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THE ACCOUNTING STORY
CHAPTERS
CHAPTERS TOPICS PAGE
NOS
1 ACCOUNTING CONCEPTS 3-43
2 THE JOURNAL BOOK 44-55
3 OTHER SUBSIDIARY BOOKS 56-
4 THE LEDGER
5 THE TRIAL BALANCE
6 THE BANK RECONCILIATION STATEMENT
7 THE FINAL ACCOUNTS
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CHAPTER ONE
ACCOUNTING CONCEPTS
CONTENTS
Sr No Particulars Page
No
1 THE ACCOUNTING STORY 4
2 LESSON NO 1-WHAT IS A BUSINESS TRANSACTION 8
3 THE ACCOUNTING STORY- continued 9
4 LESSON NO 2-THE ACCOUNTING EQUATION 12
5 THE ACCOUNTING STORY- continued 15
6 LESSON NO 3-BOOKS OF ACCOUNTS 17
7 THE ACCOUNTING STORY- continued 20
8 LESSON NO 4-DEFINITION OF ACCOUNTANCY 21
9 THE ACCOUNTING STORY- continued 22
10 LESSON NO 5-EFFECTS OF BUSINESS TRANSACTIONS 23
11 THE ACCOUNTING STORY- continued 25
12 LESSON NO 6-CLASSIFICATION OF BUSINESS
TRANSACTIONS
26
13 THE ACCOUNTING STORY.. continued 27
14 LESSON NO 7-PRINCIPLES AND RULES OF ACCOUNTANCY 28
15 THE ACCOUNTING STORY- continued 32
16 LESSON NO 8-SOME ACCOUNTING TERMINOLOGIES 33
17 ILLUSTRATIONS 35
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THE ACCOUNTING STORY
Ram had turned 24 today. He had just majored in Marketing from one of
Punes numerous management institutes.
His father, Hari Kale, had promised him an unique present for this birthday.
Hari was pretty well off, being the General Manager of Marketing in a
multinational company in India.
Ram planned to start a business enterprise- initially trading, then eventually a
manufacturing one. But today was for enjoying the party organized by his
family.
The party went on well past midnight. Ram had forgotten all about his
fathers birthday present.
After the festivities were over Hari and he were relaxing alone in their
drawing room when he remembered his fathers promise.
Dad, when are you giving me your unique present?
Ah, Ram. I was just wondering when you would ask. I have been able to
save a considerable amount of money up to now, part of which I can give
you-maybe up to Rs 1 crore, that will be my birthday present but there are
some conditions which you will have to agree to.
Ram was totally flabbergasted ! One Crore!! He had not expected
this!
Conditions-anything what you say, Dad, just name them. I am a MBA, it
should be easy for me to fulfill all your conditions.
Hari could not help smiling.
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Hey hold on, buddy, you are excited because I have promised you a crore but
first listen to my conditions.
OK, Dad, spell them out.
I know you want to start a business but I am not sure whether you are
capable of making a success of it. I know you are good at marketing and I
know that you have worked hard at it, but to run a business, just having
knowledge of marketing is not enough.
Then what, Dad?
How much do you know of Accounting and Finance?
Why? Whats this got to do with your conditions?
Ram, just answer my question.
Dad, I think that I have a fairly good knowledge of Finance but I am not very
sure about Accounting.
You mean to tell me that without knowledge of Accounting, you have a good
knowledge of Finance?
Why? Why do you require knowledge of Accounting to understand Finance?
Dad, you very well know that I did my MBA after my engineering degree. I
was never good at accounting but because today Financial Theories are more
dominated by economists than accountants, it is more statistically and
mathematically oriented than accounting wise. Therefore I had lesser
difficulty there.
Ram, I dont agree with you. You know I met a guy some 10 years back and
we got to talking about finance because he was a finance guy and I was
having some problems in understanding some finance reports. He is a
Chartered Accountant but he also teaches Accounts and Finance. Name
Vijay Korke-Professor Vijay Korke.
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He said that you just cannot understand finance without having a basic
knowledge of accounting and he proved it to me subsequently. He said that
all financial theories-statistical, economic, mathematical or otherwise werebased on financial information.
This financial information is recorded and structured in the required formats
by accounting methods and techniques. Therefore, unless one has a good
knowledge of the basics of Accounting, it can lead to wrong financial
decisions.
He taught me some basics, enough for my job of marketing-but you want to
run a business which involves everything, money, purchases, manufacturing,marketing, people-if you do not know basic accounting, where will you be?
So, condition number one, first you go to him and persuade him to teach you
the basics of accounting and finance, I give you a max of three months for
accounting and three for finance. Call it revision but you will have to get his
certificate, for me to consider loosening my purse strings!!. So, agreed to
condition one?
Ram thought for some time.
OK Dad, so what are the other conditions?
Other conditions baad me bataunga !!! Pehle yeh to kar lo!
Here is his cell number. Phone him and take his appointment.
Next day, Ram met Prof Vijay at his house at Baner in Pune city.
Hi, so you are Ram. Haris son eh!
Yes sir.
You are a MBA and still you want to learn the basics of accounts from me?
Well, sir, dad says that you will be able to make me appreciate the
importance of accounting in finance and marketing.
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And you obviously do not share his opinion!!
No I am not sure but I sure do require to revise my concepts of accounting.
OK we will find out soon enough what you know about it.
Tell me Ram, you want to start a business, right?
Yes sir.
Why?
Why? Because I think it will help me to increase my wealth.
Wow-spoken just like a MBA!! So what do you mean by your wealth?
Hmmm. I suppose it means what I own-my properties.
And how would you increase your properties?
By doing business, obviously!
Oh, we have a wise guy here! OK, Ill play along. Tell me, Ram, what is the
definition of business? Tell me in your own words.
Well, business involves buying or selling goods or services in order to
increase your wealth.
Not bad! However let me give you my definition of business, OK?
A business is a series of relationships entered into for the prime purpose of
increasing the monetary worth of each party to the relationship, by
conducting business transactions.
Therefore, Ram, in Lesson no 1, let us define a Business
Transaction.
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LESSON NO 1
WHAT IS A BUSINESS TRANSACTION
An act of exchange-
a. of things or services
b. between two or more parties
is called a transaction.
Transactions may be monetary or non-monetary i.e., they may involve
money or no money respectively.
Transactions which do not involve an exchange of money or money's worth
directly or indirectly or in more simple terms,
which do not result -immediately or in the future -into either an inflow or
outflow of cash,
are called Non-Monetary, Non-Business Transactions
Transactions involving money or money's worth
which result into either an inflow or outflow of cash-
immediately or in the future-
and which are not personal in nature,
are called Business Transactions
Examples of Business Transactions:
payment of money to buy goods which are intended to be resold for a
profit,
a sale of the same goods without receiving any money immediately but
would receive money at a later date,
receipt of moneys on sale of these goods,
In the above context, the word personal concerns any inflows and outflows of
cash which result into a personal benefit e.g., a money gift received during
marriage or paying money for buying articles for personal consumption or
spending money to buy a train ticket for personal travel----all these type of
transactions are personal in nature and are not concerned with the business!
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THE ACCOUNTING STORY-continued
So Ram, are you now clear about Business Transactions!
This is the first step to become a Bean Counter which you MBA guys call us
accountants.
Sir, I dont want to become a Bean Counter, but I would certainly like to get a
feel of accounts not because I want to make it my career, but to help me run
my business efficiently.
Right, it is presumed that you are interested in learning all about Accountancy
for this reason so as to understand and record business transactions-and not
personal ones.
Ram, you mentioned sometime earlier that you want to do business for
increasing your wealth, i.e., increasing the worth of your properties. Correct?
Yes, sir.
That means these business properties are your Assets because they are
worth something to you in monetary terms?
Yes, sir.
That means that you own these business properties, correct?
Of course, Sir.
Do you agree that you as the proprietor of your business and your
business are two different persons?
Yes, Sir
Why?
Because the proprietor invests his money into the business as opposed to his
own personal investment-and he expects the business to use this money for
making profit which ultimately belongs to the proprietor. Therefore the
proprietor and his business are two different persons.
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Then all these properties of the business are owned by whom - by the
proprietor or the business?
Ram thought for sometime.
I guess, the business.
Therefore the business which is at present holding these properties as its
assets, is it liable to the proprietor for the same?
Yes, it is I know this! The proprietor has invested his money in the business
and therefore once the business is closed, if at all, then it will have to return
the money back to the proprietor. What it purchases from these moneys
ultimately belongs to the proprietor. But since it is holding these assets in its
name, it becomes liable to return them to the proprietor either in the sameform or by converting into their monetary value, as and when the proprietor
wants his money back.
Wow!! Ram, tumne toh sixer mara! OK, what this means is that the business
is liable to the proprietor because he has provided the money for these
assets, right?
Yes, sir.
It also means that the business has assets and also has an equal liability-
towards the proprietor, isnt it? It also means that the proprietor has whatcan be termed as Property Rights over the assets of the business?
Sir, as you so easily put it, now I am beginning to understand the meaning of
the Accounting Equation!!
So you are aware of the Accounting Equation-OK, so let us discuss this in
detail in our lesson no 2 tomorrow at 10a.m sharp.
Next day, Vijay had just finished his bath when the doorbell rang. It was
Ram.
Arre, you are very early today? Its just 8.30 am!
Sir, I could not sleep last night-some questions were going round in my mind
and I wanted the answers immediately so I came early. I hope you dont
mind, do you Sir?
No-no, come on in-said Vijay.
Whats the problem? he asked.
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Sir, you mentioned yesterday that all business transactions result immediately
or in the future, either into an inflow or outflow of cash. But suppose A owes
me Rs 1000/- and he does not pay me anything-it does not result into a cashoutflow or inflow-then is it a business transaction?
When A took the money, he had promised to pay you back-it is assumed that
he had borrowed this money for a business purpose. Therefore according to
my definition it was a business transaction, because it had resulted into a
cash outflow . That is one business transaction.
Now I presume that your question is about the fact that A is not going to pay
you back and therefore, is it a business transaction? If A does not pay you
the Rs 1000/- then it is lost for you which we term in Accounting terms as a
loss.
Therefore this is a business transaction, because it has resulted into a
reduction or loss of an inflow of cash due from A and you have lost Rs
1000!!!. If A had paid you as promised, it would have resulted into an inflow
of cash, wouldnt it?
But my dear chap-you have leapt forward-these types of business
transactions we will deal with later-not now.
Let us go forward in a more structured way and start with Lesson No 2 on
The Accounting Equation.
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LESSON NO 2
THE ACCOUNTING EQUATION
All businesses necessarily start with Property and Property Rights.
What then is this Property? Property can be Tangible or Intangible.
Tangible Property can be felt and seen, and which has monetary value to
the owner of that Property like Buildings, Shares in Companies, Furniture,
Machinery, Cash, Inventory, etc . Intangibles also have monetary value but
cannot be felt or seen like patent rights, business goodwill, software
programs, customer debts etc.
This Property is created by providing resources or money to the business.
These resources can be provided by the owners contribution and/or by
borrowing these resources from someone who is willing to lend the same.Therefore at any given time the business properties are equal to the total
amount of moneys brought into the business by the owners and by the
lenders, who obtain the Rights in the Property.
BUSINESS PROPERTY = RIGHTS IN THE BUSINESS PROPERTY.
This is called the Accounting Equation
Whenever there is an increase in Business Property, there would be an
increase in the Property Rights and vice versa.
These Property Rights belong jointly to the owners of the business and the
lenders to the business in the proportion of the resources provided by each,
and as the value of property increases or decreases these rights also
automatically increase or decrease in value but not necessarily in the same
proportion for each resource provider-we will detail this out a little later.
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Therefore Business Property = Owners Funds + Lenders Funds
Therefore Owners Funds = Business Property Lenders Funds
Therefore Lenders Funds = Business Property - Owners Funds
In the Business environment, Owners Funds is called Capital, Business
Property is called Assets, and Lenders Funds is called Liabilities.
Therefore Assets = Capital + Liabilities
Capital = Assets Liabilities
Liabilities = Assets Capital
Business Transactions therefore result into either a change in the
values of Capital, Assets or Liabilities.
Let us look at a few Business Transactions and see how they affectthe above Accounting equations:
Sr No Particulars-
Effects
Total
Assets
Rs
Total
Capital
Rs
Total
Liabilities
Rs
Total
Capital +
Liabilities
Rs
1 If Assets are =
Rs 500000
Then Capital +
Liabilities = Rs
500000.
500000 300000 200000 500000
2 If Capital = Rs
300000 then
Liabilities =
Rs 500000 minus
Rs 300000 = Rs
200000
500000 300000 200000 500000
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Sr No Particulars-
Effects
Total
Assets
Rs
Total
Capital
Rs
Total
Liabilities
Rs
Total
Capital +
Liabilities
Rs
3 Suppose some
assets valued at Rs
150000 in the Total
Assets of Rs
500000 given
above, are sold for
Rs 200000 which isreceived in cash,
then
500000
-150000
(assets
sold)
+200000
(cashreceived)
=550000
300000
+50000
(Profit on
Sale of
Asset-
belongs
to Owner)
=350000
200000 550000
4 Suppose further
Plant & Machinery is
purchased for Rs
150000 by making
payment in Cash,
then
550000
+150000
(Machiner
y)
150000
(Cash)
=550000
350000 200000 550000
5 Suppose instead of
payment in cash ,
the payment is to be
made at a later date
to the Supplier of
the Machinery - M/s
A, then
550000 +
150000
(Machiner
y)
=700000
350000 200000 +
150000
(M/s A)
=350000
700000
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THE ACCOUNTING STORY-continued
Book-Keeping and Accountancy is the technique of recording these changes
in such a manner that the businessman is made aware of the results of his
business transactions in the following way:
Whether they have resulted into an increase or decrease in his Capital, i.e.,
whether he has made a profit or loss, and
What is his financial worth-i.e., what is the amount of Capital, Assets and
Liabilities of his business.
Such recordings of the business transactions are done in the Books of
Accounts maintained by him. Therefore we now come to the Books of
Accounts.
Vijay Sir, I think I am now beginning to understand the importance of
Accounting. But Sir, lets continue tomorrow-I want to do a little more
practice on my own to cement this understanding of the Accounting Equation.
Yes, Ram, do that- meet me again at 4 p.m. tomorrow.
OK, Sir, no problem!!
Next day, at 4 p.m. sharp Ram turned up.
So Ram, any problems now with the Accounting Equation?
No sir, none at all.
Good, then we can proceed with the Books of Accounts.
But sir, why do we have to learn about this- With the extent of
computerization we have today, does anybody have to know how to write or
maintain books of accounts?
No doubt Ram that there are numerous software programs available today
which automatically record all the business transactions in the required Books
of Accounts.
Therefore the topics relating to the maintenance of the books of accounts
would be purely academic as they are automatically formatted by the
software.
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However knowledge of the same may be necessary for a proper
understanding of the Accounting Technique because the same technique and
method of maintaining the books of accounts is followed in the computerizedaccounting packages.
Moreover the entries to record the actual debits and credits to the required
accounts are still to be entered manually into the package by the User and
therefore he has to have knowledge of accounting.
What is debit and credit we shall go into later.
It is also compulsory as per the various laws of our country for certain
business enterprises to maintain them but-but-but, absolutely necessary for
all businessmen to maintain them.Books of Accounts can be maintained manually or in a computer but the
formats are similar.
So on to Lesson no 3- Books of Accounts.
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LESSON NO 3
BOOKS OF ACCOUNTS
Recording of business transactions is called 'Book-Keeping' and the way or
technique or say rules for recording them is called 'Accountancy'.
Therefore in Book-Keeping and Accountancy, we are only concerned withmonetary business transactions. If a transaction has no financial character it
will not be recorded in the Books of Accounts.
From time immemorial human beings have kept some sort of a record of
things done or to be done, in some form or the other. Some have kept it in
their minds, some have written it down in their personal diaries or a notebook
or on scraps of paper and so on and so forth. Some have been very
organized and have kept proper accessible records and some have not
bothered to keep any track at all!
It was this need which gave rise to recording of dealings concerning money in
a more organized manner, and the records in which such dealings were
written down were called the 'Books of Accounts'.
The method of writing and recording these business transactions in
these books is the subject of 'Book-Keeping and Accountancy'.
The human mind is a great storehouse of data. But it suffers from a major
shortcoming- of easy, immediate and at will recall and retrieval of the
information stored in it!!
Therefore it becomes necessary to record the required data in a proper andaccessible manner. It becomes more important when any business dealing is
to be recorded because neglect in this case could result into a monetary loss.
Therefore Book Keeping & Accountancy is mainly concerned with the
recording of business dealings or what accountants call as 'business
transactions'.
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Objectives and importance of maintaining Books of Accounts
Objectives:
It is not possible for any businessman to remember all his business
transactions.
Books of Accounts serve as a permanent record of the business dealings and
they can be produced as evidence of a business transaction whenever and
where-ever required.
A businessman can know what he owes to others and what others owe to
him.Maintenance of Books of Accounts enables him to ascertain his trading
results, i.e., profits earned or losses sustained by his business, and to also
know the financial position of his business on a particular day. It also assists
him to meet the requirements of certain laws.
Importance And Utility Of Book-Keeping:
In the absence of book keeping it would be difficult to conduct business
successfully. Whether the business is profitable or not would be difficult toascertain.
A businessman would not be able to ascertain the total amount of his capital,
i.e., how much of his money has been invested into his business.
The businessman can arrive at certain conclusions by scrutinizing or checking the
accounts of the business and thereby be able to take decisions to control the
activities of the business i.e., it is the source of the Management Information
Systems of a business concern.
Required for the correct assessment of Income-tax, Sales-tax, Customs Duty,etc,.
If a legal action is required to be taken against any customer for recovery of debt
due from him, the books of accounts or its extracts are required to be produced
in the Courts as evidence.
In cases of Insolvency or Bankruptcy, the Courts may refuse or suspend the
discharge of an insolvent who cannot produce his books of accounts.
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For ascertaining the value of business in the case of admission of a partner or
amalgamation or sale of business.
Maintenance of books of accounts has been made compulsory in respect of
companies by the Indian Companies Act, 1956 and by various Laws of all the
countries in the World.
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THE ACCOUNTING STORY-continued
Ram, I am sure you now understand that the Books of Accounts have to
maintained not only to record the business transactions but also for various
other reasons which were detailed out in our Lesson no 3. Do you have any
problems?
No Sir, I do not have any problems.
Good, now if you remember in the beginning of Lesson no 3, I had
differentiated between Book-Keeping and Accountancy as follows.
Recording of business transactions is called 'Book-Keeping' and the way or
technique or say rules for recording them is called 'Accountancy.
Therefore the maintenance of the various Books of Accounts falls under
Book-Keeping.
So now to Lesson No 4 Definition of Accountancy-a small but interestinglesson.
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LESSON NO 4
DEFINITION OF ACCOUNTANCY
The term Accountancy relates to the formulation of the principles or rules to
be followed in the recording of business transactions.
Is Accountancy a Science or an Art ??? Neither !!
Though Accountancy follows rules based on common sense and logic, the
results of applying these Rules could lead to disparate and different results,
all termed as correct eg., depending on the method used for valuing the cost
of the products dealt in by the business, the profit of the business can be
varied and all such profit figures could be taken as correct!!! However
scientific results are unique for a given set of circumstances, hence
Accountancy cannot be called a Science.
At the same time it is not abstract and is based on logical and objective
principles rather than subjective ones i.e.,. results cannot be based on thewhims, fancies and talents of a particular person, and therefore it cannot
be called an Art.
Therefore it is something unique and should be viewed as such by
the student.
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THE ACCOUNTING STORY-continued
Now that you are aware about the meaning of Accountancy and the fact that
it is based on the logic of business transactions, Ram, let us consider the
effects of business transactions.
What do you mean by this , Sir?-Ram was a little puzzled by this.
Ha! You will see the logic of it when we go to the next lesson-Lesson No 5.
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LESSON NO 5
EFFECTS OF BUSINESS TRANSACTIONS
To understand how the Principles and Rules of Accountancy were formulated
we have to first evaluate the effects of Business Transactions.
Every businessman enters into a business transaction with a profit motive.
This means that his objective in starting and continuing his business is to
have more money than what he first had when he started his business. It is
possible that he may end up with less and that would mean that he has made
a loss, but that would definitely not be his intention or objective!
All business transactions have some effect on the cash flow of the business.
That would mean that cash will be either added or reduced, either
immediately or in the future, because of the business transaction.
What I mean by cash here, is the cash lying physically in the business.
Cash held by its bankers in its bank account or invested in such a way that it
can be encashed ( converted into cash) immediately whenever it wants it, aretermed as Investments. These are also called cash equivalents.
These cash inflows and outflows are of two types---Temporary and Permanent.
A temporary cash inflow would mean that cash has been received today which
will have to be returned in the future while a permanent inflow would imply that
the cash which has been received , permanently belongs to the business and
does not have to be returned.
Similarly with cash outflows-a temporary cash outflow would imply that though
cash is going out now it will come back into the business at a later date.However with a permanent cash outflow we do not expect it to come back.
What does this mean for the business??
Whenever a business transaction results into a temporary inflow of
cash, a Liability gets created.
Since the business has to return it in the future what has been temporarily
received today, it would mean that it owes this money to the person who has
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given it. A simple definition of liability is the amount owed by the business to
others.
Conversely when we pay back what we owe, which will result into a permanent
cash outflow, the liability which was created by the temporary cash inflow will
get extinguished.
When there is a permanent inflow it means that the business has
received Revenues or Income.
This means the cash received is not to be given back and therefore it belongs
permanently to the business.
This money adds to the Owners Capital which the business had originally
received from the owner, and therefore adds to the profit which it is making.
Whenever a business transaction results into a temporary outflow of
cash it results into the creation of an Asset.
A simple example is that of furniture purchased by paying cash. Here there is an
outflow of cash but furniture has been received in its stead. It is possible to sell
that piece of furniture in the future and recover the cash gone out (assuming for
the moment that the same amount can be recovered). That means that this
type of cash outflow has resulted into a receipt of some article having the same
cash (or monetary) value! Assets are articles which have a value which can beconverted to cash.
Conversely when the asset is sold, which will result into a permanent cash inflow,
the asset which was created by the temporary cash outflow will get liquidated.
Whenever a business transaction results into a permanent outflow of
cash, it results into an Expense or Loss.
This means that this cash outflow will not be received back and therefore it has
gone out permanently from the business.
This money reduces the Owners Capital which was originally received from theowner, and therefore reduces the profit of the business.
Based on the above we have now grouped our basic cash business transactions
into liabilities, incomes, assets, expenses, sale/liquidation of an asset and
repayment of a liability.
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A Chart is given below to illustrate the above:
Serial No Type of Cash Flow Meaning Effect
1 Temporary Inflow Cash comes into the
business which it will
have to give back in
the future
Creates a Liability
(Does not affect
Owners Capital
unless it has been
received from the
Owner)
2 Temporary Outflow Cash goes out of the
business which can be
received back in the
future
Creates an Asset
(Does not affect
Owners Capital)
3 Permanent Inflow Cash comes into the
business which it does
not have to give back
in the future
Creates Income
(Adds to the Owners
Capital)
4 Permanent Inflow Cash comes into the
business as a result of
sale or liquidation of
an Asset
Asset gets liquidated-
goes out of the
business
(Does not affectOwners Capital
unless more or less
cash is received than
what was originally
paid for the Asset)
5 Permanent Outflow Cash goes out of the
business which will
not be received back
in the future
Incurs Expenses
(Reduces from
Owners Capital)
6 Permanent Outflow Cash goes out for
repayment of Liability
Liability is
extinguished
(Does not affect
Owners Capital
unless paid to the
Owner)
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However there are also other business transactions which do not immediately
result into either a cash inflow or outflow but would result into such, in the
future. How then will we determine their effects?This requires a little more application of business logic.
Suppose we buy Furniture from M/s A & Co for Rs 25000 but we decide to pay A
& Co after 15 days. Now in this case there is neither an inflow nor outflow of
cash. But let us first suppose that we paid A & Co the money which then would
be considered a temporary outflow of cash. This would result into the creation of
an asset for us called Furniture. However it is assumed that this cash is then
returned by A & Co to us with a condition that it should be paid back within 15
days. This results into a Liability as this would be a temporary inflow of cash.
This means that this business transaction is an example of a simultaneoustemporary outflow and temporary inflow of cash which has resulted into both an
Asset and a Liability.
All business transactions in which the cash flow does not take place immediately
result either into an Asset and a Liability as above or an Expense and a Liability
or an Asset and an Income.
We will now make use of these basic groups of Assets, Liabilities, Incomes and
Expenses to decide the rules for entering the business transactions into the
Books of Accounts.
What we have now discussed, is the first rule of evaluating a business
transaction i.e.,
How to determine the Type of a Business Transaction!!!
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THE ACCOUNTING STORY-continued
Ram was surprised.
Sir, do you mean that it is the cash inflow or outflow which determines the
type of business transaction?
Why, dont you agree? As mentioned earlier, every business transaction
results into a cash inflow or outflow, so we make use of these cash flows to
determine a very important rule-the type of the business transaction. Do you
not agree that there is logic in the way we have formulated this rule?
Of course, Sir, it definitely has perfect logic, but all my friends who were
Commerce graduates have never explained this logic to me whenever I had
difficulties in understanding Accountancy during my MBA days!
Forget about them-do you agree with me on this?
Yes, Sir, perfectly as far as the basic cash inflows and outflows are concerned
but I am still a bit hazy on the non-cash flow transactions. Could you please
clarify?
Yes, that logic takes a little more time to understand. But once you have
properly understood it, you will have less difficulty in understanding what
follows. So let me illustrate this logic a little further for you.
Suppose you are a trader in pens. A customer comes to you to buy 1000
pens from you and you offer to sell him the same @ Rs 10/- per pen i.e., a
total of Rs 10,000/-. Now he pays you in cash. Therefore for you it is a cash
inflow and because you have given him 1000 pens in return, you will not
have to return this money to him, therefore for you it is a permanent cash
inflow which has generated income or revenue for you of Rs 10,000.
But then the customer makes a request to you to give back the money to him
and promises to pay back after 15 days and you accept for whatever reasons
he gives you for this request in the interest of your business because he is a
regular customer and you trust his promise, and you give back the Rs 10,000,
then this will be a cash outflow for you which will be a temporary one since
you are going to receive it back after 15 days. This temporary cash outflow
will create an Asset for you in the form of owing by your customer.
Therefore in this transaction, there is zero net cash flow but both an income
has been generated and an asset has been created, isnt it? You agree that
this is a business transaction because as per the definition of such given
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earlier there is an exchange of pens and promise to pay for the same and
money will flow in the future?
Yes, I suppose so.
Why do you suppose-are you not sure?
No, no what you say is very logical but it takes some getting used to!!
That is what you should understand-the logic behind a business
transaction which determines the nature of the business transaction
and recognizes its type so as to determine which of the groups it
relates to i.e., whether it creates an Asset or Liability or an Expense
or Income or a combination of these. Unless you can recognize this,
it would be difficult for you to properly account for the transactionin your Books of Accounts however expert you may be in
understanding the other rules of Accountancy which follow.
Most of my management students who have graduated in Commerce have
not understood this very vital and important fact and therefore have
problems in accounting.
I will give you another example below:
A, a businessman, contracts with a cleaning service, B & Co to clean his
business offices for a sum of Rs 5000/- and after it has done the same toAs satisfaction, to pay the contracted amount after 15 days of submission
of B & Cos Bill. Which type of transaction is this for A and which groups
has it generated?
The answer would be that this a zero cash flow type of business
transaction and that it generates an Expense and a Liability. How, Ram?
Well Sir, no cash has passed so it is a zero cash flow transaction. However
if A had paid B & Co immediately after receiving the Bill, it would have
been a Permanent Cash Outflow resulting into an Expense for him. But if
B& Co returns this money back in return of a promise from A to pay it
back after 15 days then it will be a Temporary Cash Inflow creating a
liability. This will therefore cancel out both the outflow and inflow of cash
since they are of equal amounts making it a net zero cash flow and what
will remain is the Expense and Liability for A.
Wow!! Ram, you have passed the logic test. I am sure you will think of
more such types of business transactions and arrive correctly at the
groups generated by it.
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I have given above and in the Lesson no 5 above three examples to
determine the groups of non-cash flow transactions.
This topic is very very important, Ram, for the proper understanding of
how to account for business transactions in the Books of Accounts.
Because if you do not know how, though you may apply all the other rules
of Accountancy correctly, you may account for the transaction incorrectly.
Now let us proceed ahead- these groups which we have identified will
now have to be classified further. Why? That will be explained in our
next lesson no 6-Classification of Business Transactions.
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LESSON NO 6
CLASSIFICATION OF BUSINESS TRANSACTIONS
This is the second rule to evaluate a business transaction-How to determine
in which classification a business transaction falls, based on its Type and
Groups.
Basically therefore all initial business transactions result into liabilities,
assets, incomes and expenses and all other transactions flowing from
these initial business transactions are either a sale or liquidation of an
asset or repayment of a liability as also a combination of the four
groups as explained earlier.
Liabilities are basically classified further as Personal transactions
because moneys are owed to persons maybe individuals or another business
firm or to the Government or to any other Statutory Authority etc..
Assets can either be articles and things of monetary value or persons who
owe the business some moneys. Therefore Assets are further classified aseither Real or Personal. Real is an accounting term depicting something
real belonging to the business, having monetary value. Cash is the basic Real
Asset and is always classified as such.
Incomes and Expenses are classified further into what is called Nominal
transactions i.e., they have value which adds or reduces the Owners
Capital.
Therefore Business Transactions for the purpose of accounting ( this is now
hereafter the word which we will use to substitute recording) the same in
the Books of Accounts can be a mixture of the following classifications.
Personal: Relating to personal dealings i.e., transactions involving monetary
dealings with various persons like individuals, other business concerns,
financial institutions, banks etc. Therefore all such persons to whom moneys
are owed or those from whom money is owed , are classified as Personal-i.e.,
all liabilities and some types of assets.
Real: Relating to buying and selling or transfer of an asset, not personal in
nature.
Nominal: Relating to the payment of an expense or receipt of an income.
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THE ACCOUNTING STORY-continued
Ram, these two Rules-one for determining the Type and Groups, and the other
for determining the Classification, form the basis for the third Rule which
determines the Accounting Entry in the Books of Accounts-which is explained in
the next Lesson No 7- Principles and Rules of Accountancy.
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LESSON NO 7
PRINCIPLES AND RULES OF ACCOUNTANCY
Every business transaction results into an exchange of money or money's worth.
Exchange means the act of giving or taking one thing in return for another.
Thus every such transaction results into two equivalent opposite effects like the
famous Newtons Law of Physics viz., 'every action has an equal and opposite
reaction'.
These two equivalent and opposite effects are recorded in the Books of
Accounts. From the above it is quite clear that every business transaction is
concerned with at least two accounts. Hence if any transaction is to be recorded
completely, it has to be recorded in such a manner that both the opposite sides
or effects are equalized.
Thus the Double Entry Book Keeping System of Accounting is based onthe "Dual Aspect" of each transaction. Every transaction has a double or two fold
effect, which is termed as 'debit' and 'credit'.
The recording of a transaction involves debiting one or more accounts affected
and crediting one or more different accounts with an equivalent amount. It is
therefore very clear that "every debit has a corresponding credit and vice-versa",
and therefore the system is known as the Double Entry System of Book-Keeping.
Based on the classifications arrived at earlier:
a. Business transactions are analyzed to find out which classifications arebeing affected and
b. Then after applying the Rules for passing Accounting Entries (i.e., what
to debit and what to credit) for each such classification,
c. to determine which account or accounts are to be debited and which are
to be credited.
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But what is an Account ? :-An account (short form is a/c) is a summarized
record or a statement of all the business transactions (during a particular period,
generally a year) relating to a particular person or institute, or to a particularproperty or things, or to a particular item of an expenditure or income. In order
to keep a full record of all the transactions the business has to keep:
a. An account of each person, firm, institute with whom it deals.
b. An account of each property or an article.
c. An account of each type (head) of expense or income.
The Rules for each Class of Accounts are as follows:
For Personal Accounts :-
DEBIT THE RECEIVER, AND
CREDIT THE GIVER.
Whenever any person receives any Property from the business, he becomes a
Debtor of the business and his account is therefore debited. Whenever the
business receives any Property from another person, that person becomes a
Creditor of the business, i.e., he has given to the business and therefore his
account is credited. This is related to the temporary cash outflows and inflows.
Whenever the Debtors pays the money due, he is the giver and therefore his
Account will be credited. This is related to the permanent cash flow received
due to the liquidation of a personal asset.
For Real Accounts :-
DEBIT WHAT COMES IN, AND
CREDIT WHAT GOES OUT.
Whenever Cash or any Property is bought, it comes into the business it
increases the value of the total Properties held, and its account is therefore
debited. This is related to the temporary cash outflows. Whenever a Property
goes out of the business because of it being sold/transferred/exchanged, it
reduces the value of the total Properties held and its account is thereforecredited. This is related to the permanent cash inflow received due to sale of the
asset.
For Nominal Accounts :-
DEBIT EXPENSES AND LOSSES,
CREDIT INCOMES AND PROFITS
Whenever a business makes an expense or a loss, it results into a reduction of
the Capital Fund of the business and therefore that expense or loss account is
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debited. If an income or gains result because of a business transaction, it results
into an increase in the Capital Fund of the business and therefore the income or
gain account is credited. This is related to the permanent cash outflows andinflows. Now applying the stated rules, how do we pass an Accounting
Entry ? Let us take an example-
On 1st January 2007, A brings in Rs 35000 in cash as his Capital in the business
called A & Co. Pass an entry in the books of A & Co.
The two equal and opposite sides of this transaction are -----Cash and As Capital
In this business, cash of Rs 35000 has come in. Cash is an Asset having money
value and it has come into the business. This is an a/c having the Real
classification and the rule for that classification is-Debit what comes in, Creditwhat goes out.
Since in this case, Cash has come in, Cash a/c is debited.
Capital means moneys received from the owner/s for conducting the business
operations. This money would have to be returned back to the owners as and
when he requires or when the business closes down. Therefore the receipt from
A is a temporary inflow and is therefore a liability. It is also an a/c having
Personal classification -the rule for this classification is Debit the Receiver and
Credit the Giver.
Therefore since A is the giver, his a/c will be credited. Instead of his
individual a/c , his Capital a/c is credited because he is the Owner.
So the Journal Entry is as follows:
Date Particulars LF Debit
Amount in
Rs
Credit
Amount in
Rs
01-01-07 Cash a/c Dr 35000.00
To As Capital a/c 35000.00
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Therefore each side of the business transaction has to be analyzed to determine
its classification and then using the rules for each such classification, decide
which a/c to debit and which to credit.
Therefore it can be seen that the basic knowledge required for
accounting a business transaction is as follows:
a. Understanding and recognizing the dual i.e., the two fold effect
of the business transaction by the Cash Flow and Non-Cash Flow
Evaluation Methods,
b. Determining the Accounts affected by the business transaction,
c. Finding out the Classifications of the accounts involved in the
business transaction,
d. Applying the rules of Debit and Credit to the Accounts based on
their classification,
e. Passing the Accounting Entry.
Everything else in this subject of Accountancy follows this knowledge
and therefore it should be properly understood,++++++++ before we
go on to :
a. Where and How to make the Accounting Entries, in such a way
that we are absolutely sure that we have entered all the effects
of our business transactions in the proper and required manner.
b. How to present the information available in the Books of
Accounts for the proper evaluation and understanding of the
results of the business-whether the business has made a profit or
loss- how much cash we have-how much Assets we have-how
much money we owe to others how much money is owed by
others to us and so on and so forth.
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THE ACCOUNTING STORY-continued
So now, Ram, we have, on the basis of the Type, Classification and the dual
aspect of a Business Transaction, formulated the most important and basically
the main Rule or say, the basic theory of Accountancy, and that is,
What to Debit and What to Credit???
This is the only Rule which you have to memorize or mug up. Everything which
you will learn further in Accountancy is based on the logical use and extension of
these Rules.
Therefore before you proceed further, check the two Illustrations at the end of
Lesson No 8 and then go to vikrofinacs.com on your internet , log in and solve at
least two different Problems concerning the Concepts of Accounts, in the
System, within the hours allotted to you .
Then come back to me, Ram, after three days and if you have any further
questions, then we will discuss further otherwise we will proceed to the next
Chapter.
Also in the meanwhile, go through the next Lesson No 8- Some Accounting
Terminologies- so that you become familiar with Accounting Terms.
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LESSON NO 8
SOME ACCOUNTING TERMINOLOGIES
Cash Transaction:-A business transaction in which cash is paid or received
immediately.
Credit Transaction:- A business transaction in which cash is not paid or
received immediately at the time of a transaction but it is paid or received at alater date.
Goods:- The term goods refers to merchandise, commodities, articles or things
which a business deals with i.e., either trades or manufactures.
Purchases & Sales:- Purchases and Sales are synonymous with Goods and are
used to indicate purchases and sales of goods. When goods come in due to
purchases for business purposes, the correct account affected is the Purchases
Account and not the Goods account. Similarly when goods go out due to a sale,
the account affected is the Sales Account.Stock:- It means goods which had been purchased earlier and lying unsold in
the business on any given date. Stock at the beginning of the trading year is
termed as Opening Stock. Stock at the end of the trading year is termed as
Closing Stock.
Debtor:-A person who owes money to the business becomes a debtor of the
business. e.g., A Customer who bought goods from the business and still owes
money on that account.
Creditor:- A person to whom a business owes money is a creditor of the
business. A creditor could be a Supplier from whom goods are purchased and
not yet paid for.
Debt:- The money due from a debtor.
Bad Debts:- The debts which cannot be recovered in money or moneys worth
are termed as bad debts.
Assets:- Total possessions of and debts due to the business such as building,
furniture,stocks, sundry debtors etc.
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Fixed Assets:- Assets purchased by the business for its own use and for
producing goods and not for resale, such as Buildings, Machinery, Motor car etc.
Liabilities:- Amounts payable by the business to its proprietors & other
persons, like creditors, banks, financiers etc.
Capital:- Whatever money or money's worth the proprietor brings into his
business from his private or personal estate, is his capital in the business.
Drawings:- Money or goods or other items of the business either withdrawn or
used by the proprietor for his private and personal purpose, is the drawings of
the proprietor.
Discount:- Discount means an allowance in the purchase price, given by the
seller to the purchaser. There are two types of discount viz., Trade Discount andCash Discount. A Trade Discount is is an allowance given on the catalogue or
stated price of goods. This discount is allowed at the time of purchase/sale of
goods. Trade Discount does not appear in the Books of Accounts separately." A
Cash Discount is allowed to trade debtors to induce them to pay their dues
within or before the time limit given. If payment is not so made the debtors do
not get this discount. As this discount is dependant upon the payment of cash
in time, it is required to be recorded separately in the books of accounts.
Books of Accounts:- It means suitably ruled account books in which business
transactions are recorded. Main books of accounts are Journal and Ledger.
An Accounting Entry:- An Accounting Entry means recording a transaction in
the Journal or Ledger. Thus this term may mean journal entry or ledger entry.
Turnover:- Turnover means the total sales (cash and credit) of the business
during a given business accounting period.
Voucher:- Any document which is a written evidence in support of a business
transaction is called a voucher.
Cheque:- A Cheque is an unconditional order in writing, drawn on a specified
banker ,signed by the drawer directing the banker to pay on demand, a certain
sum of money to or to the order of a person named therein or to the bearer
and which does not order any act to be done in addition to payment of money.
Bank Current Account:- It is a running account of a customer of the bank
and he is at liberty to pay into or withdraw from this account the amount
required by him from time to time.
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ILLUSTRATIONS
Illustration 1. Enter Account Type, Classification, Applicable Rule and Side for
the transactions of A & Co, given below: :-
1. A & Co receives cash from A, the proprietor.2. It receives goods from B on credit terms.
3. A deposits a cheque of his personal bank a/c into A & Cos bank account.4. Sold goods on cash to C allowing trade discount5. Withdraws cash from the bank.
Answer:
Tran
No
Account
Head
Account
Group
Classifica
tion
Applicable Rule Side
1 Cash Asset Real Debit What Comes In Dr
1 As Capital Liability Personal Credit The Giver Cr
2 Purchases Expense Nominal Debit
Expenses/Losses
Dr
2 B Liability Personal Credit The Giver Cr
3 Bank Asset Personal Debit The Receiver Dr
3 As Capital Liability Personal Credit The Giver Cr
4 Cash Asset Real Debit What Comes In Dr
4 Sales Income Nominal Credit Incomes/Gains Cr
5 Cash Asset Real Debit What Comes In Dr
5 Bank Asset Personal Credit The Giver Cr
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Justifications for the above Answers are given below:
Transaction 11. This is a temporary inflow as cash is brought in by A as his Capital which
would have to be returned whenever he requires or when the business
closes down or winds up. This therefore creates a liability of A & Co
towards A.
2. 2 accounts are therefore affected-Cash & A Capital.
3. Since A brings in cash into the business, cash a/c which is an asset and is
classified as real, is debited as the applicable rule is - debit what comes in.
4. Since A has given the cash, As Capital a/c (Capital- because A is the
owner) which is a liability of the business, is credited since itsclassification is personal and the applicable rule is - credit the giver-.
Transaction 2
1. This is a case of both inflow and outflow or non-cash flow. This creates
both an assumed permanent cash outflow incurring an expense (for goods
purchased) and an assumed temporary cash inflow (from B) creating a
liability.
2. Therefore 2 accounts-Purchases and B are created.
3. Normally when goods are purchased for trading or manufacturing
purposes, it creates a revenue asset since it should have been considered
a temporary cash outflow which will be received back when they are sold.
However it becomes difficult to keep an exact track of how much and
which of the goods purchased were sold during an accounting period.
Therefore when goods intended for trading or manufacturing are
purchased, it is considered as a permanent cash outflow and an Account
Head named as 'Purchases' is debited, having nominal classification and
the applicable rule is 'debit expenses'.
4. Purchases of goods in such cases are therefore considered as expenses
and at the end of the accounting period they are matched with the sales
made from the goods purchased to arrive at the profitability of the
business by deducting the expense (Purchases) from the income (Sales).
5. The profit made on the sale of the same i.e., the amount received over
and above the amount paid for the purchase of the goods will be a
permanent inflow and which will be accounted for as the profit of the
business.
6. The goods are given on credit by B.
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7. B is a liability a/c having personal classification and the applicable rule is '
Credit the Giver' and therefore B a/c is credited with the total amount of
the goods purchased.
Transaction 3
1. This is also a case of both inflow and outflow or non-cash flow since this is
a cheque receipt and therefore requires the services of a third party
(bank) to collect the money on A & Cos behalf. This creates both an
assumed temporary cash inflow from A creating a liability (As Capital) and
an assumed temporary outflow to the Bank creating a personal asset since
the money on the cheque is collected/received by the Bank directly on A &
Cos behalf. The Bank has to return this money to A & Co when it requiresor to pay someone on As behalf and on its instructions, out of the amount
A has given it from time to time. Therefore the amount of such money
lying with its Bank will be A & Cos Personal Asset.
2. Therefore two accounts-Bank and As Capital are affected.
3. Bank is a Personal a/c and since it receives the money on A & Cos behalf,
the applicable rule is-Debit the Receiver. Therefore the Bank a/c will be
debited.
4. A is the giver and there his Capital a/c (since he is the owner) will be
credited as per the applicable rule-Credit the Giver.
Transaction 4
1. This is a permanent cash inflow creating an income. Cash has been
received from C for goods sold to him by A & Co which will not be
returned to C because he has received equivalent goods in return from A
& Co.
2. Therefore Cash and Sales (Income Head) are affected.
3. Since Cash is received, it means it has come into the business and since it
has a Real classification, the applicable rule is-debit what comes in and
therefore Cash a/c is debited.
4. The trade discount allowed to C, reduces the Sales amount and amount
due from C and therefore the profit made on selling the same. Therefore
it is not necessary to account for it separately.
5. Normally when goods are sold,it results into a liquidation of a revenue
asset and it should have been considered as a repayment of a temporary
cash outflow made earlier and therefore goods a/c should have been
credited as the goods are going out.
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6. However it becomes difficult to keep an exact track of how much and
which of the goods purchased were sold during an accounting period.
Therefore when goods intended for trading are sold, it is considered as apermanent cash inflow which is considered as an income and an Account
Head named as 'Sales' is credited, having nominal classification and the
applicable rule is 'credit income'.
Transaction 5
1. This is a case of liquidation of a personal asset i.e., return by the Bank as
required by A & Co, of a past temporary cash outflow.
2. Therefore Cash and Bank a/cs are affected.
3. When cash is withdrawn the bank, cash comes in and then applying therelevant rule for its Real classification-Debit what comes in, Cash a/c is
debited.
4. Bank is the giver of the cash withdrawn, and having a personal
classification, it is therefore credited, the applicable rule being credit the
receiver. It is a personal asset of the business to the extent of the balance
in it of the money deposited into it by the business.
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Illustration 2. Abhijit starts a retail business in Pune called as Baner Consumer
Electronica (BCE) for trading in electronic items like TVs, Refrigerators and
Washing Machines. From the transactions given below enter Account Heads,
Group, Classification, Applicable Rule & Side:-
1. Abhijit opens a bank account in the name of his business- -with theCanara Bank, Baner Road Branch with his personal cash.
2. He also deposits his personal cheque into the bank .3. BCE pays Rent Deposit to Mr. Shrivastava, the landlord of the shop leased
out to it for its retail business,. It also pays the advance rent for the firstmonth. Both payments were made by two cheques drawn on BCEs bank.
4. BCE also pays to Pune Office Equipments Co a cheques of differentamounts for purchase of various furniture & fittings and OfficeEquipments.
5. It withdraws cash from its bank a/c.6. It pays in cash to a carpenter for some customized furniture fittings.7. It purchases the first lot of its electronic goods from its Principals-M/s
Whirlpool India, by issuing a cheque on its bank. It also obtains TVs oncredit for 30 days from M/s Vijay Traders.
8. It incurs expenses in cash for stationery and other office expenses.9. It sells Washing Machines and TVs and receives payment partly by
cheques and partly in cash.
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Answer:
TranNo
AccountHead
AccountGroup
Classification
Applicable Rule Side
1 Canara Bank Asset Personal Debit the Receiver Dr
1 Abhijit Capital Liability Personal Credit the Giver Cr
2 Canara Bank Asset Personal Debit the Receiver Dr
2 Abhijit Capital Liability Personal Credit the Giver Cr
3 Rent Deposit Asset Personal Debit the Receiver Dr
3 Canara Bank Asset Personal Credit the Giver Cr
4 Rent Expense Nominal Debit Expenses/Losses Dr
4 Canara Bank Asset Personal Credit the Giver Cr
5 Furniture &
Fittings
Asset Real Debit what comes in Dr
5 Office Equipments Asset Real Debit what comes in Dr
5 Canara Bank Asset Personal Credit the Giver Cr
6 Cash Asset Real Debit what comes in Dr
6 Canara Bank Asset Personal Credit the Giver Cr
7 Purchases Expense Nominal Debit Expenses/Losses Dr
7 Canara Bank Asset Personal Credit the Giver Cr
7 Purchases Expense Nominal Debit Expenses/Losses Dr
7 Vijay Traders Liability Personal Credit the Giver Cr
8 Stationery
Expenses
Expense Nominal Debit Expenses/Losses Dr
8 Office Expenses Expense Nominal Debit Expenses/Losses Dr
8 Cash Asset Real Credit what goes out Cr
9 Cash Asset Real Debit what comes in Dr
9 Canara Bank Asset Personal Debit the Receiver Dr
9 Sales Income Personal Credit the Giver Cr
Work out the justifications yourselves.
You can check them in vikrofinacs.com if you so wish-under Accounts Concepts
Chapter Problem No 5.
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CHAPTER TWO
THE JOURNAL
CONTENTS
Sr No Particulars Page
No
1 THE ACCOUNTING STORY 4
2LESSON NO 1- THE JOURNAL BOOK
8
3 THE ACCOUNTING STORY- continued 9
4 ILLUSTRATION 12
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THE ACCOUNTING STORY
Ram came back 3 days after attending the Lesson on Principles of Accountancy.
Sir, I have solved all the problems on Accounting Concepts and now I am ready
for the next Chapter.
You are sure you have understood it in its entirety?
Yes, the justifications for every transaction in the Problems were very clear and
I had no difficulty in understanding them. I did have to attempt each problem at
least twice-in one problem, thrice-before I got them all right.
You have done well now we can without any delay get on with the next
Chapter. It deals with the Journal which is called the Prime Book of Entry.
It was so called because the accounting entries of all business transactions of the
business were first entered into this Account Book.
Nowadays this book has been divided into different Books of Accounts. We shall
have a look at them later. But for now we will assume that there is only one
Book of Prime Entry (it means First Entry ) and that all Business Transactions
have to be first accounted for in this Book.
Accounting for a transaction means evaluating a Business for its Dual Aspects,
for Group, for Classification and then deciding which account or accounts to debit
and credit such that the total of the accounts debited will be equal to the total of
the accounts credited.
Sir. Sir, you are going too fast for me!!
Prof Vijay laughed loudly and said-Isnt this what you did when you solved the
Accounting Concepts Problems?
Yes , and so I did.
Then why the confusion-I just said you have to do that and then enter in the
Journal. OK, we will go straight away to the Topic and then you will
understand-So Lesson No 1-The Journal.
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LESSON NO 1
THE JOURNAL BOOK
In order to avoid omission of any transaction or to avoid any error in the entry
recording that transaction, it is necessary to immediately record it in the Books of
Accounts. One of the books of accounts in which an entry is first made is known
as the Journal Book.
Journal means a Day Book or a daily record. The Journal is a subsidiary book in
which all day to day transactions of a business are recorded as and when they
take place in a chronological order, in a debit and credit form and in a systematic
manner.
The act of recording a transaction in the Journal in the form required, is called
Journalizing.
FORMAT OF THE JOURNAL
Date Particulars LF Debit
Amount in
Rs
Credit
Amount in
Rs
01-01-07 Cash a/c Dr 35000.00
To As Capital a/c 35000.00
(Being the amount
received from A as his
Capital)
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The Method:
Find out the accounts involved in a transaction. There will be at least two
accounts concerned.
Ascertain the class of each of the accounts concerned and then apply the rules of
debit and credit to the class identified. On the basis of the relevant rule, debit or
credit the said account. The name of the account/s to be debited is written first
under the 'Particulars' column, and the name of the account/s to be credited is to
be written on the second line.
The word "Dr" is written after the name of the account to be debited whereas
the name of the account to be credited is to be preceded by the word "To".
The amount involved in the transaction is written under the 'Dr' and 'Cr' columnsagainst the names of debit and credit accounts respectively.
A brief explanation of the entry is given in brackets just below the entry. It is
called the 'Narration'.
LF in the Journal is the reference to the page number of the concerned Account
in the ledger. It facilitates easy reference.
The date of the transaction is written in the column 'Date'.
In simple entries there is only one debit and one credit for every transaction. But
there may be certain transactions in which there may be more than one debit
entry or more than one credit entry. However the total of debit amounts should
equalize the total of credit amounts.
The Journal is necessary for the following reasons:
a. A complete record of each transaction is available at one place.
b. As the transactions are recorded date-wise it facilitates quick and easy
reference to any transaction, whenever necessary.
c. Narration of the entry helps to understand the transaction recorded.d. Cross Checking between journal and ledger is facilitated.
e. Courts of Law consider journal entries as a proof of a transaction.
Some Useful Tips for passing (recording) Journal Entries
a. Any amount withdrawn by the proprietor for personal use or for payment
of his private expenses or any business asset used by the proprietor for
his private purposes is called as Drawings of the Proprietor.
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b. When it is not mentioned specifically whether purchase or sale is on cash
or credit and party's name is mentioned it is presumed to be a credit
transaction. If partys name is not mentioned then it is presumed to be acash transaction (not cheque).
c. Trade discount does not appear in the books of accounts. The purchases
or sales are reduced by the amount of Trade Discount and only the net
amount is recorded.
d. Goods distributed as free samples are treated as Advertisement Expenses.
e. In the Business Entitys Books of Accounts, there will never be its own
account, since obviously the Business Entity cannot enter into a business
transaction with itself, because for a transaction to be recognized as a
business transaction, there has to be more than one person different fromeach other as parties to the transaction. However in my experience as an
examiner, many students show the business entitys account in its own
books!!
ILLUSTRATION:
Journalize the following business transactions in the Journal of Hasmukhlal
Salunkhe & Bros:
Sr No Date Particulars
1 1-1-12 Withdrew cash Rs 75,000 from the bank, out of the Rs6,79,435 available in it.
2 1-1-12 Paid Rs 19,250 as salary by cheque to Hari Ram, Head
Supervisor of the business, after deducting Rs 750 as
income tax on the same.
3 1-1-12 Paid Rs 46,730 as salary to subordinate staff members in
cash
4 2-1-12 Received a cheque from Gandhi Mfg Co of Rs 1,56,395 for
credit sales made to it earlier
5 2-1-12 Sold goods to Fergusson Wholesalers Ltd of Rs 6,57,980 and
received payment immediately by cheque
6 3-1-12 Purchased goods from Wankhede Distributors of Rs
8,34,650 payable after 30 days
7 3-1-12 Paid Rs 2,361 in cash as tempo charges for bringing the
above goods to Hasmukhlals godown.
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8 3-1-12 Paid in cash Rs 835 as unloading charges of the above
goods
9 4-1-12 Paid by cheque to the Income-Tax Dept the amount of Rs
750 earlier deducted from the Head Supervisors salary
10 4-1-12 Paid to Chagan Chaiwala in cash Rs 1925 being the tea
charges for Dec 11
11 5-1-12 Incurred xerox charges of Rs 249 from Satpute Copiers. All
amounts of xeroxing work done by Satpute in every month
are payable by the 7th of next month and are accounted as
expenses when actually paid.
12 7-1-12 Paid Rs 7451 by cheque to Satpute Copiers being the
amount of xerox charges for the month of Dec 11
13 8-1-12 Paid cash of Rs 1835 for purchase of office stationery
14 9-1-12 Paid Rs 10,000 to the Proprietor Hasmukh in cash for
personal purposes
15 10-1-12 Sold goods to an employee for Rs 1545 to be accounted for
as a Salary Advance for the month.
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3-1-12 Purchases a/c Dr
To Wankhede Distributors a/c
(Being the credit purchasesfrom the latter)
8,34,650.00
8,34,650.00
3-1-12 Carriage Inward a/c Dr
To Cash a/c
(Being the cash paid for tempo
charges for inward goods)
2,361.00
2,361.00
3-1-12 Hamali charges a/c Dr
To Cash a/c
(Being the unloading charges
for goods received)
835.00
835.00
4-1-12 I-Tax on Salaries a/c Dr
To Bank a/c
(Being the cheque paid to the
I-Tax Dept on a/c of tax
deducted from salary)
750.00
750.00
4-1-12 Miscellaneous Exps a/c Dr
To Cash a/c
(Being the cash paid to Chagan
Chaiwalla for tea charges for
Dec 11)
1925.00
1925.00
5-1-12 --No entry to be done--
7-1-12 Xerox Charges a/c Dr
To Bank a/c
(Being the cheque paid to
Satpute Copiers for Xerox chgs
for Dec 11)
7451.00
7451.00
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8-1-12 Stationery Expenses a/c Dr
To Cash a/c
(Being the cash paid for officestationery)
1835.00
1835.00
9-1-12 Hasmukh Drawings a/c Dr
To Cash a/c
(Being the cash withdrawn by
Hasmukh for his personal
purposes)
10,000.00
10,000.00
10-1-12 Salary Advance a/c Dr
To Sales
( Being the goods sold to an
employee to be treated as a
Salary Advance)
1545.00
1545.00
Justifications for all the entries above are available in Problem No 5 of Journal in
vikrofinacs.com
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THE ACCOUNTING STORY- continued
Now do you understand, dear Ram, what this Journal is all about?
Yes, but I think I require to solve the Problems in vikrofinacs.com to understand
completely.
In this subject, where the Theory is not much, you have to solve the maximum
problems-at least four in each topic covering different business transactions. So
go ahead and solve them and come back after two days.
OK, Sir, no problem.
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CHAPTER THREE
THE LEDGER
CONTENTS
Sr No Particulars Page
No
1 THE ACCOUNTING STORY 4
2LESSON NO 1- THE LEDGER ACCOUNT
8
3 THE ACCOUNTING STORY- continued 9
4 LESSON NO 2- POSTING INTO THE LEDGER
5LESSON NO 3- BALANCING OF A LEDGER ACCOUNT
12
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THE ACCOUNTING STORY
Now we come to the Main Book of Account-The Ledger.
The Journal is the Prime Book and the Ledger is the Main Book. This prime book,
the Journal is divided further depending on the transactions involving some
Accounts regularly, like Cash (Cash Book), Bank (Bank Book), Sales (Sales Book),
Purchases (Purchase Book) etc., This we shall see in details in the next Chapter.
These Subsidiary Books are part of the Journal, but we find that they have
characteristics of the Ledger also. Therefore we will first familiar ourselves with the
Ledger and then understand that further. OK, Ram?
Yes, Sir.
Now we will try to understand the ledger by first finding out in the 1st Lesson-all
about the Ledger Account.
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LESSON NO 1
THE LEDGER ACCOUNT
The Ledger is the Principal Book of Account and it contains all the accounts of a
business. An account is a record of all dealings and transactions in respect of any
particular person, a particular thing or a particular item of expenditure or income.
All the transactions are recorded first in the Journal and if necessary in the other
subsidiary books and then from there they are transferred to the respective accounts in
the ledger. This is called posting to the Ledger.
The Ledger is the book wherein all transactions ultimately find their place under therespective accounts.
Therefore it is the book of final entry.
Every Account normally is opened on a new page in the Ledger. The accounting term for
a page is 'Folio'. As soon as it is opened it is entered in the alphabetical index of the
Ledger along with reference to the folio number on which it is located.
The name of the account is written in bold letters at the top center of the folio. The
folios of the Ledger as well as the Subsidiary Books should be numbered consecutivelyto facilitate reference. The left hand side of the 'T' in the account is its debit side and
the right hand side is its credit side.
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THE LEDGER
THE T FORMAT
NAME OF THE ACCOUNT
--------Debit Side---------------- -----------Credit Side--------------
THE LEDGER THE COLUMNAR FORMAT
NAME OF THE ACCOUNT
Date Particulars SBF Amt inRs
Date Particulars SBF Amt in Rs
Date Particulars SBF Debit
Amt in
Rs
Credit
Amt in
Rs
Dr/Cr Balance
Amt in Rs
This is the T format of
the Ledger-the vertical
line of the T dividing the
Debit and the Credit side
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THE ACCOUNTING STORY continued
We must understand how to enter the accounting entries made into the Journal into
the Ledger, in both the horizontal and vertical formats and then how to summarize
them in each Account.
Why? asked Ram.
Because we would want to know where our money has gone or from where it has
come in. We would like to know who owes us and to whom we owe. We would
like to know what our expenses are and what our incomes are during a particular
period .
And this we can find out from the Ledger?
You bet, and that is why it is called the Main Book of Account.
So now lets learn how to transfer the entries from the Journal into the Ledger. This
process is known in Book-Keeping as Posting into the Ledger-and that is our next
Lesson Two.
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LESSON NO 2
POSTING INTO THE LEDGER
Transferring of entries from the journal to the respective accounts in the ledger is
called Posting. Posting is to be made to the debit side of the account/s which
is/are to be debited and to the credit side of the account/s which is/are to be
credited as entered in the Journal.
While making an entry to the debit side of an account, the name of the
corresponding credit account is to be written under the column of "Particulars" and it
is to be preceded with the word "To". Whilst making an entry on the credit side of
an account the name of the corresponding account debited is written and it is
preceded by the word "By".
The date of the transaction is written under the column "date" and the amount is
written under the column "Amount". The folio No. on which the entry is made in the
Journal is to be inserted under the SBF Folio No column. Thus for the purpose of
cross references the corresponding Ledger Folio is written in the Subsidiary Book
and the Subsidiary Book folio in the Ledger.
This procedure is the same for both the T and Columnar types of Ledger Account
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THE ACCOUNTING STORY continued
After the entries have been posted into the Ledger then we have to find out whatare the balances of each of the Accounts in the Ledger.
By balancing , we summarize the effect of all the debits and credits to each account
to determine what the amount of each account is.
And how do we do that?
That is what we will now learn in Lesson No 3- Balancing of an Account.
You know Ram, I have found that the student finds this topic difficult to understandand 70% always make mistakes in balancing accounts. They try to understand it
mechanically without making a proper attempt to understand its logic.
Therefore I personally feel that it requires an elementary knowledge of Arithmetic
and a little bit of Logic.
So, understand this properly otherwise you will have a lot of problems in future.
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LESSON NO 3
BALANCING OF A LEDGER ACCOUNT
In the T format, each account in the ledger may have some entries on the debit
side and some on the credit side.
Balancing the account means finding out the difference between the two.
The procedure is to separately total the amounts on each side, write the greater
total as the total of both the sides and then subtract the smaller total from the larger
one. The difference between the two is called the Balance.
This balance is then inserted at the end of all the entries, on that side of the accountwhich has the lesser amount, writing before it as follows:
"By Balance c/d" -when inserting the difference on the credit side i.e., when the
total debit side amount is greater than the total credit side amount.
To Balance c/d" -when inserting the difference on the debit side i.e., when the
total credit side is greater than the total debit side.
Therefore by writing this balance on the side having the lesser total, it would mean
equalizing the total of the lesser side to the greater one.
This process of extracting the balance and inserting it on the lesser side of an
account is called balancing or closing of an account.
Debit Balance:-
It is therefore obvious from the above that if the balance is written on the credit
side it would mean that the debit side is greater than the credit side of the account.
Therefore this balance is called a Debit Balance even though it appears on the credit
side of the account.
Credit Balance:-
Similarly if the balance appears on the credit side of an account it means that the
credit side is greater than its debit side and therefore it is called a Credit Balance.
This method of balancing applies to the T format.
However in the Columnar format, balancing is done every time a debit entry or
credit entry is posted in the a/c, one below the other, i.e., the difference between
the debit and credit side amounts. To the balance of the earlier date, the new entry
is either added or subtracted depending on the type of the earlier balance, i.e., Debit
or Credit.
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Examples of balancing in the T and columnar formats are given below.
Balancing of Ledger- T Format
Given below is an example of a debit balance-i.e., where the debit total is more than the
credit total. This represents a Debtors a/c to whom sales have been made and moneys
received there from. The information given by the a/c is the amount of sales made to
him for the period from 12-10-06 to 30-03-07 and the moneys received from him during
that period. The balance amount which is a debit balance informs that Rs 146840.00 is
due from him and that he is a debtor to that extent as on 30-03-07, as a result of all the
business transactions concerning him during that period.
A & Cos Account (Debtors Account)
|-------------Debit Side------------------|-|-------------Credit Side---------------|
Date Particulars SBF Amt in Rs Date Particulars SBF Amt in Rs
12-10-06 To Sales 5 500000 12-11-06 By Bank 18 490000
5-11-06 To Sales 6 258978 15-11-06 By Discount 6 10000
12-12-06 To Sales 7 65890 14-01-07 By Bank 18 258978
2-2-07 To Sales 8 74250 15-02-07 By Bank 18 65890
30-3-07 To Sales 9 72590 30-03-07 By Bal c/d 146840
Total 971708 Total 971708
30-03-07 To Bal b/d 146840
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Given below is an example of a credit balance-i.e., where the credit total is more than
the debit total. Also this represents a Creditors a/c from whom purchases have been
made and moneys paid thereto. The information given by the a/c is the amount of
purchases made from him for the period from 12-10-06 to 30-03-07 and the moneys
paid to him during that period. The balance amount which is a credit balance informs
that Rs 146840.00 is due to him and that he is a creditor to that extent as on 30-03-07,
as a result of all the business transactions concerning him during that period.
A & Cos Account (Creditors Account)
|------------Debit Side---------------|-|--------------Credit Side----------------|
Date Particulars SBF Amt in Rs Date Particulars SBF Amt in Rs
12-11-06 To Bank 18 490000 12-10-06 By Purchases 7 500000
15-11-06 To Discount 6 10000 5-11-06 By Purchases 7 258978
14-01-07 To Bank 18 258978 12-12-06 By Purchases 7 65890
15-02-07 To Bank 18 65890 2-02-07 By Purchases 7 74250
30-03-07 To Bal c/d 146840 30-03-07 By Purchase 7 72590
Total 971708 Total 971708
30-03-07 By Bal b/d 146840
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Following are the same accounts-both the Debtors and Creditors
accounts with the same data in the columnar format of the Ledger
which is now presently utilized because it is more convenient to
program in the computerized accounting packages presently being
used.
A & Cos Account (Debtors Account)
(Columnar Format)
Date Particulars SBF Debit Amt in Rs Credit Amt in Rs Bal Type Bal Amt in Rs
12-10-06 To Sales 5 500000 Dr 500000
5-11-06 To Sales 5 258978 Dr 758978
15-11-06 By Bank 18 490000 Dr 268978
15-11-06 By Discount 6 10000 Dr 258978
12-12-06 To Sales 5 65890 Dr 324868
14-01-07 By Bank 18 258978 Dr 65890
2-02-07 To Sales 5 74250 Dr 140140
15-02-07 By Bank 18 65890 Dr 74250
30-03-07 To Sales 5 72590 Dr 146840
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A & Cos Account (Creditors Account)
(Columnar Format)
Date Particulars SBF Debit Amt in Rs Credit Amt in Rs Bal Type Bal A