/d
10,000
90,000
1,00,000 1,00,000
1.01.2002 To Balance b/d 90,000 31.12.2002 By Depreciation A/c
By Balance c/d
10,000
80,000
90,000 90,000
1.01.2003 To Balance b/d 80,000 31.12.2003 By Depreciation A/c
By Balance c/d
10,000
70,000
80,000 80,000
1.01.2004 To Balance b/d
To P&L A/c
(Excess dep
written back on
account of
change from
WDV method to
SLM)
70,000
2,900
31.12.2004 By Depreciation A/c
(10% of Rs 72,900)
By Balance c/d
7,290
65,610
72,900 72900
Test Exercise:
Problem1
A firm purchased on 1st Jan,1989, a second hand Machinery for Rs 36000 and spent Rs 4000 on
its installation. On 1st July in the same year another Machinery costing Rs 20000 was purchased.
On 1st July, 1991, the Machinery bought on 1
st Jan., 1989 was sold off for Rs. 12000 & on the
same date a fresh Machine is purchased for Rs 64000. Depreciation is provided annually on 31st
Dec, @ 10% p.a. on the written down value method. Show the Machine a/c from 1989 to 1992.
Problem 2:
On 1st July, 1987, a company purchased a plant for Rs 20000. Depreciation was provided at the
rate of 10% per annum on straight line method on 31st December every year. With effect from
1.1.1989, the company decided to change the method of depreciation to Dimishing balance
method @ 15% p.a. on 1.7.1990, the plant was sold for Rs 12000. Prepare a plant account from
1987 to 1990 and make adjustments for arrears of depreciation in the year 1989.
Problem 3:
A manufacturing firm purchased on 1st January, 1989 certain mill machinery for Rs. 19,4000 and
spent Rs. 600 on its erection. On 1st July in the same year additional machinery costing Rs.
10,000 was acquired. On 1st July, 1991, the machinery purchased on 1
st January , 1989 having
become obsolete, was auctioned for Rs. 8000 and on the same date fresh machinery was
purchased at a cost of Rs 15,000.
Depreciation was provided annually on 31st Dec @ 10% p.a. on the original cost of asset. In
1992, however the firm changed this method of providing depreciation and adopted the method
of writing off 15% on the written down value. Give the machinery account as it would stand at
the end of each year from 1989 to 1992. Make your calculations to the nearest rupee.
End Chapter Quizzes Choose the most appropriate answer:
Q1 Property, plant and equipment are conventionally presented in the balance sheet at:
(a) Replacement cost less accumulated depreciation
(b) Historical cost less depreciation portion thereof
(c) Historical cost less salvage value
(d) None of the above
Q2 Which of the following is true with respect to providing depreciation under diminishing
balance method?
(a) The amount of depreciation keeps increasing while the rate of depreciation keeps
decreasing
(b) The amount of depreciation & the rate of depreciation decrease every year.
(c) The amount of depreciation decreases while the rate of depreciation remains same.
(d) The amount of depreciation & the rate of depreciation increases every year.
Q3 Which of the following statements best describes the purpose of depreciation?
(a) Regular reduction of asset value to correspond to change in market value as per asset age
(b) A process of correlating the market value of an asset with its gradual decline in physical
efficiency.
(c) Allocation of cost of an asset to the period in which services are received from the asset
(d) None of the above
Q4 The main objective of providing depreciation is to:
(a) To calculate the true profit
(b) Show the true financial position in the balance sheet
(c) Reduce tax burden
(d) Both (a) & (b) above
Q5 Depreciation is a process of
(a) Valuation
(b) Valuation & Allocation
(c) Allocation
(d) Appropriation
Q6 The portion of the acquisition cost of the asset yet to be allocated is known as:
(a) Written down value
(b) Salvage value
(c) Net Realizable value
(d) Accumulated value
Q7 Which of the following statements is true with regard to written down value method of
depreciation? i. The rate at which the asset is written off reduces year after year ii. The amount of
depreciation provided reduces from year to year iii. The rate of depreciation as well as the
amount of depreciation reduce year after year iv. The value of the asset gets reduced to zero over
a period of time.
(a) Only (i)
(b) Only (ii)
(c) Both (i) & (iii)
(d) Both (iii) & (iv)
Q8 The accounting process of gradually converting the unexpired cost of fixed assets into
expenses over a series of accounting periods is:
(a) Depreciation
(b) Physical deterioration of the asset
(c) Decrease in market value of the asset
(d) Valuation of asset at a point of time
Q 9 In which of the following methods, the cost of the asset is spread over in equal proportion
during its useful economic life?:
(a) Straight Line Method
(b) Written down value Method
(c) Unit of production method
(d) None of the above
Q 10 Provision is:
(a) An appropriation of profit
(b) Charge against the profit
(c) Allocation of resources
(d) None of the above
CHAPTER 10 FINAL ACCOUNTS & ADJUSTMENTS
After reading this chapter, you will be conversant with:
10.1 Preparation of a Trial Balance from General Ledger Balances
10.2 Concept of Capital, Revenue & Deferred Revenue expenditure
10.3Preparation of Trading & Profit & Loss account from a given Trial Balance
10.4 Adjustments Entries given outside the Trial Balance
10.5 Preparation of Balance Sheet
10.1 TRIAL BALANCE:
A Trial Balance is a summary of all the General Ledger Balances outstanding as on a particular
date. All the debit balances from the ledger are shown on one side and all the credit balances are
shown on the other side. You are aware that a debit balance in a general ledger account indicates
an excess of debit side over the credit side of the ledger. Similarly, a credit balance in a ledger
account indicates the excess of credit side over the debit side. Now, if all the debit and credit
balances were recorded on the two sides of the Trial Balance, it stands to reason that the two
sides should be equal, since in the journal for each item of debit, there was a credit item.
With the help of following illustration, you will get to know „how to prepare Trial Balance from
the ledger balances:
Illustration:
From the following balances pertaining to Kiran Kumar, prepare the Trial Balance as on
March 31, 2001.
Particulars Rs.
Kiran Kumar‟s Capital
Salaries
Purchases
Sales
Trade expenses
Wages
Freight inwards
Office expenses
Discount received
Commission paid
Postage & Telegrams
Accounts receivable (1)
Accounts payable (2)
Furniture
25,000 (Cr)
6,000 (Dr)
26,000 (Dr)
47,000 (Cr)
1,000 (Dr)
7,800 (Dr)
400 (Dr)
500 (Dr)
200 (Cr)
600 (Dr)
1,200 (Dr)
30,000 (Dr)
21,000 (Cr)
3,000 (Dr)
Particulars Rs.
Machinery
Insurance
Bills receivable (3)
Bills payable (4)
Opening inventory (5)
Cash in hand
Cash at bank
10,000 (Dr)
400 (Dr)
2,000 (Dr)
6,800 (Cr)
7,000 (Dr)
500 (Dr)
3,600 (Dr)
Notes:
1. Receivables indicate the total of all personal accounts which have a debit balance. They
owe money to Kiran Kumar.
2. Payables indicate the total of all personal accounts, which have a credit balance. Kiran
Kumar owes money to them.
3. Bills receivable indicate the bills of exchange accepted by Kiran Kumar‟s debtors. Bills
receivable become due for payments by debtors on specified dates.
4. Bills payable indicate the bills of exchange accepted by Kiran Kumar himself in favor
of his creditors. Bills payable become due for payments by Kiran Kumar on specified
dates.
5. Opening inventory indicates the opening inventory of goods at the beginning of the
period.
Solution: Trial Balance of Kiran Kumar as on 31.03.2001
Particulars Debit Rs. Credit Rs.
Kiran Kumar‟s Capital
Salaries
Purchases
Sales
Trade expenses
Wages
Freight inwards
Office expenses
Discount received
Commission paid
Postage & Telegrams
Accounts receivable
Accounts payable
Furniture
Machinery
6,000
26,000
1,000
7,800
400
500
600
1,200
30,000
3,000
10,000
25,000
47,000
200
21,000
Particulars Debit Rs. Credit Rs.
Insurance
Bills receivable
Bills payable
Opening inventory
Cash in hand
Cash at bank
Total
400
2,000
7,000
500
3,600
6,800
1,00,000 1,00,000
10.2 CAPITAL AND REVENUE EXPENDITURE
Capital Expenditure
Capital expenditure refers to expenditure that the benefit of which is not fully derived in one
year but spread over several periods. Examples for capital expenditure are – acquisition of
assets for the purpose of earning, additions to fixed assets to improve its capacity, expenditure
resulting in long-term benefit to the business, etc. Expenses like Preliminary expenses, Research and
Development expenditure, Interest paid during Construction period, etc. are taken to assets side of
Balance Sheet and shown under „Miscellaneous Expenditure‟.
Revenue Expenditure
It is an expenditure incurred and the benefit of which is derived in the year in which the
expenditure was incurred. Examples are – raw materials, repairs, depreciation, rent, wages, etc.
Such expenses are debited to Profit and Loss account. Any incomes and gains are credited to
Profit and Loss account. Examples are – Commission received, Dividend received, Interest
received etc. Net Profit is transferred to capital account in the balance sheet. Format of Profit and
Loss account is given below.
Deferred Revenue Expenditure
Deferred revenue expenditure is that expenditure is that expenditure which yields benefits which
extend beyond a current accounting period, but to relatively a short period as compared to the
period for which a capital expenditure is expected to yield benefits. These are also known as
future expenditure. Such expenditure should normally be written off over a period of 3 to 5
years. The example of such expenditure include advertisement, research & development
expenditure.
10.3Preparation of Trading & Profit and Loss account from a given Trial
Balance From a given Trial Balance we can prepare a Trading and Profit and Loss account to determine
the profit or loss made by a business organization during a particular period. At the time of
preparation of Profit and Loss account, the following points may be kept in mind:
1. All expenses are debited to Profit and Loss account.
2. All incomes are credited to Profit and Loss account.
3. In addition to treating the incomes and expenses found in the Trial Balance, we may have
to give special treatment to certain „Adjustments‟ also (They are discussed in detail in the
subsequent paragraphs).
4. The profit is credited to Reserves account. If there is net loss, it is debited to Reserves
account in the Balance Sheet, in the case of companies and in the case of sole trader and
partnership, the net profit is credited to capital account and net loss is debited to capital
account.
Trading account is prepared to ascertain the Gross Profit. Gross profit is the difference between
sales and cost of goods sold.
And by deducting all administrative and selling expenses from gross profit we determine the net
profit. Profit and Loss account is prepared to ascertain net profit.
It is necessary to emphasize here that Profit and Loss account (including Trading account) is
usually prepared on ‘Accrual’ basis. In other words all expenses incurred and due are debited to
Profit and Loss account whether they are actually paid for or not. Similarly all incomes earned
and due are credited to Profit and Loss account whether they are actually received or not.
Format of a Trading account is given below:
Trading Account of XYZ Co. for the year ending
31st March, 2001
Dr. Cr.
Date Particulars J.F Amount
Rs. Date Particulars J.F
Amount
Rs.
To Opening stock
Add: Purchases
Less: Returns
To Wages
To Carriage inward
To Gas, Water, Fuel, etc.
To Packaging charges
To Other factory expenses
Gross Profit
By Sales
Less: Returns
By Closing stock
Format of a Profit & Loss account is given below:
Profit and Loss Account for the year ending 31st March, 2001
Date Particulars J.F Amount
Rs.
Date Particulars J.F Amount
Rs.
To Office salaries and wages
To Office rent, rates and taxes
To Office lighting and insurance
To Printing and stationery
To Postage and telegrams
To Legal expenses
To Trade expenses
To Audit fees
To Car upkeep expenses
To Telephone expenses
To General expenses
To Cash discounts allowed
To Interest on capital
To Interest on loans
To Discount or Rebate on bills of
exchange
To Bad debts
To Store charges
To Carriage, Freight, Cartage outwards
To Cost of samples,
catalogue expenses
To Salesmen‟s salaries, expenses and
commission
To Advertising expenses
To Depreciation on fixed assets
To Net profit (transferred to capital
By Gross profit
By Cash discounts
received
By Bad debts recovered
By Income from
investments
By Commission
received
By Interest on deposits
By Gain on sale of fixed
assets
Date Particulars J.F Amount
Rs.
Date Particulars J.F Amount
Rs.
account)
10.4 Adjustment Entries:
Before an accountant can proceed to prepare the financial statements from the trial balance, he
has to process some additional information, which he either already knows or receives from
some other divisions or departments. The following are a few examples showing where
adjustment entries would be required:
a. The accountant may know (or be instructed by the Accounts Manager) that the
depreciation on building is to be charged at the rate of 5%.
b. The accountant would ascertain that the salary of three workers for January is unpaid at
the end of the month.
c. The accountant is informed by the storekeeper that the goods lying unsold in the store
(representing closing stock) is worth Rs.17,000 at cost.
In view of the above information, certain “adjustment entries” will have to be made in the
Journal. Adjustment entries usually represent the recording of additional information and not
actual transactions. Different types of adjustment entries are discussed below.
1. Closing Inventory:
Closing stock refers to the stock of unsold goods at the end of current accounting period which is
carried forward to next accounting period as opening stock. It is valued at cost or net realizable
value whichever is lower. Adjustment Entrynt for the same is given below:
Closing Inventory a/c Dr
To Trading a/c
While the closing inventory appears on the credit side of the trading account to reduce the cost
of goods sold, it also appears as an asset in the balance sheet.
2. Outstanding or Accrued Expense
The nominal accounts record the actual expense paid during the accounting period. However,
prior to the preparation of the financial statements, it must be ensured that all expenses which
have fallen due to be paid but which have not been paid during the accounting period are also
brought into the books to help in the proper matching of revenues and expenses. For example,
ABC Trading Company has the practice of paying the salaries of the employees on the 4th of
the subsequent month. During the financial year ending 31st March, 2001 the salaries account
shows a debit balance of Rs.55,000. The salaries of Rs.6,000 pertaining to March, 2001 were
paid on 4th April, 2001.
While preparing the financial statements for the year ending 31st March, 2001, the salaries of
Rs.6,000 of March must also be included. This is done with the following adjusting journal
entry:
Salaries a/c Dr 6,000
To Outstanding Salaries a/c 6,000
The above journal entry increases the salaries to the correct amount of Rs.61,000 and the
outstanding salaries of Rs.6,000 will be shown as a liability in the balance sheet.
The adjusting journal entry to record any outstanding or accrued expense is
Expense a/c Dr
To Outstanding Expense a/c
While the amount of expense taken from the trial balance will be increased by the amount
outstanding and shown in the trading and profit and loss account, the actual amount outstanding
will be shown as a liability in the balance sheet.
In the subsequent accounting period, the outstanding expense liability will be transferred to the
expense or nominal account and will be set-off by the entry of actual payment when it is made.
3. Prepaid Expense:
Certain expenses paid may relate to more than one accounting period. In such cases, it is
necessary to identify that portion of the expenditure for which the benefit is yet to be received by
the concern and treat that part of the expenditure as prepaid.
ABC Trading Company took an insurance cover for all assets against fire on 1st October, 2000
and paid the annual premium of Rs.2,400 on the same day. Since the benefit of the entire
expenditure will expire only on 30th September, 2001, it becomes necessary to recognize this
aspect while preparing the financial statements as on 31st March, 2001.
The amount of expense prepaid on 1st October, 2000 = (1/2) 2,400 = Rs.1,200
The adjusting entry to record the prepaid insurance is,
Prepaid Insurance a/c Dr 1,200
To Insurance a/c 1,200
This entry ensures that the insurance expense is reported at the correct figure of Rs.1,200 in the
profit and loss account and the prepaid amount is shown as an asset in the balance sheet.
The journal entry to record any prepaid expense is,
Prepaid Expense a/c Dr
To Expense a/c
In the subsequent accounting period, the balance in the prepaid expense account will be
transferred back to the expense account.
4. Outstanding or Accrued Income
An income appearing in the ledger account may not represent the income that must have been
received during the year. If a portion of an income has not yet been received or is outstanding
as at the end of the accounting period then the outstanding amount must be brought into books.
ABC Trading Company holds 14% Debentures of the face value of Rs.5,000 in Bright Limited
as investments. The interest is payable on 30th June and 31st December of every year. The
debentures were purchased on 1st July, 2000.
While ABC Trading Company would have received the interest of Rs.350 (5,000 (14/100) 1/2)
during the accounting period ending 31st March, 2000 the interest of Rs.350 for the next six
months will be received only in the subsequent accounting period. However, while preparing
the financial statements, the total interest revenue to be recognized is the amount of Rs.350
actually received plus the interest of Rs.175 pertaining to the period 1st January, 2001 to 31st March,
2001.
The following adjusting entry will bring into books the amount of outstanding interest:
Outstanding Interest a/c Dr 175
To Interest Received a/c 175
While the interest received will be increased to Rs.525 and shown in the profit and loss
account, the outstanding interest account will be listed as an asset in the balance sheet.
In the subsequent accounting period, the amount in the Outstanding Interest a/c will be
transferred to Interest Received a/c and the actual receipt of the interest will offset the former
transfer entry.
To record any outstanding income in the books of accounts, the journal entry is:
Outstanding Income a/c Dr
To Income A/c
5. Income Received in Advance
While preparing the financial statements, adjustments may be necessary in respect of any
incomes received in advance.
Law Publications has received subscriptions amounting to Rs.50,000 during the financial year
ending 31st December, 2001. Out of this Rs.2,500 represent subscriptions relating to the next
financial year.
The entry to adjust for the income received in advance will be,
Subscriptions a/c Dr 2,500
To Subscriptions received in Advance a/c 2,500
With the posting of the above journal entry, the subscriptions account will be shown in the
profit and loss account at the correct figure of Rs.47,500 and in the balance sheet, the
subscriptions received in advance will be listed as a liability. Any income received in advance
is a liability as benefits are yet to be conferred to the person from whom the amount has been
received.
The journal entry to record the adjustment of any income received in advance is
Income a/c Dr
To Income Received in Advance a/c
6. INTEREST ON CAPITAL:
Interest on capital means the cost of using the capital invested in an enterprise by the proprietor
or partners. It is accounting treatment is summarized as follows:
Interest on Capital A/c Dr.
To Capital A/c
It is shown on debit side of P&L A/c & on liability side of Balance Sheet as addition to capital.
7. ADJUSTMENT OF ABNORMAL LOSS OF STOCK:
It is usually caused by fire, theft, abnormal spoilage/leakage/breakage/pilferage, etc. its
accounting treatment is summarized as given below:
Loss of stock A/c Dr.
To Trading A/c
Total value of abnormal loss (whether recovered or not) is shown on the credit side of trading
account.
And total value of irrecovered loss of stock (i.e. total loss less amount if any recovered for
insurance co) is shown on the debit side as a separate item in Profit & Loss A/c.
The amount if any due from the insurance co is shown on Asset Side as a „Current Assets‟ in the
Balance Sheet.
8. PROVISIONS FOR BAD DEBTS, CASH DISCOUNTS PAYABLE AND CASH
DISCOUNTS RECEIVABLE
(i) Bad Debts
The sales revenue recorded in the books of accounts of an organization represents the amount
realized/to be realized from the sale of goods. When goods are sold on credit it may sometimes
not be able to be realized. That unrealized sale is considered to be bad debt. For instance, if a
customer, subsequent to the date of credit sales, is adjudged as insolvent and his estate cannot
pay anything towards satisfaction of the amount due from him, then, logically, the entry passed
at the time of sale should be removed by reversing it, as the situation is similar to the sale not
having taken place. In practice, however, instead of reversing the previous entry, the amount
which cannot be recovered is considered as a loss called “bad debts”.
The general journal entry for recording bad debts is
Bad debts a/c Dr
To Accounts Receivable a/c
(ii) Provision for Bad and Doubtful Debts:
When bad debts are expected to occur in the future, (a) the exact amount of loss may not be
known and (b) a particular debtor‟s account cannot be identified to write-off the expected loss.
To circumvent these problems, usually, a provision is made for the expected bad debts loss out
of profits of the current year. This reduces the profit. For creating the provision for bad and
doubtful debts, the journal entry is,
Profit and Loss a/c Dr
To Provision for Bad Debts a/c
Treatment of Bad Debts when a Provision for Bad Debts Exists
Let us extend the example of PQR Ltd., to the financial year ending 31st March,
2000.
The following details are available:
Bad debts during the year 3,500
Accounts receivable as on 31/3/1999 1,70,000
PQR Ltd., would like to maintain the provision at 5% of sundry debtors.
The accounts receivable of Rs.1,70,000 as on 31/3/2000 is after accounting for the bad debts of
Rs.3,500.
When bad debts occurred, the following entry would have been passed.
Bad Debts a/c Dr 3,500
To Sundry Debtors a/c 3,500
Since a provision for bad debts to the extent of Rs.5,000 already exists, the actual bad debts of
Rs.3,500 will be transferred at the end of the year to this provision account and not to the profit
and loss account. The entry for the transfer will be,
Provision for Bad Debts a/c Dr 3,500
To Bad Debts a/c 3,500
At this point the provision account will appear as under:
Provision for Bad Debts Account
Particulars Rs. Particulars Rs.
31.3.2000
To Bad Debts
a/c
3,500
1.4.1999
By Balance b/d
5,000
Since the provision has been utilized to the extent of Rs.3,500, only Rs.1,500 is left for setting
off any bad debts in the forthcoming year. However, PQR Ltd. wishes to maintain the provision
at 5% on debtors. So, the balance required in the provision account as on 31.3.2000 is, (5/100)
1,70,000 = Rs.8,500
To bring up the provision to the required balance a further appropriation of Rs.7,000 (8,500 –
1,500) will have to be made from the profit and loss account. Entry will be,
Profit and Loss a/c Dr 7,000
To Provision for Bad Debts a/c 7,000
The provision account, after posting this entry, will appear as follows:
Provision for Bad Debts Account
Dr. Cr.
Particulars Rs. Particulars Rs.
31.3.2000
To Bad Debts
31.3.2000
To Balance c/d
3,500
8,500
1.4.1999
By Balance b/d
31.3.2000
By Profit and Loss a/c
5,000
7,000
12,000 12,000
The balance sheet will again show the Accounts Receivable at their realizable value.
Balance Sheet of PQR Ltd. as on 31.3.2000
Liabilities Assets Rs. Rs
Accounts Receivable 1,70,000
Less: Provision for 8,500 1,61,500
Bad Debts
(iii) Recovery of Bad Debts Written off
Sometimes, an amount written off as bad debts may be subsequently recovered. Any such
recovery must be treated as a windfall and transferred to the Profit and Loss account as a gain.
The journal entries will be,
At the time of receipt of the amount
Cash a/c Dr
To Bad Debts Recovered a/c
At the end of the financial year,
Bad Debts Recovered a/c Dr
To Profit and Loss a/c
(iv) Provision for Discounts on Debtors/Accounts Receivable
The organizations which allow the facility of making payments before the due date and enable
their debtors to avail of cash discounts, must take into account the possible amount of discounts
that may be allowed on closing debtors in the forthcoming year.
The principles for creation and maintenance of the provision for discounts on debtors are the
same as those discussed in the section on provision for bad debts. The only additional point to be
noted is that discounts will be estimated on debts considered good, i.e. closing sundry debtors
minus provision for bad debts. Adjusting entry for the same is as follows:
Profit & Loss A/c Dr.
To Provision for discount on debtors A/c
The following illustration clearly explains the mechanics of maintaining a provision for
discounts on debtors.
Illustration :
Following are the extracts from Trial Balance of a firm as at 31st March,2002:
Name of account Dr Balance Rs Cr Balance Rs
Sundry Debtors
Bad debts
Discount
2,05,000
3,000
1,800
(i) Credited a provision for doubtful debts @10% on debtors.
(ii) Credit a provision for discount on debtors @2% on debtors.
(iii) Additional discount given to the debtors Rs 5000.
Required: Pass necessary journal entries & show the relevant accounts.
Solution:
Journal entries
Particulars L.F. Dr (Rs) Cr (Rs)
Discount allowed A/c Dr.
To sundry Debtors A/c
(Being the additional discount allowed to debtors)
5,000
5,000
Profit & Loss A/c Dr.
To Bad Debts A/c
To Discount Allowed A/c
(Being the transfer of bad debts & discount to P&L A/c)
9.800
3,000
6,800
Profit & Loss A/c Dr.
To provision for doubtful debts A/c
(being the provision for DD created @10% on 2,00,000)
20,000
20,000
Profit & Loss A/c Dr.
To Provision for discount on debtors A/c
(being the provision for discount created @2% on debtors of
Rs 1,80,000 (i.e. Rs 2,00,000 – Rs 20,000)
3,600
3,600
Sundry Debtors Account
Dr Cr.
Particulars Rs Particulars Rs
To balance b/d 2,05,000 By discount Allowed A/c
By balance c/d
5,000
2,00,000
2,05,000 2,05,000
Bad debts Account
Dr Cr.
Particulars Rs Particulars Rs
To balance b/d 3,000 By profit & Loss A/c 3,000
Provision for Doubtful debts Account
Dr Cr.
Particulars Rs Particulars Rs
To balance c/d 20,000 By P&L A/c 20,000
Discount Allowed Account
Dr Cr.
Particulars Rs Particulars Rs
To balance b/d
To S Debtors
1,800
5,000
By P&L A/c 6,800
6,800 6,800
Provision for Discount on Debtors Account
Dr Cr.
Particulars Rs Particulars Rs
To Balance b/d 3,600 By P&L A/c 3,600
Profit & Loss A/c for the year ended 31st March,2002
Dr. Cr.
Particulars Rs Particulars Rs
To Bad Debts
(as given in the Trial balance)
To provision for doubtful debts
To discount 1,800
(as given in the trial balance)
Add: Additional discount 5,000
To provision for discount on debtors
3,000
20,000
6,800
3,600
Balance Sheet as at 31st March 2002
Liabilities Rs Assets Rs
Current Assets:
Debtors 2,05,000
Less: Additional Discount 5,000
2,00,000
Less: provision for doubtful debts @10% 20,000
1,80,000
Less: Provision for Discount @2% 3,600
1,76,400
(v)Reserve for Discounts on Accounts Payable/Creditors:
Organizations may like to show the sundry creditors in the balance sheet at the net payable value
by estimating in advance the amount of cash discounts that may be received at the time of
settlement of amounts due. This is usually done by creating a reserve for discounts on creditors
and then transferring the discounts received to such reserve. Since, income in respect of
discounts receivable is recognized in advance, the journal for creation of the reserve will be
Reserve for Discount on Accounts Payable a/c Dr
To Profit and Loss a/c
9. ADJUSTMENT OF DEPRECIATION:
Depreciation represents that portion of the cost of a fixed asset which has been used in the
business for the purpose of earning profits. Its accounting treatment is given below:
Depreciation A/c Dr.
To respective A/c
Note: If depreciation already appears in the Trial Balance, then no adjusting entry is required to
be passed. It will be shown only in P&L A/c , not in the balance sheet.
BALANCE SHEET:
A balance sheet is a statement of assets and liabilities of a business organization at any
particular date. At the end of each accounting period, every business organization prepares a
Balance Sheet to have a clear understanding of its assets and liabilities, which indicate the
financial position of the concern.
The Balance Sheet is prepared from the point of view of the business (as a separate entity,
distinguished from its owners). Another way to understand a Balance Sheet is to consider it as a
statement of sources of funds (i.e., liabilities) and utilization of funds (i.e., assets).
Balance Sheet can be prepared in order of (a) liquidity basis and (b) permanence basis.
When assets and liabilities are arranged according to their realizability and payment preference,
it is liquidity order basis.
When fixed assets and liabilities are arranged on the assumption that these will be sold and paid
only on the liquidation of business it is the permanence/fixity basis.
Format of a Balance Sheet in order of Liquidity:
Balance Sheet of ……..as at……
Liabilities Rs Assets Rs
Current Liabilities:
Bank overdraft
Bills payable
Outstanding expenses
Sundry creditors
Income received in advance
Long term Liabilities:
Loan
Capital:
Opening Balance xxxx
Add: Net Profit xxxx
Or Less: Net Loss xxxx
Less: Drawing xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Current Assets:
Cash in hand
Cash at bank
Bills receivable
Sundry Debtors
Prepaid expenses
Accrued income
Closing stock
Fixed Asset:
Investment
Furniture & Fixture
Plant & Machinery
Building
Land
Building
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx Xxxx
Format of a Balance Sheet in order of Permanence:
Balance Sheet of ……..as at……
Liabilities Rs Assets Rs
Long term Liabilities:
Loan
Capital:
xxxx
xxxx
Fixed Asset:
Investment
Furniture & Fixture
xxxx
xxxx
Opening Balance xxxx
Add: Net Profit xxxx
Or Less: Net Loss xxxx
Less: Drawing xxxx
Current Liabilities:
Sundry creditors
Income received in advance
Outstanding expenses
Bills payable
Bank overdraft
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
Plant & Machinery
Building
Land
Building
Current Assets:
Closing stock
Bills receivable
Sundry Debtors
Prepaid expenses
Accrued income
Cash in hand
Cash at bank
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx
xxxx xxxx
LINKAGE BETWEEN TRIAL BALANCE, PROFIT & LOSS ACCOUNT AND
BALANCE SHEET
It is necessary to understand the linkage between Trial Balance, Profit and Loss Account and
Balance Sheet as shown in the following Figure:
In other words,
– We start with a tallied trial balance.
– We give double-entry effect to all adjustments outside trial balance.
– We take some of the trial balance items (including adjustments) to Profit and Loss
Account.
– We take the result of profit and loss Account (net profit or net loss) to Balance Sheet
(Reserves or Capital).
– We take the rest of the items of trial balance (including adjustments) to Balance Sheet.
Hence the Balance Sheet has to tally. Assets side should be equal to liabilities side. Utilization of
Funds (Assets) should be equal to sources of funds (Liabilities).
We can sum up the whole process of preparation of final accounts in the following
steps:
Start with a tallied trial balance. It proves the arithmetical accuracy of entries made in
the books namely cash book, journal and ledger. However, there are certain errors
which are not disclosed by a trial balance.
On account of certain errors if the trial balance is not tallied, the Suspense Account is
opened with the difference of two sides and the same is inserted on the side having
deficit.
Adjustments given at the end of a trial balance should be given double-entry effect.
Otherwise accounts will not be complete.The balance sheet will not tally.
The treatment of adjustments for expenses and incomes in balance sheet is:
1.Outstanding liabilities for expenses shown on liabilities side;
2.Prepaid expenses shown on assets side;
3.Income received in advance shown on liabilities side;
4.Income earned but not received, and income accrued but not due, shown on assets
side;
5.Fixed assets are recorded at cost minus depreciation;
6.Closing stock recorded at cost price or market price whichever is less.
To sum up our discussion on Profit and Loss Account and Balance Sheet let us take note of the
following important points.
Profit and loss account may be divided into three components:
Trading Account To reflect gross profit or loss arising
out of trading and manufacturing
operations.
Profit and
Loss Account
To reflect the net profit or loss of the
entire business after duly accounting
for all administrative and selling
expenses.
Profit and Loss To reflect the various appropriations
Appropriation Account made out of disposable profits like
dividends, transfer to reserves etc.
Illustration
From the following Trial Balance of Sun Shine and Company prepare Trading, Profit and Loss
account and Balance Sheet.
Trial Balance as on 31.12.2001
Particulars Debit Rs. Credit Rs.
Capital 25,000
Loans 5,000
Sales 35,000
Accounts Payable 4,000
Bills Payable 5,000
Purchase Returns 2,000
Dividends Received 3,000
Plant & Machinery 13,000
Buildings 17,000
Receivables 9,650
Purchases 18,000
Discount allowed 1,200
Wages 7,000
Salaries 3,000
Traveling Expenses 750
Freight 200
Insurance 300
Commission paid 100
Cash on hand 100
Bank 1,600
Repairs 500
Interest on loans 600
Opening Inventory 6,000
Total 79,000 79,000
Additional Data:
1. Closing Inventory Rs.8,000.
2. Depreciation on Plant & Machinery at 15% and 10% on Buildings.
3. Provision for doubtful receivables Rs.500.
4. Insurance prepaid Rs.50
5. Outstanding rent Rs.100.
Solution:
Sun Shine and Company
Trading Account for the year ending 31.12.2001 Particulars R
s. Particulars
Rs.
To Opening Inventory
To Purchases 18,000
Less: Returns 2,000
To Wages
To Gross Profit c/d
6,000
16,000
7,000
14,000
43,000
By Sales
By Closing
Inventory
35000
8000
43,000
Profit and Loss Account for the year ending 31.12.2001
To Discount allowed 1,200 To Salaries 3,000 To Traveling expenses 750 To Freight 200 To Insurance 300 Less: Prepaid 50 250
To Commission paid 100
To Repairs 500 To Interest on loan 600 To Rent outstanding 100 To Provision for doubtful receivables 500
To Depreciation: Plant & Machinery 1,950 Buildings 1,700 To Net Profit c/d 6,150
By Gross Profit b/d 14,000
By Dividends received 3,000
17,000
17,000
Sun Shine and Company
Balance Sheet as on 31.12.2001
Liabilities Rs. Rs. AssetsRs.Rs.
Capital 25,000
Add: Net Profit 6,150 31,150
Loan Current Liabilities: 5,000 Accounts Payable 4,000