MEFA V UNIT MATERIAL

FINANCIAL ACCOUNTING AND ANALYSIS

INTRODUCTION:Accounting is the language of business. Companies communicate their performance to outsiders and evaluate the performance of their employees using information generated by the accounting system. Learning the language of accounting is essential for anyone that must make decisions based on financial information. Accounting is not an end in itself; it is a means to an end. It performs the service activity by providing quantitative financial information that helps the users in making better business decisions. Accounting also describes and analyses the mass of data of an enterprise through measurement, classification, and summarization, and reduces that data into reports and statements, which show the financial condition and results of operations of that enterprise. Accounting as an information system collects processes and communicates information about an enterprise to a wide variety of interested parties.

Definitions:

The American Accounting Association defines accounting as follows: “The process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information.”

American Institute of certified public Accountant defines accounting as “Accounting is an art of recording, classifying and summarizing in a significant manner and in terms of money, transaction and events which are, in part at least, of a financial character and interpreting the results thereof ”

The purpose of financial accounting statements is mainly to show the financial position of a business at a particular point in time and to show how that business has performed over a specific period.

The three main financial accounting statements that help achieve this aim are:

(1) The profit and loss account (or income statement) for the reporting period(2) A balance sheet for the business at the end of the reporting period(3) A cash flow statement for the reporting period

A balance sheet shows at a particular point in time what resources are owned by a business (“assets”) and what it owes to other parties (“liabilities”). It also shows how much has been invested in the business and what the sources of that investment finance were.

Differences between Accounting and Book-Keeping:Book keeping usually involves only the recording of business transactions (transactions) and is therefore, just one part of the accounting process. Accounting on the other hand, involves the entire accounting process, i.e. identification, measurement, recording, and communication. Now-a-days, much of the book keeping function is performed by the computer and other machines

Objectives of AccountingThe basic objective of accounting is to provide information to the interested users to enable them to make business decisions. The necessary information, particularly in the case of external users, is provided in the basic financial statements: Profit and loss statement and Balance sheet.

Besides the above sources of information, the internal users, officers and staff of the enterprise, can obtain additional information from the records of business. Thus the primary objectives of accounting can be stated as:

Maintenance of Records of Business transactions. Calculation of Profit or Loss Depiction of Financial Position. Provide Information to the Users

Maintenance of Records of Business:First record, then pay; if there is an error, trace it from the records. Human memory is short. Even the most brilliant executive or manager cannot accurately remember what he might have observed regarding the daily operations. He need not strain his memory unnecessarily, if proper and complete records of all business transactions are kept regularly. More-over, records can be used by different officials for different decision-making purposes.

Calculation of Profit or Loss:Earning profit is the main purpose for which a business is carried on. This information is available from the profit and loss statement. Profit is calculated by deducting expenses from the associated revenues. Profit is a measure of the performance of the enterprise.

Depiction of Financial PositionA balance sheet depicts the financial position of an enterprise. It is a statement of assets and liabilities. It shows the resources (assets) owned by an enterprise and depicts the claims (liabilities) against the resources. The balance of assets minus the external liabilities shows the capital (owner’s equity).

Provide Information to the UsersGeneration of information is not an end in itself. It is a means to facilitate the dissemination of information among different user groups. Therefore, communication of information is the essential function of accounting.

Users of the Financial StatementsThe most basic objective of financial accounting is preparation of general purpose financial statements, which are financial statements meant for use by stakeholders external to the entity, who do not have any other means of getting such information, i.e. people other than the management. These stakeholders include

Investors and Financial Analysts:Investors need the information to estimate the intrinsic value of the entity and to decide whether to buy, hold or sell the entity's shares. Equity research analysts use financial statements to conduct their research on earnings expectations and price targets.

Employee groups:Employees and their representative groups are interested in information about the solvency and profitability of their employers to decide about their careers, assess their bargaining power and set a target wage for themselves.

Lenders:Lenders are interested in information that enables them to determine whether their loans and the interest earned on them will be paid when due.

Suppliers and other trade creditors:Suppliers and other creditors are interested in information that enables them to determine whether amounts owing to them will be paid when due and whether the demand from the company is going to increase, decrease or stay constant.

Customers:Customers want to know whether their supplier is going to continue as an entity, especially when they have a long-term involvement with that supplier. For example, Apple is interested in long-term viability of Intel because Apple uses Intel processors in its computers and if Intel ceases operations at once, Apple will suffer difficulties in meeting its own demand and will lose revenue.

Governments and their agencies:Governments and their agencies are interested in financial accounting information for a range of purposes. For example, the tax collecting authorities are interested in calculating taxable income of the tax-paying entities and finding their tax payable. The governments themselves are interested in efficient allocation of resources and they need financial accounting information of different sectors and industries to decide on federal and state budget allocation, etc. The bureaus of statistics are interested in calculating national income, employment and other measures.

Public:The public is interested in an entity’s contribution towards the communities in which it operates, its corporate social responsibility updates, its environmental track record, etc.

The Accounting Cycle:There are ten basic steps to the accounting cycle.

1. Collect Source Documents:The very first step in the accounting cycle is to gather all the documents that are related to financial transactions of the organization. These documents, called source documents, are things like receipts, bank statements, checks and purchase orders. They are the items that describe what a transaction was for.

2. Analyze Transactions:The second step in the accounting cycle is to analyze source documents. The purpose of this is to look them over and then decide what effect they have had on company accounts.

3. Journalize Transactions:The third step in the accounting cycle is to post entries into the journal for the analyzed transactions. A journal is the book or electronic record that documents all the financial transactions of a company and the accounts that are affected by each transaction. When a journal entry is made, the 'double-entry' rule is used. This means that for every one transaction, at least two accounts are affected. There must be a debit and a credit for each transaction, and the total of debits and credits must equal the amount of the transaction. Journal entries are entered in chronological order, and debits are entered before credits.

4. Post Transactions:The fourth step in the accounting cycle is to transfer information from the journal to the ledger. A ledger is a book or an electronic record of all the accounts that a company has. These accounts are broken down

by account number and class. When the information from the journal is transferred to the ledger, it is transferred to each account that was affected by a transaction.

5. Prepare an Unadjusted Trial Balance:A trial balance is a list of all the company's accounts and their balance at the time that the trial balance is prepared. An unadjusted trial balance is a trial balance that is prepared before adjusting entries are made into accounts. This information comes directly from the ledger. The total debit balance and total credit balance must be equal.

6. Prepare Adjusting Entries:Adjusting entries are entries that are made in the journal and posted in the ledger. The purpose of these entries is to bring account balances to the proper amounts. Not all accounts will have an adjusting entry. Adjusting entries are made at the end of the accounting period, but not the end of the accounting cycle.

7. Prepare Trial Balance:Remember, the trial balance is a list of all accounts and their balances after adjustments have been made. This trial balance is prepared to check and make sure that the debits and credits equal after adjusting entries are made. It is used to prepare the financial statements.

8. Prepare Financial Statements:These are prepared in a specific order because information from one financial statement is often used in preparing another financial statement. The order that the financial statements need to be prepared is:

a) Income Statement - This statement measures how well a company is performing financially during a specific time period. If the company made money, then it had a net profit. If it lost money, then it had a net loss.

b) Balance Sheet- A balance sheet also known as the statement of financial position tells about the assets, liabilities and equity of a business at a specific point of time. It is a snapshot of a business. A balance sheet is an extended form of the accounting equation. An accounting equation is:

Assets = Liabilities + EquityAssets are the resources controlled by a business, equity is the obligation of the company to its owners and liabilities are the obligations of parties other than owners.

c) Statement of Cash Flows - A statement of cash flows is a financial statement which summarizes cash transactions of a business during a given accounting period and classifies them under three heads, namely, cash flows from operating, investing and financing activities. It shows how cash moved during the period by indicating whether a particular line item is a cash in-flow or cash out-flow.

9. Closing Entries:Closing entries are journal entries made at the end of an accounting period which transfer the balances of temporary accounts to permanent accounts. Closing entries are based on the account balances in an adjusted trial balance.

Temporary accounts include:Revenue, Income and Gain AccountsExpense and Loss AccountsDividend, Drawings or Withdrawals AccountsIncome Summary Account

The permanent account to which balances are transferred depend upon the type of business. In case of a company, retained earnings account, and in case of a firm or a sole proprietorship, owner's capital account receives the balances of temporary accounts.

10. Post-Closing Trial Balance:A post-closing trial balance is a list of balances of ledger accounts prepared after closing entries have been passed and posted to the ledger accounts. Since the closing entries transfer the balances of temporary accounts (i.e. expense, revenue, gain, dividend and withdrawal accounts) to the retained earnings account, the new balances of temporary accounts are zero and therefore they are not listed on a post-closing trial balance. However, all the other accounts having non-negative balances are listed including the retained earnings account.

The preparation of post-closing trial balance is the last step of the accounting cycle and its purpose is to be sure that sum of debits equal the sum of credits before the start of new accounting period. It provides the openings balances for the ledger accounts of the new accounting period.

Generally Accepted Accounting PrinciplesThe common set of accounting principles, standards and procedures that companies use to compile their financial statements. GAAP are a combination of authoritative standards (set by policy boards) and simply the commonly accepted ways of recording and reporting accounting information.Accountants use generally accepted accounting principles (GAAP) to guide them in recording and reporting financial information. GAAP comprises a broad set of principles that have been developed by the accounting profession and the Securities and Exchange Commission (SEC). Two laws, the Securities Act of 1933 and the Securities Exchange Act of 1934, give the SEC authority to establish reporting and disclosure requirements. However, the SEC usually operates in an oversight capacity, allowing the FASB and the Governmental Accounting Standards Board (GASB) to establish these requirements. The GASB develops accounting standards for state and local governments.

The current set of principles that accountants use rests upon some underlying assumptions. The basic assumptions and principles presented on the next several pages are considered GAAP and apply to most financial statements. In addition to these concepts, there are other, more technical standards accountants must follow when preparing financial statements. Some of these are discussed later in this book, but other are left for more advanced study.

BASIC ACCOUNTING CONCEPTSAccounting is a system evolved to achieve a set of objectives. In order to achieve the goals, we need a set of rules or guidelines. These guidelines are termed here as “BASIC ACCOUNTING CONCEPTS”. The term concept means an idea or thought. Basic accounting concepts are the fundamental ideas or basic assumptions underlying the theory and profit of FINANCIAL ACCOUNTING. These concepts help in bringing about uniformity in the practice of accounting. In accountancy following concepts are quite popular.

1. Business Entity Concept:In this concept “Business is treated as separate from the proprietor”. All the Transactions recorded in the book of Business and not in the books of proprietor. The proprietor is also treated as a creditor for the Business. In case this concept is not followed, affairs of the business will be mixed with the personal transactions of the proprietor and the true picture of the business will not be known. Even the proprietor is regarded as creditor to the extent of the capital contributed by him to the business.

2. Going Concern Concept:This concept relates with the long life of Business. The assumption is that business will continue to exist for unlimited period unless it is dissolved due to some reasons or the other.it is for this reason that fixed assets are recorded at original cost and are depreciated on the basis of their expected life rather than on the basis of market value.

3. Money Measurement Concept:In this concept “Only those transactions are recorded in accounting which can be expressed in terms of money, those transactions which cannot be expressed in terms of money are not recorded in the books of accounting”. Non-monetary events such as retirement of manager, sales policy of management, working conditions of workers etc. cannot be recorded in accounting books.

4. Cost Concept:According to this concept, an asset is recorded at its cost in the books of account. i.e., the price which is paid at the time of acquiring it. In balance sheet, these assets appear not at cost price every year, but depreciation is deducted and they appear at the amount, which is cost, less classification.

5. Accounting Period Concept:Every Businessman wants to know the result of his investment and efforts after a certain period. Usually one-year period is regarded as an ideal for this purpose. This period is called Accounting Period. It depends on the nature of the business and object of the proprietor of business.

6. Dual Aspect Concept:According to this concept “Every business transactions has two aspects”, one is the receiving benefit aspect another one is giving benefit aspect. The receiving aspect is termed as ‘Debit’; where as the giving aspect is termed as “Credit”. Therefore, for every debit there will be corresponding credit. The dual aspect is also expressed in another form of equation as under.Capital + Liabilities = AssetsCapital = Assets –Liabilities

7. Matching Cost Concept:According to this concept “The expenses incurred during an accounting period, e.g., if revenue is recognized on all goods sold during a period, cost of those good sole should also be charged to that period.

ACCOUNTING CONVENTIONS

Accounting is based on some customs or usages. Naturally accountants are here to adopt that usage or custom. They are termed as convert conventions in accounting. The following are some of the important accounting conventions.

1. Convention of Full Disclosure:According to this convention accounting reports should disclose fully and fairly the information. They purport to represent. They should be prepared honestly and sufficiently disclose information which is if material interest to proprietors, present and potential creditors and investors. The companies act, 1956 makes it compulsory to provide all the information in the prescribed form. Full disclosure does not mean disclosure of each and every item of information. It only means disclosure of such information which is of significance to owners, investors and creditors.

2. Convention of Materiality:Under this convention the trader records important factor about the commercial activities. In the form of financial statements if any unimportant information is to be given for the sake of clarity it will be given as footnotes. Its means unimportant mattes should be either left out or merged with other items.

3. Convention of Consistency:It means that accounting method adopted should not be changed from year to year. It means that there should be consistent in the methods or principles followed. Or else the results of a year cannot be conveniently compared with that of another. If change becomes necessary the change and its effect should be stated clearly.

4. Convention of Conservatism:This convention is based on the policy of playing safe. According to this convention all possible or expected losses should be provided for but unearned or unrealized profit should be left out. This convention warns the trader not to take unrealized income into account. That is why the practice of valuing stock at cost or market price whichever is lower is in vague. It takes in to consideration all prospective losses but leaves all prospective profits.

Accounting SystemThere are two systems in Accounting. They are

1. Single Entry System 2. Double entry system

Single Entry System:The system which does not totally follow the principles of double entry system is called single entry system. Under this system complete record of each and every transaction is not maintained. Under this method real and nominal accounts are not maintained. Transactions are recorded only in cash book and only personal accounts are maintained. It is not proper to call it ‘system’ because it is not based on any scientific system like Double entry system.

Double Entry System:According to this system every transaction has two aspects i.e. one part receiving and another part is giving aspect. When we receive something, we give something else in return. This method of writing every transaction in two accounts is known as ‘Double Entry System’. Every transaction is divided into two aspects, debit and credit. One account is to be debited and another account is to be credited for every transaction in order to have a complete record of the same. Every transaction affects two accounts in opposite direction. A transaction has to be recorded in two different accounts on opposite sides of an equal value. Both the accounts cannot be debited or credited.

Classifications of Accounts:An account is a summary of the record of all the transactions relating to a person, asset, expenses or gain. It has two sides the left hand called the ‘debit’ side and the right hand side called ‘credit’ side. Accounts are broadly classified into two heads. They are 1. Personal Account and 2. Impersonal Account.Impersonal account later divided into Real Account and Nominal Account

Personal Account: It is related to persons with who a concern carries on business. They are

Natural persons such as Raju, Rani, Suresh etc. Artificial persons such as Andhra Bank and Universal Trading Company etc. Representative personal accounts such as outstanding salaries, prepaid insurance accounts

etc.

Real Account:Accounts relating to properties or assets of a trader are known as real accounts. It includes tangible assets such as buildings, furniture, cash etc and also intangible assets such as good will, trade-marks etc.

Nominal Account:Accounts dealing with expenses, gains, losses, and incomes are called Nominal Account, Example:- Wages, Salaries, Interest, Commission Received.

Journal EntriesJournal is books for recording daily transaction. All the business transactions are recorded in this book in a chronological order. It is a book of prime, original or first entry, as all business transactions are first recorded in the journal. Journals help in the preparation of accounts in the ledger. The process of recording transaction in Journal is termed as ‘Journalising’. The journal is rules as follows.Format for Journal Entries:

Journal Entries in the books of XXX Company

Date Particulars LFDebit

Amount(Rs.)Credit

Amount(Rs.)

Column 1: Date: the date on which the transaction has taken place is entered in the column.

Column 2:Particulars: in the first line, the name of the account to be debited is written. The Word ‘Dr’ is written at the end of the first line. In the second lime some space is left and the word ‘To’ is written before the name of the account to be credited. Then the name of the account to be credited is written. A brief explanation usually with the word ‘Being’ is written called ‘narration’ the narration explains the reason for debiting and crediting the particular accounts and helps one to understand the nature and purpose of the journal entry at a future date.

Column 3:L.F.: it stands for ‘Ledger Folio’. In this column the page number on which the various accounts appear in the ledger are entered.

Column 4:Debit (Amount): In this column the amount to be debited against the Debit account is written

Column 4:Credit (Amount): In this column the amount to be credited against the Credit account is written.

ILLUSTRATION 1:

Journalize the following transactions in the books of Rama Krishna:

Particulars Amount2012 July 1 Mr. Ram started business with cashJuly4 Goods purchased for cash July5 He deposited in bank July7 Goods sold July10 Purchased from Mr. Kamlesh on creditJuly11 Furniture purchased July12 Wages paid July20 Interest received July25 Cash paid to Mr.KamleshJuly 30 Additional capital brought by Mr. Ram

2,00,00020,00040,00015,00025,00018,0004,000500

25,00050,000

Solution: Journal Entries in the Books of Ram Company

Date Particulars L.F Debit(Amount) Rs.

Credit(Amount) Rs.

July- 1-2012 Cash A/c Dr To Capital A/c (Being start of business by Ram)

2,00,000 2,00,000

July -4- 2012 Purchase A/c Dr To Cash A/c(Being Purchased Goods for Cash)

20,000 20,000

July -5-2012 Bank A/c Dr To Cash A/c(Being Deposit Cash into Bank)

40,000 40,000

July -7-2012 Cash A/c Dr To Sales A/c(Being Sale of Goods in Cash )

15,000 15,000

July -10-2012 Purchase A/c Dr To Kamlesh A/c(Being Purchases goods on credit from Kamlesh )

25,000 25,000

July-11-2012 Furniture A/c Dr To Cash A/c (Being Furniture Purchased)

18,000 18,000

July-12-2012 Wages A/c Dr To Cash A/c(Being Wages paid in Cash)

8,000 8,000

July- 20-2012 Cash A/c Dr To Interest A/c(Being Receipt of Interest )

500 500

July -25-2012 Kamlesh A/c Dr To Cash A/c(Being Payment of Credit Purchases )

25,000 25,000

July -30-2012 Cash A/c Dr To Capital A/c(Being Introduction of Additional Capital in Business )

50,000 50,000

ILLUSTRATION 2: Journalize the following transactions in the books of Ravi:

Particulars Amount 2008 March 1 Purchase of goods from ram March10 Paid rent for the month March11 Purchase of Machine March12 Paid salaries March15 Paid to ram March20 Sold goods to shyam March25 Received from shyam March31 Received cash from cash sales March31 Wages paid

3, 20,0002,0001, 00,00012,0001, 00,00020,00030,0002, 50,0005,000

Solution: Journal Entries in the Books of Ravi Company Date Particulars L.F Amount(Dr)

Rs.Amount(Cr) Rs.

1-March-2008 Purchase A/c Dr To Ram A/c(Being purchased goods on credit from Ram )

3, 20,0003, 20,000

10-March-2008 Rent A/c Dr To Cash A/c(Being rent paid )

2,0002,000

11-March-2008 Machine A/c Dr To Cash A/c(Being purchase of plant)

1, 00,0001, 00,000

12-March-2008 Salaries A/c Dr To Cash A/c(Being salaries paid)

12,00012,000

15-March-2008 Ram A/c Dr To Cash A/c(Being cash payment to Ram )

1, 00,0001, 00,000

20-March-2008 Shyam A/c Dr To Sales A/c(Being goods sold on credit to Shyam)

20,00020,000

25-March-2008 Cash A/c Dr To Shyam A/c (Being Cash Received from shyam)

30,00030,000

31-March-2008 Cash A/c Dr To Sales A/c (Being goods sold for cash)

2, 50,0002, 50,000

31-March-2008 Wages A/c Dr To Cash A/c (Being wages paid)

5,0005,000

Illustration:3 Following are the transactions in the month of January, 2009 of Mr. Prasad & Co:

Jan 1 Purchase goods worth Rs. 5,000 for cashless 20% trade discount and 5% cash discount.

Jan 4 Purchase of goods from Bharat Rs. 5,000Jan 12 Sold goods to Rohan on credit Rs. 600Jan 18 Sold goods to Ram for cash Rs. 1000.Jan 20 Paid salary to Ratan Rs. 2000Jan 26 Interest received from Madhu Rs. 200Jan 31 Sold goods for cash Rs. 500.Jan 31 Withdrew goods from business for personal use Rs. 200

Solution: Journal Entries in the Books of Mr.Prasad & CoDate Particulars L.F Amount(Dr)

Rs.Amount(Cr) Rs.

1-Jan-2009 Purchase A/c Dr To Cash A/c To Discount A/c(Being Purchase of goods for cash worth Rs. 5,000 and allowed trade and cash discount)

4,0003,800200

04-Jan-2009 Purchase A/c Dr To Bharat A/c(Being goods purchased from Bharat)

5,0005,000

12-Jan-2009 Rohan A/c Dr To Sales a/c(Being goods sold on Credit to Rohan)

600600

18-Jan-2009 Cash A/c Dr To Sales A/c(Being Goods sold on cash)

1,0001,000

20-Jan-2009 Salary A/c Dr To Cash A/c(Being Salaries Paid)

2,0002,000

26-Jan-2009 Cash A/c Dr To Interest A/c(Being Interest paid)

200200

31-Jan-2009 Cash A/c Dr To sales (Being goods sold for cash)

500500

31-Jan-2009 Drawings A/c Dr To Purchases A/c (Being goods withdrawn for personal use )

200200

LedgersIt is a book of final entry. All business transactions are first recorded in the journal and finally recorded in the ledger. The process of transferring the transaction from journal to the ledger is called posting. Ledger is the main or principal or most important book of the business .ledger is a book where the various accounts pertaining to a particular person thing or service are grouped together in one place in the form of an account. It contains accounts for all the persons with whom the business deals, for all the assets or things held by the business and for all the expenses incurred and incomes earned by the business. Ledger may be defined as a book which contains records of all transaction permanently in a summariased and classified form.

The following are the guidelines for posting transactions in the ledger.

After the completion of Journal entries only posting is to be made in the ledger.For each item in the Journal a separate account is to be opened. Further, for each new item a new account is to be opened.Depending upon the number of transactions space for each account is to be determined in the ledger.For each account there must be a name. This should be written in the top of the table. At the end of the name, the word “Account” is to be added.The debit side of the Journal entry is to be posted on the debit side of the account, by starting with “TO”.The credit side of the Journal entry is to be posted on the debit side of the account, by starting with “BY”.The journal entries should be posted to the ledger accounts in the order of their dates.

Format for Ledger Posting:Dr. Cr.

Date Particulars JF Amount(Rs)

Date Particulars JF Amount(Rs)

Journalize the following transactions in the books of Ravi and post them into ledgers:Particulars Amount

2008 March 1 Started business with cash March 1 Purchase of goods from ram March10 Paid rent for the month March11 Purchase of Machine March12 Paid salaries March15 Paid to ram March20 Sold goods to shyam March25 Received from shyam March31 Received cash from cash sales March31 Wages paid

4,50,0003, 20,0002,0001, 00,00012,0001, 00,00020,00030,0002, 50,0005,000

Solution: Journal Entries in the Books of Ravi Company Date Particulars L.F Amount(Dr)

Rs.Amount(Cr) Rs.

1-March-2008 Cash A/c Dr To Capital A/c(Being business started with cash )

4,50,0004,50,000

1-March-2008 Purchase A/c Dr To Ram A/c(Being purchased goods on credit)

3, 20,0003, 20,000

10-March-2008 Rent A/c Dr To Cash A/c(Being rent paid )

2,0002,000

11-March-2008 Machine A/c Dr To Cash A/c(Being purchase of plant)

1, 00,0001, 00,000

12-March-2008 Salaries A/c Dr To Cash A/c(Being salaries paid)

12,00012,000

15-March-2008 Ram A/c Dr To Cash A/c(Being cash payment to Ram )

1, 00,0001, 00,000

20-March-2008 Shyam A/c Dr To Sales A/c(Being goods sold on credit to Shyam)

20,00020,000

25-March-2008 Cash A/c Dr To Shyam A/c (Being Cash Received from shyam)

30,00030,000

31-March-2008 Cash A/c Dr To Sales A/c (Being goods sold for cash)

2, 50,0002, 50,000

31-March-2008 Wages A/c Dr To Cash A/c (Being wages paid)

5,0005,000

Ledger Posting

Dr. Cash Account Cr.Date Particulars JF Amount

(Rs)Date Particulars JF Amount

(Rs)01-03-200825-0331-03-2008

To Capital A/cTo Syam A/cTo Sales A/c

4,50,00030,000

2,50,000

10-03-200811-0312-0315-0331-03-2008

31-03-2008

By Rent A/cBy Machine A/cBy Salaries A/cBy Ram A/cBy Wages A/c

By Balance C/d

2,0001,00,00012,000

1,00,0005,000

5,11,0007,30,000 7,30,000

01-04-2008

To Balance B/d 5,11,000

Dr. Capital Account Cr.Date Particulars JF Amount


(Rs)31-03-2008

To Balance C/d 4,50,000 01-03-2008

By Cash A/c 4,50,000

4,50,000 4,50,00001-04-2008

By Balance B/d 4,50,000

Dr. Purchase A/c Cr.Date Particulars JF Amount


(Rs)15-03-2008

To Ram A/c 3,20,000 31-03-2008

By Balance C/d 3,20,000

3,20,000 3,20,00001-04-2008


Dr. Ram Account Cr.Date Particulars JF Amount


(Rs)01-03-2008

31-03-2008

To Cash A/c

To Balance C/d

1,00,000

2,20,000

01-03-2008

By Purchase A/c 3,20,000

3,20,000 3,20,00001-04-2008

By Balance B/d 2,20,000

Dr. Rent Account Cr.Date Particulars JF Amount


(Rs)10-03-2008

To Cash A/c 2,000 31-03-2008

By Balance C/d 2,000

2,000 2,00001.04-2008

To Balance B/d 2,000

Dr. Machine A/c Cr.Date Particulars JF Amount


(Rs)11-03-2008

To Cash A/c 1,00,000 31-03-2008

By Balance C/d 1,00,000

1,00,000 1,00,00001.04-2008


Dr. Salaries Account Cr.Date Particulars JF Amount


(Rs)12-03-2008

To Cash A/c 12,000 31-03-2008


12,000 12,00001-04-2008


Dr. Shyam Account Cr.Date Particulars JF Amount


(Rs)20 -03 -2008

31-03-2008

To Sales A/c

To Balance C/d

20,000

2,30,000

25 -03 -2008

By Cash A/c 2,50,000

2,50,000 2,50,00001-04-2008


Dr. Sales Account Cr.Date Particulars JF Amount


(Rs)31-03-2008

To Balance C/d 2,70,000 25-03-2008

31-03-2008

By Shyam A/cBy Cash A/c

20,0002,50,000

2,70,000 2,70,00001-04-2008


Dr. Wages Account Cr.Date Particulars JF Amount


(Rs)25-03-2008

To Cash A/c 5,000 31-03-2008


5,000 5,00001-04-2008


Trail Balance“Trail balance is a statement containing the balances of all ledger accounts, as at any given date, arranged in form of debit and credit columns placed side by side and prepared with the object of checking the arithmetical accuracy of ledger posting. The fundamental principle of double entry system of book keeping is that every debit has a corresponding credit and vice versa of equal moment. Therefore, the total of the debit balances must equal in aggregate to the total of the credit balances when accounts are balances when accounts are balances.A trail balance can be prepared in two ways. They are

1. Total Method2. Balance Method

1. Total Method:Under this method, the debit totals of each account shown in the debit and credit column of the trail balance.

2. Balance Method:Under this method, the difference of each account is extracted. If the debit side of an account is bigger in amount than the credit side the difference is put in the debit column of the trail balance and if the credit side is bigger, the difference is written on the credit column of train balance

How to prepare Trail Balance?1. Accounts dealing with assets, expenses & losses will shown debit balance2. Accounts dealing with liabilities, incomes and gain will show credit balance3. ‘Sundry Debtors’ are the total amount due from various debtors and ‘Sundry Creditors”

are the total amount due to various creditors4. Opening stock will show debit balance, generally closing stock will not appear in Trail

Balance5. Reserves and provisions such as General Reserve, Provision for doubtful debts, reserve

for discount on debtors will show credit balance. However Reserve for Discount on Creditors will show debit balance.

Problem 1:From the following list of balance of Mr. X. Prepare a Trail Balance as on 30-06-2005

Particulars Amount Particulars AmountOpening Stock 1,800 Wages 1,000Sales 12,000 Bank Loan 440Coal 300 Purchases 7,500Repairs 200 Carriage 150Income tax 150 Debtors 2,000Land 600 Cash in hand 20Plant 750 Machinery 180Lighting 230 Creditors 800Capital 4,000 Bills receivables 60Office furniture 60 Office salaries 250Patents 100 Good will 1500Bank 510

6th, April set-3

Solution:Trail Balance of Mr. X as on 30-06-2005

Debit (Rs.) Credit (Rs.)Opening Stock 1,800Wages 1000Sales 12,000Bank Loan 440Coal 300Purchases 7,500Repairs 200Carriage 150Income tax 150Debtors 2,000Land 600Cash in hand 20Plant 750Machinery 180Lighting 230Creditors 800Capital 4,000Bills receivables 60Office furniture 60Patents 100Good will 1,500Bank 510Office salaries 250

17,300 17,300

Problem 2:Prepare trail balance for the following informationParticulars AmountCapital 1,00,000Plant & Machinery 1,60,000Sales 3,54,000Purchases 1,20,000Returns outwards 1,500Returns inwards 2,000Opening stock 60,000Discount allowed 700Discount Received 1,600Bank Charges 150Sundry Debtors 90,000Sundry Creditors 50,000Salaries 13,600Manufacturing Wages 20,000Carriage inwards 1,500Carriage outwards 2,400Provision for bad debts 1,050Rent, rates and taxes 20,000Advertisements 4,000Cash 1,800Bank 12,000Closing stock 70,000

Particulars Debit Particulars CreditPlant & Machinery 1,60,000 Capital 1,00,000Purchases 1,20,000 Sales 3,54,000Return inwards 2,000 Return outwards 1,500Opening stock 60,000 Discount received 1,600Discount allowed 700 Sundry Creditors 50,000Sundry Debtors 90,000 Provision for bad debts 1,050Salaries 13,600Manufacturing wages 20,000Carriage inwards 1,500Carriage outwards 2,400Rent, rates and taxes 20,000Advertisements 4,000Cash in hand 1,800Bank 12,000Bank Charges 150

508150 508150

FINAL ACCOUNTSOne of the main objects of maintain Accounts is to findout the profit or loss made by the business during a period and to ascertain the financial position of the business as on a given data. In order to know the profit or loss made by the business trading and profit and loss account is prepaid. The position of the business on the last date of the financial year will be reveled by the balance sheet the trading and profit and loss account and balance prepare by the business man at the end of the trading period are called final accounts.

TRADING ACCOUNT

Trading account is prepared mainly to know the profitability of the goods bought and sold by the business man. It shows the result of trading that is buying and selling of goods called gross profit or gross loss. The difference between sales and the cost of the goods sold is gross profit or gross loss. Trading account is prepared in T form, just like any other account except the Date and Journal Folio Columns are not provided. As the Trading Account shows the results of operation over a period, the heading will be “Trading Account for year (or Period) ended… Opening Stock, Purchases and other direct expenses are taken on the Debit side and Sales and Closing Stock are taken on the Credit Side. The Balance between the two sides is Gross Profit or Gross Loss. The excess of credit side over Debit side is called ‘Gross Profit’. And excess of Debit side over Credit side is called ‘Gross Loss’. The ‘Gross Profit’ or ‘Gross Loss’ is transferred to Profit and Loss Account.

PROFIT AND LOSS ACCOUNT

The profit and loss account is an account which shows the net profit or net loss of a business for a particular period. All indirect expenses such as Administrative or Management Expenses, Selling and Distribution Expenses, Financial Expenses and Other Expenses such as Depreciation and provisions etc are taken on the Debits side. Gross profit and other items of incomes such as Interest received, Discount received etc are taken on the credit side. The difference between two sides is either Net Profit or Net Loss which is transferred to Capital Account. Trading and Profit and Loss account will appear as follows

The format of Trading and Profit and Loss Account

Trading account and Profit and Loss for the year ending of 31-12-XXXXParticulars Amount Particulars AmountTo Opening StockTo Purchases xxxLess Returns xxxTo WagesTo Fuel & PowerTo Carriage InwardsTo Coal, waterTo OctraiTo Import DutyTo Manufacturing ExpensesTo factory LightingTo Gross Profit (Transfer to P & L A/C)

xxx

xxxxxxxxxxxxxxxxxxxxxxxxxxx

xxx

By Sales xxxLess Sales Returns xxx

By Closing Stock

xxx

xxx

Xxx xxxTo Gross LossTo SalariesTo RentTo CommissionTo DiscountTo Insurance PremiumTo Telephone ExpensesTo AdvertisementsTo Audit FeeTo legal FeeTo Interest on LoanTo Carriage outwardsTo Bad debtsTo Provision for depreciationTo Printing & StationaryTo Postage & TelegramTo General ExpensesTo Packing ExpensesTo Transportation FeeTo Net Profit(Transfer to Balance Sheet)

Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx

By Gross ProfitBy Rent ReceivedBy Commission ReceivedBy Interest receivedBy Other incomes

xxxxxxxxxxxxxxx

xxx Xxx

BALANCE SHEET

Balance sheet is prepared to know the financial position of business on a particular date. It is a statement which shows the assets and liabilities of a business as on a particular date. It shows what a business owns and what it owes. This statement is prepared from real and personal account left after the nominal accounts are transferred to Trading and Profit and loss account. Balance sheet is a “Statement” and not an “Account”. It does not have ‘Debit’ and ‘Credit’ sides. It is divided into two sides i.e. left hand side and right hand side. The left hand side is called the liabilities side and right hand side is called assets side. All the liabilities and capital are entered on the liabilities side and all properties and assets are entered on the Assets side.

“A balance sheet is a statement with a view to measure exact financial position of a business at a particular date.” ------ J. R. Botliboi

Format of Balance Sheet:Balance Sheet of Mr. X as on the date of 32-12-XXXX

Liabilities Amount Assets AmountCapital xxx(+) Net Profit xxx

xxx(-) Net Loss xxx

xxx(+) Interest on Capital xxx

xxx(-) Drawing xxx

xxx(-)Interest on Drawingxxx

ReserveLong term loansBank Over Draft

Current Liabilities:Sundry CreditorsBills PayableOutstanding Expenses

xxx

xxxxxxxxx

xxxxxxxxx

Fixed Assets:Plant & Machinery(-) DepreciationFurniture and fixtures(-) DepreciationLand & Buildings(-) DepreciationFurniture(-) DepreciationMotor Vehicles

Current Assets:Sundry Debtors(-) Bad DebtCash in HandCash in BankBills Receivable Closing StockPrepaid Expenses

xxx

xxx

xxx

xxxxxx

xxxxxxxxxxxxxxxxxxxxx

xxx xxx

AdjustmentsWhile preparing the Profit and Loss account for a particular period it is essential that expenses, losses and incomes and gains relating only to that period are considered. We know that business is a going concern. It has to be carried on indefinitely at the end of every accounting year. The trader prepares the Trading and Profit and Loss account and Balance Sheet. While preparing these financial statements, sometimes the trader may come across certain problems .The expenses of the current year may be still payable or the expenses of the next year have been prepaid during the current year. In the same way, the income of the current year still receivable and the income of the next year have been received during the current year. Without these adjustments, the profit figures arrived at or the financial position of the concern may not be correct. As such these adjustments are to be made while preparing the final accounts.

The adjustments to be made to final accounts will be given under the Trial Balance. While making the adjustment in the final accounts, the student should remember that “every adjustment is to be made in the final accounts twice i.e. once in trading, profit and loss account and later in balance sheet generally”. The following are some of the important adjustments to be made at the time of preparing of final accounts:-

1. Closing Stock:-(i) If closing stock is given in Trail Balance: It should be shown only in the balance sheet “Assets Side”.(ii) If closing stock is given as adjustment:

1. First, it should be posted at the credit side of “Trading Account”.2. Next, shown at the asset side of the “Balance Sheet”.

2. Outstanding Expenses:- (i) If outstanding expenses given in Trail Balance: It should be only on the liability side of Balance Sheet.(ii) If outstanding expenses given as adjustment:

1. First, it should be added to the concerned expense at the debit side of profit and loss account or Trading Account.

2. Next, it should be added at the liabilities side of the Balance Sheet.

3. Prepaid Expenses:- (i) If prepaid expenses given in Trial Balance: It should be shown only in assets side of the Balance Sheet. (ii) If prepaid expense given as adjustment:

1. First, it should be deducted from the concerned expenses at the debit side of profit and loss account or Trading Account.

2. Next, it should be shown at the assets side of the Balance Sheet.

4. Income Earned But Not Received [Or] Outstanding Income [Or] Accrued Income:-(i) If incomes given in Trial Balance: It should be shown only on the assets side of the Balance Sheet.(ii) If incomes outstanding given as adjustment:

1. First, it should be added to the concerned income at the credit side of profit and loss account.

2. Next, it should be shown at the assets side of the Balance sheet.

5. Income Received in Advance or Unearned Income:-(i) If unearned incomes given in Trail Balance: It should be shown only on the liabilities side of the Balance Sheet.(ii) If unearned income given as adjustment:

1. First, it should be deducted from the concerned income in the credit side of the profit and loss account.

2. Secondly, it should be shown in the liabilities side of the Balance Sheet.

6. Depreciation:-(i) If Depreciation given in Trail Balance: It should be shown only on the debit side of the profit and loss account.(ii) If Depreciation given as adjustment

1. First, it should be shown on the debit side of the profit and loss account.2. Secondly, it should be deduced from the concerned asset in the Balance sheet assets side.

7. Interest on Loan (or) Capital:-(i) If interest on loan (or) capital given in Trail balance: It should be shown only on debit side of the profit and loss account.(ii) If interest on loan (or) capital given as adjustment:

1. First, it should be shown on debit side of the profit and loss account.2. Secondly, it should add to the loan or capital in the liabilities side of the Balance Sheet.

8. Bad Debts:-

(i) If bad debts given in Trail balance: It should be shown on the debit side of the profit and loss account.(ii) If bad debts given as adjustment:

1. First, it should be shown on the debit side of the profit and loss account.2. Secondly, it should be deducted from debtors in the assets side of the Balance Sheet.

9. Interest on Drawings:-(i) If interest on drawings given in Trail balance: It should be shown on the credit side of the profit and loss account.(ii) If interest on drawings given as adjustments:

1. First, it should be shown on the credit side of the profit and loss account.2. Secondly, it should be deducted from capital on liabilities side of the Balance Sheet.

10. Interest on Investments:-(i) If interest on the investments given in Trail balance: It should be shown on the credit side of the profit and loss account.(ii) If interest on investments given as adjustments:

1. First, it should be shown on the credit side of the profit and loss account.2. Secondly, it should be added to the investments on assets side of the Balance Sheet.

Example 1:Trail Balance of Bharat is given below. Prepare the Trading Account and Profit and Loss Account for the year ending 31st December, 2005 and Balance Sheet as on that date

Particulars Debit Rs. Credit Rs.Drawings and CapitalPlant & MachinerySundry Debtors and CreditorsWagesPurchases and SalesOpening StockSalariesInsuranceCash at BankInterest on LoanDiscount allowedFurnitureLoan PayableLand & Buildings

10,55038,30062,00043,7502,56,59095,30012,88093018,97014,3704,87012,590

43,990

1,19,400

59,360

79,630

6,15,090 6,15,090Closing Stock was Values at Rs. 90,000 (Feb-08, set-2, Q7)

Solution:Trading and Profit and Loss Account of Mr. Bharat at the end of the year 31st December,

2005Dr. Cr.Particulars Amount Amount Particulars Amount Amount To Opening StockTo PurchaseTo Wages

To Gross Profit(Transfer to P & L A/c

To Salaries To InsuranceTo Interest on LoanTo Discount

To Net Profit (Transfer to Balance Sheet)

95,3002,56,59043,750

50,790

By Sales

By Closing Stock

By Gross Profit

3,56,430

90,000

4,46,430 4,46,430

12,88093014,3704,870

17,740

50,790

50,790 50,790

Balance Sheet of Mr. Bharat as on the date of 31-12-2005Liabilities Amount Amount Assets Amount Amount

Capital(+) Net Profit

Drawing

Loan Payable

Current Liabilities:Sundry CreditorsSuspense A/c

1,19,40017740

1,37,14010,550

1,26,590 79,630

59,360 270

Fixed Assets:Plant & MachineryFurniture Land & Buildings

Current Assets:Sundry DebtorsCash in BankClosing Stock

38,30012,59043,990

62,00038,30090,000

2,65,850 2,65,850

Example 2:The following are the particulars of Ledger Account balances taken from the books of Bhaskar for the year ending 31st March 2005. You are required to prepare Trading Account and Profit and Loss Account and Balance Sheet as on that date

Particulars Debit Rs. Credit Rs.CapitalBills receivables and Bills PayableSundry Debtors and CreditorsCash BankBusiness PremisesLoan PayableOpening stockPurchase & ReturnsSales & ReturnsWagesSalariesRent, Taxes and ratesDepreciationFurnitureAdvertisement

4,00,00075,00015,00025,000

2,50,000

40,00060,00037,00035,00065,00015,0005,00078,00058,000

1,00,0007,00,00050,000

25,000

8,0002,75,000

11,58,000 11,58,000Adjustments:

1. Closing Stock was Values at Rs. 80,0002. Write off Bad Debts of Rs. 5,000 out of sundry debtors3. Prepaid Insurance amounted Rs. 1,000 (Feb-08, set-3, Q7)

Solution:Trading and Profit and Loss Account of Mr. Bhaskar at the end of the year 31st March,

2005Dr. Cr.Particulars Amount Amount Particulars Amount Amount To Opening StockTo PurchaseLess: ReturnsTo Wages


To Salaries To Rent, Taxes and InsuranceLess: InsuranceTo DepreciationTo AdvertisementsTo Bad Debts


60,000 8,000

15,0001,000

40,000

52,00035,000

1,91,000

By Sales

By Closing Stock

By Gross Profit

2,75,00037,000 2,38,000

80,000

3,18,000 3,18,000

65,000

14,0005,00058,0005,000

44,000

1,91,000

1,91,000 1,91,000

Balance Sheet of Mr. Bhaskar as on the date of 31-03-2005Liabilities Amount Amount Assets Amount Amount


Loan Payable

Current Liabilities:Sundry CreditorsBills Payable

1,00,00044,000

1,44,000

25,000

50,000 7,00,000

Fixed Assets:Furniture Business Premises

Current Assets:Sundry DebtorsLess: Bad DebtsBills ReceivableCash in HandPre-paid InsuranceClosing Stock

75,0005,000

78,0002,50,000

70,0004,00,00015,00025,0001,00080,000

9,19,000 9,19,000

From the following Trail Balance of Mr. Surya & Co as on 31 st December 2009. Prepare the Trading Account, Profit and Loss Account and Balance Sheet as on dateParticulars Debit Rs. Credit Rs.CapitalPurchasesSalesReturnsOpening StockWages Coal , PowerCarriage InwardsSalariesSundry CreditorsSundry DebtorsBills PayableBill ReceivablePlant & MachineryCashBankDiscountDiscount ReceivedLoansBank ODBuildings

40,000

1,00020,0001,0001,5003,0002,000

15,000

10,0007,50027,00015,000500

33,000

70,000

75,0002,000

10,000

5,000

2,0005,0005,000

1,74,000 1,74,000Adjustments:

1. Closing Stock Rs. 30,0002. Bad Debts on Sundry Debtors Rs. 1,0003. Depreciation on Buildings Rs. 3,0004. Outstanding Salaries Rs. 500 (Nov-2010, Set-2, Q8)

Solution:Trading and Profit and Loss Account of Mr. Surya & Co at the end of the year

31st December, 2005Dr. Cr.Particulars Amount Amount Particulars Amount Amount To Opening StockTo PurchaseLess: ReturnsTo WagesTo Coal and PowerTo Carriage Inwards


To Salaries Less: Outstanding SalariesTo Bad DebtsTo DepreciationTo Discount


40,000 2,000

2,000500

20,000

38,0001,0001,5003,000

40,500

By Sales

By Closing Stock

By Gross ProfitBy Discount Received

75,0001,000 74,000

30,000

1,04,000 1,04,000

2,5001,0003,000500

35,500

40,5002,000

42,500 42,500

Balance Sheet of Mr. Surya as on the date of 31-03-2005Liabilities Amount Amount Assets Amount Amount


Loan PayableBank OD

Current Liabilities:Sundry CreditorsBills PayableOutstanding SalariesSuspense Account

70,00035,000 1,05,500

5,0005,000

10,0005,000500

2,500

Fixed Assets:BuildingsLess: DepreciationPlant & Machinery

Current Assets:Sundry DebtorsLess: Bad DebtsBills ReceivableCash in HandClosing Stock

33,0003000

15,0001,000

30,000750

14,00010,00027,00030,000

1,33,500 1,33,500