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INTRODUCTION TO ACCOUNTING
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 Contents
Meaning of accounting........................................................................................................................... 3
Accounting is an art as well as science .................................................................................................. 4
Branches of accounting .......................................................................................................................... 4
Book-keeping, Accounting and Accountancy ........................................................................................ 5
Advantages of accounting ...................................................................................................................... 6
Disadvantages of accounting ................................................................................................................. 7
Types of Accounting Information .......................................................................................................... 8
Users of accounting information ........................................................................................................... 9

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 Meaning of accounting
Accounting is the art of recording, classifying and summarizing in a significant manner and in
terms of money, transactions and events, which are, in part at least, of a financial character,
and interpreting results thereof.

Identification IMRCSAC

Measurement

Recording

Classifying

Summarising

Analysis and Interpretation

Communicating

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 Accounting is an art as well as science
Accounting; like science follows a systematic and organized path to understand the
economic status of an entity.
Science is obtaining knowledge by a systematic pattern including observation, study,
practice, experiments and investigation. Like Science; Accounting requires gaining
knowledge about the economic status of an entity by systematic study. An accountant
finalizes the economic results by identifying, analyzing, classifying using the method of
double entry book keeping system.
So, Accounting is a science that comprises of rules, principles, concepts, conventions and
standards in science.
Art is the application of techniques and methods. Accounting is an art because it presents
the financial findings by following and implementing universally accepted principles (GAAP)
Art is the study of application of scientific method to practical use. Accounting is an art as
the established rules and principles of accounting are applied to bookkeeping process of an
economic entity.

Branches of accounting

Accounting

Financial Management
Cost Accounting
Accounting Accounting

 Financial accounting records the business transactions in a systematic manner to

ascertain profit and loss of the accounting period and determine the financial position
and progress of the business.
 Cost accounting ascertains the total cost and per unit cost of goods produced and
services provided by the business. It helps the management to estimate the cost in
advance and exercise cost controls.
 Management accounting uses various techniques to make accounting data more useful
for managerial decision making.

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 Book-keeping, Accounting and Accountancy

• Book-keeping is an art of recording day to day

transactions and is a part of accounting. It ensures
that records of the individual financial transactions
Book- are correct, up-to-date and comprehensive.
keeping

• The systematic and comprehensive recording of

financial transactions or statements of business
that also includes storing,retrieving , summarizing
and presenting the information in the form of
Accounting reports and their analysis is known as accounting.

• Accountancy is a body of knowledge that

prescribes the sets of principles that are used
during the process of accounting to maintain
Accountancy uniformity, and assess the information easliy.

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 Advantages of accounting

Protecting Facilitates
Replaces
business settlement of
memory
assets tax liabilities

Facilities
Facilitates Facilities sale
comparative
loans of business
study

 Protecting business assets

 Facilitates settlement of tax liabilities: A systematic accounting record immensely
helps settlement of taxes as it is good evidence of the correctness of transactions.
 Replaces memory: A systematic and timely recording of transactions obviates the
necessity to remember the transactions. The accounting record provides the
necessary information.
 Facilitates comparative study: A systematic record enables a businessman to
compare one year’s results with those of other years and locate significant factors
leading to the change, if any.
 Facilitates loans: Loan is granted by the banks and financial institutions on the basis
of growth potential which is supported by the performance. Accounting makes the
information available with respect to performance.
 Facilitates sale of business: If someone desires to sell his business, the accounts
maintained by him will enable the ascertainment of the proper purchase price.

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 Disadvantages of accounting

Accounting ignores Accounting may Accounting is

the qualitative lead to window based on historical
element dressing costs

Accounting is not
fully exact

 Accounting ignores the qualitative element: Since accounting is confined to

monetary matters only, qualitative elements like the quality of staff, industrial
relations and public relations are ignored.
 Accounting may lead to window dressing: The term window dressing means
manipulation of accounts in a way so as to conceal vital facts and present the
financial statements in a way to show a better position than what it is actually.
 Accounting is based on historical costs: Accounting often uses historical costs to
measure the values. This fails to take into consideration factors such as inflation, price
changes, etc. This skews the relevance of such accounting records and information. This
is one of the major limitations of accounting.
 Accounting is not fully exact: Although most of the transactions are recorded on the
basis of evidence such as sale or purchase or receipt of cash, yet some estimates are
also made for ascertaining profit or loss. Examples of this are providing depreciation
on the basis of the estimated useful life of an asset, possible bad debts, the probable
market price of the stock of goods, etc.

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 Types of Accounting Information

Information relating to profit or surplus

Information relating financial position

Infirmation about cash flow

Information relating to profit or surplus: The income statement i.e., profit and loss account
makes available the accounting information about the profit earned or loss incurred as a
result of business operations or otherwise during an accounting period.
Information relating to financial position: The position statement, i.e., the balance sheet
makes the information available about the financial position of the entity.
In the case of not-for-profit organisation, the difference between assets and liabilities is
termed as ‘General Fund.’
Information about cash flow: Cash flow statement is a statement that shows flow, both
inflow and outflow, of cash during a specific period. It is of immense use as many decisions
such as payment of liabilities, payment of dividend and expansion of business etc., are
based on the availability of cash.

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 Users of accounting information

Internal Users External Users

Banks and financial
Owners
institutios

Management Creditors

Employees and Investors and

workers potential investors

Government

Researchers

Consumers

Public

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Accounts Numericals Practise
Questions
[Type here]

Q.1) From the following information, calculate Net profit ratio:

Gross profit is 1/4th of cost and sales is Rs. 2,00,000
Indirect expenses is Rs. 12,000
[a] 19%
[b] 20%
*[c] 14%
[d] 25%
Explanation:
Let cost be x
Sales – cost = gross profit
200000 – x = 0.25x
x = 1,60,000
Gross profit = 160000/4 = 40,000
Net profit = GP – indirect expenses = 28000
Net profit ratio = 28,000 / 2,00,000 = 14%

Q.2) Current ratio is 2.5:1 and Liquid ratio is 1:1. Stock is Rs. 60,000. Calculate Current
liability.
*[a] Rs. 40,000
[b] Rs. 60,000
[c] Rs. 1,00,000
[d] Rs. 90,000
[e] Rs. 50,000
Explanation:
Current ratio = current assets / current liabilities
Liquid ratio = Liquid assets / current liabilities
current assets = 2.5 * current liabilities
liquid assets = current liabilities
current assets = 2.5 * liquid assets
current assets – liquid assets = 60,000
2.5 * liquid assets – liquid assets = 60,000
liquid assets = 40,000 = current liabilities

Q.3) The following information pertains to X Ltd. : Equity share capital called up
Rs.5,00,000; Calls in arrear Rs. 40,000 ; Calls in advance Rs. 25,000 ; Proposed dividend
12%. The amount of dividend payable will be:
[a] Rs. 60,000
*[b] Rs. 55,200
[c] Rs. 58,200
[d] Rs. 43,500
pg. 1
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[e] Rs. 52,200

Q.4) The profits of last three years are Rs 43,000; Rs 38,000 and Rs 45,000. Find out the
goodwill if it is valued at two years purchase of average profits.
[a] Rs 42,000
*[b] Rs 84,000
[c] Rs 1,26,000
[d] Rs 36,000
Explanation:
Average profit = 42,000
Goodwill = 42,000 * 2 = 84,000

Q.5) If capital employed by a partnership firm is Rs 1,00,000 and its average profit is Rs
20,000 normal rate of return is 15%, then find goodwill if it is valued on the basis of one
year purchase of super profits.
[a] Rs 30,000
*[b] Rs 5,000
[c] Rs 1,33,333
[d] Rs 33,333
[e] Rs 8,000
Explanation:
Normal profit = 1,00,000 * 15% = 15,000
Super profit = average profit – normal profit
Super profit = 5,000
Goodwill = 5,000

Q.6) Total capital employed by a partnership firm is Rs 1,00,000 and its average profit is
Rs 25,000. Normal rate of return is 20% in similar firms working under similar conditions.
The firms earns super profit of:
[a] Rs 3,000
*[b] Rs 5,000
[c] Rs 4,000
[d] Rs 2,000
[e] Rs 10,000
Explanation:
Normal profit = 1,00,000 * 20% = 20,000
Super profit = average profit – normal profit = 5,000

Q.7) If sales are Rs 2,000 and the rate of gross profit on cost of goods sold is 25%, then the
cost of goods sold will be
[a] Rs 2,000
pg. 2
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[b] Rs 1,500
*[c] Rs 1,600
[d] Rs 2,500
Explanation:
Sales – COGS = Gross profit
Let COGS be x
2,000 – x = 0.25x
x = Rs 1600

Q.8) If cost of goods sold is Rs 80,700, Opening stock Rs 5,800 and Closing stock Rs 6,000.
Then the amount of purchase will be
[a] Rs 80,500
[b] Rs 74,900
[c] Rs 74,700
*[d] Rs 80,900
Explanation:
COGS = Opening stock + Purchases – Closing stock
Purchases = COGS – Opening stock + Closing stock
Purchases = 80700 – 5800 + 6000
Purchases = 80900

Q.9) Preference shares amounting to Rs 1,00,000 are redeemed at a premium of 5% by

issue of shares amounting to Rs 50,000 at a premium of 10%. The amount to be
transferred to capital redemption reserve account will be
[a] Rs 55,000
*[b] Rs 50,000
[c] Rs 45,000
[d] Rs 57,500
Explanation: A capital redemption reserve account can be used to pay any unissued
shares of the company to be issued as fully paid bonus shares to the members of the
company.

Q.10) Debit balance as per Cash Book of Yeti Enterprises as on 31.3.2013 is Rs 20,000.
Cheques deposited but not cleared amounts to Rs 2,000 and Cheques issued but not
presented of Rs 4,000. Balance as per pass book should be
*[a] 22,000
[b] 18,000
[c] 20,000
[d] 24,000
Explanation:
Balance as per pass book = 20,000 – 2,000 + 4,000 = 22,000
pg. 3
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Q.11) In the books of Deepak Ltd. the machinery account shows a debit balance of Rs
60,000 as on April 1, 2011. The machinery was sold on September 30, 2012 for Rs 30,000.
The company charges depreciation @ 20% p.a. on diminishing balance method. Profit /
Loss on sale will be
[a] Rs 13,200 Profit
*[b] Rs 13,200 loss
[c] Rs 6,800 profit
[d] Rs 6,800 loss
Explanation:
Depreciation from 1-4-2011 to 31-03-2012 = 60000*20% = 12,000
Depreciation from 1-4-2012 to 30-09- 2012 = 48,000 * 20% * 0.5 = 4,800
Total depreciation = 16,800
Book value as on 30-09-2012 = 60,000 – 16,800 = 43,200
Loss on sale = 43,200 – 30,000 = 13,200

Q.12) If the rate of gross profit is 25% on cost of goods sold and the sales are Rs 5,00,000,
the amount of gross profit will be __________.
*[a] Rs 1,00,000
[b] Rs 1,50,000
[c] Rs 1,25,000
[d] Rs 1,20,000
Explanation:
Gross profit = Sales – COGS
Let COGS be x
0.25 x = 5,00,000 – x
x = 4,00,000
Gross profit = 25% of 4,00,000
Gross profit = Rs 1,00,000

Q.13) A & B are partners sharing profits and losses in the ratio 5:3 respectively. On
admission of C, new profit-sharing ratio between A, B and C is 7:5:4 respectively. Find the
sacrificing ratio as between A and B.
[a] 3:2
[b] 4:7
[c] 5:4
[d 2:1
*[e] 3:1
Explanation:
A’s sacrifice = 5/8 – 7/16 = 3/16
B’s sacrifice = 3/8 – 5/16 = 1/16
pg. 4
[Type here]

Sacrificing ratio = 3:1

Q.14) Ram and Shyam are partners sharing profits and losses in the ratio of 3:2
respectively having the capital of Rs 180,000 and Rs 150,000 respectively. They are
entitled to 10% p.a. interest on capital before distributing the profits. During the year
firm earned Rs 7,800 after allowing interest on capital. Profits apportioned among Ram
and Shyam are:
*[a] Rs 4,680 and Rs 3,120
[b] Rs 4,800 and Rs 3,000
[c] Rs 5,000 and Rs 2,800
[d] Rs 6,000 and Rs 1,800
Explanation:
Ram’s share = 7800 * 3/5 = 4680
Shyam’s share = 7800 * 2/5 = 3120

Q.15) A, B and C are equal partners. D is admitted to the firm for one-fourth share. D
brings Rs 20,000 capital and Rs 5,000 for goodwill. The value of goodwill of the firm is
[a] Rs 10,000
[b] Rs 40,000
*[c] Rs 20,000
[d] Rs 50,000

Q.16) If Average Stock = Rs 24,000. Closing stock is Rs 6,000 more than opening stock then
the value of closing stock will be
[a] Rs 24,000
[b] Rs 48,000
[c] Rs 20,500
*[d] Rs 27,000
Explanation:
average stock = (opening stock + closing stock) / 2
opening stock + closing stock = 48000
closing stock = 6000 + opening stock
opening stock = 21000
closing stock = 27000

Q.17) Q Ltd. forfeited 500 shares of Rs 10 each, Rs 8 called-up, on which the shareholder
has paid application money of Rs 3 and allotment money of Rs 2 per share. Of these, 200
shares were reissued as fully paid-up for Rs 8 per share. What amount of Forfeited Shares
Account is to be transferred to Capital Reserve?
[a] Rs 2500
[b] Rs 2100
pg. 5
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*[c] Rs 600
[d] Rs 900
[e] Rs 400
Explanation:
Amount forfeited on 200 shares (200 * 5) = Rs 1000
Less: Discount on reissue of 200 shares (200*2) = Rs 400
Gain on reissue of 200 shares transferred to Capital Reserve = Rs 600

Q.18) A fixed asset was bought for Rs. 5000. Its accumulated depreciation is Rs. 3000 and
rate of depreciation is 20%. Calculate its depreciation expenses for the current accounting
period using reducing balance method?
[a] 600
[b] 2000
[c] 300
*[d] 400
Explanation:
Written down value of asset = 5000 – 3000 = 2000
Current year depreciation = 2000 * 20% = 400

Q.19) P to whom 100 shares of Rs 10 each were allotted at par paid the application
money of Rs 2 and allotment money of Rs 4 per share. He did not pay the call money of Rs
4 per share. His shares were forfeited. The amount to be credited to Share forfeiture
account is
[a] Rs. 400
[b] Rs. 1000
*[c] Rs. 600
[d] Rs. 200

Q.20) X Ltd. forfeited 100 shares of Rs 10 each for non-payment of the final call of Rs 2;
the shares were reissued @ Rs 9 per share. How much was credited to shares forfeited
account and what amount was transferred to capital reserve?
[a] Rs 200; Rs 700
[b] Rs 200; Rs 100
[c] Rs 800; Rs 100
*[d] Rs 800; Rs 700
[e] Rs 800; Rs 900
Explanation:
Amount called up per share = Rs 10
Amount paid up per share = 10 – 2 = Rs 8
Amount credited to shares forfeited account = 8 * 100 = Rs 800
Discount per share on reissue = Rs 1
pg. 6
[Type here]

Total discount = 1 * 100 = Rs 100

Amount transferred to Capital Reserve = 800 – 100 = Rs 700

Q.21) Z Ltd. forfeited 150 shares of Rs 10, issued at a premium of Rs 2, for non-payment
of the final call of Rs 3. Of these 100 shares were re-issued @ Rs 11 per share. How much
would be transferred to capital reserve?
[a] Rs 600
*[b] Rs 700
[c] Rs 1050
[d] Rs 900
[d] Rs 1350
Explanation:
Amount paid-up per share = Rs 7
Amount transferred to capital reserve = 7 * 100 = Rs 700

Q.22) Original cost of a machine was Rs 4,05,200. Salvage value was Rs 42,000,
Depreciation for 2nd year @ 10% under WDV method is _________
*[a] Rs 36,468
[b] Rs 36,320
[c] Rs 40,520
[d] Rs 32,688
Explanation:
First year depreciation = 405200 * 10% = 40520
Second year depreciation = (405200 – 40520) * 10% = 36468

Q.23) Income and expenditure account shows subscriptions at Rs 20,000. Subscriptions

accrued in the beginning of the year and at the end of the year were Rs 1000 and Rs 1500
respectively. The figure of subscription received appearing in receipts and payments
account will be
[a] Rs 18,500
[b] Rs 21,000
[c] Rs 20,000
[d] Rs 20,500
*[e] Rs 19,500
Explanation:
Subscription received = 20,000 + 1,000 – 1,500 = 19,500

Q.24) A machinery with original cost of Rs 8,00,000 and nil salvage value acquired on 1 st
April 2018 with 4 years useful life was depreciated using straight line method. It was
decided to sell the machinery on 1st October 2021 for Rs 1,10,000. What shall be the gain
or (loss) on the sale of Machinery?
pg. 7
[Type here]

*[a] Gain of Rs 10,000

[b] Loss of Rs 10,000
[c] Loss of Rs 90,000
[d] Gain of Rs 90,000
Explanation:
Annual depreciation = Rs 2,00,000
Written down value as on 1st October 2o21 = 1,00,000
Gain = 1,10,000 – 1,00,000 = Rs 10,000

Q.25) The cash book showed an overdraft of Rs 1,20,000, but the pass book made up to
the same date showed that cheques of Rs 8000, Rs 7000 and Rs 11500 respectively had
not been presented for payments; and the cheque of Rs 5000 paid into account had not
been cleared. The balance as per the pass book will be:
[a] Rs 93,500
[b] Rs 1,25,000
*[c] Rs 98,500
[d] Rs 1,41,500
Explanation:
Balance as per pass book = 1,20,000 – 8,000 – 7,000 – 11,500 + 5,000 = 98,500

Q.26) A plant was purchased on 01-04-2018 for Rs 6,00,000. The useful life was estimated
to be 4 years and scrap value as Rs 1,00,000. Calculate the rate of depreciation under
Straight line method.
*[a] 20.83%
[b] 25%
[c] 30%
[d] 20%
Explanation:
Straight line depreciation = (cost of asset – scrap value) / useful life
Straight line depreciation = (6,00,000 – 1,00,000) / 4 = 1,25,000
Straight line depreciation rate = (Straight line depreciation / Cost of asset) * 100
Straight line depreciation rate = (1,25,000 / 6,00,000) * 100 = 20.83%

Q.27) General Manager gets 5% commission on net profit after charging such commission.
Gross profit Rs 1,30,000 and other indirect expenses other than manager's commission
are Rs 25,000. Commission amount will be
[a] Rs 5,250
*[b] Rs 5,000
[c] Rs 7,380
[d] Rs 7,750
Explanation:
pg. 8
[Type here]

Let net profit be x

x = 130000 – 25000 – 0.05x
x = 1,00,000
Commission = 5% of 1,00,000 = Rs 5,000

Q.28) From the following information, calculate inventory turnover ratio:

Revenue from operations: Rs 400000, Average inventory: Rs 55000, The rate of Gross Loss
on Revenue from Operations was 10%.
[a] 7.27 times
[b] 6.54 times
*[c] 8 times
[d] 1.375 times
Explanation:
Gross loss = 10% of 4,00,000 = 40,000
Cost of revenue from operations = revenue from operations + gross loss
Cost of revenue from operations = 4,00,000 + 40,000 = 4,40,000
Inventory turnover ratio = cost of goods sold / average inventory
Inventory turnover ratio = 4,40,000 / 55,000 = 8 times

Q.29) ABC Ltd. has a current ratio of 3.5:1 and quick ratio of 2:1. If excess of current assets
over quick assets represented by inventory is 24000, calculate current assets.
[a] Rs 16,000
*[b] Rs 56,000
[c] Rs 32,000
[d] Rs 24,000
Explanation:
Let current liabilities = x
Current assets = 3.5x
Quick assets = 2x
Inventory = current assets – quick assets
24,000 = 3.5x – 2x
x = Rs 16,000
Current assets = 3.5 * 16,000 = Rs 56,000

Q.30) When Sales = Rs 1,80,000, Purchase = Rs 1,60,000, Opening Stock = Rs 34,000 and
rate of the Gross Profit is 20% on cost, the Closing Stock would be
[a] Rs 50,000
[b] Rs 24,000
[c] Rs 46,000
*[d] Rs 44,000
Explanation:
pg. 9
[Type here]

Opening stock + Purchase – Closing Stock = COGS

COGS + Gross profit = Sales
Let COGS be x
x + 0.2x = 1,80,000
x = 1,50,000
34,000 + 1,60,000 – Closing stock = 1,50,000
Closing stock = Rs 44,000

Q.31) Salary debited to Income and Expenditure Account for the year was Rs 48,000.
Outstanding salary paid in the beginning of the year and the outstanding salary at the end
of the year were Rs 6,000 and Rs 7,500 respectively. The amount of Salary to be shown in
Receipts and Payments Account will be:
[a] Rs 48,000
[b] Rs 40,500
[c] Rs 54,000
*[d] Rs 46,500
Explanation:
Salary received = 48000 + 6000 – 7500 = 46500

Q.32) A and B are partners in a firm sharing profits in the ratio of 4:3. They agreed to
admit C in the firm for 1/6th share in profit. The new profit-sharing ratio of A, B and C will
be
[a] 4 : 3 : 1
[b] 3 : 2 : 1
*[c] 20 : 15 : 7
[d] 8 : 2 : 3
Explanation:
A’s new share = 4/7 * 5/6 = 20/42
B’s new share = 3/7 * 5/6 = 15/42
C’s share = 1/6 = 7/42

Q.33) The closing capital of Mr. B as on 31.3.2018 was Rs 4,00,000. On 1.4.2017, his
capital was Rs 3,50,000. His net profit for the year ended 31.3.2018 was Rs 1,00,000. He
introduced Rs 30,000 as additional capital in January 2018. Find out the amount drawn by
Mr. B for his domestic expenses.
[a] Rs 1,20,000
*[b] Rs 80,000
[c] Rs 1,00,000
[d] Rs 60,000
Explanation:
Profit = Closing capital + drawings – additional capital – opening capital
pg. 10
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1,00,000 = 4,00,000 + drawings – 30,000 – 3,50,000

Drawings = 80,000

Q.34) Calculate total assets to debt ratio from the below data:
Total liabilities = Rs 12,00,000
Shareholders’ Funds = Rs 2,00,000
Reserves & Surplus = Rs 50,000
Current assets = Rs 5,00,000
Working capital = Rs 1,00,000
[a] 2:1
[b] 1.5:1
*[c] 1.75:1
[d] 2.5:1
[e] 3:1
Explanation: Total assets to Debt ratio = Total assets / Long term debt
Current liabilities = Current assets – Working capital
Current liabilities = 4,00,000
Non-current (or long term) liabilities = Total liabilities – Current liabilities
Non-current liabilities = 8,00,000
Total assets = Total liabilities + shareholders’ funds
Total assets = 14,00,000
Total assets to debt ratio = 14,00,000 / 8,00,000
Total assets to debt ratio = 1.75

Q.35) From the following financial data, compute inventory turnover ratio —
Opening stock : 58,000
Purchases : 5,02,000
Return outwards : 18,000
Sales : 6,53,000
Return inwards : 13,000
Gross profit : 25% on sales
[a] 6 times
*[b] 8 times
[c] 10.67 times
[d] 7.74 times
Explanation: Net sales = 6,53,000 -13,000 = 6,40,000
Gross profit = 1,60,000
Sales – Gross profit = COGS
COGS = 4,80,000
COGS = Opening stock + Net Purchase – Closing Stock
4,80,000 = 58,000 + (5,02,000 – 18,000) – Closing stock
pg. 11
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Closing stock = 5,42,000 – 4,80,000

Closing stock = 62,000
Average inventory = 60,000
Inventory turnover ratio = COGS / Avg inventory
Inventory turnover ratio = 4,80,000 / 60,000
Inventory turnover ratio = 8 times

Q.36) Stock turnover ratio = 6 times

Average stock = Rs 8000
Selling price = 25% above cost
What is the amount of gross profit?
[a] Rs 2000
[b] Rs 4000
[c] Rs 10000
*[d] Rs 12000
[e] Rs 15000
Explanation: Stock turnover ratio = COGS / Avg stock
6 = COGS / 8000
COGS = 48000
COGS = Sales – Gross Profit
Sales = 1.25 * 48000
Sales = 60,000
Gross profit = Sales – COGS
Gross profit = 60,000 – 48,000 = 12,000

Q.37) The budgeted annual sales of a firm is Rs. 80 lakhs and 25% of the same is cash sale.
If the average amount of debtors of the company is Rs. 5 lakhs, the average collection
period of credit sales is
[a] 2 months
*[b] 1 month
[c] 15 days
[d] 3 months
[e] 45 days
Explanation:
Average collection period (number of months) = 12 / debtors turnover ratio
Debtors turnover ratio = Net credit sales / average trade receivable
Credit sales = 0.75*80 = 60 lakhs
Debtors turnover ratio = 60,00,000 / 5,00,000
Debtors turnover ratio = 12
Average collection period (in months) = 12 / 12 = 1 month

pg. 12
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Q.38) Amit and Bharat are partners sharing profits in the ratio of 3:2. They admitted
Chetan as a new partner for 3/10 share which he acquired 2/10 from Amit and 1/10 from
Bharat. Calculate the new profit-sharing ratio of Amit, Bharat and Chetan.
[a] 3:2:3
[b] 6:4:3
*[c] 4:3:3
[d] 3:4:3
Explanation:
Chetan’s share = 3/10
Amit’s new share = 3/5 – 2/10 = 4/10
Bharat’s new share = 2/5 – 1/10 = 3/10
New profit sharing ratio between Amit, Bharat and Chetan = 4:3:3

Q.39) Rahul and Avinash had a firm in which they had invested Rs 50,000. On an average,
the profits were Rs 16,000. The normal rate of return in the industry is 15%. Goodwill is to
be valued at four years’ purchase of profits in excess of profits @15% on the money
invested. Calculate the value of goodwill.
[a] Rs 8,500
*[b] Rs 34,000
[c] Rs 7,500
[d] Rs 30,000
[e] Rs 20,400
Explanation:
Normal profit = 0.15 * 50000 = 7500
Super profit = average profit – normal profit
Super profit = 16000 – 7500 = 8500
Goodwill = Super profit * Number of years purchased
Goodwill = 8500 * 4 = 34000

Q.40) A firm earned Rs 3,00,000 as profit, the normal rate of return being 12%. Assets of
the firm are Rs 36,00,000 (excluding goodwill) and Liabilities are Rs 12,00,000. Find the
value of goodwill by Capitalisation of Average Profit Method.
*[a] Rs 1,00,000
[b] Rs 11,00,000
[c] Rs 13,00,000
[d] Rs 24,00,000
Explanation:
Total capitalised value of firm = Average profit * 100 / Normal rate of return
Total capitalised value of firm = 3,00,000 * 100 / 12 = 25,00,000
Net assets = 36,00,000 – 12,00,000 = 24,00,000
Goodwill = Total capitalised value – Net Assets = 1,00,000
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Q.41) Rakesh and Suresh are sharing profits in the ratio 4:3. Zaheer join and the new ratio
among Rakesh, Suresh and Zaheer is 7:4:3. Find out the sacrificing ratio.
[a] 2:1
[b] 1:1
*[c] 1:2
[d] 1:3
[e] 3:1
Explanation:
Rakesh’s old share = 4/7
Rakesh’s new share = 7/14
Rakesh’s sacrifice = 1/14
Suresh’s old share = 3/7
Suresh’s new share = 4/14
Suresh’s sacrifice = 2/14
Sacrifice ratio among Rakesh and Suresh = 1:2

Q.42) Goodwill of a firm is to be valued at three years’ purchase of four years’ average
profit. The profits earned by the firm in the previous four years’ were Rs 15000, Rs 11000,
Rs 18000 and Rs 16000. Calculate the amount of goodwill.
[a] Rs 5000
*[b] Rs 45000
[c] Rs 15000
[d] Rs 60000
[e] Rs 20000
Explanation:
Average profit = (15000 + 11000 + 18000 + 16000) / 4 = Rs 15000
Goodwill = Average profit * Number of years’ purchase
Goodwill = 15000 * 3 = Rs 45000

Q.43) If balance in the bank statement shows Rs. 3,000 (Dr.) and there are deposits of Rs.
800 not yet credited and unpresented cheques totalling Rs. 500, the balance in the Cash
Book should be
[a] Rs 3300 (Cr.)
*[b] Rs 2700 (Cr.)
[c] Rs 4300 (Cr.)
[d] Rs 1700 (Dr.)
Explanation:
Balance as per cash book = (-)3000 + 800 – 500 = (-)2700
Negative balance in cash book indicates credit balance.

pg. 14
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Q.44) A business receives its bank statement showing the closing balance as Rs. 8,500
overdrawn. It is found that there were unpresented cheques amounting to Rs. 2,000 and
uncredited deposits amounting to Rs. 1,500. Overdraft as per Cash Book is
[a] Rs 5,000
[b] Rs 8,000
*[c] Rs 9,000
[d] Rs 12,000
Explanation:
Balance as per cash book = (-)8500 – 2000 + 1500 = Rs 9000 (overdraft)

Q.45) Cash book balance was Rs. 1,790 (Dr.). When compared with the bank statement, it
was identified that unpresented cheques were Rs. 1,040 and deposits not credited were
Rs. 820. Balance of the bank statement will be
[a] Rs 70 (Dr.)
[b] Rs 1570 (Cr.)
*[c] Rs 2,010 (Cr.)
[d] Rs 3,650 (Cr.)
Explanation:
Balance of the bank statement = 1790 + 1040 – 820 = Rs 2,010 (Cr.)

Q.46) Mohan’s bank reconciliation statement shows cheques deposited but not credited
by bank of Rs. 3,800 and cheques issued but not presented by suppliers of Rs. 3,500. His
bank balance as per Cash Book is Rs. 25,000. Balance as per pass book statement is
[a] Rs 25,000
*[b] Rs 24,700
[c] Rs 25,300
[d] Rs 32,300
Explanation:
Balance as per pass book = 25000 – 3800 + 3500 = Rs 24,700

Q.47) Credit balance as per Cash Book is Rs. 1,500. Cheques for Rs.400 were deposited
but were not collected. The cheques issued but not presented were Rs.100, Rs. 125 and
Rs.50. Balance as per Pass Book will be:
[a] Rs 1,100 debit
*[b] Rs 1,625 debit
[c] Rs 2,175 credit
[d] Rs 1,625 credit
Explanation:
Balance as per pass book = (-)1500 – 400 + 100 + 125 + 50 = (-)1625
Negative balance means debit balance in pass book.

pg. 15
[Type here]

Q.48) Find out the Bank Balance as per Cash Book from the following particulars:
(i) Overdraft as per Pass Book = Rs. 5,000.
(ii) Cheques deposited into the bank but not credited = Rs.2,000
[a] Favourable Balance = Rs.3,000
*[b] Overdraft = Rs.3,000
[c] Favourable = Rs.7,000
[d] Overdraft = Rs.7,000
Explanation:
Bank balance as per cash book = (-)5000 + 2000 = (-)3000
Negative balance means overdraft.

Q.49) A Limited Company forfeited 100 equity shares of the face value of Rs 10 each, Rs 6
per share called-up, for non-payment of first call of Rs 2 per share. 40 out of these 100
shares were subsequently reissued as fully paid-up @ Rs 7 each. What is the amount that
will be transferred to Capital Reserve?
[a] Rs 120
[b] Rs 100
[c] Rs 280
[d] Rs 480
*[e] Rs 40
Explanation:
Amount in Share forfeiture account = 100*4 = 400
Discount on reissued shares = Rs 3 per share
Amount transferred to capital reserve = 40*4 – 40*3 = Rs 40

Q.50) A Company is registered with an authorized share capital of 1,25,000 equity shares
of Rs 10 each. The company offered 80,000 equity shares to the public for subscription.
The public applied for 75,000 equity shares payable in the following manner: 25% on
application, 25% on allotment, 25% on first call and the balance on final call. The
company duly allotted these shares. Upto the current date, it has made only the first call
which has been received on all the shares except 300 equity shares. What is the
company’s paid-up share capital?
[a] Rs 5,62,500
[b] Rs 8,00,000
[c] Rs 5,99,250
*[d] Rs 5,61,750
[e] Rs 5,61,250
Explanation:
Subscribed capital = 12,50,000
Issued capital = 8,00,000
Subscribed capital = 7,50,000
pg. 16
[Type here]

Called up capital = 75000*7.5 = 5,62,500

Paid-up capital = 5,62,500 – 300*2.5 = 5,61,750

Q.51) Zebra Ltd. Invites applications for 50,000 shares for which Rs.2 per share is payable
on application. Applications were received for 80,000 shares and 50,000 shares are
allotted on pro-rata basis to the applications for 70,000 shares. Calculate the excess
application money from X, who was allotted 200 shares.
*[a] Rs 160
[b] Rs 240
[c] Rs 200
[d] Rs 100
[e] Rs 150
Explanation: Shares applied by X = 200 * (7/5) = 280
Excess shares = 280 – 200 = 80
Excess application money = 80*2 = Rs 160

Q.52) J Ltd. reissued 2,000 shares which were forfeited by crediting share forfeiture
account by Rs. 3,000. These shares were reissued at Rs. 9 Per share. The amount
transferred to Capital Reserve will be
[a] Rs 2000
[b] Rs 3000
*[c] Rs 1000
[d] Rs 1500
[e] Rs 500
Explanation: Discount given on reissued shares = 2000*1 = Rs 2000
Amount transferred to capital reserve = 3000 – 2000 = Rs 1000

Q.53) A company forfeited 2,000 shares of Rs 10 each (which were issued at par) held by
Mr. X for non-payment of first & final call money of Rs 4 per share. The called-up value
per share was Rs 10. On forfeiture, the amount debited to share capital will be
[a] Rs 10,000
[b] Rs 8,000
*[c] Rs 20,000
[d] Rs 18,000
[e] Rs 12,000

Q.54) E Ltd. had allotted 10,000 shares to the applicants of 14,000 shares on pro-rata
basis. The amount payable on application is Rs. 2. F applied for 420 shares. The number of
shares allotted and the amount carried forward for adjustment against allotment money
due from F is ?
[a] 60 shares; Rs 120
pg. 17
[Type here]

[b] 340 shares; Rs 160

[c] 320 shares; Rs 200
*[d] 300 shares; Rs 240
[e] 588 shares; Rs 336
Explanation: Shares allotted to F = 420 * (10/14) = 300
Excess shares = 420 – 300 = 120
Excess application money = 120*2 = Rs 240

pg. 18
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pg. 21
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 DISSOLUTION AND INSOLVENCY OF PARTNERSHIP FIRMS
Dissolution of the partnership firm means that the firm close down its business and comes
to an end. On dissolution of firm, the assets of the firm are sold and liabilities are paid off
and out of the remaining amount, the accounts of the partners are settled.

MODES OF DISSOLUTION OF PARTNERSHIP

FIRM

ON
BY MUTUAL COMPULSORY BY ORDER OF
HAPPENING BY NOTICE
AGREEMENT DISSOLUTION THE COURT
OF AN EVENT

ACCOUNTING PROCEDURE ON DISSOLUTION OF FIRM

In order to close the books of the firm on dissolution the following accounts are opened in
order given below:
1. Realisation account: it is opened for disposing of all the assets of the firm and
making payment to all the creditors. Realisation account is a nominal account and
the object of such an account is to find out the profit or loss on realisation of assets
and payments of liabilities.
2. Partner’s loan account: if a partner has given a loan to the firm, his loan will be paid
off after all the outside liabilities are paid in full. Therefore, partner’s loan account is
not transferred to the realisation account and his loan account is prepared
separately.
3. Partner’s capital account: after the transfer of profit or loss on realisation,
undistributed profits, reserves etc. to the capital account of the partners the balance
of the capital accounts are closed.
4. Cash or bank account: opening balance of cash or bank and all receipts are entered
on the debit side of this account. This account must be prepared and closed last of
all and the total of both the sides of this account must be equal. In this way this
account also helps in the verification of the arithmetical accuracy of the accounts.

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 BASIS OF DISTINCTION REVALUATION ACCOUNT REALISATION ACCOUNT
When prepared This account is prepared on This account is prepared on
the admission, retirement the dissolution of
or death of a partner partnership firm.
Object of preparation This account is prepared to This account is prepared to
make necessary find out the profit or loss
adjustments in the value of on the sale of assets and
assets and liabilities. repayment of liabilities.
Result Even after the preparation The firm comes to an end
of revaluation account the after the preparation of
firm continues to function, this account.
though with a changed
relationship among
partners.
Value of assets and Only the difference Book value of assets and
liabilities recorded between the book values liabilities, the realised value
and revised values of assets of assets and the actual
and liabilities is recorded in payment of liabilities is
this account. recorded in this account.

Insolvency refers to the situation in which a firm or individual is unable to meet financial
obligations to creditors as debts become due.

TYPES OF INSOLVENCY
CASH FLOW INSOLVENCY
This occurs when the firm or
individual theoretically has enough BALANCE SHEET INSOLVENCY
assets to pay off creditors but not the
When the firm or individual does not
appropriate form of payment. In
have enough assets to meet financial
short, the debtor may have
obligations to creditors, it is called
considerable assets but lack cash on
balance-sheet insolvency.
hand. Cash flow insolvency refers to
the lack of liquid assets to fulfill debt
obligations.

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 Garner vs. Murray Case
In dissolution, if the capital account of a partner shows a debit balance, he will have to pay
the amount to the firm. But if he is insolvent, he will not be able to do so. According to the
decision in Garner v. Murray, in case of insolvency of a partner:

• First, the solvent partners should bring in cash equal to their respective shares of the
loss on realisation, and
• then, the loss due to the insolvency of a partner should be divided among the other
partners in the ratio of capitals then standing.
• The effect of this decision practically is that the deficiency in the capital account of
the insolvent partner has to be borne by the solvent partners in the ratio of capitals
standing just prior to dissolution.

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ADMISSION OF A PARTNER

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Contents
Reconstitution of a Partnership Firm ................................................................................................................................ 4
Admission of a partner...................................................................................................................................................... 4
New profit sharing ratio ................................................................................................................................................ 5
Sacrificing ratio ............................................................................................................................................................. 7
Goodwill ........................................................................................................................................................................ 8
Average profit method.............................................................................................................................................. 9
Super profit method ............................................................................................................................................... 10
Capitalisation method ............................................................................................................................................. 11
Accounting treatment of Goodwill on the Admission of a New Partner .................................................................... 13
Adjustment for accumulated profits and losses ......................................................................................................... 15
Revaluation of assets and reassessment of liabilities ................................................................................................. 16
Adjustment of capitals ................................................................................................................................................ 21
Reconstitution of a Partnership Firm
Any change in the partnership agreement brings to an end the existing agreement and a
new agreement comes into force.

The change in the agreement results in changes in the relationship among the partners
which amounts to reconstitution of the partnership firm.

Reconstitution of the partnership firm happens in following situations:

Admission of a new partner

Change in Profit Sharing Ratio Among the

Existing Partners

Retirement of an existing partner

Death of a Partner

Admission of a partner
A new partner is needed into the business when

 More capital is needed for expansion of business

 A competent and experienced person is needed for the efficient running of the
business
 To encourage a capable employee by taking him into the partnership.
Following are the other important points which require attention at the time of admission
of a new partner:

 New profit sharing ratio

 Sacrificing ratio
 Valuation and adjustment of goodwill
 Revaluation of assets and Reassessment of liabilities
 Distribution of accumulated profits (reserves)
 Adjustment of partners’ capitals

New profit sharing ratio

When new partner is admitted he acquires his share in profits from the old partners

Examples

Anil and Vishal are partners sharing profits in the ratio of 3:2. They admitted Sumit as a new
partner for 1/5 share in the future profits of the firm. Calculate new profit sharing ratio of
Anil, Vishal and Sumit.

Solution

Sumit’s share = 1/5

Remaining share = 1 – 1/5 = 4/5

Anil’s new share = 3/5 of 4/5 = 12/25

Vishal’s new share = 2/5 of 4/5 = 8/25

New profit sharing ratio of Anil, Vishal and Sumit will be 12:8:5.

Note: It has been assumed that the new partner acquired his share from old partners in old
ratio.
Anshu and Nitu are partners sharing profits in the ratio of 3:2. They admitted Jyoti as a new
partner for 3/10 share which she acquired 2/10 from Anshu and 1/10 from Nitu. Calculate
the new profit sharing ratio of Anshu, Nitu and Jyoti.

Solution

Jyoti’s share = 3/10

Anshu’s new share = 3/5 – 2/10 = 4/10

Nitu’s new share = 2/5 – 1/10 = 3/10

The new profit sharing ratio between Anshu, Nitu and Jyoti will be 4:3:3.

Ram and Shyam are partners in a firm sharing profits in the ratio of 3:2. They admit
Ghanshyam as a new partner. Ram sacrifices 1/4 of his share and Shyam 1/3 of his share in
favour of Ghanshyam. Calculate new profit sharing ratio of Ram, Shyam and Ghanshyam.

Solution

Ram’s old share = 3/5

Share sacrificed by Ram = 1/4 of 3/5 = 3/20

Ram’s new share = 3/5 – 3/20 = 9/20

Shyam’s old share = 2/5

Share sacrificed by Shyam = 1/3 of 2/5 = 2/15

Shyam’s new share = 2/5 – 2/15 = 4/15

Ghanshyam’s new share = Ram’s sacrifice + Shyam’s Sacrifice = 3 2 17 20 15 6New profit

sharing ratio among Ram, Shyam and Ghanshyam will be 27:16:17
Sacrificing ratio
The ratio in which the old partners agree to sacrifice their share of profit in favour of the
incoming partner is called sacrificing ratio.

Sacrificing ratio = Old share of profit – New share of profit

Example

Rohit and Mohit are partners in a firm sharing profits in the ratio of 5:3. They admit Bijoy as
a new partner for 1/7 share in the profit. The new profit sharing ratio will be 4:2:1.
Calculate the sacrificing ratio of Rohit and Mohit.

Solution

Rohit’s old share = 5/8

Rohit’s new share = 4/7

Rohit’s sacrifice = 5/8 – 4/7 = 3/56

Mohit’s old share = 3/8

Mohit’s new share = 2/7

Mohit’s sacrifice = 3/8 – 2/7 = 5/56

Sacrificing ratio among Rohit and Mohit will be 3:5.

Goodwill
Goodwill means the ‘good-name’ or the reputation earned by a firm through the hard work
and honesty of its owners. If a firm renders good service to the customers, they will be able
to earn more profits in future.

PURCHASED GOOWILL
it is the goodwill which is acquired SELF GENERATED GOODWILL
by making a payment. it is internally generated goodwill
For example, when a business is which arises from a numbere of
purchased, the excess of purchase characteristics or attributes which
consideration over its net assets is an on-going business possesses.
referred to as purchased goodwill.

METHODS OF VALUATION OF
GOODWILL

AVERAGE PROFIT SUPER PROFIT CAPITALISATION

METHOD METHOD METHOD
Average profit method
In this method, goodwill is calculated on the basis of the number of past years profits.
Average of such profits is multiplied by the agreed number of years to find out the value of
goodwill.

Value of goodwill = Average Profit * Number of Years of Purchase

For example,

Goodwill of a firm is valued at three year’s purchase of the average profits of the last five
years. The profits of each year ending 31st March are as under:

Year Profit/loss Amount (Rs)

2011 Profit 50,000
2012 Loss 20,000
2013 Profit 10,000
2014 Profit 60,000
2015 Profit 80,000

Total profits of last five years = 50,000 – 20,000 + 10,000 + 60,000 + 80,000 = 1,80,000

Average profits = 1,80,000/5 = 36,000

Goodwill = average profits * number of year’s purchased

= 36,000 * 3 = Rs. 1,08,000

Super profit method
In this method goodwill is calculated on the basis of surplus (excess) profits earned by a
firm in comparison to average profits earned by other firms. Such excess profits are called
super profits.

Normal profits = Capital invested * Normal rate of return / 100

Super profits = Actual or Average profit – Normal profit

Goodwill = Super profit * No. of years purchased

For example,

A firm’s average profits are Rs.70,000. It includes an abnormal profit of Rs.5,000. Capital
invested in the business is Rs.5,50,000 an the normal rate of return is 10%. Calculate
goodwill at four times the super profit.

Calculation of actual average profit

Average profit = 70,000

Less: Abnormal profit = 5,000

Actual average profit = 65,000

Normal profits

Capital invested * normal rate of return/100

= 5,50,000*10/100 = 55,000

Super profit

Actual average profit – Normal profit

= 65,000 – 55,000 = 10,000

Goodwill

Super profit * Number of years purchased

= 10,000 * 4 = 40,000

Capitalisation method
Under this method goodwill can be calculated in two ways:

1. By capitalising the average profits

2. By capitalising the super profits
Capitalisation of average profits method

Under this method first of all we calculate the average profits and then we assess the
capital needed for earning such average profits on the basis of normal rate of return.

Capitalised value of average profits = average profits * 100 / normal rate of return

Goodwill = capitalised value of average profits – net assets

For example,

From the figures given below, calculate goodwill according to the capitalisation of average
profits method:

Actual average profits = Rs.72,000

Normal rate of return = 10%

Assets = Rs.9,70,000

Liabilities = Rs.4,00,000

Capitalised value of average profits = 72,000 *100/10 = Rs.7,20,000

Capital employed = assets – liabilities = 9,70,000 – 4,00,000 = Rs.5,70,000

Goodwill = 7,20,000 – 5,70,000 = Rs.1,50,000

Capitalisation of super profit method

Under this method first of all we need to calculate the super profits and then we assess the
capital needed for earning such super profits on the basis of normal rate of return.

Goodwill = super profits * 100 / normal rate of return

For example,

From the figures given below, calculate goodwill according to the capitalisation of super
profits method:

Actual average profits = Rs.72,000

Normal rate of return = 10%

Assets = Rs.9,70,000

Liabilities = Rs.4,00,000

Capital employed = assets – liabilities = 9,70,000 – 4,00,000 = Rs.5,70,000

Super profits = 72,000 – 57,000(10% * 5,70,000) = Rs.15,000

Goodwill = 15,000 * 100/10 = Rs.1,50,000

Goodwill is paid to the old partners in their sacrifice ratio because the goodwill is the
amount of compensation to be paid by the new partner to the old partners for acquiring
the share of profits which they have surrendered in favour of the new partner.
Accounting treatment of Goodwill on the Admission of a
New Partner
Case Treatment
1. Amount of goodwill is paid No entries are required to be passed
privately
2. New partners brings his share
of goodwill in Cash:
(A) Goodwill is retained in the Cash/Bank A/c Dr.
business To Premium for Goodwill A/c

Premium for Goodwill A/c Dr.

(B) Goodwill is withdrawn by To old Partner’s Capital A/c
the old partners

Old Partner’s Capital A/c Dr.

To Cash/Bank A/c
(If goodwill is withdrawn by the old partners)
** in addition to above two entries

3. New partner does not bring New Partner’s Current A/c*** Dr.
his share of goodwill in cash To old Partner’s Capital A/c (in sacrificing ratio)
*** Not Capital A/c so that Capital remains intact

When Goodwill already appears in the Books

Old Partner’s Capital A/c Dr. (Goodwill written off in old ratio)

To Goodwill A/c
Hidden goodwill

Sometimes the value of goodwill is not given at the time of admission of a new partner. In
such a situation it has to be inferred from the arrangement of the capital and profit sharing
ratio.

Example

Hem and Nem are partners in a firm sharing profits in the ratio of 3:2. Their capitals were
Rs. 80,000 and Rs. 50,000 respectively. They admitted Sam on Jan. 1, 2017 as a new partner
for 1/5 share in the future profits. Sam brought Rs. 60,000 as his capital. Calculate the value
of goodwill of the firm and record necessary journal entries on Sam’s admission, if:

(a) Sam brings his share of goodwill

(b) Sam does not bring his share of goodwill.

(a) When Sam brings his share of goodwill

Bank a/c Dr. 82,000

To capital a/c 60,000

To premium for goodwill a/c 22,000

Premium for goodwill A/c Dr. 22,000

To Hem's Capital A/c 13,200

To Nem's Capital A/c 8,800

(b) Sam does not bring his share of goodwill

Bank A/c Dr. 60,000

To Sam's Capital A/c 60,000

Sam's Current A/c Dr. 22,000

To Hem's Capital A/c 13,200

To Nem's Capital A/c 8,800

Working Notes:

Value of Firm's goodwill

Sam's Capital = Rs. 60,000

Sam's Share = 1/5

Total capital of Firm = Rs. 60,000 x 5 = Rs. 3,00,000

Hem + Nem + Sam = Rs. 80,000 + Rs. 50,000 + Rs. 60,000 = Rs. 1,90,000

Goodwill of the firm = Rs. 3,00,000 - Rs. 1,90,000 = Rs. 1,10,000

Sam's Share = Rs. 1,10,000 x 1/5 = Rs. 22,000

Adjustment for accumulated profits and losses

Sometimes a firm may have accumulated profits not yet transferred to capital accounts of
the partners. These are usually in the form of general reserve, reserve and/or Profit and
Loss Account. The new partner is not entitled to have any share in such accumulated
profits. These are distributed among the partners by transferring it to their capital current
accounts in old profit sharing ratio. Similarly, if there are some accumulated losses in the
form of a debit balance of profit and loss account and/or deferred revenue expenditure
appearing in the balance sheet of the firm.

Example
Rajinder and Surinder are partners in a firm sharing profits in the ratio of 4:1. On April 15,
2017 they admit Narender as a new partner. On that date there was a balance of Rs. 20,000
in general reserve and a debit balance of Rs. 10,000 in the profit and loss account of the
firm. Pass necessary journal entries.

General reserve a/c Dr. 20,000

To Rajinder capital a/c 16,000

To Surinder capital a/c 4,000

Rajinder capital a/c Dr. 8,000

Surinder capital a/c Dr. 2,000

To profit and loss a/c 10,000

Revaluation of assets and reassessment of liabilities

 At the time of admission of a new partner, it is always desirable to ascertain whether
the assets and liabilities of the firm are shown in books at their current values.
 In case assets are understated or overstated then they are revalued. Similarly, if
liabilities are understated or overstated then they are reassessed.
 At times there may also be some unrecorded assets and liabilities of the firm. These
also have to be brought into the books of the firm.
 For all these purposes the firm has to prepare the Revaluation Account.
 The revaluation account is credited with increase in the value of each asset and
decrease in its liabilities because it is a gain and is debited with decrease in the value
of assets and increase in its liabilities is debited to revaluation account because it is a
loss.
 The unrecorded assets are credited and unrecorded liabilities are debited to the
revaluation account.
  If the revaluation account finally shows a credit balance then it indicates net gain and
if there is a debit balance then it indicates net loss, which will be transferred to the
capital accounts of the old partners in old ratio.

The journal entries recorded for revaluation of assets and reassessment of liabilities are as
follows:

(i) For increase in the value of an asset

Asset A/c Dr.

To Revaluation A/c (Gain)

(ii) For reduction in the value of an asset

Revaluation A/c Dr.

To Asset A/c (Loss)

(iii) For appreciation in the amount of a liability

Revaluation A/c Dr.

To Liability A/c (Loss)

(iv) For reduction in the amount of a liability

Liability A/c Dr.

To Revaluation A/c (Gain)

(v) For an unrecorded asset

Asset A/c Dr.

To Revaluation A/c (Gain)

(vi) For an unrecorded liability

Revaluation A/c Dr.

To Liability A/c (Loss)

(vii) For transfer of gain on Revaluation if credit balance

Revaluation A/c Dr.

To Old Partners Capital A/cs (Old ratio)

(viii) For transferring loss on revaluation

Old partner’s Capital A/cs Dr. (Old ratio)

To Revaluation A/c

Example

Following in Balance Sheet of A and B who share profits in the ratio of 3:2
On that date C is admitted into the partnership on the following terms:

1. C is to bring in Rs. 15,000 as capital and Rs. 5,000 as premium for goodwill for 1/6 share.

2. The value of stock is reduced by 10% while plant and machinery is appreciated by 10%.

3. Furniture is revalued at Rs. 9,000.

4. A provision for doubtful debts is to be created on sundry debtors at 5% and Rs. 200 is to
be provided for an outstanding electricity bill.

5. Investment worth Rs. 1,000 (not mentioned in the balance sheet) is to be taken into
account.

6. A creditor of Rs. 100 is not likely to claim his money and is to be written off.

Record journal entries and prepare revaluation account and capital account of partners.

Bank a/c Dr. 20,000

To C’s capital a/c 15,000

To goodwill a/c 5,000

Goodwill a/c Dr. 5,000

To A’s capital a/c 3,000

To B’s capital a/c 2,000

Revaluation a/c Dr. 3,100

To stock a/c 1500

To furniture a/c 1000

To provision for doubtful debt a/c 600

Plant and machinery a/c Dr. 3,000

Investment a/c Dr. 1,000

To revaluation a/c 4,000

Revaluation a/c Dr. 200

To outstanding electricity a/c 200

Sundry creditors a/c Dr. 100

Revaluation a/c 100

Revaluation a/c Dr. 800

To A’s capital a/c 480

To B’s capital a/c 320

(Source – NCERT)

Adjustment of capitals
Sometimes, at the time of admission, the partners agree that their capitals should also be
adjusted so as to be proportionate to their profit sharing ratio. In such a situation, if the
capital of the new partner is given, the same can be used as a base for calculating the new
capitals of the old partners. The capitals thus ascertained should be compared with their

old capitals after all adjustments relating to goodwill reserves and revaluation of assets and
liabilities, etc. have been made; and then the partner whose capital falls short, will bring in
the necessary amount to cover the shortage and the partner who has a surplus, will
withdraw the excess amount of capital.
Example

A and B are partners sharing profits in the ratio of 2:1. C is admitted into the firm for 1/4
share of profits. C brings in Rs. 20,000 in respect of his capital. The capitals of old partners A
and B, after all adjustments relating to goodwill, revaluation of assets and liabilities, etc.,
are Rs. 45,000 and Rs. 15,000 respectively. It is agreed that partners’ capitals should be
according to the new profit sharing ratio. Determine the new capitals of A and B and record
the necessary journal entries assuming that the partner whose capital falls short, brings in
the amount of deficiency and the partner who has an excess, withdraws the excess amount.

Assuming that the new partner acquires his share from A and B in their old profit sharing
ratio.

Total share = 1

C’s share = 1/4

Remaining share = 1 – 1/4 = 3/4

A’s new share = 3/4 * 2/3 = 2/4

B’s new share = 3/4 * 1/3 = 1/4

New profit sharing ratio = 2:1:1

C’s capital = 20,000

Total capital = 20000 * 4 = 80,000

A’s capital = 2/4 * 80,000 = 40,000

B’s capital = 1/4 * 80,000 = 20,000

The capital of A and B after all adjustments have been made, are Rs. 45,000 and Rs. 15,000
respectively. Hence, A will withdraw Rs. 5,000 (Rs. 45,000– Rs.40,000) from the firm
whereas B will contribute additional amount of Rs. 5,000 (Rs. 20,000–Rs.15,000).

Journal entries

A’s capital a/c Dr. 5,000

To cash a/c 5,000

Cash a/c Dr. 5,000

To B’s capital a/c 5,000

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PARTNERSHIP BASIC CONCEPTS

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Contents
Meaning ............................................................................................................................................................................ 4
Partnership Deed .............................................................................................................................................................. 4
Rules applicable in the absence of partnership deed ....................................................................................................... 5
Fixed Capital Account in Partnership ................................................................................................................................ 6
Drawings - current or capital?........................................................................................................................................... 7
Fluctuating Capital Account .............................................................................................................................................. 7
Profit and loss appropriation account .............................................................................................................................. 8
Interest on capital ............................................................................................................................................................. 9
Interest on drawings ....................................................................................................................................................... 10
Interest on Monthly drawings .................................................................................................................................... 11
When Varying Amounts are Withdrawn at Different Intervals .................................................................................. 11
When Dates of Withdrawal are not specified............................................................................................................. 12
Guarantee of Profit to a Partner ..................................................................................................................................... 12
Past adjustments............................................................................................................................................................. 13
Meaning
Partnership - Partnership is defined in Section 4 of the Indian Partnership Act, 1932 as “the
relation between persons who have agreed to share the profits of a business carried on by
all or any of them acting for all”.

Partnership Deed
Agreement to carry on a business between the partners, partnership comes into existence.
The partnership agreement can be either oral or written. The Partnership Act does not
require that the agreement must be in writing. But when the agreement is in written form, it
is called ‘Partnership Deed’. Partnership deed should be duly signed by the partners, stamped
& registered.

Partnership deed generally contains the following details:

 Names and Addresses of the firm and its main business;

 Names and Addresses of all partners;
 A contribution of the amount of capital by each partner;
 The accounting period of the firm;
 The date of commencement of partnership;
 Rules regarding an operation of Bank Accounts;
 Profit and loss sharing ratio;
 The rate of interest on capital, loan, drawings, etc;
 Mode of auditor’s appointment, if any;
 Salaries, commission, etc, if payable to any partner;
 The rights, duties, and liabilities of each partner;
 Rules to be followed in case of admission, retirement, a death of a partner; and
 Any other matter relating to the conduct of business. Normally, all the matters
affecting the relationship of partners amongst themselves are covered in partnership
deed.
Rules applicable in the absence of partnership
deed

INTEREST ON
PROFIT SHARING INTEREST ON
DRAWINGS
RATIO CAPITAL
no interest on
shared equally no interest on capital
drawings

ADMISSION OF NEW
SALARY TO PARTNER
INTEREST ON LOAN PARTNER
no partner is entitled
6% per annum with consent of all
to any salary
existing partners

Q: Arti and Anita are partners in the firm without a partnership deed with a capital of
Rs5,00,000 and Rs. 3,00,000 respectively. Arti wants to share the profits in the ratio of
capitals. Whether the claim is valid, state with a reason.

Solution: In the absence the partnership deed, profits are shared equally between the
partners, according to the Indian Partnership Act, 1932. So, the claim of Arti is not
valid to share profits in the ratio of capitals.
Fixed Capital Account in Partnership

Partner’s Capital Account – Transactions

Partner’s Current Account –
relating to bringing in and taking out
Transactions relating to appropriation
capital are considered capital natured
of profits and drawings are considered
and are recorded through the regular
current natured and are recorded
capital account. Capital accounts have a
through an account named with the
fixed balance unless capital is either
partners name suffixed with the term
withdrawn or additional capital is
current.
contributed.
Drawings - current or capital?
Regular drawings as agreed upon among partners are also treated to be transactions of
current nature and are thus recorded through the current accounts. This is on the premise
that, as the firm keeps making profits, the partners would be entitled to withdraw and use
some of the profits for their necessities.

Where there is a specific instruction to treat drawings as capital i.e., to be debited to the
capital accounts, it would have to be done accordingly.

Fluctuating Capital Account

Just as in a sole proprietorship concern, in partnership also, profits or losses, drawings,
interest on capital, interest on drawings, salary (to partners), commission, additional capital
introduced etc., may all be recorded in the capital accounts. Such capital accounts are
called Fluctuating Capital Accounts because the balances of these accounts continue to
fluctuate due to various debits and credits. Under this method, there is no need to maintain
respective current accounts because all transactions passing through current accounts are
passed through capital accounts.
Profit and loss appropriation account
It shows how the profits are appropriated or distributed among the partners. All
adjustments in respect of partner’s salary, partner’s commission, interest on capital,
interest on drawings, etc. are made through this account. It starts with the net profit/net
loss as per Profit and Loss Account.

(Source – NCERT)

Example

Amit, Babu and Charu set up a partnership firm on April 1, 2019. They contributed Rs.
50,000, Rs. 40,000 and Rs. 30,000, respectively as their capitals and agreed to share profits
and losses in the ratio of 3 : 2 :1. Amit is to be paid a salary of Rs. 1,000 per month and
Babu, a Commission of Rs. 5,000. It is also provided that interest to be allowed on capital at
6% p.a. The drawings for the year were Amit Rs. 6,000, Babu Rs. 4,000 and Charu Rs. 2,000.
Interest on drawings of Rs. 270 was charged on Amit’s drawings, Rs. 180 on Babu’s
drawings and Rs. 90, on Charu’s drawings. The net profit as per Profit and Loss Account for
the year ending March 31, 2020 was Rs. 35,660. Prepare the Profit and Loss Appropriation
Account to show the distribution of profit among the partners.
 Profit and loss appropriation account

Particulars Amount Particulars Amount

(Rs.) (Rs.)
Amit’s salary 12,000 Net profit 35,660
Babu’s commission 5,000 Interest on drawings:
Interest on capital: Amit 270
Amit 3,000 Babu 180
Babu 2,400 Charu 90 540
Charu 1,800 7,200
Share of profit
transferred to capital
accounts:
Amit 6,000
Babu 4,000
Charu 2,000
12,000

36,200 36,200

Interest on capital
Interest on capital is generally provided for in two situations:

 when the partners contribute unequal amounts of capitals but share profits equally,
and
 where the capital contribution is same but profit sharing is unequal.
Interest on capital is calculated with due allowance for any addition or withdrawal of capital
during the accounting period
Example

Saloni and Srishti are partners in a firm. Their capital accounts as on April 01. 2016 showed
a balance of Rs. 2,00,000 and Rs. 3,00,000 respectively. On July 01, 2016, Saloni introduced
additional capital of Rs. 50,000 and Srishti, Rs. 60,000. On October 01 Saloni withdrew Rs.
30,000, and on January 01, 2016 Srishti withdraw, Rs. 15,000 from their capitals. Interest is
allowed @ 8% p.a. Calculate interest payable on capital to both the partners during the
financial year 2016–2017.

For Saloni

Interest on Rs.2,00,000 for 3 months = 2,00,000 * 8 * 3/ 100 * 12 = 4,000

Add: Interest on Rs.2,50,000 for 3 months = 2,50,000 * 8 * 3/ 100 * 12 = 5,000

Add: Interest on Rs.2,20,00 for 6 months = 2,20,000 * 6 * 8/ 100 * 12 = 8,800

Total interest = 17,800

For Srishti

Interest on Rs.3,00,000 for 3 months = 3,00,000 * 8 * 3/ 100 * 12 = 6,000

Add: Interest on Rs.3,60,000 for 6 months = 3,60,000 * 8 * 6/ 100 * 12 = 14,400

Add: Interest on Rs.3,45,000 for 3 months = 3,45,000 * 8 * 3/ 100 * 12 = 6900

Total interest = 27,300

Interest on drawings
Charging interest on drawings discourages excessive amounts of drawings by the partners.
The calculation of interest on drawings under different situations is shown as here under.
Interest on Monthly drawings
Average period = (Time left after first drawing + Time left after last drawing)/2

S.No. Cases Formulae of Average Period

1. When drawings are made in (12 months + 1 month)/2 = 6.5
the beginning of every month months
2. When drawings are made at (11 months + 0 month)/2 = 5.5
the end of every month months
3. When drawings are made in (11.5 months + .5 month)/2= 6
the middle or any time during the months
month
4. When drawings of equal amount (12 months + 3 months)/2 = 7.5
are made in the beginning of each months
quarter
5. When drawings of equal amount (9 months + 0 month)/2 = 4.5
are made at the end of each months
quarter

When Varying Amounts are Withdrawn at Different

Intervals

When the partners withdraw different amounts of money at different time intervals, the
interest is calculated using the product method. Under this method, first of all the products
are computed by multiplying the each set of drawings from its duration.

The different products are added and the interest is calculated on the total of products so
arrived at for one month.

Interest on Drawings = Total of products × (Rate of interest/100) × (1/12)

When Dates of Withdrawal are not specified
When the total amount withdrawn is given but the dates of withdrawals are not specified,
it is assumed that the amount was withdrawn evenly throughout the year.

For example; Shakila withdrew Rs. 60,000 from partnership firm during the year ending
March 31, 2020 and the interest on drawings is to be charged at the rate of 8 per cent per
annum. For calculation of interest, the period would be taken as six months, which is the
average period assuming, that amount is withdrawn evenly in the middle of the month,
throughout the year. The amount of interest on drawings works out to be Rs. 2,400 as
follows:
60,000 * 8 * 6/ 100 * 12 = 2,400

Guarantee of Profit to a Partner

Sometimes a partner is admitted into the firm with a guarantee of certain minimum
amount by way of his share of profits of the firm. Such assurance may be given by all the
old partners in a certain ratio or by any of the old partners, individually to the new partner.
The minimum guaranteed amount shall be paid to such new partner when his share of
profit as per the profit sharing ratio is less than the guaranteed amount.

For example, Madhulika and Rakshita, who are partners in a firm decide to admit Kanishka
into their firm, giving her the guarantee of a minimum of Rs.25,000 as her share in firm’s
profits. The firm earned a profit of Rs.1,20,000 during the year and the agreed profit
sharing ratio between the partners is decided as 2:3:1.

Madhulika’s share in profit comes to Rs.40,000 (2/6 of Rs. 1,20,000)

Rakshita, Rs. 60,000 (3/6 of Rs. 1,20,000)
Kanishka Rs. 20,000 (1/6 of Rs. 1,20,000)
The share of Kanishka works out to be Rs.5,000 short of the guaranteed amount.
This shall be borne by the guaranteeing partners Madhulika and Rakshita in their profit
sharing ratio, which in this case is 2:3
Madhulika’s share in the deficiency comes to Rs.2,000 (2/5 of Rs. 5,000)
Rakshita’s share in the deficiency comes to Rs.3,000 (3/5 of Rs. 5000)
The total profit of the firm will be distributed among the partners as follows:
Madhulika will get Rs.38,000 (her share 40,000 minus share in deficiency Rs.2,000)
Rakshita Rs.57,000 (60,000–3,000)
Kanishka Rs. 25,000 (Rs. 20,000 + Rs. 2,000 + Rs. 3,000)

Past adjustments
Sometimes a few omissions or errors in the recording of transactions or the preparation of
summary statements are found after the final accounts have been prepared and the profits
distributed among the partners. The omission may be in respect of interest on capitals,
interest on drawings, interest on partners’ loan, partner’s salary, partner’s commission or
outstanding expenses. There may also be some changes in the provisions of partnership
deed or system of accounting having impact with retrospective effect. All these acts of
omission and commission need adjustments for correction of their impact.

The adjustments can be made either

(a) through ‘Profit and Loss Adjustment Account’, or

(b) directly in the capital accounts of the concerned partners.

Example

Rameez and Zaheer are equal partners. Their capitals as on April 01, 2015 were Rs. 50,000
and Rs. 1,00,000 respectively. After the accounts for the financial year ending March 31,
2016 have been prepared, it is discovered that interest at the rate of 6 per cent per annum,
as provided in the partnership deed has not been credited to the partners’ capital accounts
before distribution of profit.

(a) Through profit and loss adjustments account

Profit and loss adjustment a/c …. Dr 9,000

To Rameez’s capital a/c 3,000

To Zaheer’s capital a/c 6,000

Rameez’s capital a/c Dr. 4,500

Zaheer’s capital Dr. 4,500

To profit and loss adjustment a/c 9,000

(b) Directly in partner’s capital accounts

(Source – NCERT)

Rameez’s capital a/c Dr 1,500

To Zaheer’s a/c 1,500

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Contents
Meaning of accounting ratio ............................................................................................................................................. 4
Objectives of Ratio Analysis .............................................................................................................................................. 4
Advantages and disadvantages ......................................................................................................................................... 4
Classification of Ratios ...................................................................................................................................................... 5
Liquidity ratio .................................................................................................................................................................... 6
Current ratio.................................................................................................................................................................. 6
Quick/Acid Test/ Liquid Ratio ....................................................................................................................................... 7
Solvency ratios .................................................................................................................................................................. 8
Debt Equity Ratio .......................................................................................................................................................... 9
Total Assets to Debt Ratio ........................................................................................................................................... 11
Proprietary Ratio ......................................................................................................................................................... 12
Interest Coverage Ratio .............................................................................................................................................. 13
Equity ratio .................................................................................................................................................................. 14
Profitability ratios ........................................................................................................................................................... 14
Gross Profit Ratio ........................................................................................................................................................ 14
Net Profit Ratio ........................................................................................................................................................... 16
Operating Profit Ratio ................................................................................................................................................. 18
Operating Ratio ........................................................................................................................................................... 20
Return on Investment ................................................................................................................................................. 22
DuPont Formula .............................................................................................................................................................. 23
Activity/ turnover/efficiency ratios................................................................................................................................. 23
Inventory Turnover Ratios .......................................................................................................................................... 24
Asset turnover ratio .................................................................................................................................................... 25
Trade Receivables Turnover Ratio .............................................................................................................................. 25
Trade Payables Turnover Ratio ................................................................................................................................... 27
Working Capital Turnover Ratio.................................................................................................................................. 29
Meaning of accounting ratio
Relationship between two terms expressed in arithmetical terms is called as ‘ratio’.

Accounting ratios refer to the ratios which gives significant relationship between two
accounting terms. It helps in analyzing the financial statements and for comparison and
decision making.

Objectives of Ratio Analysis

- Locate weak spots in the business.
- Provide deeper analysis of the liquidity, solvency, activity and profitability of the
business.
- Provide information useful for making estimates and preparing the plans for the
future.
- Provide information for making cross-sectional analysis (for making comparison with
that of some selected firms in the same industry)
- Provide information for making time-series analysis (for making comparison of a
firm’s present ratios with its past ratios)

Advantages and disadvantages

Advantages Limitations
- Analysis of financial statements - Less effective due to price level
changes
- Simplification of Accounting Data - Limited use of a single ratio
- Helpful in Comparative Study - Window dressing
- Helpful in Forecasting - Lack of proper standards
- Estimate trends - Ignores Qualitative Factors
- Effective Control - Misleading in the Absence of
Absolute Data
Classification of Ratios

• Current Ratio
• Quick Ratio
Liquidity
Ratios

• Debt equity ratio

• Total Assets to Debt Ratio
• Proprietary Ratio
Solvency • Interest Coverage Ratio
Ratios • Equity ratio

• Inventory Turnover Ratio

• Asset turnover ratio
• Debtors/Receivables Turnover Ratio
Activity • Creditors/Payables Turnover Ratio
Ratios • Working Capital Turnover Ratio

• Gross Profit ratio

• Operating Ratio
• Operating Profit Ratio
Profitabilty • Net Profit Ratio
Ratios • Return on Investment
Liquidity ratio
Liquidity ratios are calculated to measure the short-term solvency of the business, i.e. the
firm’s ability to meet its current obligations. These are analysed by looking at the amounts
of current assets and current liabilities in the balance sheet.

Types of liquidity ratios-

Current ratio
 Current ratio is a relationship of current assets to current liabilities and is computed
to assess the short term financial position of the enterprise.
 Ideal current ratio: 2:1

Current Ratio= current assets/ current liabilities

Current assets include current investments, inventories, trade receivables (debtors and bills
receivables), cash and cash equivalents, short-term loans and advances and other current
assets such as prepaid expenses, advance tax and accrued income, etc.

Current liabilities include short-term borrowings, trade payables (creditors and bills
payables), other current liabilities and short-term provisions.

*** Items excluded from current assets:

 Loose tools, Stores and Spares

 Provision for doubtful debts is deducted from sundry trade receivables and the
amount so arrived at is taken as current asset.

Significance:

Current assets of a business must at least, be twice of its current liabilities so that even if
half the amount is realized from the current assets on time, the firm can still meet its
current liabilities in full.
Quick/Acid Test/ Liquid Ratio
Liquid assets are the assets which are either in the form of cash and cash equivalents or can
be converted into cash within a very short period.

Quick Ratio = Quick assets / Current Liabilities

Quick assets = Current assets – Inventories – Prepaid Expenses and Advance

Taxes

OR

Quick assets = Current investments + Trade Receivables (Excluding provision

for doubtful debts) + cash and cash equivalents + short term loans and
advances

*Inventory is excluded as it has to be sold before being converted into cash.

**Prepaid expenses are excluded as they are not expected to be converted into cash.

Ideal Quick Ratio: 1:1

Significance:

For every rupee of current liabilities, there should at least be one rupee of liquid assets. It is
a better test of short term financial position of a company than the current ratio as it
considers only those assets which can be easily and readily converted into cash.

Example:

From the following information, calculate Current ratio, Liquid ratio and Super quick ratio.

Items Amount Items Amount

Marketable securities 40,000 Cash & Cash equivalents 10,000
Inventories 5,000 Advance tax 8,000
Prepaid expenses 2,000 Short term loans & 4,000
Advances
Short term Borrowings 20,000 Goodwill 1,00,000
Trade Payables 2,000 Short term Provisions 3,000
Trade Receivables 2,000 Other current liabilities 5,000

Current Liabilities = Short term Borrowings + Trade Payables + Short term Provisions +
Other current liabilities

= 30,000

Current Assets = Marketable securities + Inventories + Prepaid expenses + Trade

Receivables + Cash & Cash equivalents + Advance tax + Short term loans & Advances =
71000

(a) Current ratio = Current Assets/ Current Liabilities = 71000/30000

=2.37:1 (Greater than 2:1)
(b) Quick ratio = Quick Assets / Current Liabilities = 56000/30000

= 1.87:1 (Greater than 1:1)

Quick assets = Current assets – Inventories – Prepaid expenses – Advance Tax

Solvency ratios
Solvency ratios are those ratios which show the ability of the enterprise to meet its long
term liabilities.

Many people confuse solvency ratios with liquidity ratios. Although they both measure the
ability of a company to pay off its obligations, solvency ratios focus more on the long-term
sustainability of company instead of the current liability payments.
Debt Equity Ratio
This ratio expresses the relationship between long term debts and shareholder’s funds. This
ratio indicates the proportion of funds which are acquired by long term borrowings in
comparison to shareholder’s funds.
Debt equity ratio is computed to assess long term financial soundness of the enterprise.

Debt Equity Ratio = Debt/Equity

Or
Debt Equity Ratio = Long term Debts/Shareholders funds or Net worth

Long term debt includes long term borrowings and long term provisions.
Shareholder’s funds = Share Capital + Reserves and Surplus

= Equity Share capital+ Preference Share capital + Capital Reserve + Securities Premium +
General Reserve + Balance in Statement of Profit & Loss
OR
Shareholder’s funds = Non-current assets + Working Capital- Non-current Liabilities

Working Capital = Current Assets – Current Liabilities

Ideal Ratio: 2:1

Significance:

This ratio is calculated to ascertain the soundness of the long term financial policies of the
firm. It also indicates the extent to which the enterprise depends on external funds for its
business.

Example:
Calculate Debt Equity Ratio from the following:

Items Amount
Land & Building 15,00,000
Plant & Machinery 6,00,000
Intangible Assets 1,00,000
Inventory 5,50,000
Trade Receivables 1,70,000
Trade Payables 1,20,000
Long Term Borrowings 12,00,000

Debt Equity Ratio = Debt/Equity = Long term Debts/Shareholder’s funds

Long term Debts = Long Term Borrowings = 12,00,000

Shareholder’s funds = Non-current assets + Working Capital- Non-current Liabilities

Non-Current Assets = Land & Building + Plant & Machinery + Intangible Assets
= 22,00,000

Working Capital = Current Assets – Current Liabilities

= 6,00,000

Shareholder’s funds = 22,00,0000 + 6,00,000 – 12,00,000

= 16,00,000

Debt Equity Ratio = 12,00,000/16,00,000 = 0.75:1

It implies a more financially stable business as it is less than 2:1.

Total Assets to Debt Ratio
It measures the relationship between total assets and long-term debts. It measures the
extent to which long term debts are covered by assets which indicates the margin of safety.

Total Assets to Debt Ratio = Total Assets/Long Term Debt

Total Assets = Non-Current Assets (Tangible Assets + Intangible Assets +

Non-Current Investments + Long Term Loans &
Advances) + Current Assets

Debt = Long Term Borrowings + Long Term Provisions

Example:

Calculate Total Assets to Debt Ratio from the following:

Items Amount
Land & Building 15,00,000
Plant & Machinery 6,00,000
Intangible Assets 1,00,000
Inventory 5,50,000
Trade Receivables 1,70,000
Trade Payables 1,20,000
Long Term Borrowings 12,00,000

Total Assets = Land & Building + Plant & Machinery + Intangible Assets +
Inventory + Trade Receivables = 29,20,000

Long Term Debt = 12,00,000

Total Assets to Debt Ratio = Total Assets/Long Term Debt

= 29,20,000/12,00,000

= 2.43:1

Proprietary Ratio
This ratio indicates the proportion of total assets funded by owners or shareholders.

Proprietary Ratio = Shareholder’s Funds/ Total Assets

Example:

Calculate Proprietary Ratio from the following:

Items Amount
Total debt 30,00,000
Shareholder’s funds 12,00,000
Reserves and Surplus 8,00,000
Current Assets 15,00,000
Working Capital 9,00,000

Proprietary Ratio = Equity/ Total Assets

Current Liabilities = Current Assets – Working Capital

= 6,00,000

Long term Debts = Total Debt – Current Liabilities

= 24,00,000

Total assets = Total debt + Shareholder’s funds

 = 42,00,000

Proprietary Ratio = Shareholder’s funds/ Total assets

= 12,00,000/42,00,000 = 0.285:1

*Reserves and surplus are already included in Shareholder’s funds.

Interest Coverage Ratio

This ratio is calculated by dividing the profit before charging interest and income tax (PBIT)
by fixed interest charges.

Interest Coverage Ratio = (Profit before charging Interest and Income Tax)/
Fixed Interest Charges

Fixed Interest Charges include interest on fixed (long-term) loans or debentures.

Significance
This ratio indicates how many times the interest charges are covered by the profits
available to pay interest charges.

Example:

From the following information, Calculate Interest Coverage Ratio:

Net Profit after Tax Rs.1,20,000

12% Long term Debt Rs.20,00,000

Tax Rate 40%

Net profit before tax = 120,000 × 100/60 = 2,00,000

Interest @12% on long term debt = 2,40,000

Profit before interest and tax = Rs.4,40,000

Interest Coverage Ratio = 4,40,000/2,40,000 = 1.833 times

Equity ratio
The shareholder equity ratio indicates how much of a company's assets have been
generated by issuing equity shares rather than by taking on debt.

Equity Ratio = Total Equity/ Total Assets

Profitability ratios

Profitability ratios compare income statement accounts to show a company's ability to

generate profits from its operations. Profitability ratios focus on a company's return on
investment in inventory and other assets. These ratios basically show how well companies
can achieve profits from their operations.
Investors and creditors can use profitability ratios to judge a company's return on
investment based on its relative level of resources and assets. In other words, profitability
ratios can be used to judge whether companies are making enough operational profit from
their assets.

Gross Profit Ratio

Gross margin compares the gross margin of a business to the net sales. This ratio measures
how profitably a company sells its inventory.
In other words, the gross profit ratio is essentially the percentage markup on merchandise
from its cost.

Gross Profit ratio = Gross Profit/ Net sales

Cost of goods sold = Opening stock + Purchases + Direct expenses – Closing

stock

Net sales = Gross sales minus any Returns or Refunds.

Gross Profit = Net sales - Cost of goods sold

Direct expenses are the expenses incurred directly in the production process of a product.

Indirect expenses are expenses incurred on administrative and office work of the company.

For example, labour expense is a direct expense but salary of accountant is indirect as
labour is used for production process whereas accountant is used to prepare financial
accounts for the company, which is not something it sells to the customer.

** Spare parts and Loose Tools are excluded from inventory.

Significance
Gross Profit Ratio should be adequate enough not only to cover operating expenses but
also to provide for depreciation, interest on loans, dividends and creation of reserves.

Example

Calculate the Gross Profit Ratio from the following information:

Revenue from operations Rs.4,00,000
Gross Profit 25% on cost

If Gross Profit is 25% on cost, then goods costing 100 have been sold for 125.

Gross Profit = (Revenue from operations × 25)/125

= 80,000

Gross Profit Ratio = (Gross Profit/Revenue from Operations) × 100

= 20%

Net Profit Ratio

It measures the amount of net income earned with each rupee of sales generated by
comparing the net income and net sales of a company. In other words, the net profit ratio
shows what percentage of sales are left over after all expenses are paid by the business.

Net Profit Ratio = (Net Profit / Net sales)* 100

Net profit = Gross profit - Indirect Expenses & Losses +

Indirect income

Indirect expenses & losses = Office exp. + Selling exp. + Interest on Long
term Borrowings + Accidental Losses
Significance
This ratio measures the rate of net profit earned on Revenue from Operations. It helps in
determining the overall efficiency of the business operations. An increase in the ratio over
the previous year shows improvement in the overall efficiency and profitability of the
business.

Example

From the following information, calculate Net Profit Ratio:

Items Amount (Rs.)

Opening Inventory 3,00,000
Closing Inventory 4,20,000
Purchases 14,00,000
Wages 3,70,000
Carriage Inwards 1,50,000
Administrative Exp. 84,000
Selling Exp. 36,000
Income Tax 1,00,000
Profit on sale of Fixed Assets 20,000
Revenue from Operations 24,00,000

Cost of Revenue from Operations = Opening Inventory + Purchases + Wages + Carriage

Inwards – Closing Inventory
= 18,00,000

Gross Profit = Revenue from Operations - Cost of Revenue from Operations

= 6,00,000
Net Profit = Gross Profit - Administrative Expenses - Selling Expenses –
Income Tax + Profit on sale of Fixed Assets
= 4,00,000

Net Profit Ratio = (Net Profit after Tax/ Net sales)* 100

= (4,00,000 /24,00,000) *100

= 16.67%

Operating Profit Ratio

This ratio shows the relationship between operating profit and net Revenue from
Operations.
 Operating Profit Ratio = (Operating Profit /Revenue from
Operations) * 100

Operating profit = Gross profit - Other Operating Expenses

or
Net profit (before tax) + Non-operating expenses/
losses - Non-Operating Incomes

Other operating expenses = Employee Benefit Expenses + Depreciation and

Amortization Expenses + Other expenses (i.e. Office
and Administration Expenses + Selling and
Distribution Expenses + Discount + Bad debts +
Interest on short term loans)

Relation

Operating Ratio and Operating Profit Ratio are inter-related. Total of both these ratios will
be 100. A rise in ‘Operating Ratio’ will lead to a similar amount of decline in ‘Operating
Profit Ratio’ and vice versa. For example, if Operating Ratio is 60%, it means that the
Operating Profit Ratio is 40%.
Operating Ratio

Operating ratio establishes relationship between operating costs and net sales.
Operating cost includes “direct cost of goods sold, administrative, selling and distribution
expenses, interest on working capital loans, discounts, bad debts”.
It excludes incomes and expenses, which have no relation with production or sales.
For example “interest and dividend received on investment, interest on loans and
debentures, profit or loss on sale of fixed assets”.

Operating Ratio = (Cost of Goods Sold + Operating Expenses) * 100 / Net

Sales

** Depreciation and Amortization Expenses are included in Operating Expenses.

Operating income includes Trading Commission received and Cash discount received.

Significance

It is the measurement of the efficiency and profitability of the business enterprise.

Lower the operating ratio, the better it is, as it will leave higher margin of profit on Revenue
from Operations.

Example

Calculate Operating Profit Ratio and Operating Ratio from the following information:

Items Amount
Cash revenue from operations 1,00,000
Net purchases 2,97,000
Credit Revenue from Operations 3,00,000
Carriage Inward 3,000
Administrative Expenses 40,000
Profit on Sale of Fixed Assets 10,000

Revenue from Operations = Cash revenue + Credit revenue

= 4,00,000

Cost of Revenue from Operations = Net Purchases + Carriage Inwards

= 3,00,000

Gross Profit = Revenue from Operations - Cost of Revenue from

Operations

= 1,00,000

Operating Expenses = Administrative Expenses

= 40,000

Operating Profit = Gross Profit - Operating Expenses

= 60,000

Operating Profit Ratio = (Operating Profit/ Revenue from Operations)*100

= 15%

Operating Ratio = (Cost of Goods Sold + Operating Expenses) * 100 / Net

Sales

= (3,40,000/4,00,000) *100

= 85%
Return on Investment
This ratio shows the overall profitability of the business. It is calculated by comparing the
profit earned and the capital employed to earn it.

It is also known as ‘Rate of Return’ or ‘Return on Capital Employed’ or ‘Yield on Capital’.

Return on Investment = (Net Profit before Interest, Tax and

Dividends)/Capital Employed * 100

Liabilities side approach

Capital Employed = Shareholder’s Funds + Non-Current Liabilities – Fictitious Assets

Assets side approach

Capital Employed = Non-current assets + Working capital

Example

From the following details calculate the return on investment

Share Capital : Equity (Rs.10) Rs. 4,00,000

12% Preference Rs. 1,00,000

General Reserve Rs. 1,84,000

10% Debentures Rs. 4,00,000

Current Liabilities Rs. 1,00,000

Fixed Assets Rs. 9,50,000

Current Assets Rs. 2,34,000

Profit before interest and tax = Rs. 1,50,000 + Debenture interest + Tax

= Rs. 1,50,000 + Rs. 40,000 + Rs. 50,000 = Rs.2,40,000

Capital Employed = Equity Share Capital + Preference Share Capital + Reserves +

Debentures

= Rs. 4,00,000 + Rs. 1,00,000 + Rs. 1,84,000 + Rs. 4,00,000 = Rs. 10,84,000

Return on Investment = Profit before Interest and Tax/ Capital Employed × 100 = Rs.
2,40,000/Rs. 10,84,000 × 100 = 22.14%

DuPont Formula
Return on Equity = Net Profit Margin × Assets Turnover × Equity Multiplier

= Net Profit/ Sales × Sales/Assets × Assets/Equity

Activity/ turnover/efficiency ratios

They measure how well companies utilize their assets to generate income. Efficiency ratios
often look at the time it takes companies to collect cash from customer or the time it takes
companies to convert inventory into cash—in other words, make sales. These ratios are
used by management to help improve the company as well as outside investors and
creditors looking at the operations of profitability of the company.

These ratios are known as turnover ratios as they indicate the rapidity with which the
resources available to the concern are being used to produce revenue from operations.
Inventory Turnover Ratios

It shows how effectively inventory is managed by comparing cost of goods sold with
average inventory for a period.

Inventory turnover ratio = Cost of goods sold/ average inventory

COGS = Opening stock + Purchases + Direct Expenses –

Closing Stock

Average stock = (Opening stock + Closing stock)/ 2

Significance
This measures how many times average inventory is "turned" or sold during a period.
Low turnover of inventory may be due to bad buying, obsolete inventory, etc., and is a
danger signal. High turnover is good but it must be carefully interpreted as it may be due to
buying in small lots or selling quickly at low margin to realise cash.

Example

From the following information, Calculate Inventory Turnover Ratio:

Cost of Revenue from Operations 5,40,000

Purchases 5,50,000

Direct Expenses 30,000

Opening Inventory 70,000

Cost of Revenue from Operations = Opening Inventory + Purchases + Direct Expenses –

Closing Inventory

Closing inventory = 1,10,000

Average inventory = (Opening Inventory + Closing Inventory)/2

 = 90,000

Inventory turnover ratio = cost of goods sold/ average inventory

= 5,40,000/90,000
= 6 times

Note: Cost of goods sold is also known as cost of revenue from operations.

Asset turnover ratio

The asset turnover ratio measures the efficiency of a company's assets to generate revenue
or sales.

Asset turnover ratio = Net sales / Average total assets

Average total assets = Assets in the beginning + Assets in the end / 2

Trade Receivables Turnover Ratio

It measures how many times a business can turn its accounts receivable into cash during a
period.
In other words, the accounts receivable turnover ratio measures how many times a
business can collect its average accounts receivable during the year.
This ratio shows how efficient a company is at collecting its credit sales from customers.
Higher ratios mean that companies are collecting their receivables more frequently
throughout the year.

Trade receivable turnover ratio = Net credit sales/ average Trade

receivable
Net credit sales = credit sales – sales return
Average debtors = (opening debtors + opening bills
receivable + closing debtors + closing
bills receivable)/ 2
** Doubtful debtors are not to be deducted from debtors since the purpose is to find out
days for which sales are tied up in debtors.

Average collection period is calculated after calculating debtors turnover ratio.

The formula is:

Debt collection period (number of months) = 12/ debtors turnover ratio

Debt collection period (number of days) = 365/ debtors turnover ratio

Example

From the following information, Calculate:

(i) Trade receivable turnover ratio

(ii) Average Collection Period

Total revenue operations for the year 2,00,000

Cash revenue operations for the year 40,000

Trade Receivables at the beginning 20,000

Trade Receivables at the end of the year 60,000

Credit revenue from operations = Total revenue operations for the year - Cash
revenue operations for the year

= 1,60,000
Average Trade Receivables = (Trade Receivables at the beginning +Trade Receivables at
the end of the year)/2

= 40,000

Trade receivable turnover ratio = 160,000/40,000 = 4 times

Average Collection Period = 12/ Trade receivable turnover ratio

= 12/4 = 3 months

Trade Payables Turnover Ratio

Enterprises from whom goods have been purchased are known as creditors or trade
payables. Creditors and bills payable are together called as total payables. The ratio shows
relationship between net credit purchases and average payables.

Creditor’s Turnover Ratio = Net Credit Purchases/ Average Payables

Average Payables = (Opening creditors + Opening bills payable

+ Closing creditors and Closing bills payable)/
2

Significance:

It indicates the speed with which the amount is being paid to trade payables.

The higher the ratio – The better it is – Trade Payables are being paid more quickly –
Increases credit worthiness of the firm.

Average Payment Period indicates the period which is normally taken by the firm to make
payments to its trade payables.

Average Payment Period (in days) = 365/ Creditor’s Turnover Ratio

Average Payment Period (in months) = 12/ Creditor’s Turnover Ratio

Example:

From the following information, Calculate:

(i) Trade Payables turnover ratio

(ii) Average Payment Period

Revenue from operations 5,25,00,000

Bills Payable 5,00,000

Bills Receivable 6,00,000

Total Purchases 3,15,00,000

Creditors 20,00,000

Debtors 54,00,000

Trade Payables turnover ratio = Net Credit Purchases/ Average Payables

= 3,15,00,000 / 25,00,000
= 12.6 times

Average Payment Period = 365/ Trade Payables turnover ratio

= 29 days (approx.)

Note: Since credit purchases are not mentioned, amount of total purchases has been taken.

Also average trade payables are not mentioned in the question, the ratio has been
calculated on the basis of total figures.
Working Capital Turnover Ratio
It establishes relationship between working capital and sales.
It shows the number of times a unit of rupee invested in working capital produces sales.

Working Capital Turnover Ratio = Net Sales/ Working Capital

Net Working capital = Current Assets – Current Liabilities

Example

Calculate Working Capital Turnover Ratio from the following:

Items Amount
Revenue from Operations 18,00,000
Inventory 3,60,000
Trade Receivables 1,70,000
Marketable securities 50,000
Cash and Bank 20,000
Trade Payables 1,40,000
Provision for Tax 10,000

Current Assets = Inventory + Trade Receivables + Marketable securities +

Cash and Bank

= 6,00,000
Current Liabilities = Trade Payables + Provision for Tax

= 150,000

Working Capital = Current Assets – Current Liabilities

= 4,50,000

Working Capital Turnover Ratio = Revenue from Operations/ Working Capital

= 18,00,0000/ 4,50,000
= 4 times
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NOT FOR PROFIT
ORGANIZATIONS
[Type here]

NOT-FOR-PROFIT ORGANISATIONS:

Non-profit making organization are those, which do not buy/manufacture and sell
goods and whose primary object is not to earn profit. Their object is to do good to the
society through welfare activities. Examples of non-profit organizations are clubs,
schools, colleges, Hospitals, Libraries etc.

Main features of Not-for- Profit Organisations:

- Main aim is service
- Form: set up as charitable trusts or societies and subscribers to these
organisations are called members.
- Separate entity
- Managed by elected members
- Major sources of income: (a) subscriptions from members; (b) donations etc.
- Surplus not distributed among members (added to Capital fund)

Distinction between Not for Profit Organisation and Profit Earning Organisation

FINANCIAL STATEMENTS OF NON-PROFIT ORGANISATIONS:

Financial statements include;

A) Receipt and Payment Account
[Type here]

B) Income and Expenditure Account

C) Balance Sheet

Receipt and Payment account:

It is the summarized cash book for a given accounting period.

All cash receipts during the whole year are recorded on its left hand (i.e., debit) side.
While all the cash payments during the whole year written on its right hand (i.e.,
credit) side. Its closing balance indicates cash in hand and cash at bank at the year
end.

Cash Book Receipts and Payments Account

1 It is a book of account within 1 It is an account outside the double

the double entry system. entry system.
2 Each transaction is recorded here 2 Each transaction is not recorded
separately in chronological order. separately - all the transactions are
recorded at a time at the end of
accounting year in a classified from.
3 Ledger reference is recorded here 3 No ledger reference is recorded

4 Daily cash balance can be 4 Daily cash balance cannot be

ascertained from this book. ascertained.
[Type here]

5 All concerns (non-profit seeking 5 Only non-profit seeking

and profit seeking) organizations organizations prepare it.
prepare it.
6 Whenever a cash transaction takes 6 It is prepared on the last day of the
place, it is recorded in this book. In year. In other words, it is a
other words, it is a current account. periodical account.
7 It is a must. 7 It is not indispensable - it may not
be prepared.

Income and Expenditure Account:

This is similar to Profit and Loss Account and which is prepared for finding the excess
of income over expenditures or excess of expenditures over incomes.

Notes:
1. All expenses are recorded on Debit side and all revenues on Credit side.
2. Only revenue transactions are included in it. No capital item is taken into
account.
3. All the items of income/revenue concerning current year — whether received
in cash or not—and all items of expense —whether paid in cash or not—are
taken into account.
4. Surplus or deficit of a concern is ascertained through this account. Credit
balance "indicates surplus, while debit balance indicates deficit.
5. Its balance is transferred to Capital Fund Account.
[Type here]

Difference between Income and Expenditure Account A/c and Profit and Loss A/c
[Type here]

Basis of Income and Expenditure A/c Profit and Loss A/c

Difference
1. Definition Income and expenditure Profit and loss account is
account is account which is the account which is
prepared for finding the prepared for finding net
excess of income over profit or net loss.
expenditures or excess of
expenditures over incomes.
2. Not for Income and expenditure Profit and loss account is
Profit account is prepared by not - prepared
organisation or for profit organisation whose by business whose aim is
Business aim is not to earn money. to earn money.

3. Basis of Income and expenditure Profit and loss account is

Preparation account is prepared on the prepared on the basis of
basis of receipt and payment trial balance and some
account and some other other information.
information.

4. Balance of When we compare debit and The balance of profit and

Account credit side of this account, loss account will be net
balance will be surplus profit or net loss.
or deficit.

DISTINCTION BETWEEN RECEIPTS & PAYMENT ACCOUNT and INCOME &

EXPENDITURE ACCOUNT
[Type here]

Balance Sheet:
This shows the financial position of non-profit organizations at the end of the
accounting year. It contains only capital items, grouped together as Assets and
Liabilities.
[Type here]

IMPORTANT TERMINOLOGIES:

1. Subscription:
It is the major source of revenue income of a non-profit organization. It is periodically
paid by the members of the club.
It can be calculated as:

Or it can be calculated through:

[Type here]

2. Entrance /Admission Fees:

It is the initial amount paid by new members apart from regular subscriptions.
Recurring Nature- Treated as revenue receipt and credited to Income &
Expenditure Account. (if nothing is stated, it is taken as regular)
Non-recurring Nature- Treated as Capital Receipt and shown as liabilities Side
of Balance sheet.

3. DONATION:
It is received from persons, institutions etc. in the form of money or kind.
It can be:
A) General Donation:
• Big Amount- shown on Liability side of Balance Sheet as it is non-
recurring in nature.
• Small Amount- shown on credit side of Income and Expenditure
Account as it is recurring in nature.
B) Specific Donation: (given for a specific purpose)
It is capitalized and shown on liabilities side in Balance Sheet.

4. LEGACY:
It is the amount received as per the WILL of a deceased person. It is not
recurring, hence shown on Liability side of Balance Sheet. If given for a specific
purpose, then it is added to that specific account.

5. SALE OF FIXED ASSETS

[Type here]

Sale of fixed assets should be treated as capital revenue and hence debited to
Revenue & Expenditure Account. Asset account should be credited with book
value of asset and profit and loss should be recorded in Income & Expenditure
Account.

6. USE OF CONSUMABLE ITEMS:

Every non-profit organization uses some consumable items, like, stationery,
sports materials, medicines etc. these items must be debited to Income and
Expenditure Account.

7. PAYMENT OF HONORARIUM:
The amount paid to persons who are not the employees of the institution is
called as honorarium and is debited to the Income and Expenditure Account.

8. FUNDS:
[Type here]

• Special funds are opened to maintain a record of amount received and

spent out for that special purpose.
• General or Capital fund is the difference between assets and outside
liabilities and the difference of income and expenditure is transferred to
this fund every year.

9. PURCHASE AND SALE OF NEWSPAPER:

It is recurring in nature, hence, purchase of newspaper will be debited to
Income and Expenditure Account and sale will be credited to it.

10.LIFE MEMBERSHIP FEES

Some members may pay a lump sum amount to become a life member. It is
non-recurring, hence, shown on Liabilities side of the Balance Sheet.

QUESTIONS

Q.1) Amount received from sale of old grass by a club is treated as:

[a] Capital receipt

*[b] Revenue receipt
[c] Asset
[d] None of the above

Q.2) Receipts and Payment Account generally shows:

*[a] A Debit Balance

[b] A Credit Balance
[c] Surplus or Deficit
[d] Capital Fund
[Type here]

Q.3) Consider the following statements and identify the correct ones:

1. Not for profit organizations need not maintain proper accounts.

2. Donations for specific purposes are always capitalized.
3. Not for profit organizations do not maintain any Capital Account.

[a] 1 and 2
*[b] 2 and 3
[c] 1 and 3
[d] 1, 2 and 3

Q.4) If there is a ‘Match Fund’, then match expenses and incomes are
transferred to:
[a] Income and Expenditure Account
[b] Asset side of Balance Sheet
*[c] Liability side of Balance Sheet
[d] Both Income & Expenditure A/c and to Balance Sheet

Q.5) Subscription received by a school for organizing annual function is

treated as:

*[a] Capital Receipt

[b] Revenue Receipt
[c] Asset
[d] Earned Income

Q.6) Salary paid in cash during the current year was Rs.70,000; Outstanding
salary at end was Rs.4000; Salary paid in advance last year pertaining to
the current year was Rs.3200; Paid in advance during current year for
next year was Rs.5000. The amount debited to Income & Expenditure
A/c will be:

[a] 75,800
[b] 67,800
*[c] 72,200
[d] 64,200
[Type here]

Q.7) Consider the following statements and identify the correct ones:

1. Scholarships granted to students out of funds provided by

government will be debited to Income & Expenditure A/c.
2. Receipt & Payment A/c is equivalent to profit and loss account.

[a] 1 only
[b] 2 only
[c] Both 1 and 2
*[d] Neither 1 nor 2

Q.8) Subscription received in advance during the current year is:

[a] an income
*[b] an asset
[c] a liability
[d] none of these
[Type here]
[Type here]
[Type here]
[Type here]
COMPARATIVE AND COMMON SIZE
STATEMENTS

Chanchal Phore
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Contents
Comparative statements................................................................................................................................................... 4
Comparative balance sheet .......................................................................................................................................... 4
Comparative Statement of Profit and Loss ................................................................................................................... 5
Common size statements.................................................................................................................................................. 5
Common size balance sheet ......................................................................................................................................... 6
Common size statement of profit & loss ...................................................................................................................... 6
Comparative statements
When financial statement figures of two or more years are placed side-by-side to facilitate
comparison, they are called ‘Comparative Financial Statements’.

Comparative balance sheet

COMPARATIVE BALANCE SHEET

As at 31st March 2016 and 2017

Particulars Note 31.3.2016 31.3.2017 Absolute Percentage

No. Change Change
(Increase or (Increase or
Decrease) Decrease)
A B C= B-A D= (C/A)
×100
I. Equity and Liabilities
(1) Shareholder’s funds
(2) Non-current
liabilities
(3) Current liabilities

TOTAL

II. Assets
(1) Non-Current Assets
(2) Current Assets

TOTAL
Comparative Statement of Profit and Loss

Common size statements

Common size statements are those in which individual figures are converted into
percentages to some common base.
Common size balance sheet

COMMON SIZE BALANCE SHEET

As at 31 March, 2016 and 2017

Particulars Note Absolute Amounts Percentage of Balance

No. Sheet Total
31.3.2016 31.3.2017 31.3.2016 31.3.2017
I. Equity and Liabilities
(1) Shareholder’s
funds
(2) Non-current
liabilities
(3) Current
liabilities

TOTAL 100 100

II. Assets
(1) Non-Current
Assets
(2) Current Assets

TOTAL 100 100

Common size statement of profit & loss

It is a statement in which the figure of revenue from operations is assumed to be equal to
100 and all other figures are expressed as percentage of revenue from operations.
Check our website www.anujjindal in for enrolment,
Course details and other updates!

Or

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“HALL OF FAME”
 RBI

550+ Students cleared RBI Phase 1

300+ Students clear RBI Phase 2
48 Students got selected in RBI
SEBI
NABARD
UGC NET JRF
FINANCIAL STATEMENTS OF A
COMPANY
Chanchal Phore
 KEY BENEFITS OF OUR COURSES

Our course structure includes a lot of perks that

are otherwise unavailable elsewhere.
It is a comprehensive guide to help you crack the
paper & secure your dream position.

We provide personal solutions all queries using a Telegram

group wherein Anuj Jindal himself will clarify your doubts.

We curate the learning strategies of past year toppers to help

you learn from the success of the best
Contents
Meaning ............................................................................................................................................................................ 4
Nature of financial statements ......................................................................................................................................... 5
Balance sheet ................................................................................................................................................................ 5
Shareholder’s Funds:................................................................................................................................................. 7
Share application money pending allotment ............................................................................................................ 9
Non- Current Liabilities ............................................................................................................................................. 9
Current Liabilities .................................................................................................................................................... 10
Non-current assets and current assets ................................................................................................................... 12
Notes to account ......................................................................................................................................................... 13
Statement of profit and loss ....................................................................................................................................... 13
Meaning
Financial statements are the basic and formal annual reports through which the corporate
management communicates financial information to its owners and various other external
parties which include investors, tax authorities, government, employees, etc.

These include:

A) A balance sheet
B) A statement of profit and loss
C) Notes to accounts
D) Cash flow statement
Nature of financial statements
Recorded facts: The term recorded facts means recording of transactions based on
evidences in the books of accounts. For example, figures relating to cash in hand, debtors,
sales, purchases etc. are recorded facts.

Accounting concepts and conventions: These are followed while preparing financial
statements.

Personal judgments: Personal judgments also have an important bearing on financial

statements. For example, the choice of selecting a method of depreciation lies with the
management.

Balance sheet
This is new vertical format of Balance Sheet as per Schedule 3 of Companies Act 2013.
Shareholder’s Funds:

Shareholder's Funds:
Share Capital:

Reserves and Surplus:

Money received against share

warrants

A) Share capital:
The sub-categories of share capital is shown in Notes to Accounts.
Its format is as follows:

 Authorised Capital: This refers to the maximum capital that the company is
authorized to issue its share for its lifetime and this is shown in Memorandum of
Association.
  Issued Capital: This refers to the amount of Authorised Capital which is offered by
the company to the public for subscription. The remaining part is known as
‘Unissued Capital’.
 Subscribed Capital: This refers to that amount of issued capital that is subscribed
by the public.
For example: If a company has 20,000 shares of Rs.100 each, then authorized capital would
be Rs.20,00,000. If a company issues 15,000 shares then issued capital would be
Rs.15,00,000 and if public subscribes only for 10,000 shares then, subscribed capital would
be Rs.10,00,000.

Now, subscribed capital can be:

 Subscribed and fully paid up OR

 Subscribed but not fully paid
In fully paid, the whole amount is paid by the public to the company, like Rs.100 in previous
example, but in case of not fully paid up, some amount remains to be collected from the
public.

There can be some ‘Calls-in-arrear’ which refers to the amount which has been called up by
the company but is due to be paid by the public. This will be deducted from Subscribed
Capital.

There can be Shares forfeited amount which includes the amount that was paid up on the
shares that are forfeited. This amount is added to the Subscribed Capital.

B) Reserves and Surplus:

This includes all the reserves and surplus accounts. Example- Capital Reserve, Capital
Redemption Reserve, Securities Premium Reserve, Debenture Redemption Reserve etc.

C) Money received against share warrants:

A share warrant is a financial instrument issued by a public company which gives the
holder the right to acquire a certain number of equity shares specified in the instrument
at a later date.
Share application money pending allotment
If a company has received application money but date of allotment falls after the Balance
Sheet date, such application money pending allotment will be shown as:

 Share application money not refundable will be disclosed under this line item.
 Share application money refundable will be disclosed under ‘Other Current Liabilities’

Non- Current Liabilities

Non-current liabilities are those liabilities which are not current liabilities.

LONG TERM BORROWINGS

• They are payable after 12 months.

• Bonds/debentures, Long term Loans, Public Deposits

DEFERRED TAX LIABILTIES

• This arises when accounting income is more than

taxable income. It is a tax liability for future years.

OTHER LONG TERM LIABILITIES

• This includes all long term liabilties which do not

come under any other head.

LONG TERM PROVISIONS

• Provisions whose related claims are expected to be

settled beyond 12 months.
• Provison for Employee Benefits, Provision for Gratuity.
Current Liabilities
A liability is classified as current when it is:

A) Expected to be settled in company’s normal *operating cycle, or

B) Held primarily for the purpose of being traded (sale and purchase), or
C) Due to be settled within 12 months.

*Operating cycle refers to the time between the acquisition of assets for processing
and their realization in cash or cash equivalents.
In case operating cycle cannot be identified, it is assumed to have a duration of 12 months
from the date of Balance Sheet.

Current Liabilities has following sub-heads

SHORT TERM BORROWINGS

•They are payable within 12 months.
•Overdraft, Deposits, LOans from other
parties etc.

TRADE PAYABLES
•It includes 'Sundry Creditors' and 'Bills
Paybale'.

OTHER SHORT TERM LIABILITIES

•This includes all short term liabilties which
do not come under any other head.

SHORT TERM PROVISIONS

•Provisions whose related claims are
expected to be settled within 12 months.
•Provison for Doubtful Debts, etc.
 Assets

Non-current assets and current assets

Tangible assets

Intangible Assets
Fixed assets
Capital work in
progress
Non-current
investments
Intangible assets
under development
Non-Current Assets Deferred Tax asset

Long term Loans

and Advances

Other Non-current
ASSETS

assets

Current Investments

Inventories

Trade Receivables
Current Assets
Cash and Cash
equivalents

Short term loans

and advances

Other current assets

Notes to account

CONTINGENT LIABILITIES

• Liabilities which have not arisen, but may arise upon the
happening of a certain event.

Statement of profit and loss

Format of Statement of Profit and Loss is as follows

Particulars No Figures for Figures for

te the current the
No reporting previous
. period reporting
period
I. Revenue from operations

Il. Other Income

11 Total Revenue (1 + 11)

1.
 IV. Expenses :
Cost of materials consumed
Purchases of Stock-in-Trade
Changes in inventories of finished
goods, work-in progress and
Stock-in-Trade
Employee benefits expenses
Finance costs
Depreciation and amortization
expenses

Other expenses
Total expenses

v. Profit before tax (Ill-IV)

VI. Tax

VII. Profit after tax (V—VI)

 • It is revenue earned from business activities.
Revenue from
Operations

• Revenue that is not earned from business activities.

• Interest income, Dividend Income etc.
Other income

• Cost of raw materials and other materials consumed in

manufacturing the goods.
Cost of Materials • Cost of materials consumed= Opening Inventory of materials +
Consumed Purchases of materials - Closing inventory of Materials

• Opening inventory- Closing Inventory

Change in
Inventory

• It includes all interest expenses and other borrowing costs

Finance Costs
** In case of a Finance Company the following will become revenue from operations:

(i) Interest Income

(ii) Dividend Income
(iii) Net gain/loss on sale of investments
(iv) Revenue from other financial services
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DEBENTURES
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Contents
Meaning ............................................................................................................................................................................ 4
Sources of Finance for the Redemption of Debentures ................................................................................................... 4
Debenture redemption reserve ........................................................................................................................................ 5
Guidelines for redemption of debentures (Companies Act, 2013) .................................................................................. 5
Exceptions to the Rule of Creating DRR ............................................................................................................................ 5
Conditions of Investing 15% of the debentures maturing during the year ...................................................................... 6
Redemption of Debentures .............................................................................................................................................. 6
When debentures are issued at par and are redeemable at par ................................................................................. 6
When debentures are issued at a discount and are redeemable at par ...................................................................... 7
When debentures are issued at a premium and are redeemable at par ................................................................... 7
When debentures are issued at a par and are redeemable at a premium ............................................................... 8
When debentures are issued at a discount and are redeemable at a premium ......................................................... 8
When debentures are issued at a premium and are redeemable at a premium ........................................................ 9
Redemption by purchase in open market ...................................................................................................................... 10
Redemption of debentures by conversion ..................................................................................................................... 11
Meaning
Redemption of debentures means repayment of the amount of debentures to debenture
holders. It refers to discharge of liability on account of debentures by repaying the due
amount of debentures.

Sources of Finance for the Redemption of

Debentures
• Proceeds of fresh issue of share capital & debentures are
utilised for redeeming old debentures.
Fresh issue of • In this, financial position of the company is not adversely
shares & affected.
debentures

• No profits are set aside for redemption of debentures.

Out of Capital

• Atleast 25% of the nominal value of outstanding debentures is

transferred from Surplus in Statement of P&L to 'Debenture
Redemption Reserve A/c'.
Out of Profits
Debenture redemption reserve
Transfer to Debenture Redemption Reserve A/c reduces profits because transfer of profit
to DRR reduces the amount of profit available for dividend. It means that the profits set
aside for DRR is not available for payment as dividend but would be utilized to redeem the
debentures.

Guidelines for redemption of debentures

(Companies Act, 2013)
Creation of DRR is obligatory only for non-convertible debentures and non-convertible
portion of partly convertible debentures.

A company shall create DRR equivalent to at least 25% of the amount of debentures issued
before starting the redemption of debentures.

Exceptions to the Rule of Creating DRR

 All India Financial Institutions regulated by RBI
 Banking companies
Conditions of Investing 15% of the debentures
maturing during the year
Every company required to create DRI shall before the 30th day of April of each year,
deposit or invest, a sum which shall not be less than 15% of the amount of its debentures
maturing (to be redeemed) during the year ending on the 31st March of the next year.

The amount so deposited or invested can be utilized only for the purpose of repayment of
debentures maturing during the year

Redemption of Debentures
When debentures are issued at par and are redeemable at
par
Entries for Issue Entries for Redemption
Bank A/c 100 Debentures A/c Dr. 100
Dr. To Debenture holders A/c 100
To Debenture 100
Application & Allotment
A/c
Debenture Application 100 Debenture holders A/c Dr. 100
& Allotment A/c To Bank A/c 100
Dr. 100
To Debentures A/c
When debentures are issued at a discount and are
redeemable at par

Entries for Issue Entries for Redemption

Bank A/c 95 Debentures A/c Dr. 100
Dr. To Debenture holders A/c 100
To Debenture 95
Application & Allotment
A/c
Debenture Application Debenture holders A/c Dr. 100
& Allotment A/c 95 To Bank A/c 100
Dr.
Discount on issue of 5
Debentures A/c 100
Dr.
To Debentures A/c

When debentures are issued at a premium and are

redeemable at par

Entries for Issue Entries for Redemption

Bank A/c 105 Debentures A/c Dr. 100
Dr. To Debenture holders A/c 100
To Debenture 105
Application & Allotment
A/c
Debenture Application Debenture holders A/c Dr. 100
& Allotment A/c 105 To Bank A/c 100
Dr. 100
To Debentures A/c
To Securities 5
Premium Reserve
A/c
When debentures are issued at a par and are redeemable
at a premium

Entries for Issue Entries for Redemption

Bank A/c 100 Debentures A/c Dr. 100
Dr. Premium on Redemption of
To Debenture 100 Debentures A/c Dr. 5
Application & Allotment To Debenture holders A/c 105
A/c
Debenture Application Debenture holders A/c Dr. 105
& Allotment A/c 100 To Bank A/c 105
Dr.
Loss on issue of 5
Debentures A/c 100
Dr.
To Debentures A/c 5
To Premium on
Redemption of
Debentures A/c

When debentures are issued at a discount and are

redeemable at a premium

Entries for Issue Entries for Redemption

Bank A/c 98 Debentures A/c Dr. 100
Dr. Premium on Redemption of
To Debenture 98 Debentures A/c Dr. 5
Application & Allotment To Debenture holders A/c 105
A/c
Debenture Application Debenture holders A/c Dr. 105
& Allotment A/c 98 To Bank A/c 105
Dr.
Loss on issue of 7
Debentures A/c 100
Dr.
To Debentures A/c 5
To Premium on
Redemption of
Debentures A/c

When debentures are issued at a premium and are

redeemable at a premium

Entries for Issue Entries for Redemption

Bank A/c 106 Debentures A/c Dr. 100
Dr. Premium on Redemption of
To Debenture 106 Debentures A/c Dr. 10
Application & Allotment To Debenture holders A/c 110
A/c
Debenture Application Debenture holders A/c Dr. 110
& Allotment A/c 106 To Bank A/c 110
Dr.
Loss on issue of 10
Debentures A/c 100
Dr.
To Debentures A/c 6
To Securities
Premium Reserve A/c
To Premium on 10
Redemption of
Debentures A/c
Redemption by purchase in open market
When a company purchases its own debentures in the open market for the purpose of
immediate cancellation, the purchase and cancellation of such debentures are termed as
redemption by purchase in the open market.

On purchase of own debentures for immediate cancellation

Debentures A/c Dr.

To Bank A/c

To Profit on Redemption of Debentures A/c

On transfer of Profit on Redemption

Profit on Redemption of Debenture A/c Dr.

To Capital Reserve

In case, the debentures are purchased from the market at a price which is above the
nominal value of debenture, the excess will be debited to loss on redemption of
debentures.

The journal entry in that case will be

Debentures A/c Dr.

Loss on Redemption of Debentures A/c Dr.

To Bank A/c

Statement of profit and loss Dr.

To Loss on Redemption of Debentures A/c

Redemption of debentures by conversion
As stated earlier the debentures can also be redeemed by converting them into shares or
new debentures. If debenture holders find that the offer is beneficial to them, they will take
advantage of this offer. The new shares or debentures may be issued at par, at a discount
or at a premium.
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ANALYSIS
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Contents
Meaning ............................................................................................................................................................................ 4
Significance/Importance of Financial Analysis/Parties interested in financial statement analysis .................................. 4
Tools of financial statement analysis ................................................................................................................................ 5
Comparative Statements .............................................................................................................................................. 5
Common Size Statements ............................................................................................................................................. 5
Trend Analysis ............................................................................................................................................................... 6
Ratio Analysis ................................................................................................................................................................ 6
Cash Flow Analysis ........................................................................................................................................................ 6
Limitations of Financial Analysis ................................................................................................................................... 7
Meaning
Analysis of financial statements is a systematic process of critical examination of the
financial information contained in the financial statements to understand and make
decisions regarding the operations of the enterprise.

Significance/Importance of Financial
Analysis/Parties interested in financial statement
analysis

 Management

Management of a firm is always interested in the solvency, profitable structure and

the capital structure of the firm.

 Investors

They are interested in the longevity of the business enterprise and therefore, they
want to know the earning capacity of the business and its prospects for future
growth and prosperity.

 Creditors

Short term Creditors- want to know the liquidity of the business through current ratio
and quick ratio.

Long term Creditors- want to know

- Whether the company will be able to pay the interest consistently.

- Whether the company will be able to pay their debts when they fall due.

 Government
 It can judge which industry is progressing on the desired lines and which industry
needs the financial help.

 Employees

They can ascertain as to how much bonus and increase in their wages is possible
from the profits of the company. Analysis also helps the trade unions in negotiating
wages agreements.

Tools of financial statement analysis

Comparative Statements
These are the statements showing the profitability and financial position of a firm for
different periods of time in a comparative form to give an idea about the position of two or
more periods. It usually applies to the two important financial statements, namely, balance
sheet and statement of profit and loss prepared in a comparative form. The financial data
will be comparative only when same accounting principles are used in preparing these
statements. If this is not the case, the deviation in the use of accounting principles should
be mentioned as a footnote. Comparative figures indicate the trend and direction of
financial position and operating results. This analysis is also known as ‘horizontal analysis’

Common Size Statements

These are the statements which indicate the relationship of different items of a financial
statement with a common item by expressing each item as a percentage of that common
item. The percentage thus calculated can be easily compared with the results of
corresponding percentages of the previous year or of some other firms, as the numbers are
brought to common base. Such statements also allow an analyst to compare the operating
and financing characteristics of two companies of different sizes in the same industry. Thus,
common size statements are useful, both, in intra-firm comparisons over different years
and also in making inter-firm comparisons for the same year or for several years. This
analysis is also known as ‘Vertical analysis’.
Trend Analysis
It is a technique of studying the operational results and financial position over a series of
years. Using the previous years’ data of a business enterprise, trend analysis can be done to
observe the percentage changes over time in the selected data. The trend percentage is the
percentage relationship, in which each item of different years bear to the same item in the
base year. Trend analysis is important because, with its long run view, it may point to basic
changes in the nature of the business. By looking at a trend in a particular ratio, one may
find whether the ratio is falling, rising or remaining relatively constant. From this
observation, a problem is detected or the sign of good or poor management is detected.

Ratio Analysis
It describes the significant relationship which exists between various items of a balance
sheet and a statement of profit and loss of a firm. As a technique of financial analysis,
accounting ratios measure the comparative significance of the individual items of the
income and position statements. It is possible to assess the profitability, solvency and
efficiency of an enterprise through the technique of ratio analysis.

Cash Flow Analysis

It refers to the analysis of actual movement of cash into and out of an organisation. The
flow of cash into the business is called as cash inflow or positive cash flow and the flow of
cash out of the firm is called as cash outflow or a negative cash flow. The difference
between the inflow and outflow of cash is the net cash flow. Cash flow statement is
prepared to project the manner in which the cash has been received and has been utilised
during an accounting year as it shows the sources of cash receipts and also the purposes for
which payments are made. Thus, it summarises the causes for the changes in cash position
of a business enterprise between dates of two balance sheets.
Limitations of Financial Analysis

Affected by Window-dressing

Window dressing refers to the presentation of a better financial position than what it
actually is by manipulating the books of accounts. On the account of such a situation
financial analysis may give false information to the users.

Do not reflect changes in price levels

If in 2017 a furniture dealer sells set of 100 tables for Rs.15 lacs and in 2018 sells the same
set of 100 tables for Rs.18 lacs, it discloses an increase of 20% in sales, whereas , in actual,
the sales have not increased at all.

Effect of Personal Ability and Bias

In many situations, the accountant has to make a choice out of alternatives available, e.g.,
choice in the method of inventory valuation or choice in the method of depreciation.

Difficulty in Forecasting

Financial statements are a record of past events and historical facts. Due to continuous
changing business requirements, no estimate based on the analysis of historical facts can
be made for future.

Lack of Qualitative Analysis

Qualitative aspects of business units such as efficiency of management, satisfaction of

firm’s customers etc. are omitted from the books at all as these cannot be expressed in
monetary terms.
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Contents
Meaning of debentures .................................................................................................................................................... 4
Difference between shares and debentures .................................................................................................................... 4
Kinds of Debentures.......................................................................................................................................................... 5
From the Point of view of Security ............................................................................................................................... 5
From the Point of view of Tenure ................................................................................................................................. 5
From the Point of view of Convertibility ....................................................................................................................... 5
From Coupon Rate Point of view .................................................................................................................................. 5
From the view Point of Registration ............................................................................................................................. 6
Issue of debentures........................................................................................................................................................... 6
Issue of Debentures at Par ............................................................................................................................................ 6
Issue of Debentures at Premium .................................................................................................................................. 8
Issue of Debentures at Discount ................................................................................................................................... 9
Issue of Debentures for Consideration other than Cash ............................................................................................ 10
Issue of Debentures as Collateral Security ................................................................................................................. 12
Terms of issue of debentures ......................................................................................................................................... 14
Issue at par and redeemable at par ............................................................................................................................ 14
Issue at a discount and redeemable at par ................................................................................................................. 14
Issue at premium and redemption at par ................................................................................................................... 15
Issue at par and redeemable at premium................................................................................................................... 15
Issue at discount and redemption at premium .......................................................................................................... 16
Issued at a premium and redeemable at premium .................................................................................................... 16
Interest on debentures ................................................................................................................................................... 17
Meaning of debentures
A debenture is a written acknowledgement of a debt taken by the Company as these are
issued under the seal of the Company.

A Debenture Certificate contains the terms of the repayment of the principal sum at a
specified date and the terms of payment of interest at a fixed percent.

Difference between shares and debentures

Ownership: A ‘share’ represents ownership of the company whereas a debenture is only
acknowledgement of Debt. A share is a part of the owned capital whereas a debenture is a
part of borrowed capital.

Return: The return on shares is known as dividend while the return on debentures is called
interest. The rate of return on shares may vary from year to year depending upon the
profits of the company but the rate of interest on debentures is prefixed. The payment of
dividend is an appropriation of profits, whereas the payment of interest is a charge on
profits and is to be paid even if there is no profit.

Repayment: Normally, the amount of shares is not returned during the life of the company,
whereas, generally, the debentures are issued for a specified period and repayable on the
expiry of that period.

Voting Rights: Shareholders enjoy voting rights whereas debenture holders do not normally
enjoy any voting right.

Security : Shares are not secured by any charge whereas the debentures are generally
secured and carry a fixed or floating charge over the assets of the company.

Convertibility: Shares cannot be converted into debentures whereas debentures can be

converted into shares if the terms of issue so provide, and in that case these are known as
convertible debentures.
Kinds of Debentures
From the Point of view of Security
Secured Debentures: Secured debentures refer to those debentures where a charge is
created on the assets of the company for the purpose of payment in case of default.

Unsecured Debentures: Unsecured debentures do not have a specific charge on the assets
of the company.

From the Point of view of Tenure

Redeemable Debentures: Redeemable debentures are those which are payable on the
expiry of the specific period either in lump sum or in Instalments during the life time of the
company. Debentures can be redeemed either at par or at premium.

Irredeemable Debentures: Irredeemable debentures are also known as Perpetual

Debentures because the company does not give any undertaking for the repayment of
money borrowed by issuing such debentures. These debentures are repayable on the
winding-up of a company or on the expiry of a long period.

From the Point of view of Convertibility

Convertible Debentures: Debentures which are convertible into equity shares or in any
other security either at the option of the company or the debenture holders are called
convertible debentures. These debentures are either fully convertible or partly convertible.

Non-Convertible Debentures: The debentures which cannot be converted into shares or in

any other securities are called nonconvertible debentures. Most debentures issued by
companies fall in this category.

From Coupon Rate Point of view

Specific Coupon Rate Debentures: These debentures are issued with a specified rate of
interest, which is called the coupon rate.
Zero Coupon Rate Debentures: These debentures do not carry a specific rate of interest. In
order to compensate the investors, such debentures are issued at substantial discount and
the difference between the nominal value and the issue price is treated as the amount of
interest related to the duration of the debentures.

From the view Point of Registration

Registered Debentures: Registered debentures are those debentures in respect of which all
details including names, addresses and particulars of holding of the debenture holders are
entered in a register kept by the company. Such debentures can be transferred only by
executing a regular transfer deed.

Bearer Debentures: Bearer debentures are the debentures which can be transferred by way
of delivery and the company does not keep any record of the debentures Interest on
debentures is paid to a person who produces the interest coupon attached to such
debentures.

Issue of debentures
Debentures may be issued either at par, or at a premium or at a discount. There are no
restrictions on the issue of debentures at discount, whereas shares cannot be issued at
discount.

Journal entries on issue of debentures are also the same as in the case of issue of shares.

Issue of Debentures at Par

Example

Shayma Ltd. issued 5,000, 10% Debentures of Rs.100 each, at par, payable as follows: On
Application Rs.20, On Allotment Rs.20, On First Call Rs.30 and On Final Call Rs.30.

Public applied for 6000 debentures. Applications for 4500 debentures were accepted in full.
Applications for 800 debentures were allotted 500 debentures and applications for 700
debentures were rejected. Money overpaid on applications was utilized towards allotment.
Pass journal entries.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c 1,20,000
Dr.
To 10% Debenture Application A/c 1,20,000

10% Debenture Application A/c 120,000

Dr.
To 10% Debentures A/c 100,000
To 10% Debenture Allotment A/c 6,000
To Bank A/c 14,000

10% Debenture Allotment A/c 100,000

Dr.
To 10% Debentures A/c 100,000

Bank A/c 94,000

Dr.
To 10% Debenture Allotment A/c 94,000

10% Debenture First Call A/c 150,000

Dr.
To 10% Debentures A/c 150,000

Bank A/c 150,000

Dr.
To 10% Debentures First Call A/c 150,000

10% Debenture Second Call A/c 150,000

Dr.
To 10% Debentures A/c 150,000

Bank A/c 150,000

Dr.
To 10% Debentures A/c 150,000
Issue of Debentures at Premium
Example

ABC Products Ltd. issued 1000, 10% Debentures of Rs.100 each at a premium of 10%. Rs.40
is payable on application and Rs.70 (including premium) is payable on allotment.

Pass necessary journal entries.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c 4,00,000
Dr.
To 10% Debenture Application A/c 4,00,000

10% Debenture Application A/c 4,00,000

Dr.
To 10% Debentures A/c 400,000

10% Debenture Allotment A/c 700,000

Dr.
To 10% Debentures A/c 6,00,000
To Securities Premium Reserve A/c 1,00,000

Bank A/c 7,00,000

Dr.
To 10% Debenture Allotment A/c 7,00,000
Issue of Debentures at Discount

Example

Modi Ltd. issued 2500, 15% Debentures of Rs.100 each at a discount of 10% payable as
follows: Rs.25 on Application; Rs.25 on Allotment and balance on Final Call.

Applications were received for 2000 debentures and the allotment was made. Expenses on
issue of debentures amounted to Rs.8000. Directors decided to write off 1/5th of “Expenses
on Issue A/c” and “Discount on Debentures A/c” from Statement of Profit and Loss each
year.

Pass journal entries (for first year only)

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c 50,000
Dr.
To 15% Debenture Application A/c 50,000

15% Debenture Application A/c 50,000

Dr.
To 15% Debentures A/c 50,000

15% Debenture Allotment A/c 50,000

Dr. 20,000
Discount on Debentures A/c
Dr.
To 15% Debentures A/c 70,000

Bank A/c 50,000

Dr.
To 15% Debenture Allotment A/c 50,000
 15% Debenture First and Final Call A/c 80,000
Dr.
To 15% Debentures A/c 80,000

Bank A/c 80,000

Dr.
To 15% Debentures First and Final Call 80,000
A/c

Expenses on Issue A/c 8,000

Dr.
To Bank A/c 8,000

Statement of Profit & Loss 5,600

Dr.
To Discount on Debentures A/c 4,000
To Expenses on Issue A/c 1,600

Issue of Debentures for Consideration other than Cash

Particulars Entries
On purchase of assets Assets A/c Dr.
To Vendor’s A/c

Issue of debentures to vendor at par Vendor’s A/c Dr.

To Debentures A/c

Issue of debentures to vendor at Vendor’s A/c Dr.

premium To Debentures A/c
To Securities Premium Reserve
A/c

Issue of debentures to vendor at Vendor’s A/c Dr.

discount Discount on Debentures A/c Dr.
To Debentures A/c
Example

Jai Ltd. purchased a business from Veeru Ltd. for a sum of Rs.15,00,000, payable
Rs.3,00,000 by cheque and for the balance issued 9% Debentures of Rs.100 each at par.

The assets and liabilities consisted of the following:

Plant & Machinery 4,00,000

Buildings 6,00,000

Stock 5,00,000

Sundry Debtors 3,00,000

Sundry Creditors 2,00,000

Books of Jai Ltd

JOURNAL

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Plant & Machinery A/c 4,00,000
Dr.
Buildings A/c 6,00,000
Dr.
Stock A/c 5,00,000
Dr.
Sundry Debtors A/c 3,00,000
Dr.
To Sundry Creditors A/c 2,00,000

To Veeru Ltd. 15,00,000

To Capital Reserve (B/f) 1,00,000

Veeru Ltd. 3,00,000

Dr.
To Bank A/c 3,00,000
 Veeru Ltd. 12,00,000
Dr.
To 9% Debentures A/c 12,00,000

Issue of Debentures as Collateral Security

Sometimes, when a Company takes a loan from a Bank or from some other party, the
Company may have to issue debentures as a subsidiary or secondary security in addition to
the principal security.

Holders on such debentures are not entitled to any interest on these debentures.

If a default is made either in the payment of interest or in the payment of principal debt,
the lender will first realize its debt from the principal security. But if the full amount of debt
is not realized from the principal security, it may claim all the rights of a debenture holder.

There are two methods of dealing with such debentures in the books of accounts:

First method

No entry is made in the books of accounts since no liability is created by such issue.
However, on the liability side of the balance sheet, below the item of loan, a note to the
effect that it has been secured by issue of debentures as a collateral security is appended.
Second method

Journal Entries

Issue of 10,000, 9% debentures of Rs. 100 each as collateral security for bank loan of Rs.
10,00,000.

Debenture Suspense A/c Dr. 10,00,000

To 9% Debentures A/c 10,00,000

For cancellation of 9% debentures as collateral security on repayment of bank loan.

When loan is repaid the above entry will be cancelled by a reverse entry

9% Debentures A/c Dr. 10,00,000

To Debenture Suspense A/c 10,00,000

Debenture Suspense account will appear as a deduction from the debentures in notes to
accounts of long-term borrowings.
Terms of issue of debentures
Issue at par and redeemable at par
Bank A/c Dr.

To Debenture Application & Allotment A/c

(Receipt of application money)

Debenture Application & Allotment A/c Dr.

To Debentures A/c

(Allotment of debentures)

Issue at a discount and redeemable at par

Bank A/c Dr.

To Debenture Application & Allotment A/c

(Receipt of application money)

Debenture Application & Allotment A/c Dr.

Discount on Issue of Debentures A/c Dr.

To Debentures A/c

(Allotment of debentures at a discount)

Issue at premium and redemption at par
Bank A/c Dr.

To Debenture Application & Allotment A/c

(Receipt of application money)

Debenture Application & Allotment A/c Dr.

To Debentures A/c

To Securities Premium Reserve A/c

(Allotment of debentures at a premium)

Issue at par and redeemable at premium

Bank A/c Dr.

To Debenture Application & Allotment A/c

(Receipt of application money)

Debenture Application & Allotment A/c Dr.

Loss on Issue of Debentures A/c Dr. (with premium on redemption)

To Debentures A/c (with nominal value of debenture)

To Premium on Redemption of Debenture A/c (with premium on

redemption)

(Allotment of debentures at par and redeemable at a premium)

Issue at discount and redemption at premium
Bank A/c Dr.

To Debenture Application & Allotment A/c

(Receipt of application money)

Debenture Application & Allotment A/c Dr.

Loss on Issue of Debentures A/c Dr. (with discount on issue plus premium on redemption)

To Debentures A/c (with nominal value of debenture)

To Premium on Redemption of Debentures A/c (with premium on redemption)

(Allotment of debentures at a discount and redeemable at premium)

Issued at a premium and redeemable at premium

Bank A/c Dr.

To Debenture Application & Allotment A/c

(Receipt of application money)

Debenture Application & Allotment A/c Dr.

Loss on Issue of Debentures A/c Dr. (with premium on redemption)

To Debentures A/c (with nominal value of debenture)

To Securities Premium Reserve A/c (with premium on issue)

To Premium on Redemption of Debentures A/c (with premium on redemption)

Notes:

1. When debentures are redeemable at a premium, the premium payable on redemption is

debited to ‘Loss on Issue of Debentures A/c’. It may be noted that when debentures are
issued at a discount and are redeemable at a premium, the amount of discount on issue is
also debited to ‘Loss on Issue of Debentures’. It may be noted that when the debentures
are issued at a discount and are redeemable at par, the amount debited to ‘Discount on
Issue of Debentures A/c’ as usual.

2. Premium on redemption is a liability of a company payable in future.

Interest on debentures
When interest is due

Debenture Interest A/c Dr.

To Income Tax payable A/c

To Debenture holders A/c

(Amount of interest due on debenture and tax deducted at source )

For payment of interest to debenture holders

Debenture holders A/c Dr.

To Bank A/c

(Amount of interest paid to debenture holders)

On transfer debenture Interest Account to statement of Profit and Loss

Statement of Profit and Loss Dr.

To Debenture Interest A/c

(Debenture interest transferred to profit and loss A/c)

On payment of tax deducted at source to the Government

Income Tax Payable A/c Dr.

To Bank A/c

(Payment of tax deducted at source on interest on debentures)

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COMPANY ACCOUNTS – ISSUE OF
SHARES
Chanchal Phore
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Contents
Definition .......................................................................................................................................................................... 5
Characteristics of a company ............................................................................................................................................ 5
Kinds of a company ........................................................................................................................................................... 6
Company Limited by Shares .......................................................................................................................................... 6
Unlimited Company ...................................................................................................................................................... 6
Company Limited by Guarantee ................................................................................................................................... 7
Private Company ........................................................................................................................................................... 7
Public Company............................................................................................................................................................. 8
One Person Company (OPC) ......................................................................................................................................... 8
Meaning of shares............................................................................................................................................................. 8
Types of shares ................................................................................................................................................................. 9
Preference Shares ......................................................................................................................................................... 9
Equity Shares................................................................................................................................................................. 9
Share capital...................................................................................................................................................................... 9
Kinds of share capital ...................................................................................................................................................... 10
Authorized, Registered or Nominal Capital ................................................................................................................ 10
Issued Capital .............................................................................................................................................................. 10
Subscribed Capital....................................................................................................................................................... 10
Called up Capital ......................................................................................................................................................... 10
Paid-up Capital ............................................................................................................................................................ 10
Reserve Capital............................................................................................................................................................ 10
Capital Reserves .............................................................................................................................................................. 11
Distinction between reserve capital and capital reserves ............................................................................................ 11
Issue of shares - Steps ..................................................................................................................................................... 13
Issue of Prospectus ..................................................................................................................................................... 13
Receipt of Applications ............................................................................................................................................... 13
Allotment of Shares .................................................................................................................................................... 14
Entries on issue of shares................................................................................................................................................ 14
Journal Entries when shares are issued at par................................................................................................................ 16
Issue of shares at premium ............................................................................................................................................. 17
Accounting Entries for the Amount of Securities Premium ............................................................................................ 18
Issue of shares at discount .............................................................................................................................................. 20
Issue of shares for consideration other than cash .......................................................................................................... 20
Calls in arrear a/c ............................................................................................................................................................ 21
Interest on Calls in Arrear .......................................................................................................................................... 22
Calls Paid-in-Advance ...................................................................................................................................................... 22
Interest on Calls in Advance ........................................................................................................................................ 23
Under subscription of shares .......................................................................................................................................... 25
Oversubscription of shares ............................................................................................................................................. 26
Forfeiture of shares......................................................................................................................................................... 29
Entries on Forfeiture of Shares ................................................................................................................................... 29
Re-issue of forfeited shares ............................................................................................................................................ 30
Forfeiture in case of oversubscription and pro-rata allotment .................................................................................. 34
Definition
A company may be viewed as an association of person who contribute money or money’s
worth to a common inventory and use it for a common purpose. It is an artificial person
having corporate legal entity distinct from its members (shareholders) and has a common
seal used for its signature.

Characteristics of a company
Body Corporate: A company is formed according to the provisions of Law enforced from
time to time. Generally, in India, the companies are formed and registered under
Companies Law except in the case of Banking and Insurance companies for which a
separate Law is provided for.

Separate Legal Entity: A company has a separate legal entity which is distinct and separate
from its members. It can hold and deal with any type of property. It can enter into contracts
and even open a bank account in its own name.

Limited Liability: The liability of the members of the company is limited to the extent of
unpaid amount of the shares held by them. In the case of the companies limited by
guarantee, the liability of its members is limited to the extent of the guarantee given by
them in the event of the company being wound up.

Perpetual Succession: The company being an artificial person created by law continues to
exist irrespective of the changes in its membership. A company can be terminated only
through law. The death or insanity or insolvency of any member of the company in no way
affects the existence of the company. Members may come and go but the company
continues.

Common Seal: The company being an artificial person, cannot sign its name by itself.
Therefore, companies use common seal in order to authenticate the documents.

The authentication of a document, in case the company does not have a common seal, shall
be made in two ways as detailed below:

 By two directors; or
 By a director and the Company Secretary.
Transferability of Shares: The shares of a public limited company are freely transferable.
The permission of the company or the consent of any member of the company is not
necessary for the transfer of shares.

May Sue or be Sued: A company being a legal person can enter into contracts and can
enforce the contractual rights against others. It can sue and be sued in its name if there is a
breach of contract by the company

Kinds of a company

On the basis of liability of its members

Company Company
Unlimited
limited by limited by
company
shares guarantee

Company Limited by Shares

In this company, the liability of the members is limited to the extent of the nominal value of
shares held by each of them.

Unlimited Company
It is a company where there is no limit on the liability of its members. As the risk involved in
such companies is too high, these are not found in India even though permitted by the
Companies Act.
Company Limited by Guarantee
In this company, liability of the members is limited to the extent of the guarantee given by
them in the event of the winding up of the company.

The liability of its members will arise only in the event of the winding up of the company.

On the basis number of members

Private Public One person

company company company

Private Company
A private company is one which by its Article of Association

(i) Restricts the right to transfers its shares.

(ii) Limits the number of its members to two hundred (exclusive of past and present
employee)
(iii) Prohibits any invitation to the public to subscribe for any securities i.e. shares or
debentures of the company.

The name of every private company must end with the words ‘Private Limited’.
Public Company
A public company means a company which (a) is not a private company; (b) is a company
which is not a subsidiary of a private company.

DISTINCTION BETWEEN PRIVATE COMPANY AND PUBLIC COMPANY

Basis Private Company Public Company

Number of members Minimum- 2 Minimum- 7
Maximum- 200 Maximum- No limit
Invitation to public Cannot invite Can invite
Transfer of shares Restricted No restrictions
Number of Directors At least 2 At least 3
Use of word ‘Limited’ Compulsory to use the Only the word ‘Limited’ is
words ‘Private Limited’ at used at the end of its
the end of its name. name.

One Person Company (OPC)

An OPC means a private limited company with only one person as its member.

Characteristics

 Only a natural person being an Indian citizen and resident in India can form one
person company
 Its paid up share capital is not more than Rs. 50 Lakhs
 Its average annual turnover of three years does not exceed Rs. 2 Crores

Meaning of shares
Total Capital of the Company is divided into units of small denomination. Each such unit is
called ‘share’.

Example:
 If total capital of a company is Rs.1,00,000 and it is divided into 10,000 units of Rs.10
each.

Each unit of Rs.10 will be called a share.

The persons who contribute money through shares are called shareholders.

Types of shares
As per Companies Act, 2013, a Company may issue two types of shares:

(1) Preference Shares

(2) Equity shares

Preference Shares
Shares which carry the following two rights:

(i) Right to receive dividend at a fixed rate before any dividend is paid on the equity
shares.
(ii) On the winding up of the company, they have right to return of capital before that
of equity shares.

Equity Shares
Those shares which are paid dividends only when profits are left after the preference
shareholders have been paid fixed rate of dividends.

Shares which do not enjoy any preferential right in the payment of dividend or repayment
of capital, are termed as equity/ordinary shares

Share capital
Share Capital means the capital raised by a Company by the issue of shares.
Kinds of share capital
Authorized, Registered or Nominal Capital
It is the amount which is stated in the Memorandum of Association. This is the maximum
capital for which a Company is authorized to issue shares during its lifetime.

Issued Capital
It is that part of Authorized Capital which is actually offered to the public for subscription.

Subscribed Capital
It is that part of Issued Capital which has been subscribed for by the public. When the
shares offered for public subscription are subscribed fully by the public the issued capital
and subscribed capital would be the same.

Called up Capital
It means such part of Subscribed Capital, which has been called by the directors from
shareholders for payment.

Paid-up Capital
It refers to the portion of called-up capital which has been actually received from the
shareholders.

Reserve Capital
Sometimes a company, by means of special resolution, decides that the certain portion of
its uncalled shall not be called up during its existence and it would be available to the
creditors in the event of its liquidation. Such a portion of uncalled capital is termed as
‘reserved capital’.
Capital Reserves
They are the reserves which are created out of Capital profits. Capital profits which are not
earned in the normal course of business. These reserves cannot be utilized for the
distribution of dividends.

Following items give rise to Capital profits and hence, Capital reserves:

(1) Profit on sale of fixed assets

(2) Profit on revaluation of fixed assets
(3) Premium on issue of shares and debentures
(4) Profit on redemption of debentures
(5) Profit earned by a company prior to its incorporation
(6) Profit on forfeiture and re-issue of shares.

Capital Reserves are shown on the liabilities side of the Balance Sheet under the head
“Reserves and Surplus”.

Distinction between reserve capital and

capital reserves
Basis Reserve Capital Capital Reserve
Meaning & Creation It refers to that portion of It is that reserve which is
increased nominal capital created out of Capital
or uncalled share capital profits.
which shall not be called
up, except in the event of
winding up.
Necessity Not necessary Necessary
Resolution Required for its creation. Not required.
Realized or Not realized It refers to the amount It refers to the amount
which has not been which has already been
 received. received.
Disclosure in Balance Not shown in the Shown under the head,
Sheet Company’s Balance ‘Reserves and Surplus’ on
Sheet. the equity and liabilities
side of the balance sheet.
Time when it can be used Only at the time of It can be used to write off
winding up of company. Capital losses or to
declare a share bonus any
time during the life time
of a company.

Example

A company had registered capital of Rs.100,000 divided into 10,000 equity shares of Rs.10
each. It decided to issue 6000 shares for subscription. It allotted 6000 shares and called Rs.9
per share. All shareholders have duly paid the amount called, except one shareholder,
holding 500 shares who has paid only Rs.7 per share.

Balance Sheet as at ………..

Particulars Note No. Amount Amount

Current Previous Year
Year
EQUITY AND LIABILITIES 1. 53,000
Shareholder’s Funds
(a) Share Capital
Total 53,000

ASSETS
Current Assets
Cash and cash equivalents 53,000
Total 53,000
Notes to Accounts

1. Share Capital Rs. Rs.

Equity Share Capital
Authorized Share Capital 10,000 Equity shares of Rs.10 1,00,000
each
Issued share capital 6000 Equity shares of Rs.10 each 60,000
Subscribed share capital 6000 Equity shares of Rs.10 60,000
each
Called up and Paid up share capital 54,000
6000 Equity shares called up Rs.9
- Calls unpaid 500 shares @ 2 per share (1000) 53,000

Issue of shares - Steps

Issue of Prospectus
The company first issues the prospectus to the public. Prospectus is an invitation to the
public that a new company has come into existence and it needs funds for doing business. It
contains complete information about the company and the manner in which the money is
to be collected from the prospective investors.

Receipt of Applications
When prospectus is issued to the public, prospective investors intending to subscribe the
share capital of the company would make an application along with the application money
and deposit the same with a scheduled bank as specified in the prospectus. The company
has to get minimum subscription within 120 days from the date of the issue of the
prospectus. If the company fails to receive the same within the said period, the company
cannot proceed for the allotment of shares and application money should be returned
within 130 days of the date of issue of prospectus.

Allotment of Shares
If minimum subscription has been received, the company may proceed for the allotment of
shares after fulfilling certain other legal formalities.

It is to be noted that ‘minimum subscription’ of capital cannot be less than 90% of the
issued amount according to SEBI.

Entries on issue of shares

Entries on Receiving Applications

(1) On receiving application amount:

Bank A/c Dr.

To Share Application A/c

(2) Application money transferred to Share Capital:

Share Application A/c Dr.

To Share Capital A/c

Application money returned on un-allotted shares

Share Application A/c Dr.

To Bank A/c

Entries on Allotment
 (3) Amount due on Allotment

Share Allotment A/c Dr.

To Share Capital A/c

(4) On receipt of allotment money

Bank A/c Dr.

To Share Allotment A/c

Entries on First Call

(5) When shareholders are informed to pay the first call:

Share First Call A/c Dr.

To Share Capital A/c

(6) On receipt of First Call money:

Bank A/c Dr.

To Share First Call

Similarly, entries for other calls may be prepared.

Points to remember regarding the calls on shares

1. The amount on any call should not exceed 25% of the face value of
shares.
2. There must be an interval of at least one month between the making of
two calls unless otherwise provided by the articles of association of the
company.
Issue of shares (Face Value of share Rs.10)

Category Issue price Description

At par 10 Issue price = Face
Value
At premium 11 Issue price > Face
Value
At discount 9 Issue price < Face
Value

Journal Entries when shares are issued at par

ABC Ltd. invited 20,000 applications of Rs.10 each. Payments were to be made as follows –
Rs.3 on Applications; Rs.3 on Allotment; Rs.2 on First Call and Rs.2 on Final call.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c 60,000
Dr.
To Equity Share Application A/c 60,000

Equity Share Application A/c 60,000

Dr.
To Equity Share Capital A/c 60,000

Equity Share Allotment A/c 60,000

Dr.
To Equity Share Capital A/c 60,000

Bank A/c 60,000

Dr.
To Equity Share Allotment A/c 60,000
 Equity Share First Call A/c 40,000
Dr.
To Equity Share Capital A/c 40,000

Bank A/c 40,000

Dr.
To Equity Share First Call A/c 40,000

Equity Share Final Call A/c 40,000

Dr.
To Equity Share Capital A/c 40,000

Bank A/c 40,000

Dr.
To Equity Share Final Call A/c 40,000

Issue of shares at premium

The premium on issue of shares is a Capital Profit and is credited to ‘Securities Premium
Reserve Account’. It must be shown separately in the Balance Sheet on the equity and
liabilities side under the head ‘Reserves and Surplus’.

U/s 52(2) of the Companies Act, 2013, the amount of securities premium reserve may used
only for the following purposes:
 Writing off the
Writing off the expenses, Issuing fully paid bonus
preliminary expenses commission/discount shares to shareholders
of the Company allowed on issue of of the Company
share or debenture

Premium payable on
Buy Back of its own
redemption of
shares and other
redeemable preference
securities
shares/ debentures

Accounting Entries for the Amount of Securities

Premium
If amount of premium is received along with application money:

Bank A/c Dr.

To Share Application A/c

Share Application A/c Dr.

To Share Capital A/c

To Securities Premium Reserve A/c

If amount of premium is received along with allocation money:

Share Allotment A/c Dr.

To Share Capital A/c

To Securities Premium Reserve A/c

Bank A/c Dr.

To Share Allotment A/c

Example

POR Ltd. received on October 1, 2017 applications for 25,000 equity shares of Rs.100 each
to be issued at a premium of 25% payable.

On application Rs.25

On Allotment Rs.75 (including premium)

Balance amount As and when required

The shares were allotted by the Company on October20, 2017 and the allotment money
was duly received on October 31, 2017.

PQR Ltd.

JOURNAL

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 625,000
To Equity Share Application A/c 625,000

Equity Share Application A/c 625,000

Dr.
To Equity Share Capital A/c 625,000
 Equity Share Allotment A/c 18,75,000
Dr.
To Equity Share Capital A/c 12,50,000
To Securities Premium Reserve A/c 6,25,000

Bank A/c 18,75,000

Dr.
To Equity Share Allotment A/c 18,75,000

Issue of shares at discount

As per Section 53 of Companies Act 2013, Companies would no longer be permitted to
issue shares at a discount. The only shares that could be issued at a discount are sweat
equity.

Sweat equity shares

It means equity shares issued by the Company to its employees or directors

at a discount or for consideration other than cash providing know-how or
making available intellectual property rights.

Issue of shares for consideration other than cash

(1) Issue of shares to promoters

Incorporation Cost/ Formation Expenses A/c Dr.

To Share Capital A/c

 (2) Issue of shares for purchase of assets

(a) When assets are purchased from vendors:

Sundry Asset A/c Dr.

To Vendor A/c

(b) When shares are issued to vendors:

Vendor’s A/c Dr.

To Share Capital A/c

Calls in arrear a/c

When some shareholders fail to pay the amount of allotment or call when it becomes due,
it is known as calls in arrears.

There are two methods to deal with Calls in Arrear which have been explained by the
following example:

PNB Ltd. made a first call of Rs.2 per share on its 10000 shares. One shareholder (Nirav
Modi) holding 500 shares did not pay the first call but when the company made final call of
Rs.4 per share, he paid all his arrears.

Particulars Without opening Calls in By Opening Calls in Arrear A/c

Arrear A/c
On making first Share First Call A/c Dr. 20,000 Share First Call A/c Dr. 20,000
call due To Share Capital To Share Capital
20,000 20,000
On receipt of Bank A/c Dr. 19,000 Bank A/c Dr. 19,000
first call To Share First Call A/c Calls in Arrear A/c Dr. 1,000
19,000 To Share First Call A/c
20,000

On making Share Final Call A/c Dr. 40,000 Share Final Call A/c Dr. 40,000
final call due To Share Capital To Share Capital
40,000 40,000

On receipt of Bank A/c Dr. 41,000 Bank A/c Dr.

final call To Share Final A/c 41,000
40,000 To Share Final Call A/c
To Share First call A/c 40,000
1,000 To Calls in Arrear A/c
1,000

Note:

Whether the calls in Arrear/c is opened or not, the amount of calls in arrears is shown as a
deduction from the amount of subscribed but not fully paid capital on the equity and
liabilities side of the Balance Sheet. This account is closed when the amount of arrear is
received or the relevant shares are forfeited.

Interest on Calls in Arrear

The Company is authorized to charge interest on calls in arrears at a specified rate
mentioned in its articles, from the due date to the date of actual payment. But if the articles
are silent, Table F of Schedule I of the Companies Act, 2013 shall be applicable, according to
which interest shall be charged at a rate not exceeding 10% p.a.

Calls Paid-in-Advance
It is when a shareholder pays a part, or whole of the amount not yet called upon his shares
in order to save himself the trouble of paying different calls at different times.
JOURNAL ENTRIES

Particulars Entries
When amount Bank A/c Dr.
of Calls-in- To Calls in Advance A/c
Advance

On call made Share Call A/c Dr.

by the To Share Capital
directors

On receipt of Bank A/c Dr.

final call Calls in Advance A/c Dr.
To Share First call A/c

Interest on Calls in Advance

 The amount of Call in Advance is a debt of the Company and it is liable to pay interest
on Calls in Advance from the date of receipt till the date when the call is due for
payment.
 If the Articles do not contain the rate of interest, Table F of Schedule I of the
Companies Act, 2013 shall be applicable which leaves the matter to the Board of
Directors subject to a maximum rate of 12% p.a.
 It is a charge against profits.
 No dividend is payable on it as amount of Calls in Advance is not a part of share
capital.

Example
ABC Ltd. was registered with a capital of Rs.4,00,000 in equity shares of Rs.100 each. It
issued 2000 of such shares payable Rs.25 per share on application; Rs.25 on allotment;
Rs.20 on first call; and the balance as and when required.

All moneys payable on application and allotment were duly received; but when the first call
of the Rs.20 per share was made, one shareholder holding 100 shares failed to pay the
amount due and another shareholder holding 200 shares paid them in full. Record the
transactions.

JOURNAL

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 50,000
To Equity Share Application A/c 50,000

Equity Share Application A/c 50,000

Dr.
To Equity Share Capital A/c 50,000

Equity Share Allotment A/c 50,000

Dr.
To Equity Share Capital A/c 50,000

Bank A/c 50,000

Dr.
To Equity Share Allotment A/c 50,000

Equity Share First Call A/c 40,000

Dr.
To Equity Share Capital A/c 40,000

Bank A/c 44,000

Dr.
To Equity Share First Call A/c 38,000
To Calls in Advance A/c 6,000
 Calls-in-Arrear A/c Dr. 2,000
To Equity Share First Call A/c 2,000

Under subscription of shares

An issue when number of shares applied for by the public is less than the number of shares
offered by the Company.

In such a case the accounting entries are made on the basis of the number of shares applied
for.

Example

Raj Ltd. issued 20,000 equity shares of Rs.10 each at a premium of 10%. Payments were to
be made as – on Application Rs.5 (including premium); on Allotment Rs.4 and on First and
Final Call Rs.2

Applications were received for 18000 shares and all were accepted. All money was duly
received.

Pass necessary relatives in the Books of the Company.

JOURNAL

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 90,000
To Equity Share Application A/c 90,000

Equity Share Application A/c 90,000

Dr.
To Equity Share Capital A/c 72,000
 To Securities Premium Reserve A/c 18,000

Equity Share Allotment A/c 72,000

Dr.
To Equity Share Capital A/c 72,000

Bank A/c 72,000

Dr.
To Equity Share Allotment A/c 72,000

Equity Share First and Final Call A/c 36,000

Dr.
To Equity Share Capital A/c 36,000

Bank A/c 36,000

Dr.
To Equity Share First and Final Call A/c 36,000

Oversubscription of shares
Shares are said to be oversubscribed when the number of shares applied for is more than
the number of shares offered to the public for subscription.

In such case, the Board of Directors have to allot shares on Pro-rata basis which means
smaller number of shares are allotted to each applicant according to the number of shares
applied by him.

JOURNAL ENTRIES
Particulars Entries
When applicants are not Share Application A/c Dr.
allotted any shares To Bank A/c

When some applicants are Bank A/c Dr.

allotted smaller number of To Share Application A/c
shares, excess amount is (Application money received)
utilized towards amount due
on allotment Share Application A/c Dr.
To Share Capital A/c
To Share Allotment A/c
(Transfer of application money to share
capital and the excess application money
credited to share allotment account)

Share Allotment A/c Dr.

To Share Capital A/c
(Amount due on allotment)

Bank A/c Dr.

To Share Allotment A/c
(Allotment money received after adjusting
the amount already received as excess
application money

Example

Raj Ltd. invited applications for 20,000 shares of Rs.10 each payable as follows: Rs.3 on
Application, Rs.2 on Allotment, Rs.2.5 on First Call and Rs.2.5 on Second Call.

Public applied for 30,000 shares and the allotments were made as under:

To Applicants for 8000 shares……….Full

To Applicants for 16,000 shares…….12,000 shares

To Applicants for 6,000 shares………Nil

All moneys were duly received.

Pass Journal Entries.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 90,000
To Share Application A/c 90,000

Share Application A/c Dr. 90,000

To Share Capital A/c 60,000
To Share Allotment 12,000
To Bank A/c 18,000

Share Allotment A/c Dr. 40,000

To Share Capital A/c 40,000

Bank A/c 28,000

Dr.
To Share Allotment A/c 28,000

Share First Call A/c Dr. 50,000

To Share Capital A/c 50,000

Bank A/c 50,000

Dr.
To Share First Call A/c 50,000

Share Final Call A/c Dr. 50,000

To Share Capital A/c 50,000

Bank A/c 50,000

Dr.
To Share Final Call A/c 50,000
Forfeiture of shares
 When any shareholder fails to pay the amount due on allotment or on any call within
the specified period, the Directors may cancel his shares.
 Shares can be forfeited only if the Articles of Association of the Company allows them
to be forfeited.
 If no rules are given in Articles, the provisions of Table F of Schedule I of the
Companies Act, 2013 regarding forfeiture apply.
 Procedure: Defaulting shareholder must be given a minimum of 14 days’ notice
requiring him to pay the unpaid amount on his shares together with the accrued
interest thereon. If, in spite of this notice, the shareholder still does not pay the
unpaid amount on his shares, his shares may be forfeited by a resolution of the Board
of Directors.

Entries on Forfeiture of Shares

Particulars Entries
When shares are Share Capital A/c Dr.
issued at par To Share Allotment A/c
To Share Call A/c
To Share Forfeiture A/c

When shares are

issued at premium

- When Share Capital A/c Dr. (Amount called up so

forfeiture far)
takes place Securities Premium Reserve A/c Dr. (Premium not
before the received)
premium is To Share Allotment A/c (Amount not received on
received Allotment)
To Share Call A/c (Amount not received on
calls)
To Share Forfeiture A/c (Amount received on
Application and calls so far)
 - When According to Section 52 of Companies Act, 2013, if
forfeiture premium has been fully collected, it cannot be cancelled
takes place even if that share is forfeited later on.
after the
premium is
received

Re-issue of forfeited shares

Forfeited shares can be re-issued at par, at premium or at discount.

Particulars Entries
When forfeited Bank A/c Dr.
shares are To Share Capital A/c
reissued at par

When Bank A/c Dr.

forfeited To Share Capital A/c
shares are To Securities Premium Reserve A/c
reissued at
premium

When Bank A/c Dr.

forfeited Share Forfeiture A/c Dr.
shares are To Share Capital A/c
reissued at
discount
Transfer of Share Forfeiture A/c Dr.
Share To Capital Reserve A/c
Forfeiture A/c (** If all the forfeited shares are not re-issued, only that
to Capital proportion of share forfeiture account which belongs to
Reserve A/c the re-issued shares should only be transferred to Capital
Reserve A/c)

Example1. Shares issued at par

X Ltd. invited applications for 20,000 shares of Rs.10 each payable as under: Rs.3 per share
on application, Rs.3 per share on allotment; Rs.2 per share on First Call and Rs.2 per share
on Final Call.

Final Call was not made by the Company. An applicant who had been allotted 100 shares
failed to pay Allotment and First Call money due from him. His shares were forfeited after
the First Call and were immediately re-issued at Rs.8.5 per share. Make necessary journal
entries.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 60,000
To Share Application A/c 60,000

Share Application A/c Dr. 60,000

To Share Capital A/c 60,000

Share Allotment A/c Dr. 60,000

To Share Capital A/c 60,000

Bank A/c 59,700

Dr.
To Share Allotment A/c 59,700

Share First Call A/c Dr. 40,000

To Share Capital A/c 40,000

Bank A/c 39,800

Dr.
To Share First Call A/c 39,800

Share Capital A/c Dr. 800

To Share Allotment A/c 300
To Share First Call A/c 200
To Share Forfeiture A/c 300

Bank A/c 850

Dr.
To Share Capital A/c 800
 To Securities Premium Reserve A/c 50

Share Forfeiture A/c 300

To Capital Reserve A/c 300

** Final call of Rs.2 per share has not been made in the question, as such only Rs.8 have
been called up. Thus, Share Capital A/c will be debited only from Rs.8 per share at the time
of forfeiture.

Example2. When premium on forfeited shares becomes due but is not received.

Akshay Ltd. issued 5,000 shares of Rs.100 each at a premium of Rs.10 each payable as
follows:

On Application Rs.30

On Allotment Rs.40 (including premium)

On First and Final Call Rs.40

All the shares were applied for and instalments received on due dates with the exception of
the Allotment and First and Final Call on 100 shares; these shares were forfeited and re-
issued as fully paid @Rs.105 per share.

Pass necessary journal entries.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 1,50,000
To Share Application A/c 1,50,000

Share Application A/c Dr. 1,50,000

To Share Capital A/c 1,50,000

Share Allotment A/c Dr. 2,00,000

To Share Capital A/c 1,50,000
To Securities Premium Reserve A/c 50,000

Bank A/c 1,96,000

Dr.
 To Share Allotment A/c 1,96,000

Share First & Final Call A/c 2,00,000

Dr.
To Share Capital A/c 2,00,000

Bank A/c 1,96,000

Dr.
To Share First Call A/c 1,96,000

Share Capital A/c 10,000

Dr. 1,000
Securities Premium Reserve A/c
Dr.
To Share Allotment A/c 4000
To Share First Call A/c 4000
To Share Forfeiture A/c 3000

Bank A/c 10,500

Dr.
To Share Capital A/c 10,000
To Securities Premium Reserve A/c 500

Share Forfeiture A/c 3000

To Capital Reserve A/c 3000

** Allotment money on 100 forfeited shares has not been received and as the premium
was also due on allotment, thus, premium also has not been received.

Therefore, Securities Premium Reserve A/c has been debited in the entry for forfeiture of
shares.

Example3. When Premium on Forfeited Shares is Received

PQR Ltd. forfeited 1000 shares of Rs.10 each, Rs.7 called up, issued at a premium of 20% (to
be paid at the time of allotment) for non-payment of a first call of Rs.2 per share. Out of
these, 600 shares were re-issued as Rs.7 paid up for Rs.4 per share.
Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)
Share Capital A/c Dr. 7,000
To Share First Call A/c 2,000
To Share Forfeiture A/c 5,000

Bank A/c Dr. 2400

Share Forfeiture A/c Dr. 1800
To Share Capital A/c 4200

Share Forfeiture A/c Dr. 1200

To Capital Reserve A/c 1200

Working Notes:

As profit on 1000 shares = Rs.5000

Profit on 600 shares = (5000/1000) * 600 = Rs.1800

Transfer to Capital Reserve = Rs.1200

Forfeiture in case of oversubscription and pro-rata

allotment
A company offered 1,00,000 shares of Rs.10 each payable as Rs.3 on application, Rs.2.5 on
allotment, Rs.2.5 on first call and Rs.2 on the final call.

The public applied for Rs.152,000 shares. The shares were allotted on a pro-rata basis to
the applicants of 150,000 shares. All shareholders paid the allotment money excepting 1
shareholder who was allotted 200 shares. These shares were forfeited. The first call was
made thereafter. The forfeited shares were re-issued @ 9 per share, Rs.8 paid up. The final
call was not yet made.

Pass necessary journal entries.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 456,000
To Share Application A/c 456,000
 Share Application A/c Dr. 456,000
To Share Capital A/c 3,00,000
To Share Allotment A/c 1,50,000
To Bank A/c 6,000

Share Allotment A/c Dr. 250,000

To Share Capital A/c 250,000

Bank A/c Dr. 99,800

To Share Allotment A/c 99,800

Share Capital A/c Dr. 1,100

To Share Allotment A/c 200
To Share Forfeiture A/c 900

Share First Call A/c Dr. 2,49,500

To Share Capital A/c 2,49,500

Bank A/c Dr. 2,49,500

To Share First Call A/c 2,49,500

Bank A/c Dr. 1800

To Share Capital A/c 1600
To Securities Premium Reserve A/c 200

Share Forfeiture A/c Dr. 900

To Capital Reserve A/c 900

Working Notes:

(1) Excess amount received from the holder of 200 shares on application:

The shareholder who has been allotted 200 shares must have applied for more shares.

If shares allotted were 1,00,000, shares applied for were = 1,50,000

Thus, if shares allotted were 200, shares applied for were= (150,000/100,000)*200= 300
shares

Excess application money received = 300 shares – 200 shares = 100 shares*3 = Rs.300

(2) Amount due on allotment on these shares = 200 shares* 2.5 = Rs.500
- Excess received on these shares on application = Rs.300
Amount not received on allotment Rs.200
(3) Amount received on allotment:

Total amount due on allotment 1,00,000 shares* 2.5 = 2,50,000

(-) Excess received on application = 1,50,000

(-) Amount not received on allotment = 200

Net amount received on allotment in cash 99,800

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Contents
Meaning ............................................................................................................................................................................ 4
Features ............................................................................................................................................................................ 4
Advantages........................................................................................................................................................................ 5
Disadvantages ................................................................................................................................................................... 6
Difference between double entry system and single entry system ................................................................................. 7
Ascertaining profit under the single entry system ........................................................................................................... 8
Statement of Affairs ...................................................................................................................................................... 8
Net Formula .................................................................................................................................................................. 9
Examples ....................................................................................................................................................................... 9
Meaning
Accounting records not made according to the double entry system, are known as
‘Accounts from Incomplete Records’ or ’Single Entry System of Accounting’.

Kohler defines Single Entry System as, “A system of book keeping in which as a rule only
records of cash and of personal account are maintained, it is always incomplete double
entry varying with the circumstances.”

Features

Maintenance
Non
Suitability of personal
uniformity
accounts

Maintenance Preparation of
of cash book finala accounts

Suitablility: This system is suitable for sole trader.

Non uniformity: This system may differ from firm to firm as it is a mere adjustment of
double entry system according to the requirements and convinience of the persons.

Maintenance of personal accounts: Usually under this system, only personal accounts are
maintained and real and nominal accounts are avoided. Therefore sometimes, it is defined
as a system where only personal accounts are kept.
Maintenance of cash book: Geerally, a cash book is maintained under this system.

Preparation of final accounts: In the absence of all nominal and real accounts, the final
accounts cannot be prepared.

Advantages

Simple

Less expensive

Suitable for small business

Flexible

 Simple method: Single entry system is a very simple method of recording business
transactions
 Less expensive: It is less expensive when it is compared to double entry system of
book keeping
 Suitability: It is mainly suited to small business concerns with limited number of
transactions and very few assets and liabilities. Limited companies, because of legal
provisions, cannot maintain accounting books on single entry system.
 Flexibility: The records under this system can be maintained as per the requirements
of the business.
Disadvantages

Arithmetical Correct profit and

accuracy cannot loss cannot be
be proved known

Financial position
Comparitive study
of the business
is difficult
cannot be judged

 Arithmetical accuracy cannot be proved: Trial balance cannot be prepared and hence,
arithmetical accuracy of books cannot be proved or tested. Chances of error, mischief
or fraud remaining undetected are high.
 Correct profit and loss cannot be known: Trading and profit and loss account cannot
be prepared and hence, the correct profit earned or loss incurred during the
accounting period is not known.
 Comparative study is difficult: A major defect of this system is that the financial
position of the current year cannot be compared with that of the previous year due
to incomplete information of transactions of business.
 Financial position of the business cannot be judged: Balance sheet, called statement
of affairs, under single entry system, is prepared in an unsatisfactory manner. The
assets and liabilities are not provided from the records but are put down by physical
inspection and on estimated basis. Hence, balance sheet cannot be drawn up with a
view to ascertain the correct financial position of the business on a particular date.
Thus, exact position of total net assets cannot be known.
Difference between double entry system and
single entry system

Basis Double entry system Single entry system

Both aspects Under this system, both Under this system, both
aspects of a transaction are aspects of transactions are not
recorded recorded.
Accounts Under this system, personal, Under this system, only
real and nominal accounts personal accounts and cash
are maintained. Thus, it is a book is maintained. Hence, it
complete and scientific remains an incomplete record
system of accounting of accounts
Trial balance Under this system, trial Under this system, trial
balance is prepared and balance could not be prepared
thus, the arithmetical due to incomplete system of
accuracy of the books of accounting
account is verified
Profit and loss Under this system, after a Under this system, profit and
certain period, net profit or loss account is not prepared to
net loss can be ascertained ascertain the net profit or loss.
by preparing the profit and
loss account
Financial Under this system correct Under this system, balance
position financial position of the sheet is not prepared. Only
business can be ascertained statement of affairs is
by preparing the balance prepared. The reason is that
sheet the assets and liabilities do not
stand at real amounts but at
estimated amounts
Use This system is used by This system is used by only
 almost all the businesses tiny businesses and
institutions

Ascertaining profit under the single entry system

The profit or loss in case of single entry system can be ascertained by using statement of
affairs method.

Statement of Affairs
A statement of affairs is a statement of assets and liabilities. The difference between the
amounts of two sides is taken as capital.

In this method the capital of the business in the beginning of the period is compared with
its capital at the end of the period. The difference represents profit or loss during the
period.

 If the closing capital is more than opening capital, it shows a profit for the business.
 If the closing capital is less than opening capital, the business had a loss.

Two adjustments must be borne in mind for ascertaining the profit:

1. Adjustment for capital introduced: If the proprietor brought in some additional

capital during the year, it should be deducted from the capital at the end since this
increase is not due to profit but fresh introduction of capital)
2. Adjustment for drawings: The drawings of the proprietor should be added to the
capital at the end – had the drawings not been made, the capital at the close of the
year would have been higher.
Net Formula

Profit = Closing Capital + Drawings – Additional Capital – Opening Capital

The above formula may be shown as follows in the form of statement of profit and loss:

Statement of profit and loss

Particulars Amount
Capital at the end
Add: Drawings during the year
Less: Additional capital introduced during the year
Adjusted capital at the end
Less: Capital in the beginning
Profit or loss for the year

Examples

Mohan maintains books on single entry system. He gives you the following information:

Capital on 1st April 2019 30,400

Capital on 1st April 2020 33,800

Drawings made during the year 9,600

Capital introduced on 1st April 2019 4,000

You are required to calculate the profit or loss made by Mohan

 Statement of profit or loss

For the year ended 31st March 2020

Particulars Amount
Closing capital 33,800
Add: Drawings 9,600
Less: Capital introduced (4,000)
Adjusted capital on 1st April 2020 39,400
Less: Opening capital (30,400)
Profit made during the year 9,000

Rama keeps his books under single entry system. His assets and liabilities were as under

31st March 2019 31st March 2020

Cash 1,000 900
Sundry debtors 39,000 45,000
Stock 34,000 32,000
Plant and machinery 60,000 80,000
Sundry creditors 15,000 14,900
Bills payable 5,000

During 2019-2020, he introduced Rs.10,000 as new capital. He withdrew Rs.3,000 every

month for his household expenses. Ascertain his profit for the year ended 31st march 2020

Statement of affairs

As at 31st march 2019

Particulars Amount Particulars Amount

Sundry creditors 15,000 Cash 1,000
Capital (balancing 1,19,000 Sundry debtors 39,000
figure)
Stock 34,000
Plant and machinery 60,000
1,34,000 1,34,000

Statement of affairs

As at 31st march 2020

Particulars Amount Particulars Amount

Sundry creditors 14,900 Cash 900
Bills payable 5,000 Sundry debtors 45,000
Capital (balancing 1,38,000 Stock 32,000
figure)
Plant and machinery 80,000
1,57,900 1,57,900

Statement of profit and loss

Particulars Amount
Closing capital 1,38,000
Add: Drawings (3000*12) 36,000
Less: Capital introduced (10,000)
Adjusted capital on 1st April 2020 1,64,000
Less: Opening capital (1,19,000)
Profit made during the year 45,000
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Course details and other updates!

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“HALL OF FAME”
 RBI

550+ Students cleared RBI Phase 1

300+ Students clear RBI Phase 2
48 Students got selected in RBI
SEBI
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FINANCIAL STATEMENTS OF
SOLE PROPRIETORSHIP

Chanchal Phore
 KEY BENEFITS OF OUR COURSES

Our course structure includes a lot of perks that

are otherwise unavailable elsewhere.
It is a comprehensive guide to help you crack the
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We provide personal solutions all queries using a Telegram

group wherein Anuj Jindal himself will clarify your doubts.

We curate the learning strategies of past year toppers to help

you learn from the success of the best
Contents
Meaning ............................................................................................................................................................................ 4
Trading Account ................................................................................................................................................................ 4
Profit and loss account...................................................................................................................................................... 6
Balance sheet .................................................................................................................................................................... 8
Marshalling of Assets and Liabilities in Balance Sheet ................................................................................................. 8
Permanency Preference Method .............................................................................................................................. 8
Liquidity Preference Method .................................................................................................................................... 9
Classification of Assets ................................................................................................................................................ 10
Classification of Liabilities ........................................................................................................................................... 11
Meaning

Financial Statements are the summaries of the accounts of a business enterprise and shows
the profitability and financial position at the end of the accounting period.

It includes at least two basic statements:

A) Trading and & Profit and Loss Account

B) Balance Sheet

Trading Account
It is prepared for calculating the gross profit or gross loss arising out of the trading activities
of a business.

Format of a Trading Account

All expenses which relate to either purchase of raw material or manufacturing of goods are
recorded in the Trading account. All such expenses are called ‘Direct Expenses’.

Examples of direct expenses:

 Carriage or freight inwards

 Manufacturing wages
 Power and fuel
 Factory lighting
 Factory rent and rates
 Royalties
 Consumable stores

Calculation of Cost of Goods Sold:

Cost of Goods Sold = Opening stock + Net Purchases + Direct Expenses – Closing stock

Cost of Goods Sold = Sales – Gross Profit

Case:

Calculate Net Sales and Gross Profit from the following information:

Cost of Goods Sold Rs.1,00,000

Gross Profit 20% on Sales

Solution: Sales will be 1,00,000 × (100/80) = Rs.1,25,000

Gross Profit = Sales – Cost of Goods Sold

= Rs.1,25,000 – Rs.1,00,000

= Rs.25,000
Profit and loss account
Trading account only shows gross profit earned as a result of buying and selling goods.
However, there are other expenses also which must be included to get the net profit, for
this Profit and Loss Account is prepared.

All Distribution, office, selling, administrative and miscellaneous expenses like, interest on
loan, interest on capital etc. are included in Profit and Loss Account.

A Profit & Loss A/c is an account into which all gains and losses are collected, in order to
ascertain the excess of gains over the losses or vice-versa.

Name of Business
Profit and Loss Account for the year ended .....

Rs. Rs.

Trading A/C Trading A/C

Gross loss (transferred) ----- Gross profit (transferred) -----

Office and Administration

----- Interest received -----
Expenses:

Salaries ----- Rent received -----

Rent, rates, taxes ----- Discount received -----

Postage & telegrams ----- Dividend received -----

Office electric charges ----- Bad debts recovered -----

Telephone charges ----- Provision for discount on -----

 creditors

Printing and stationary ----- Miscellaneous revenue -----

Selling and Distribution Net loss - transferred to

-----
Expenses: capital A/C

Carriage outward -----

Advertisement -----

Salesmen's salaries -----

Commission -----

Insurance -----

Traveling expenses -----

Bad debts -----

Packing expenses -----

Financial and Other Expenses:

Depreciation -----

Repair -----

Audit fee -----

Interest paid -----

Commission paid -----

Bank charges -----

Legal charges -----

Net profit - transferred to

-----
capital A/C
Balance sheet

A Balance Sheet is a statement at a particular date showing on one side the trader’s
property and possessions and on the other hand the liabilities.

Balance sheet contains all the Assets and Liabilities to show the exact financial position of
the business. It is known as Balance Sheet because it shows the balances of ledger accounts
which are left open after transferring all the nominal accounts to Trading & Profit & loss
Account. Balances of all the Real and Personal Accounts are grouped together and shown in
Balance Sheet as Assets and Liabilities.

Marshalling of Assets and Liabilities in Balance Sheet

The assets and liabilities must be shown in such a manner that the financial position of the
business can be assessed through it easily and quickly. Thus an arrangement is made in
which assets and liabilities are shown in the balance sheet. Such an arrangement is called
marshalling of assets and liabilities. There are three methods of marshalling:

1. Permanency Preference Method

2. Liquidity Preference Method

Permanency Preference Method

Under this method, the assets and liabilities are shown in balance sheet in the order of their
permanence. In other words, the more permanent the assets and liabilities, the earlier they
are shown.
Balance Sheet as on....

Liabilities Assets

Fixed Liabilities: Fixed Assets:

Capital Good will

Reserves Patent
Long term loans Land
Building
Current Liabilities: Plant & Machinery
Furniture & Fixtures
Sundry creditors
Bills payable Current Assets:
Bank overdraft
Outstanding expenses Investment
Stock
Sundry debtors
Bills receivable
Prepaid expenses

Liquid Assets:

Cash at bank
Cash in hand

Liquidity Preference Method

Under this method, assets and liabilities are shown in order of their liquidity. The more
liquid the assets, the earlier are they shown.
Balance Sheet as on.....

Liabilities Assets

Current Liabilities: Liquid Assets:

Sundry creditors Cash at bank

Bills payable Cash in hand
Bank overdraft
Outstanding expenses Current Assets:

Fixed Liabilities: Investment

Stock
Capital Sundry debtors
Reserves Bills receivable
Long term loans Prepaid expenses

Fixed Assets:

Good will
Patent
Land
Building
Plant & Machinery
Furniture & Fixtures

Classification of Assets
1. Non-current Assets: Acquired for continuous use and last for many years.

Example: Furniture, Motor Vehicles etc.

2. Current Assets: Either in the form of cash or can be easily converted into cash within
1 year of the date of Balance Sheet.

Example: Accrued Income, Closing stock etc.

Classification of Liabilities
1. Non-Current/ Long-term Liabilities

Liabilities which are to be paid after 1 year or more.

Example: Debentures, Public Deposits, etc.

2. Current or Short term liabilities

Liabilities which are expected to be paid within 1 year of the date of the Balance
Sheet.

Example: Bank overdraft, Bills Payable etc.

3. Contingent Liabilities

They are liabilities which will become payable only on the happening of some
specific event, otherwise not.

Examples:

a. Liabilities for bill discounted

b. Liabilities in respect of a suit pending in a court of law
c. Liability in respect of a guarantee given for another person.

***Contingent liabilities are not shown in the Balance Sheet but as a footnote below the
Balance Sheet.

(Note: All the items of balance sheet are discussed in detail in future lectures)
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Contents
Meaning ............................................................................................................................................................................ 4
Characteristics of a bill of exchange ................................................................................................................................. 4
Parties to a bill of exchange .............................................................................................................................................. 4
Drawer........................................................................................................................................................................... 4
Drawee or Acceptor ...................................................................................................................................................... 4
Payee ............................................................................................................................................................................. 5
Contents of bill of exchange ............................................................................................................................................. 5
Promissory note ................................................................................................................................................................ 6
Parties to a Promissory Note ........................................................................................................................................ 6
Date of Maturity (Due date) and Days of Grace ............................................................................................................... 7
Discounting of bill ............................................................................................................................................................. 8
Endorsement of bill ........................................................................................................................................................... 8
Journal entries under various cases .................................................................................................................................. 9
........................................................................................................................................................................................ 10
Dishonour of Bill.............................................................................................................................................................. 10
Entries in the book of drawer ..................................................................................................................................... 10
Entries in the book of drawee ..................................................................................................................................... 11
Renewal of bill................................................................................................................................................................. 11
Retiring a Bill ................................................................................................................................................................... 12
Accommodation Bill ........................................................................................................................................................ 13
Meaning
According to Indian Negotiable Instrument Act, 1881:

A bill of exchange is an instrument in writing, an unconditional order signed by the maker

directing to pay a certain sum of money only to or to the order of a certain person or to the
bearer of the instrument.

Characteristics of a bill of exchange

 A bill of exchange must be in writing.
 It is an order to make payment.
 The order to make payment is unconditional.
 The maker of the bill of exchange must sign it.
 The payment to be made must be certain.
 The date on which payment is made must also be certain.
 The bill of exchange must be payable to a certain person.
 The amount mentioned in the bill of exchange is payable either on demand or on the
expiry of a fixed period of time.

Parties to a bill of exchange

Drawer
He is the seller or creditor entitled to receive money from someone. He writes or draws the
bill.

Drawee or Acceptor
He is the purchaser or the debtor on whom the bill is drawn and who is liable to pay the
amount mentioned in the bill. He accepts to pay the amount by writing the word
“Accepted” on the bill and then signs it.

A bill is called a draft before it is accepted.

Payee
The person to whom the payment is to be made is called payee.

The drawer of the bill himself will be the payee if he keeps the bill with him till the date of
its payment. The payee may change in the following situations:

(a) In case the drawer has got the bill discounted, the person who has discounted the bill
will become the payee;

(b) In case the bill is endorsed in favour of a creditor of the drawer, the creditor will become
the payee.

Contents of bill of exchange

1. DATE - The date on which a bill is drawn, is written on the top right corner of the bill. It
helps in determining the date of maturity of the bill.
2. Term/Tenure - Term specifies the time period for which a bill is written. It should be
specified in the body of the bill.

3. Amount - Amount in figure should be mentioned in the top left corner and amount in
words should be mentioned in body of the bill.

4. Stamp - Stamp of proper value depending upon the amount of bill must be affixed on the
bills of exchange.

5. Name of parties - The name and addresses of the drawer and the drawee should be
mentioned in the bill of exchange.

6. For Value Received – It means the bill has been issued in exchange of some
consideration.

Promissory note
According to Indian Negotiable Instrument Act, “A Promissory Note is an instrument in
writing (not being a bank note or a currency note) containing an unconditional undertaking
signed by the maker to pay a certain sum of money to, or to the order of, a certain person.”

Parties to a Promissory Note

1. Maker: He is the person who writes a promissory note and signs it.
2. Payee: He is the person who is entitled to get the payment.
There is no acceptor in case of promissory note (as the maker himself is liable to pay the
amount)
Basis Bill of exchange Promissory note
Drawer It is drawn by the creditor It is drawn by the debtor
Order or It contains an order to make It contains a promise to make
promise and payment. There can be three payment. There are only two
parties parties – the drawer, the parties to it – the drawer and the
drawee and the payee payee
Acceptance It requires acceptance by the It does not require any
drawee or someone else on his acceptance
behalf
Payee Drawer and payee can be the Drawer cannot be the payee of it
same party

Date of Maturity (Due date) and Days of Grace

The date on which the payment of the bill becomes due is called the ‘date of maturity’.

While calculating the date of maturity of the bill, it is compulsory to add three days to the
period of the bill. These three days are called Days of Grace.

Where the date of maturity is a public holiday, the instrument will become due on the
preceding business day.

Bills Description
Bill at Sight / On Payable on demand. They become due as soon as
Presentation the bill is presented for payment.
Bill after Date Period starts from the date of drawing the bill.
Bill after Sight Period starts from the date of acceptance of the
bill.
 Case:

X draws a bill on Y dated 1 March 2018. It is accepted on 15 March 2018.

Type of Bill Due date

Payable 2 months ‘after date’ 4 May 2018
At sight Payable on demand
Payable 2 months ‘after sight’ 18 May 2018

Discounting of bill
If the holder of the bill needs funds, he can approach the bank for encashment of the bill
before the due date. The bank shall makes the payment of the bill after deducting some
interest (called discount in this case). This process of encashing the bill with the bank is
called discounting the bill. The bank gets the amount from the drawee on the due date.

Endorsement of bill
The holder of the bill may transfer a bill to another person in discharge of his debt. This is
known as endorsement.
Journal entries under various cases
Dishonour of Bill
A bill of exchange is said to be dishonored when its acceptor refuses to pay the amount of
the bill to the holder of the bill on its maturity.

Noting charges: To establish beyond doubt that the bill was dishonoured, despite its due
presentation, it may preferably to be got noted by Notary Public. Noting authenticates the
fact of dishonour. For providing this service, a fees is charged by the Notary Public which is
called Noting Charges.

Entries in the book of drawer

1. When the bill is retained by the drawer till the maturity and dishonoured on due date
Debtor a/c Dr.

To bills receivable

To cash or bank a/c (noting charges if any)

2. When the bill is discounted with the bank and is dishonoured, the entry will be
Debtor a/c Dr,

To cash or bank a/c

 3. When the bill is endorsed to the endorsee and is dishonoured , the entry will be
Debtor a/c Dr.

To endorsee a/c

4. When the bill has been sent to the bank for collection and is dishonoured
Debtor a/c

To bills sent for collection a/c

To cash or bank a/c

Entries in the book of drawee

Bills Payable a/c Dr.

Noting charges a/c Dr.

To creditor a/c

Renewal of bill
Sometimes, acceptor of a bill finds unable to pay his dues on the due date. So he may
approach the drawer of the bill before the maturity date arrives, to cancel the old bill and
draw a new bill with extended date. The acceptor in this case will have to pay interest for
the extended period. Thus the cancellation of the old bill maturity in return for a new bill
for an extended period is called "renewal of a bill of exchange".
Retiring a Bill
Sometimes the acceptor of a bill of exchange desires to meet the bill before its maturity if
he has sufficient funds at his disposal. He may ask the holder of the bill to accept the
payment before the due date. If the holder agrees to his proposal, he will withdraw the bill.
Such a withdrawal is called "retirement of a bill of exchange". The holder generally allows
the acceptor a rebate or discount for the unexpired period of the bill. This rebate is an
expense for the holder and a revenue for the acceptor of the bill.

When a bill of exchange is retired by an acceptor, the following entry is made in books of
the holder:

Cash A/C...................Dr. (with actual amount of cash received)

Rebate A/C................Dr. (amount of rebate allowed)
Bill receivable A/C (full amount of bill)
In the books of acceptor, the following entry is passed:

Bill payable A/C...........Dr. (with full amount)

Cash A/C (amount actually paid)
Rebate A/C (rebate earned)

Accommodation Bill
Sometimes, in order to oblige a friend, a bill may be accepted without consideration. Such a
bill is known as ‘accommodation bill’.

Suppose A is in need of money, he approaches his friend B and asks him to give him a loan
for Rs.5,000. B also shows his inability but agrees that he will accept a bill of exchange. A
draws a bill on B which he accepts at three months. A discounts the bill with his bank and
gets the money. After three months but before the due date, A sends Rs.5,000 to B in order
to meet his acceptance. B receives amount and pays his acceptance.
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PROVISIONS AND RESERVES

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Contents
Meaning of provisions....................................................................................................................................................... 4
Examples of provisions.................................................................................................................................................. 4
Reserves ............................................................................................................................................................................ 5
Examples of reserves .................................................................................................................................................... 5
Difference between Provision and Reserves .................................................................................................................... 6
Types of Reserves.............................................................................................................................................................. 7
General Reserves .......................................................................................................................................................... 7
Specific reserves............................................................................................................................................................ 7
Revenue reserves .......................................................................................................................................................... 7
Capital reserves ............................................................................................................................................................. 8
Secret reserve ............................................................................................................................................................... 8
Meaning of provisions
There are certain expenses/losses which are related to the current accounting period but
amount of which is not known with certainty because they are not yet incurred. It is
necessary to make provision for such items for ascertaining true net profit.

Examples of provisions
• Provision for depreciation;

• Provision for bad and doubtful debts;

• Provision for taxation;

• Provision for discount on debtors; and

• Provision for repairs and renewals.

In the balance sheet, the amount of provision may be shown either:

• By way of deduction from the concerned asset on the assets side. For example, provision
for doubtful debts is shown as deduction from the amount of sundry debtors and provision
for depreciation as a deduction from the concerned fixed assets;

• On the liabilities side of the balance sheet along with current liabilities, for example
provision for taxes and provision for repairs and renewals.
Reserves
A part of the profit may be set aside and retained in the business to provide for certain
future needs like growth and expansion or to meet future contingencies such as workmen
compensation.

Unlike provisions, reserves are the appropriations of profit to strengthen the financial
position of the business. Reserve is not a charge against profit as it is not meant to cover
any known liability or expected loss in future. However, retention of profits in the form of
reserves reduces the amount of profits available for distribution among the owners of the
business. It is shown under the head Reserves and Surpluses on the liabilities side of the
balance sheet after capital.

Examples of reserves
• General reserve;

• Workmen compensation fund;

• Investment fluctuation fund;

• Capital reserve;

• Dividend equalisation reserve;

• Reserve for redemption of debenture.

Difference between Provision and Reserves
Basis of difference Provision Reserve
Basic nature Charge against profit Appropriation of profit
Purpose It is created for a known It is made for strengthening
liability or expense the financial position of the
pertaining to current business.
accounting period, the
amount of which is not
certain
Presentations in It is shown either by way of It is shown on the liabilities
balance sheet deduction from the item on side after capital amount
the asset side for which it is
created or in the liabilities
side along with current
liability
Element of Creation of provision is Generally, creation of reserve
compulsion necessary to ascertain true is at the discretion of the
and fair profit or loss in management. Reserve cannot
compliance with be created unless there are
conservatism concept profits. However, in certain
cases law has stipulated for
the creation of specific
reserves such as ‘Debenture
Redemption Reserve’
Use for the It cannot be used for It can be used for dividend
payment of dividend distribution distribution
dividend
Types of Reserves

General Reserves
When the purpose for which reserve is created is not specified, it is called General Reserve.
It is also termed as free reserve because the management can freely utilise it for any
purpose. General reserve strengthens the financial position of the business.

Specific reserves
These are created for specific purposes, example:

Dividend equalization reserve: To maintain steady rate of dividend.

Investment Fluctuation Fund: Provide for decline in the value of investments due to market
fluctuations.

Workmen Compensation Fund: It is created to provide for claims of the workers due to
accident, etc.

Debenture Redemption Reserve: Provide funds for Redemption of debentures.

Revenue reserves
These reserves are made out of profits which are earned from day-to-day business
operations.

Examples of revenue reserves are:

 General reserve
 Workmen compensation fund
 Investment fluctuation fund
 Dividend equalisation reserve
 Debenture redemption reserve
Capital reserves
Reserves made out of capital profits are known as Capital Reserves.

Capital profits may arise out of:

A) Profits on the sale of fixed assets

B) Profits on revaluation of fixed assets and liabilities.
C) Premiums received on issue of Shares or Debentures
D) Profit on purchase of running business
E) Profit prior to the incorporation of a company
F) Profit from the reissue of forfeited share
G) Profit on redemption of debentures.

Capital reserves must be used to write off Capital losses and for the issue of fully paid
bonus shares. Usually, the capital reserves are not available for distribution as cash
dividends.

Secret reserve
Secret reserve is a reserve which does not appear in the balance sheet. It may also help to
reduce the disclosed profits and also the tax liability. The secret reserve can be merged with
the profits during the lean periods to show improved profits. Management may resort to
creation of secret reserve by charging higher depreciation than required. It is termed as
‘Secret Reserve’, as it is not known to outside stakeholders. Secret reserve can also be
created by way of:

 Undervaluation of inventories/stock
 Charging capital expenditure to profit and loss account
 Making excessive provision for doubtful debts
 Showing contingent liabilities as actual liabilities
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Depreciation...................................................................................................................................................................... 4
Meaning ........................................................................................................................................................................ 4
Other related terms ...................................................................................................................................................... 5
Depletion................................................................................................................................................................... 5
Amortisation ............................................................................................................................................................. 5
Features ........................................................................................................................................................................ 5
Need, Importance or Objects of Providing Depreciation.............................................................................................. 6
Factors determining the amount of depreciation ........................................................................................................ 7
Total cost of the asset ............................................................................................................................................... 7
Estimated useful life.................................................................................................................................................. 7
Estimated useful life.................................................................................................................................................. 8
Methods of Allocating Depreciation ............................................................................................................................. 8
Straight line method ................................................................................................................................................. 8
Merits .................................................................................................................................................................. 10
Demerits .............................................................................................................................................................. 10
Written down value method................................................................................................................................... 11
Merits .................................................................................................................................................................. 13
Demerits .............................................................................................................................................................. 13
Difference Between Straight Line Method and Reducing Balance Method .................................................... 14
Methods of recording depreciation ............................................................................................................................ 15
Charging Depreciation to Asset account ................................................................................................................. 15
Accumulated depreciation account ........................................................................................................................ 16
Asset Disposal A/c ....................................................................................................................................................... 17
Depreciation
Meaning
Assets have a definite span of life after the expiry of which the assets will lose their
usefulness for the business purposes. The value of these assets keeps on declining, which is
known as depreciation.

Depreciation is the diminution in intrinsic value of the asset due to use and/ or lapse of
time.

Example: ABC Construction Ltd. Purchased a heavy machinery at Rs.10,00,000, now if he

charges this amount to the year of purchase, it will lead to distortion of matching principle
as this machinery will yield revenue in future years too. Therefore, to get the right profits,
the cost of machinery must be allocated to the years for which it will generate revenue.
This allocation of cost is known as depreciation.
Other related terms
Depletion
The term depletion is used in the context of extraction of natural resources like mines,
quarries, etc. that reduces the availability of the quantity of the material or asset.

For example, if a business enterprise is into mining business and purchases a coal mine for
Rs.10,00,000. Then the value of coal mine declines with the extraction of coal out of the
mine. This decline in the value of mine is termed as depletion.

The main difference between depletion and depreciation is that the former is concerned
with the exhaustion of economic resources, but the latter relates to the usage of an asset.

Amortisation
Amortisation refers to writing-off the cost of intangible assets like patents, copyright,
trademarks, franchises, goodwill which have utility for a specified period of time.

Features
 It is decline in the book value of fixed assets.
 It is a continuing process.
 It is an expired cost and hence must be deducted before calculating taxable profits.
 It is a non-cash expense. It does not involve any cash outflow.
Need, Importance or Objects of Providing Depreciation

Fair view of financial position

• Depreciation, if not charged, would result in assets being stated at a

higher value. As a result of this the balance sheet would not present a
true and fair view of financial position.

Avoid over-payment of Income Tax

• Depreciation charged will decrease the net profit, which will lead to
less tax payment.

Provide funds for Replacement of assets

• Depreciation charged every year to Profit and Loss account is not paid
in cash, therefore, it can be retained by the business and can be used
to replace the asset.

Compliance of legal provisions

• It is necessary to cahrge depreciation to comply withthe provisions of

the Companies Act and the Income Tax Act.
Factors determining the amount of depreciation

Total cost
of the
Asset

Estimated
useful life

Estimated Scrap
Value

Total cost of the asset

Cost will include all the expenses incurred like freight and installation charges up to the
point the asset is ready for use.

Estimated useful life

Physical life is not important - an asset may still exist physically but may not be capable of
producing goods at a reasonable goods. If, for instance, an asset can be used for twenty
years but is likely to lose its useful value within ten years, its life for the purpose of
accounting should be considered as only ten years.
Estimated useful life
Residual value is an estimated sale value of the asset at the end of its economic life to the
firm. Difference between the cost and residual or scrap value is the amount written off over
the useful life of the asset.

Amount to be written off = Cost of asset – Residual or scrap

Methods of Allocating Depreciation

Straight line method

Written Down Value Method

Straight line method

It is also known as fixed installment method and original cost method. In this method, the
number of years of use is estimated and the cost is then divided by the number of years to
give the depreciation charge each year.

The amount of depreciation will be equal each year, since depreciation is charged at fixed
rate on cost of asset. If the annual depreciation is plotted on a graph paper, it will show a
straight line, since the amount of depreciation is equal every year. This is why this method
is called straight line method.
Formula:
Depreciation charge under this method is calculated by using the following formula:

𝐂𝐨𝐬𝐭 𝐥𝐞𝐬𝐬 𝐬𝐚𝐥𝐯𝐚𝐠𝐞 𝐯𝐚𝐥𝐮𝐞

= 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧 𝐜𝐡𝐚𝐫𝐠𝐞
𝐄𝐬𝐭𝐢𝐦𝐚𝐭𝐞𝐝 𝐬𝐞𝐫𝐯𝐢𝐜𝐞 𝐥𝐢𝐟𝐞

Example:
Assume a machine was bought for Rs.500,000 and estimated salvage value of the machine
is Rs.50,000 after four years, the depreciation to be charged each year would be calculated
as follows:

𝐂𝐨𝐬𝐭 𝐥𝐞𝐬𝐬 𝐬𝐚𝐥𝐯𝐚𝐠𝐞 𝐯𝐚𝐥𝐮𝐞

= 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧 𝐜𝐡𝐚𝐫𝐠𝐞
𝐄𝐬𝐭𝐢𝐦𝐚𝐭𝐞𝐝 𝐬𝐞𝐫𝐯𝐢𝐜𝐞 𝐥𝐢𝐟𝐞

𝟓, 𝟎𝟎, 𝟎𝟎𝟎 − 𝟓𝟎, 𝟎𝟎𝟎

𝟒
=Rs.1,12,500
This amount will be charged to Profit & Loss Account for 4 consecutive years.
Merits
 It is very simple, easy to understand and apply. Simplicity makes it a popular method
in practice;
 Asset can be depreciated upto the net scrap value or zero value. Therefore, this
method makes it possible to distribute full depreciable cost over useful life of the
asset;
 Every year, same amount is charged as depreciation in profit and loss account. This
makes comparison of profits for different years easy;
 This method is suitable for those assets whose useful life can be estimated accurately
and where the use of the asset is consistent from year to year such as leasehold
buildings.
Demerits
With the passage of time, work efficiency of the asset decreases and repair and
maintenance expense increases. Hence, under this method, the total amount charged
against profit on account of depreciation and repair taken together, will not be uniform
throughout the life of the asset, rather it will keep on increasing from year to year.

Journal Entries:
Under this method depreciation is recorded as follows:

When depreciation is provided:

Depreciation Account Dr.
Asset Account Cr.
(Being depreciation charged on -@- for the year)

When depreciation is transferred to profit and loss account:

Profit and Loss Account Dr.
Depreciation Account Cr.
(Being depreciation account transferred to profit and loss
account)
 When asset is sold on expiry of its useful life:
Bank Account Dr.
Asset Account Cr.
(Being scrap of asset sold)

If profit is earned on sale of asset:

Asset Account Dr.
Profit and Loss Account Cr.
(Being profit on sale of scrap transferred to profit and loss
account)

If loss is incurred on sale of asset:

Profit and Loss Account Dr.
Asset Account Cr.
(Being loss on sale of scrap transferred to profit and loss
account)

Written down value method

Under this method, the amount of depreciation is charged every year on the Book Value of
the asset. The amount of depreciation goes on declining every year along with the declining
Book Value of the asset with constant rate of depreciation.

Suppose the cost of asset is Rs.1,000 and rate of depreciation 10% p.a.

COST OF ASSET 1,000

DEPRECIATION:
1ST YEAR: 10% OF 1,000 100

BOOK VALUE 900

 2ND YEAR: 10% OF 900 90

BOOK VALUE 810

3RD YEAR: 10% OF 810 81

BOOK VALUE 729

AND SO ON.......

Formula for the Calculation of Depreciation Rate:

r = 1 - (S/C)1/n

Where:

r = Rate of depreciation

n = Estimated useful life of asset

S = Residual value after the expiry of useful life

C = Original cost of asset

Example:

Merits
 This method is based on a more realistic assumption that the benefits from asset go
on diminishing (reducing) with the passage of time. Hence, it calls for proper
allocation of cost because higher depreciation is charged in earlier years when asset’s
utility is higher as compared to later years when it becomes less effective.
 It results into almost equal burden of depreciation and repair expenses taken
together every year on profit and loss account;
 Income Tax Act accept this method for tax purposes;
 This method is suitable for fixed assets which last for long and which require
increased repair and maintenance expenses with passage of time. It can also be used
where obsolescence rate is high.

Demerits
 As depreciation is calculated at fixed percentage of written down value, depreciable
cost of the asset cannot be fully written-off. The value of the asset can never be zero;
 It is difficult to ascertain a suitable rate of depreciation.
Difference Between Straight Line Method and Reducing
Balance Method
Straight Line Method Reducing Balance Method

1. The rate and amount of 1. The rate remains the same, but the amount of
depreciation remain the same depreciation diminishes gradually.
each year.

2. Depreciation is calculated on 2. Depreciation is calculated on the diminishing

the original cost of fixed asset balance or written down value of a fixed asset

3. At the end of its life the value 3. The value of asset is never reduced to zero at
of asset is reduced to zero or the end of its life.
scrap value.

4. The older the asset the larger 4. The amount of depreciation decreases
the cost of its repair. But the gradually, while the cost of repairs increases. So
amount of depreciation remain the total of depreciation and repairs remain
the same each year. Hence, the more or less the same each year. Hence, it
total of depreciation and causes little or no change in annual profit/loss.
repairs increases every year.
This reduces annual profit
gradually.
5. Computation of depreciation 5. Depreciation can be computed without any
under straight line method is difficulty, but it is not easy and simple.
comparatively easy and simple.
Methods of recording depreciation
Charging Depreciation to Asset account
According to this arrangement, depreciation is deducted from the depreciable cost of the
asset (credited to the asset account) and charged (or debited) to profit and loss account.
Journal entries under this recording method are as follows:

1. For recording purchase of asset (only in the year of purchase)

Asset A/c Dr. (with the cost of asset including installation, freight, etc.)

To Bank/Vendor A/c

2. Following two entries are recorded at the end of every year

(a) For deducting depreciation amount from the cost of the asset.

Depreciation A/c Dr. (with the amount of depreciation)

To Asset A/c

(b) For charging depreciation to profit and loss account.

Profit & Loss A/c Dr. (with the amount of depreciation)

To Depreciation A/c

3. Balance Sheet Treatment

When this method is used, the fixed asset appears at its net book value (i.e. cost less
depreciation charged till date) on the asset side of the balance sheet and not at its original
cost (also known as historical cost).
Accumulated depreciation account
This method is designed to accumulate the depreciation provided on an asset in a separate
account generally called ‘Provision for Depreciation’ or ‘Accumulated Depreciation’
account. By such accumulation of depreciation the asset account need not be disturbed in
any way and it continues to be shown at its original cost over the successive years of its
useful life.

The following journal entries are recorded under this method:

1. For recording purchase of asset (only in the year of purchase)

Asset A/c Dr. (with the cost of asset including installation, expenses etc.)

To Bank/Vendor A/c (cash/credit purchase)

2. Following two journal entries are recorded at the end of each year:

(a) For crediting depreciation amount to provision for depreciation account

Depreciation A/c Dr. (with the amount of depreciation)

To Provision for depreciation A/c

(b) For charging depreciation to profit and loss account

Profit & Loss A/c Dr. (with the amount of depreciation)

To Depreciation A/c

3. Balance sheet treatment

In the balance sheet, the fixed asset continues to appear at its original cost on the asset
side. The depreciation charged till that date appears in the provision for depreciation
account, which is shown either on the “liabilities side” of the balance sheet or by way of
deduction from the original cost of the asset concerned on the asset side of the balance
sheet.
Asset Disposal A/c
When part of the asset is sold or disposed off, it is appropriate to open a new A/c called
‘Asset Disposal Account’.

Entries are as follows:

When Provision for When Provision for Depreciation A/c is

Depreciation A/c is not maintained:
maintained:
For transferring the book value For transferring Original Cost of the asset
of the asset sold sold:

Asset Disposal A/c Dr.

Asset Disposal A/c Dr.
To Asset A/c
To Asset A/c

For transferring the Accumulated

Depreciation of the asset sold:

Provision for Depreciation A/c Dr

To Asset Disposal A/c

For recording sale proceeds of For recording sale proceeds of the asset:
the asset: Bank A/c Dr.
Bank A/c Dr. To Asset Disposal A/c
To Asset Disposal A/c

For Profit on sale: For Profit on sale:

Asset Disposal A/c Asset Disposal A/c
To P & L A/c To P & L A/c
In case of loss, above entry will In case of loss, above entry will be reversed.
be reversed.
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Contents
Meaning of trial balance ................................................................................................................................................... 4
Format of trial balance ...................................................................................................................................................... 4
Purpose of Trial Balance ................................................................................................................................................... 4
Methods of Preparing Trial Balance.................................................................................................................................. 5
Total or Gross Trial Balance .......................................................................................................................................... 5
Balance or Net Trial Balance ......................................................................................................................................... 5
Example ......................................................................................................................................................................... 5
Types of errors ................................................................................................................................................................ 10
Errors of omission ....................................................................................................................................................... 10
Errors of commission .................................................................................................................................................. 11
Errors of principle ....................................................................................................................................................... 11
Compensating errors .................................................................................................................................................. 12
Errors affecting Trial Balance ...................................................................................................................................... 12
Errors not affecting Trial Balance................................................................................................................................ 12
Rectification of errors ..................................................................................................................................................... 14
Rectification of errors which do not affect the trial balance (Two sided errors) ....................................................... 14
Rectification of errors affecting trial balance (one sided errors)................................................................................ 16
Rectification of errors before preparation of the trial balance .............................................................................. 17
Rectification of errors after preparation of trial balance ....................................................................................... 18
Suspense account................................................................................................................................................ 18
Meaning of trial balance
A trial balance is a statement showing the balances, or total of debits and credits, of all the
accounts in the ledger with a view to verify the arithmetical accuracy of posting into the
ledger accounts.

Format of trial balance

Purpose of Trial Balance

1. To check the equality of debits and credits - an arithmetical or mathematical test of
accuracy.
2. To help in preparation of final accounts.
3. To locate errors.
4. To obtain a summary of ledger accounts.
If the trial balance agrees we may reasonably assume that the books are correct. On the
other hand, if it does not agree, it indicates that the books are not correct - there are
mistakes somewhere. There are however, a few types of errors which the trial balance
cannot detect. In other words, the trial balance will agree in spite of the existence of those
errors.

Methods of Preparing Trial Balance

There are two methods for the preparation of trial balance. These methods are:

1. Total or gross trial balance

2. Balance or net trial balance

Total or Gross Trial Balance

Under this method the two sides of all the ledger accounts are totaled up. The total of
debit side and credit side of each account is then placed on "debit amount" column and
"credit amount" column respectively of a list. Finally the two columns are added separately
to see whether they agree of not.

Balance or Net Trial Balance

Under this method, first of all the balances of all ledger accounts are drawn. Thereafter,
the debit balances and credit balances are recorded in "debit amount" and "credit amount"
column respectively and the two columns are added separately to see whether they agree
or not.

Example
Enter the following transactions in journal and post them into the ledger and also prepare a
trial balance.

2018
Jan. 1 Mr. X started business with cash Rs.80,000 and furniture Rs.20,000.
Jan. 2 Purchased goods on credit worth Rs.30,000 from Y.
Jan. 3 Sold goods for cash Rs.16,000.
Jan. 4 Sold goods on credit to S for Rs.10,000
Jan. 8 Cash received from S Rs.9,800 in full settlement of his account.

Solution:

Journal

Date Particulars L.F DR. Cr.

2018 Amount (Rs.) Amount (Rs.)
Jan.
Cash A/C 80,000
1
Furniture A/C 20,000
Capital A/C 1,00,000
(Owner invested cash and furniture)

Jan.
Purchases Account 30,000
2
Y 30,000
(Bought goods on credit)

Jan.
Cash A/C 16,000
3
Sales A/C 16,000
(Sold goods for cash)

Jan.
S A/C 10,000
4
Sales A/C 10,000
(Sold goods on credit)

Jan.
Cash A/C 9,800
8
Discount A/C 200
S A/C 10,000
(Cash received and discount allowed)
 Ledger

Cash Account

Date Particulars JF Amount Date Particulars JF Amount

Jan 1 Capital a/c 80,000 Jan 31 Balance 1,05,800
c/d
Jan 3 Sales a/c 16,000
Jan 8 S a/c 9,800
1,05,800 1,05,800

Feb 1 Balance 1,05,800

b/d

Furniture Account

Date Particulars JF Amount Date Particulars JF Amount

Jan 1 Capital a/c 20,000 Jan 31 Balance 20,000
c/d
20,000 20,000

Feb 1 Balance 20,000

b/d

Capital Account

Date Particulars JF Amount Date Particulars JF Amount

Jan 31 Balance 1,00,000 Jan 1 Cash a/c 80,000
c/d
Jan 1 Furniture 20,000
a/c
 1,00,000 1,00,000

Feb 1 Balance 1,00,000

b/d

Purchases Account

Date Particulars JF Amount Date Particulars JF Amount

Jan 2 Y a/c 30,000 Jan 31 Balance 30,000
c/d
30,000 30,000

Feb 1 Balance 30,000

b/d

Y Account (No.13)

Date Particulars JF Amount Date Particulars JF Amount

Jan 31 Balance 30,000 Jan 2 Purchases 30,000
c/d a/c
30,000 30,000

Feb 1 Balance 30,000

b/d

Sales Account

Date Particulars JF Amount Date Particulars JF Amount

Jan 31 Balance 40,000 Jan 3 Cash a/c 16,000
c/d
Jan 4 S a/c 10,000
 40,000 40,000

Feb 1 Balance 40,000

b/d

S Account

Date Particulars JF Amount Date Particulars JF Amount

Jan 4 Sales a/c 10,000 Jan 8 Cash a/c 9,800
Jan 8 Discount 200
a/c
10,000 10,000

Discount Account (No.19)

Date Particulars JF Amount Date Particulars JF Amount

Jan 8 S a/c 200 Jan 31 Balance 200
c/d
200 200

Feb 1 Balance 200

b/d

Trial Balance (Balances method)

A/C
S. No. Account Name Debit Credit
No.
1 Cash Account 105,800
2 Furniture Account 20,000
 3 Capital Account -- 100,000
4 Purchases Account 30,000
5 Y Account -- 30,000
6 Sales Account -- 26,000
7 S Account -- --
8 Discount Account 200 --
Total 156,000 1,56,000

Note: If an account shows zero balance, it is not necessary to record it in trial balance.

Types of errors

Types of errors

Errors of Errors of Errors of Compensating

omission commission principle errors

Errors of omission
The errors of omission may be committed at the time of recording the transaction in the
books of original entry or while posting to the ledger. These can be of two types:

(i) error of complete omission

(ii) error of partial omission

When a transaction is completely omitted from recording in the books of original record, it
is an error of complete omission. For example, credit sales to Mohan Rs. 10,000, not
entered in the sales book. When the recording of transaction is partly omitted from the
books, it is an error of partial omission. If in the above example, credit sales had been duly
recorded in the sales book but the posting from sales book to Mohan’s account has not
been made, it would be an error of partial omission.

Errors of commission
These are the errors which are committed due to wrong posting of transactions, wrong
totaling or wrong balancing of the accounts, wrong casting of the subsidiary books, or
wrong recording of amount in the books of original entry, etc.

For example: Raj Hans Traders paid Rs.25,000 to Preetpal Traders (a supplier of goods). This
transaction was correctly recorded in the cashbook. But while posting to the ledger,
Preetpal’s account was debited with Rs.2,500 only. This constitutes an error of commission.

Such an error by definition is of clerical nature and most of the errors of commission affect
in the trial balance.

Errors of principle
Accounting entries are recorded as per the generally accepted accounting principles. If any
of these principles are violated or ignored, errors resulting from such violation are known as
errors of principle.

An error of principle may occur due to incorrect classification of expenditure or receipt

between capital and revenue.

Examples:

 Amount spent on additions to the buildings should be treated as capital expenditure

and must be debited to the asset account. Instead, if this amount is debited to
maintenance and repairs account, it has been treated as a revenue expense. This is
an error of principle.
 If a credit purchase of machinery is recorded in purchases book instead of journal
proper or rent paid to the landlord is recorded in the cash book as payment to
landlord, these errors of principle. These errors do not affect the trial balance.
Compensating errors
When two or more errors are committed in such a way that the net effect of these errors
on the debits and credits of accounts is nil, such errors are called compensating errors.

Example: Shyam’s account was debited with Rs.100 instead of Rs.1000 while Ram’s account
was debited with Rs.1000 instead of Rs.100. Thus, Shyam’s account which was debited by
Rs.900 less was compensated by another error in Ram’s account, whose account was
debited excess of Rs.900.

From another point of view, errors may be divided into two categories:

Errors affecting Trial Balance

1. Posting only one aspect of the journal entry in the ledger
2. Posting a journal entry on the wrong side of an account
3. Wrong totalling of the subsidiary books
4. Posting the correct amount in one account and wrong amount in another account
5. Wrong totalling or balancing of the ledger account
6. Omission in writing the balance of an account in the trial balance
7. Writing balance in the wrong column of trial balance
8. Totalling the trial balance wrongly

Errors not affecting Trial Balance

1. Errors of complete omission
Transaction remains altogether unrecorded either in Journal or in Subsidiary books.

2. Compensating Errors
Effect of one error is neutralized by the effect of some other error.
 3. Errors of Principle
Some fundamental principle of accounting is violated while recording a transaction.

Suppose on the purchase of a typewriter, office expenses account is debited, the trial
balance will still agree

4. Errors of Posting in wrong account

While posting from the books of original entry, posting is made to a wrong account but on
the correct side.

5. Recording both the aspects of a transaction twice in the books of accounts

Case study (for errors)

Mr. Roy is a furniture dealer. Some of the transactions undertaken through the year are as
follows:

Transactions Errors Affect Trial

Balance
Total of purchase book was added Rs Error of commission Yes
2,000 in excess due to wrong calculations

Dining table was sold to Ram. Error of commission Yes

Ram’s A/c was credited by Rs 20,000.

Rs 10,000 spent on repairs of old Error of Principle No

machinery debited to Machinery A/c

Sold study table to Shyam for Rs 15,000 Errors of Omission No

but was omitted to be recorded in the
books.
Rs 5,000 received from Rahul was posted Error of commission Yes
on the credit side of Rahul’s A/c twice but
correctly entered in Cash Book

Purchased wood from Mr X for Rs 10,000. Error of commission Yes

Credited Mr X with Rs 1000

Sold a bed for Rs 40,000 but cash A/c was Error of omission Yes
not debited

Purcahse book was overcast by Rs 1,000 Compensating Errors No

and Purchase Returns book was overcast
by Rs 1,000

Sale of table to Meena for Rs 5000 has Errors of Commission No

been entered in the Journal as Rs 500

Rectification of errors
From the point of view of rectification, the errors may be classified into the following two
categories:

(a) errors which do not affect the trial balance.

(b) errors which affect the trial balance.

Rectification of errors which do not affect the trial balance

(Two sided errors)
These errors are committed in two or more accounts. Such errors are also known as two
sided errors. They can be rectified by recording a journal entry giving the correct debit and
credit to the concerned accounts.
Examples of such errors are – complete omission to record an entry in the books of original
entry; wrong recording of transactions in the book of accounts; complete omission of
posting to the wrong account on the correct side, and errors of principle.

Such errors are rectified by passing a rectifying entry.

The procedure for rectification for such errors is explained with the help of following
examples:

(a) Credit sales to Mohan Rs. 10,000 were not recorded in the sales book. This is an error
of complete omission. Its affect is that Mohan’s account has not been debited and
Sales account has not been credited. Accordingly, recording usual entry for credit
sales will rectify the error.
Mohan’s a/c Dr. 10,000

To sales a/c 10,000

(b) Credit sales to Mohan Rs. 10,000 were recorded as Rs. 1,000 in the sales book. This is
an error of commission.
Wrong entry Mohan’s a/c 1000
To sales a/c 1000

Correct entry Mohan’s a/c 10000

should have been To sales a/c 10000

Rectifying entry Mohan’s a/c 9000

To sales a/c 9000

(c) Credit sales to Mohan Rs.10,000 were recorded as Rs. 12,000. This is an error of
commission.
Wrong entry Mohan’s a/c 12000
To sales a/c 12000

Correct entry Mohan’s a/c 10000

 should have been To sales a/c 10000

Rectifying entry Sales a/c 2000

To Mohan’s a/c 2000

(d) Credit sales to Mohan Rs.10,000 was correctly recorded in the sales book but was
posted to Ram’s account.
Wrong entry Ram’s a/c 10000
To sales a/c 10000

Correct entry Mohan’s a/c 10000

should have been To sales a/c 10000

Rectifying entry Mohan’s a/c 10000

To Ram’s a/c 10000

(e) Rent paid Rs.2,000 was wrongly shown as payment to landlord in the cash book
Wrong entry Landlord a/c 2000
To cash a/c 2000

Correct entry Rent a/c 2000

should have been To cash a/c 2000

Rectifying entry Rent a/c 2000

To landlord a/c 2000

Rectification of errors affecting trial balance (one sided

errors)
The errors which affect only one account can be rectified by giving an explanatory note in
the account affected or by recording a journal entry with the help of the Suspense Account.
Rectification of errors before preparation of the trial balance
If the one sided errors come into notice before preparing the trial balance, they should be
rectified by debiting the concerned account for short debit or excess credit and by crediting
the concerned account for short credit or excess debit.

Examples:

Shyam’s account was credited short by Rs.190. This will be rectified by an additional entry
for Rs.190 on the credit side of his account as follows:

(Source – NCERT)

The purchases book was undercast by Rs.1,000. The effect of this entry is on purchases
account (debit side) where the total of purchases book is posted

(Source – NCERT)
Rectification of errors after preparation of trial balance
One sided errors will be rectified by passing the journal entry either debiting or crediting
the suspense account.

Suspense account
Sometimes, in spite of best efforts some errors are not located and due to which Trial
Balance does not tally. In such a situation, to avoid delay in preparing the Final Accounts,
the difference in the Trial Balance is placed to a newly opened account known as ‘Suspense
Account’ and the Trial Balance tallies.

Later, when errors are detected, rectification entries are passed. When all the errors are
rectified, the account will close.

But if suspense account shows balance, it will be shown on the Asset side of the Balance
sheet if it has debit balance and if it has credit balance, then it is shown on Liabilities side.

Examples

Credit sales to Mohan Rs.10,000 were not posted to his account. This is an error of partial
omission committed while posting entries of the sales book.

Wrong entry Mohan’s a/c Nil

To sales a/c 10000

Correct entry Mohan’s a/c 10000

should have been To sales a/c 10000

Rectifying entry Mohan’s a/c 10000

To suspense a/c 10000

Purchases book overcast by Rs.1,000

Suspense a/c 1,000

To purchases a/c 1,000

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Contents
Subsidiary books ............................................................................................................................................................... 4
Purchase book ............................................................................................................................................................... 4
Purchase return book.................................................................................................................................................... 6
Sales book ..................................................................................................................................................................... 7
Sales return book .......................................................................................................................................................... 8
Journal proper ............................................................................................................................................................... 9
Subsidiary books

CASH BOOK PURCHASE BOOK

• All transactions relating to cash • This book records credit
receipts and cash payments are purchases.
entered in this book

SALES BOOK PURCHASE RETURN OR

• This book records credit sales. RETURN OUTWARD BOOK
• When goods previously
purchased on credit are
returned to the suppliers, such
returns are added to this book

SALES RETURN OR JOURNAL PROPER

RETURN INWARD BOOK • This book records transactions
• When goods previously sold on which are not entered in
credit are returned by the previous mentioned books
customers, such returns are
added to this book

Purchase book
All credit purchases of goods are recorded in the purchases journal whereas cash purchases
are recorded in the cash book. Other purchases such as purchases of office equipment,
furniture, building, are recoded in the journal proper if purchased on credit or in the cash
book if purchased for cash. The source documents for recording entries in the book are
invoices or bills received by the firm from the supplies of the goods.

The format of the purchases journal

Date Invoice no. Name of supplier L.F. Amount

The monthly total of the purchases book is posted to the debit of purchases account in the
ledger. Individual supplier’s accounts may be posted daily.

Books of Kanika Electronics

Purchase Book

Date Invoice no. Name of supplier L.F. Amount

2017
Aug 04 3250 Neema Electronics 1,82,000
Aug 10 3260 Pawan electronics 31,050
Aug 18 4256 Northern Electronics 3,06,250
Aug 26 3294 Neema Electronics 54,000
Aug 29 3281 Pawan Electronics 38,700
Aug 31 6,12,000

(Source – NCERT)
(Source – NCERT)

Purchase return book

In this book, purchases return of goods are recorded. Sometimes goods purchased are
returned to the supplier for various reasons such as the goods are not of the required
quality, or are defective, etc. For every return, a debit note (in duplicate) is prepared and
the original one is sent to the supplier for making necessary entries in his book. The supplier
may also prepare a note, which is called the credit note.
 Books of Kanika Electronics

Purchase Return Book

Date Debit note Name of supplier L.F. Amount

no.

Neema Electronics 13,200

(Source – NCERT)

Sales book
All credit sales of merchandise are recorded in the sales journal. Cash sales are recorded in
the cash book. The format of the sales journal is similar to that of the purchases journal
explained earlier. The source document for recording entries in the sales journal are sales
invoice or bill issued by the firm to the customers.

Date Invoice no. Name of customer L.F. Amount

2017
Apr 6 178 Raman traders 4,850
Apr 09 180 Nutan Enterprises 21,000
Apr 28 209 Raman traders 85,000
Apr 30 1,10,850
(Source – NCERT)

Sales return book

This journal is used to record return of goods by customers to them on credit.

Date Credit no. Name of customer L.F. Amount

Raman traders 2,100

(Source – NCERT)

Journal proper
Entries recorded in journal proper are:

Opening Entry: In order to open new set of books in the beginning of new accounting year
and record therein opening balances of assets, liabilities and capital, the opening entry is
made in the journal.

Adjustment Entries: In order to update ledger account on accrual basis, such entries are
made at the end of the accounting period. Such as Rent outstanding, Prepaid insurance,
Depreciation and Commission received in advance.

Rectification entries: To rectify errors in recording transactions in the books of original

entry and their posting to ledger accounts this journal is used.

Transfer entries: Drawing account is transferred to capital account at the end of the
accounting year. Expenses accounts and revenue accounts which are not balanced at the
time of balancing are opened to record specific transactions. Accounts relating to operation
of business such as Sales, Purchases, Opening Stock, Income, Gains and Expenses, etc., and
drawing are closed at the end of the year and their Total/balances are transferred to
Trading and Profit and Loss account by recording the journal entries. These are also called
closing entries.

Other entries: In addition to the above mentioned entries, recording of the following
transaction is done in the journal proper:

 Purchase/sale of items on credit other than goods.

 Goods withdrawn by the owner for personal use.
 Goods distributed as samples for sales promotion.
 Endorsement and dishonour of bills of exchange.
 Transaction in respect of consignment and joint venture, etc.
 Loss of goods by fire/theft/spoilage.
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Contents
BANK RECONCILIATION STATEMENT ................................................................................................................................ 4
Meaning ........................................................................................................................................................................ 4
Reasons of difference between cash book and pass book balances ............................................................................ 5
Difference caused by Time Gap in recording transactions ....................................................................................... 5
Cheques issued but not yet presented for payment ............................................................................................ 5
Cheques paid into the bank but not yet collected ................................................................................................ 5
Direct debits made by the bank on behalf of the customer ................................................................................. 5
Amounts directly deposited in the bank account ................................................................................................. 6
Interest and dividends collected by the bank ....................................................................................................... 6
Direct payments made by the bank on behalf of the customers ......................................................................... 6
Dishonour of a bill discounted with a bank .......................................................................................................... 6
Differences caused by Errors Committed in Recording Transactions ....................................................................... 7
Errors committed in recording transaction by the firm ........................................................................................ 7
Errors committed in recording transactions by the bank ..................................................................................... 7
Procedure of preparing a bank reconciliation statement ............................................................................................. 8
By debit balance of Bank Column of Cash Book ....................................................................................................... 8
By debit balance (Overdraft) of Pass Book ............................................................................................................... 9
By credit balance (favourable) of Pass Book ............................................................................................................. 9
Example ....................................................................................................................................................................... 10
BANK RECONCILIATION STATEMENT

Meaning
A bank reconciliation statement is a statement is a statement prepared on a particular date
to reconcile the bank balance as per the cash book with the balance as per the bank pass
book by showing reasons for differences between the two.

As the transactions relating to deposits and withdrawals made during a period are recorded
in both cash book and the pass book, the balances shown by the two records at the end of a
period should normally agree. But, sometimes the two balances differ. If the two balances
differ, it becomes necessary to know the reasons for the difference. A statement showing
the reasons or causes of differences is prepared. This statement is known as a bank
reconciliation statement.
Reasons of difference between cash book and pass book
balances
Difference caused by Time Gap in recording transactions

Cheques issued but not yet presented for payment

When cheques are issued by the firm to suppliers or creditors of the firm, these are
immediately entered on the credit side of the cash book. However, the receiving party may
not present the cheque to the bank for payment immediately. The bank will debit the firm’s
account only when these cheques are actually paid by the bank. Hence, there is a time lag
between the issue of a cheque and its presentation to the bank which may cause the
difference between the two balances.

Cheques paid into the bank but not yet collected

When firm receives cheques from its customers (debtors), they are immediately recorded
in the debit side of the cash book. This increases the bank balance as per the cash book.
However, the bank credits the customer account only when the amount of cheques are
actually realised. The clearing of cheques generally takes few days especially in case of
outstation cheques or when the cheques are paid-in at a bank branch other than the one at
which the account of the firm is maintained. This leads to a cause of difference between the
bank balance shown by the cash book and the balance shown by the bank passbook.

Direct debits made by the bank on behalf of the customer

Sometimes, the bank deducts amount for various services from the account without the
firm’s knowledge. The firm comes to know about it only when the bank statement arrives.
Examples of such deductions include: cheque collection charges, incidental charges,
interest on overdraft, unpaid cheques deducted by the bank – i.e., stopped or bounced, etc.
As a result, the balance as per passbook will be less than the balance as per cash book.
Amounts directly deposited in the bank account
There are instances when debtors (customers) directly deposits money into firm’s bank
account. But, the firm does not receive the intimation from any source till it receives the
bank statement. In this case, the bank records the receipts in the firm’s account at the bank
but the same is not recorded in the firm’s cash book. As a result, the balance shown in the
bank passbook will be more than the balance shown in the firm’s cash book.

Interest and dividends collected by the bank

When the bank collects interest and dividend on behalf of the customer, then these are
immediately credited to the customer’s account. But the firm will know about these
transactions and record the same in the cash book only when it receives a bank statement.
Till then the balances as per the cash book and passbook will differ.

Direct payments made by the bank on behalf of the customers

Sometimes the customers give standing instructions to the bank to make some payment
regularly on stated days to the third parties. For example, telephone bills, insurance
premium, rent, taxes, etc. are directly paid by the bank on behalf of the customer and
debited to the account. As a result, the balance as per the bank passbook would be less
than the one shown in the cash book.

Dishonour of a bill discounted with a bank

If the bank is not able to receive payment on bill discounted by it, it will debit the
customer’s account together with any charges that I may have incurred. The customer will
naturally record the entry only when he peruses the pass book.
Differences caused by Errors Committed in Recording
Transactions

Errors committed Errors committed

in recording in recording
transactions by the transactions by the
firm bank

Errors committed in recording transaction by the firm

Omission or wrong recording of transactions relating to cheques issued, cheques deposited
and wrong totalling, etc., committed by the firm while recording entries in the cash book
cause difference between cash book and passbook balance.

Errors committed in recording transactions by the bank

Omission or wrong recording of transactions relating to cheques deposited and wrong
totalling, etc., committed by the bank while posting entries in the passbook also cause
differences between passbook and cash book balance.
Procedure of preparing a bank reconciliation statement

By debit balance of Bank Column of Cash Book

If there is a debit balance in Bank Column of Cash book then, it will be added to Bank
Reconciliation Statement.

Items to be added: Items to be deducted:

1. Cheques issued but not yet presented 1. Cheques sent to the bank for
for payment collection but not yet credited by the
2. Credit made by the bank for interest bank
3. Amount directly deposited by 2. Dishonour of a bill discounted with the
customers in bank bank
4. Interest and dividend collected by the 3. Direct payment made by the bank on
bank behalf of the customers
5. Cheques paid into bank but omitted to 4. Debits made by the bank for
be recorded in cash book commission, bank charges etc.
5. Cheques issued but omitted to be
recorded in the cash book.
By debit balance (Overdraft) of Pass Book

If there is Debit balance of Pass Book, the starting balance will be written in minus items
and all the other items will be reversed.

Items to be added: Items to be deducted:

1. Cheques sent to the bank for 1. Cheques issued but not yet presented
collection but not yet credited by the for payment
bank 2. Credit made by the bank for interest
2. Dishounour of a bill discounted with 3. Amount directly deposited by
the bank customers in bank
3. Direct payment made by the bank on 4. Interest and dividend collected by the
behalf of the customers bank
4. Debits made by the bank for 5. Cheques paid into bank but omitted to
commission, bank charges etc. be recorded in cash book
5. Cheques issued but omitted to be
recorded in the cash book.

By credit balance (favourable) of Pass Book

If there is credit balance of Pass Book, the starting balance will be written in Plus items and
all items will be written in same columns as in overdraft balance of pass book.
Example
From the following particulars of Mr. Vinod, prepare bank reconciliation statement as on
March 31, 2017.

1. Bank balance as per cash book Rs.50,000.

2. Cheques issued but not presented for payment Rs.6,000.

3. The bank had directly collected dividend of Rs.8,000 and credited to bank account but
was not entered in the cash book.

4. Bank charges of Rs.400 were not entered in the cash book.

5. A cheque for Rs.6,000 was deposited but not collected by the bank.

Solution

Particulars Plus items (Rs.) Minus items

(Rs.)
Balance as per cash book 50,000
Cheques issued but not presented for 6,000
payment
Dividends collected by the bank 8,000
Cheque deposited but not credited by the 6,000
bank
Bank charges debited by bank 400
Balance as per pass book 57,600
64,000 64,000
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Chanchal Phore
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Contents
CASH BOOK ....................................................................................................................................................................... 4
Special Journals ............................................................................................................................................................. 4
Cash book (A Subsidiary and Principal Book) ................................................................................................................ 5
TYPES OF CASH BOOKS ..................................................................................................................................................... 5
Single Column Cash Book .............................................................................................................................................. 5
Format of single column cash book .......................................................................................................................... 6
Posting in single column cash book .......................................................................................................................... 6
Balancing of single column cash book ...................................................................................................................... 6
Example ..................................................................................................................................................................... 7
Double Column Cash Book ............................................................................................................................................ 9
Format of double cash book ..................................................................................................................................... 9
Contra Entry .............................................................................................................................................................. 9
Example ................................................................................................................................................................... 10
Three column cash book ............................................................................................................................................ 12
Format of triple column cash book ......................................................................................................................... 12
Petty Cash ....................................................................................................................................................................... 12
Imprest system of petty cash book ............................................................................................................................. 13
Example ....................................................................................................................................................................... 13
Solution:.................................................................................................................................................................. 14
CASH BOOK
Special Journals
If the size of business is small, then it is possible to enter every transaction in Journal only,
but if the size of business is large, it is no longer possible to enter every transaction in one
book only. Therefore, Journal is divided into sub-parts, known as Special Journals.

Therefore, following subsidiary books are prepared:

CASH BOOK PURCHASE BOOK

• All transactions relating to cash • This book records credit
receipts and cash payments are purchases.
entered in this book

SALES BOOK PURCHASE RETURN OR

• This book records credit sales. RETURN OUTWARD BOOK
• When goods previously
purchased on credit are
returned to the suppliers, such
returns are added to this book

SALES RETURN OR JOURNAL PROPER

RETURN INWARD BOOK • This book records transactions
• When goods previously sold on which are not entered in
credit are returned by the previous mentioned books
customers, such returns are
added to this book
Cash book (A Subsidiary and Principal Book)
It plays a dual role. It is both a book of original entry as well as a book of final entry. All cash
transactions are primarily recorded in it as soon as they take place; so it is a journal (a book
of original entry/subsidiary book). On the other hand, the cash aspect of all cash
transactions is finally recorded in the Cash Book (no posting in Ledger); so a Cash Book is
also a Ledger (a book of final entry/Principal Book)

When a cashbook is maintained, transactions of cash are not recorded in

the journal, and no separate account for cash or bank is required in the
ledger.

TYPES OF CASH BOOKS

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

It does not record:

1. Non-cash transactions
2. Cheques received or given
3. Cash discount allowed or received
Format of single column cash book

(Source – NCERT)

1. Date: Date for the transaction is written

2. Particulars: The name of the account under which the cash has been received or
payment has been made is written. Cash book starts with the opening balance of
cash written on the receipts side as “To balance b/d”. A new business will not have
an opening balance.
3. Ledger Folio (L.F.): It records the page number in the ledger where the amount has
been posted in the account.
4. Amount: The amounts received are written on the debit side and the amounts paid
are written on the credit side.

Posting in single column cash book

The left side of the cash book shows the receipts of the cash whereas the right side of the
cash book shows all the payments made in cash. The accounts appearing on then debit side
for the cash book are credited in the respective ledger accounts because cash has been
received in respect of them. Similarly, all the account names appearing on the credit side of
the cash book are debited as cash/cheque has been paid in respect of them.

Balancing of single column cash book

A cash book is balanced like any other account. The receipts column is always bigger than
the payments column. The difference is written on the credit side as ‘By balance c/d’.
Example
Enter the following transactions in the cash book of Mr. Jamil:
2018. Rs.
Jan. 1 Mr. Jamil started business with cash 2,00,000
Jan. 3 Bought goods for cash 1,40,000
Jan. 5 Paid for stationary 2,000
Jan. 7 Sold goods for cash 80,000
Jan. 10 Paid for trade expenses 2,000
Jan. 11 Sold goods for cash 20,000
Jan. 14 Received cash from Mr. Asif 10,000
Jan. 15 Paid cash to Mr. Qadir 20,000
Jan. 18 Withdrew cash for personal use 6,000
Jan. 22 Bought goods for cash 40,000
Jan. 25 Sold goods for cash 90,000
Jan. 27 Paid for electricity bill 4,000
Jan. 31 Paid salary 10,000
Jan. 31 Paid rent 3,000
Solution:

Single Column Cash Book of Mr. Jamil

Date Particulars V.N L.F Amount Date Particulars V. L. Amount

. . (Rs.) N. F. (Rs.)
2018 2018
Jan. Capital A/C 200,000 Jan. Purchases A/C 140,000
1 3
Jan.7 Sates A/C 80,000 Jan. Stationery A/C 2,000
5
Jan. Sales A/C 20,000 Jan. Trade expenses 2,000
11 10
Jan. Mr. Asif A/C 10,000 Jan. Mr. Qadir A/C 20,000
14 15
Jan. Sales A/c 90,000 Jan. Drawing A/C 6,000
25 18
Jan. Purchase A/C 40,000
22
Jan. Electricity A/C 4,000
27
Jan. Salary A/C 10,000
31
Jan. Rent A/C 3,000
31
Jan. Balance c/d 173,000
31

4,00,00 4,00,00

Feb. Balance b/d 173,000

1
Double Column Cash Book
In this cash book, there are two columns on each side, one column for recording cash
transactions and the other column for recording bank transactions.

Format of double cash book

(Source – NCERT)

Contra Entry
In any account we can only have one half of a double entry. An account cannot be debited
and credited at the same time. For example, when we sell goods for cash, cash received will
be recorded on the debit side of Cash Book and the goods sold will be posted on the credit
side of Sales Account.

But in Double Column Cash Book, we have two accounts, Cash A/c and the Bank A/c, so it is
possible to have both a debit entry and a credit entry at the same time. For example, cash
of Rs.5,000 is deposited into the bank. In this transaction both Bank A/c and Cash A/c are
involved and they will be recorded on both sides of Double Column Cash Book i.e. on the
debit side in bank column and on the credit side in cash column.

Thus a transaction in which Cash A/c and Bank A/c are involved, is recorded on both the
sides of Double Column Cash Book, it is called "contra entry".

In recording such a transaction the letter "C", is written in 'L.F' column because both
aspects of the transactions are recorded and there is no need to post them into the ledger.
Example
Enter the following transactions in a double column cash book/two column cash book.

2018 Rs.
March 1 Cash in hand 80,000
March 1 Bank Balance 120,000
March 3 Received a cheque from Osman 24,000
March 4 Deposited Osman's cheque with bank --
March 8 Withdrawn from bank for business use 20,000
March 10 Goods sold for cash 30,000
March 15 Goods bought for cash 80,000
March 18 Goods sold for cash 60,000
March 20 Paid Rahim by cheque 26,000
March 30 Deposited into bank 16,000
March 31 Paid salary in cash 10,000
March 31 Paid rent by cheque 6,000
Solution:

Double Column Cash Book

Date Particulars V L/ Cash Rs. Bank Rs. Date Particulars V L/ Cash Rs. Bank Rs.
/ F / F
N N
2018 2018
Mar. Balance b/d 80,000 120,000 Mar. Bank A/c C 24,000
1 4
3 Osman A/c 24,000 8 Cash A/c C 20,000

4 Cash A/c C 24,000 15 Purchase 80,000

A/c

8 Bank A/c C 20,000 18 Cash A/c C 16,000

10 Sales A/c 30,000 20 Rahim A/c 26,000

18 Sales A/c 60,000 31 Salary A/c 10,000

30 Cash A/c C 16,000 31 Rent A/c 6,000

31 Balance c/d 84,000 108,000
214,000 160,000 214,000 160,000

Apr 1 Balance b/d 84,000 108,000

Three column cash book
The triple column cash book (also referred to as three column cash book) is the most
exhaustive form of cash book which has three money columns on both receipt (Dr) and
payment (Cr) sides to record transactions involving cash, bank and discounts. A triple
column cash book is usually maintained by large firms which make and receive payments in
cash as well as by bank and which frequently receive and allow cash discounts

Format of triple column cash book

Discount: The amount of discount allowed is recorded on debit side and the amount of
discount received is recorded on credit side in discount column. The totals of debit column
and credit column are posted to discount allowed account and discount received account
respectively.

Note: All other columns are similar to the double column cash book.

Petty Cash
It is another Cash Book which is maintained, generally, in large business concerns to reduce
the burden of 'Main Cash Book', in which numerous transactions involving petty (small)
amounts are recorded. For this purpose, a Petty Cashier is appointed by the Chief Cashier.
The Chief Cashier advances a sum of money to the Petty Cashier to enable him to meet
petty expenses for a fixed period. The Petty Cashier will record this amount on the Debit
Side of the Petty Cash Book while the Chief Cashier will record the same amount on the
Credit Side of the Main Cash Book.
Imprest system of petty cash book
Under this system, a definite sum, say Rs.2,000 is given to the petty cashier at the beginning
of a certain period. This amount is called imprest amount. The petty cashier goes on making
all small payments out of this imprest amount and when he has spent the substantial
portion of the imprest amount say Rs.1,780, he gets reimbursement of the amount spent
from the head cashier. Thus, he again has the full imprest amount in the beginning of the
next period. The reimbursement may be made on a weekly, fortnightly or monthly basis,
depending on the frequency of small payments.

The balance of the Petty Cash Book will be shown on the asset side of balance sheet as
"Cash in hand" at the end of the year.

Example
From the following particulars prepare a Petty Cash Book under Imprest System.

2018

Jan. 1. Received from the Chief Cashier as imprest cash Rs.400.

Jan. 2. Paid Taxi hire Rs.20.
Jan. 3. Paid postage Rs.28 and stationery Rs.60.
Jan. 4. Purchased stationery Rs.48.
Jan. 5. Paid telegram charges Rs.28 and bus fare Rs.4.
Jan. 6. Bought postage stamps Rs.96.
Jan. 7. Paid Rs.72 for repairs of typewriter.
Solution:

Petty Cash Book

Amount Date Particulars V. Total Traveling Postag Station Office Misc.

Received No Rs. Expenses es Rs. ery Rs. Expenses Expenses
Rs. . Rs. Rs. Rs.
400 2018 Cash Received
Jun.
1
Jun. Taxi hire A/c 20 20
2
Jun. Postage A/c 28 28
3
Jun. Stationery A/c 60 60
3
Jun. Stationery A/c 48 48
4
Jun. Telegram A/c 28 28
5
Jun. Bus fare A/c 4 4
5
Jun. Postage A/c 96 96
6
Jun. Repairs A/c 72 72
7

356 24 152 108 72

Balance c/d 44

400 400

44 Jun. Balance b/d

8
356 Cash received
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LEDGER
[Type here]

LEDGER
The journal provides a complete listing of the daily transactions of a business, but it does not
provide information about a specific account in one place. For example, to know how much cash
balance we have, the accounting clerk would have to check all the journal entries in which cash is
involved which is very difficult. To avoid this difficulty, the debit and credit of journalized
transactions are transferred to ledger accounts. Thus all the changes for a single account are located
in one place - in a ledger account. This makes it easy to determine the current balance of any
account.

Standard Form of Ledger Account:

To understand clearly as to how to write the accounts in ledger, the standard form of an account is
given below with two separate transactions:
Date Particulars J.R Amount Date Particulars J.R Amount
2005 2005
Dec. 17 Cash A/C 1,200 Dec. 17 Purchases A/C 2,000

Posting Procedure:

Transferring information i.e. entries from journal to ledger accounts is called posting. The procedure
of posting from journal to ledger is as follows:

1. Locate the ledger account from the first debit in the journal entry.
2. Record the date in the date column on the debit side of the account. The date is the date of
transaction rather than the date of the posting.
3. Record the name of the opposite account (account credited in entry) in the particular (also
known as reference column, description column etc.) column.
4. Record the page number of the journal in the journal reference (J.R) column from where the
entry is being posted.
5. Record the amount of the debit in the "amount column"
6. Locate the ledger account for the first credit in the journal and follow the same procedure.

Balancing An Account:

The difference between the two sides of an account is its balance. The balance is written on the
lesser side to make the two sides equal. The process of equalizing the two sides of an account is
known as balancing.

The rules for balancing an account are stated as below:

1. Add up the amount columns of both the sides of an account and write the totals in a
separate slip of paper.
2. Find out the difference of the two totals.
3. Write down the difference on the lesser side of the account.
[Type here]

4. Now total up both the sides and write the totals and draw double lines under them.
5. Again write the difference on the opposite side below the double line.

If the debit side of an account is heavier, its balance is known as debit balance. and if the credit side
of an account is heavier its balance is known as credit balance. If the two sides are equal, that
account will show zero balance. The rules for determining the balance is as follows:

Total debit More than total credit = Debit balance

Total credit More than total debit = Credit balance
Total debit Total credit = Nil balance

It may be noted that at the time of balancing an account debit balance is placed on the credit side
and credit balance on debit site. This balance is known as closing balance. What is closing balance in
this year, is the opening balance of the next year.

Example:

Enter the following transactions in journal and post them into ledger:

2018
Jan. 1 Mr. Javed started business with cash Rs.100,000
2 He purchased furniture for Rs.20,000
3 He purchased goods for Rs.60,000
5 He sold goods for cash Rs.80,000
6 He paid salaries Rs.10,000

Solution:

Journal

Date Particular L.F Amount Amount

2018
Jan. Cash A/C .....................................................Dr. 9 100,000
1 Capital 11 100,000
(Being capital brought in)
2 Furniture 13 20,000
A/C.................................................Dr. 9 20,000
[Type here]

Cash A/C
(Being furniture purchased for cash)
3 Purchases A/C...............................................Dr. 15 60,000
Cash A/C 9 60,000
(Goods purchased for cash)
5 Cash A/C......................................................Dr. 9 80,000
Sales A/C 17 80,000
(Sold goods for cash)
6 Salaries A/C..................................................Dr. 19 10,000
Cash A/C Return 9 10,000
(Salaries paid)

Ledger

Cash Account (No.9)

Date Particular J.R Amount Date Particulars J.R Amount

20018 2018
Jan.1 Capital A/C 1 100,000 Jan.2 Furniture A/C 1 20,000
Jan.5 Sales A/C 1 80,000 Jan.3 Purchases A/C 1 60,000
Jan.6 Salaries A/C 1 10,000
Balance c/d 90,000
Total 180,000 Total 180,000

Capital Account (No.11)

Date Particular J.R Amount Date Particulars J.R Amount

2018 2018
Jan.6 Balance c/d 100,000 Jan.1 Cash A/C 1 100,000
Total 100,000 Total 100,000

Furniture Account (No.13)

Date Particular J.R Amount Date Particulars J.R Amount

2018 2018
Jan.2 Cash A/C 1 20,000 Jan.6 Balance c/d 20,000
Total 20,000 Total 20,000

Purchases Account (No.15)

Date Particular J.R Amount Date Particulars J.R Amount

[Type here]

2018 2018
Jan.3 Cash A/C 1 60,000 Jan.6 Balance c/d 60,000
Total 60,000 Total 60,000

Sales Account (17)

Date Particular J.R Amount Date Particulars J.R Amount

2018 2018
Jan.6 Balance c/d 80,000 Jan.5 Cash A/C 1 80,000
Total 80,000 Total 80,000

Salaries Account (19)

Date Particular J.R Amount Date Particulars J.R Amount

2018 2018
Jan.6 Cash A/C 1 10,000 Jan.6 Balance c/d 10,000
Total 10,000 Total 10,000

DISTINCTION BETWEEN BOOKS OF ORIGINAL ENTRY AND LEDGER

Basis Books of original entry Ledger

Recording of transactions Transactions are entered for the Transactions are entered in
first time in these books, they Journal or Subsidiary Books are
are also referred to as books of later transferred to the Ledger.
primary entry. Thus, ledger is also called a
They are also referred to as book of final entry.
books of primary entry.
Narrations Narrations are recorded. Narrations are not recorded.
Order of transactions Transactions are entered in Transactions are entered in
chronological order. analytical order.
Final Accounts Final accounts can’t be Final accounts can be prepared
prepared with the help of books with the help of Ledger
of original entry. balances.
Accuracy Accuracy of these books can’t Accuracy of the Ledger
be tested. Accounts is tested by preparing
a Trial Balance.
Process of recording Journalising Posting
entries

CLOSING OF ACCOUNTS
[Type here]

1. Personal Accounts
If a personal account shows a debit balance, it indicates the amount owing from him.
On the contrary, if a personal account shows a credit balance, it indicates the amount owing
to him.

2. Real Accounts
Method of closing the Cash A/c and the accounts of all other assets is the same as that of
personal accounts. When balanced, these will always show debit balances.

3. Nominal Accounts
These accounts do not require balancing. As the main purpose of opening such accounts is
to ascertain the net profit or loss of the firm, all such accounts are transferred to the trading
and profit and loss account of the firm at the end of the financial period.

QUESTIONS

Q.1) The total of purchase returns book will be posted to the:

[a] Debit of purchases A/c

[b] Credit of purchases A/c
[c] Debit side of Purchase Returns A/c
*[d] Credit side of Purchases Return A/c

Q.2) Which of the following is known as “Principal Book of Accounting”?

*[a] Ledger
[b] Journal
[c] Trial Balance
[d] Balance Sheet

Q.3) Purchased goods from Mohan of Rs 40,000 at 20% trade discount. Posting will be
made in Manoj A/c:
[a] Debit side Rs 40,000
[b] Credit side Rs 40,000
*[c] Debit side Rs 32,000
[d] Credit side Rs 32,000
[Type here]

Q.4) Which of the following has a debit balance?

[a] Bank loan

[b] Income received in advance
*[c] Prepaid insurance premium
[d] Creditors for goods

Q.5) Journal and ledger record transactions in

*[a] A chronological order and analytical order respectively

[b] An analytical order and chronological order respectively
[c] A chronological order only
[d] An analytical order only

Q.6) At the end of the accounting year all the nominal accounts of ledger book are:

[a] Balanced but not transferred to profit and loss account.

[b] Not balanced and their balance is not transferred to the profit and loss account.
[c] Balanced and the balance is transferred to the balance sheet.
*[d] Not balanced and their balance is transferred to the profit and loss account.

Q.7) The technique of finding the net balance of account after considering the totals of
both debits and credits appearing in the account is known as:

[a] Posting
*[b] Balancing of account
[c] Accuracy test
[d] None of the above

Q.8) Consider the following statements and identify the correct ones:

1. The balance of an account is always known by the side which is in excess.

2. Asset accounts may have either debit or credit balance.
3. L.F. in the journal is filled at the time of posting.

[a] 1 and 2
[b] 2 and 3
*[c] 1 and 3
[d] 1, 2 and 3

Q.9) Proprietor of the business withdrew goods from business for private use. It will be
posted to the:
[Type here]

[a] Credit of drawings A/c

[b] Debit of Purchases A/c
*[c] Credit of Purchases A/c
[d] None of the above

Q.10) Received Rs 8,000 from Ram in full settlement of Rs 10,000. Posting of Rs 2,000 will
be made to the:
[a] Debit side of Ram’s A/c
[b] Credit side of Ram’s A/c
*[c] Debit side of Discount A/c
[d] Credit side of Discount A/c
[Type here]
[Type here]
[Type here]
JOURNAL
Chanchal Phore
 KEY BENEFITS OF OUR COURSES

Our course structure includes a lot of perks that

are otherwise unavailable elsewhere.
It is a comprehensive guide to help you crack the
paper & secure your dream position.

We provide personal solutions all queries using a Telegram

group wherein Anuj Jindal himself will clarify your doubts.

We curate the learning strategies of past year toppers to help

you learn from the success of the best
Contents
Journal ............................................................................................................................................................................... 4
Meaning ........................................................................................................................................................................ 4
Format of Journal .......................................................................................................................................................... 4
Date ........................................................................................................................................................................... 4
Particulars or Details Column.................................................................................................................................... 5
Ledger Folio (L.F) ....................................................................................................................................................... 5
Amount ..................................................................................................................................................................... 5
Rules for Journalizing .................................................................................................................................................... 5
Simple Entry and Compound Entry ............................................................................................................................... 6
Example of Simple Entry ........................................................................................................................................... 6
Example of Compound Entry .................................................................................................................................... 7
Personal Books and Business Books ............................................................................................................................. 7
Capital Account ......................................................................................................................................................... 7
Drawings ................................................................................................................................................................... 8
Entries of some specific transactions............................................................................................................................ 9
Cash Discount ............................................................................................................................................................ 9
Trade Discount .......................................................................................................................................................... 9
Bad Debts .................................................................................................................................................................. 9
Bad Debts Recovered .............................................................................................................................................. 10
Outstanding Expenses ............................................................................................................................................. 10
Prepaid Expenses .................................................................................................................................................... 10
Depreciation............................................................................................................................................................ 10
Accrued Income ...................................................................................................................................................... 11
Income received in advance ................................................................................................................................... 11
Purchase and sale of fixed asset ............................................................................................................................. 11
Expenditure on installation of Machinery .............................................................................................................. 12
Transactions related to goods................................................................................................................................. 12
Opening Entry ............................................................................................................................................................. 13
Example of Journal ...................................................................................................................................................... 14
Journal
Meaning
The books in which transactions are recorded for the first time from a source document are
called ‘Book of Original Entry’.

Journal is one of the basic books of original entry in which transactions are originally
recorded in a chronological order according to the principles of double entry system.

After Journal, transactions are entered in Ledger.

The process of recording a transaction in a journal is known as

journalising

The transfer of journal entry to a ledger account is called posting

Format of Journal
Date Particulars L.F Amount Amount

Account to be debited XXX

.............................Dr. XXX
Account to be credited
(Narration)

The various columns of journal are explained in details below:

Date
This column is used to write the date of the business transaction. Different date formats are
used in different countries. Different formats of date are: 15.03.2001, 03.15.2011, 15
March 2021 etc.
Particulars or Details Column
In this column the names of the two connected accounts are written in two consecutive
lines - in the first line the name of account debited and in the second line the name of
account credited.

The world "Dr." is used at the end of the name of account debited. It is not necessary to
place the word "Cr." after the name of the credited account, because if one account is Dr. It
follows that the other account must be Cr.

Ledger Folio (L.F)

In this column, the number of the ledger page is written to which the amount is posted

Amount
The debit amount is written in the first "amount" column against the name of account
debited and the credit amount in the second "amount" column against the name of
account credited.

All the columns, except the Ledger Folio column are completed at the time
of journalising. The Ledger Folio column is filled in at the time of posting.

Rules for Journalizing

How a transaction is recorded in journal, is discussed below:

Suppose the transaction is:

Purchased furniture from Mr. A on 10.01.20 for Rs.16,000, for cash

Here furniture accounting is debited and cash account is credited.

Date Particulars L.F Amount Amount

10.01.20 Furniture A/c .............................Dr. 16,000

Cash A/c 16,000
(Being the furniture purchased
against the cash)

Simple Entry and Compound Entry

Simple entry - Every transaction effects two accounts - one is debited and another account
is credited. Thus in recording a transaction in a journal one account is debited and another
account is credited. This type of entry is called simple entry.

Compound entry - The entry in which more than one account is debited or more than one
account is credited, is known as compound entry. Three or more accounts are connected
with a compound entry.

Example of Simple Entry

For example, on 10.04.20 we bought furniture from S. The entry is:

Date Particulars L.F Amount Amount

10.04.20 Furniture A/C .............................Dr. 10,000

S A/C 10,000
(Being furniture purchased on
credit)
Example of Compound Entry
For example on 16.05.20 we paid Rs. 1,000 on account of salaries and Rs.600 on account of
rent. For this the entry will be:

Date Particulars L.F Amount Amount

16.05.20 Salary A/C .............................Dr. 1,000

Rent A/C 600
Cash A/C 10,000
(Being salaries and rent)

Here two accounts have been debited and the entry involves three accounts. Hence, it is
a compound entry.

Personal Books and Business Books

It should be noted here that no private transactions of the proprietor can be recorded in
the books of business. On the other hand, no transactions of the business can be recorded
in the books of its proprietor. But the transactions in between proprietor and business must
be recorded in the books of both the proprietor and business. If these rules are not strictly
followed, the books of account will fail to disclose the true result of business.

We are concerned with the books of business, not with the private books of proprietor.
Transactions between the business and its proprietor are recorded in the following two
accounts:

Capital Account
The money with which proprietor starts his business is called capital. When proprietor
brings capital in the business, it is recorded in capital A/C. Capital account is in fact the
personal account of the proprietor. So, it is a personal account. The proprietor has given the
benefit to the business through introduction of capital. So proprietor's account A/C, i.e.
capital account will be credited. From the view point of bookkeeping the introduction of
capital to the business by proprietor means that the proprietor lends the money to his
business and the business becomes indebted to him. The proprietor is regarded as a special
or internal creditor to the business.

Example: Mr. R started a business with Rs.20,000

Date Particulars L.F Amount Amount

16.05.20 Cash A/C .............................Dr. 20,000

Capital A/C 20,000
(Being capital brought in)

Drawings
If the proprietor draws any money or takes goods from his business for his personal use, it
will be recorded in drawings A/C. Drawings A/C is the personal account of the proprietor, so
it is classified as the personal account. Proprietor receives benefit, when he withdraws
money or goods from business. So the proprietor's account i.e. drawing is debited.

Example:

Date Particulars L.F Amount Amount

16.05.20 Drawings A/C .............................Dr. 2,000

Cash A/C 2,000
(Being amount withdrawn by
proprietor)
Entries of some specific transactions
Cash Discount
The manufacturers and whole sellers frequently grant cash discount to their debtors who
will pay their debts before due date for goods purchased by them on credit. The seller
regards it a "cash discount" or "sale discount" or "discount allowed". The buyer calls the
discount as "purchase discount" or "discount received".

Trade Discount
This discount is allowed by wholesaler or manufacturer to the retailer at a fixed percentage
on the listed price of goods. It is allowed when goods are manufactured in bulk. No
separate entry is passed for the trade discount, as it is deducted from the invoice of the
goods.

If both trade discount and cash discount are allowed, first trade discount is
allowed and thereafter, cash discount is allowed.

Bad Debts
When the goods are sold on credit to a customer, and if the amount becomes
irrecoverable, the amount is called as bad debts. For recording it, bad debts is debited and
customer account is credited.

Bad Debts A/c Dr.

To debtor’s personal A/c

Bad Debts Recovered
Sometimes, it happens if the bad debts previously written off are subsequently recovered.
In such case:

Cash A/c Dr.

To Bad Debts Recovered A/c

Outstanding Expenses
Sometimes, there are some expenses which are yet to be paid at the end of the accounting
period, they are called as Outstanding Expenses

Expenses A/c Dr.

To Outstanding expenses A/c

Prepaid Expenses
These are those expenses which are related to the next accounting year but paid in advance
during the current year.

Prepaid Expenses A/c Dr.

To Expenses A/c

Depreciation
It is the gradual decrease in the value of an asset due to wear and tear and passage of time.

Depreciation A/c Dr.

To Asset A/c
Accrued Income
The income which has been earned but not yet received is called accrued income.

Accrued income/c Dr.

To income A/c

Income received in advance

Income received but not earned during the accounting period is called income received in
advance.

Income A/c Dr.

To income received in advance A/c

Purchase and sale of fixed asset

Fixed asset includes land, building, plant, machinery, furniture etc. When fixed asset is
purchased, the asset account is debited. It is not debited to purchases account as fixed
asset is not for the purpose of sales. Similarly, when fixed asset is sold, it is credited to asset
account and not sales account.

 On purchase of asset for cash

Asset A/c Dr.
To cash A/c

 On purchase of asset on credit

Asset A/c Dr.
To suppliers A/c

 On sale of asset for cash

Cash A/c Dr.
To assets A/c
  On sale of asset on credit
Purchaser A/c Dr.
To assets A/c

Expenditure on installation of Machinery

Any expenditure incurred on the carriage and installation of machinery is treated as capital
expenditure and included in the cost of the machinery.

Asset A/c Dr.

To cash A/c

Transactions related to goods

Drawings of Goods
Drawings A/c Dr.

To Purchases A/c

Goods given away as charity

Charity A/c Dr.

To Purchases A/c

Goods distributed as samples

Advertisement expenses A/c Dr.

To Purchases A/c
Loss of Goods by theft or fire
Loss by Theft A/c Dr.

Loss by Fire A/c Dr.

To Purchases A/c

In case goods were insured

Insurance Company A/c Dr.

To Loss by Theft or Fire A/c

If full claimed amount is received

Bank A/c Dr.

To Insurance Company A/c

When stock is not insured

Profit and Loss A/c Dr.

To loss by theft/fire A/c

Opening Entry
Business firms close their books of accounts at the end of each year and start a new set of
books in the beginning of each new year. The first entry in journal is to record the closing
balances of individual assets and liabilities of the previous year. These balances become the
opening balances of the new year. The entry passed to record the closing balances of the
previous year is called the opening entry.

While passing the opening entry all the assets are debited and capital and liabilities are
credited. If capital is not given, total liabilities are deducted from total assets.
Example of Journal
Journalise the following transactions:

2020

Feb. 3 X commenced business with a capital of Rs.15,000

05 Purchased good Rs.6,000

07 Purchased goods on credit from S & Co. Rs.3,000

10 Purchased furniture Rs.2,400

11 Sold goods Rs.3,900

15 Sold goods on credit to D Rs.2,250

20 Paid salaries Rs.960

25 Received commission Rs.75

26 Returned goods to S & Co. Rs.600.

27 Returned goods by D Rs.450

28 Received from D Rs.1,500

Paid to S & Co. Rs.1,800

X withdrew from business Rs.900
Charged depreciation on Rs.240
Borrowed from K Rs.1,500
Solution:

Journal

Date Particular L.F Amount Amount

2020

Feb. Cash A/C Dr. 15,000

3 Capital 15,000
(Being capital brought in)

5 Purchases A/C Dr. 6,000

Cash A/C 6,000
(Being goods purchased for cash)

7 Purchases A/C Dr. 3,000

S & Co. A/C 3,000
(Being goods purchased form S & Co on
credit)

10 Furniture A/C Dr. 2,400

Cash A/C 2,400
(Being furniture purchased for cash)

11 Cash A/C Dr. 3,900

Sales A/C 3,900
(Being goods sold for cash)

15 D Bros. A/C Dr. 2,250

Sales A/C 2,250
(Being goods sold on credit to D)

20 Salaries A/C Dr. 960

Cash A/C 960
 (Being salaries paid)

25 Cash A/C Dr. 75

Commission A/C 75
(Being commission received)

26 S & Co. A/C Dr. 600

Purchases A/C Return 600
(Being goods returned to S & co.)

27 Sales Returns A/C Dr. 450

D Bros. A/C 450
(Being goods returned by D Bros.)

28 Cash A/C Dr. 1,500

D Bros. A/C 1,500
(Being amount received from D Bros.)

" S & Co. A/C Dr. 1,800

Cash A/C 1,800
(Being amount paid to S & Co.)

" Drawings A/C Dr. 900

Cash A/C 900
(Being amount paid to S & Co.)

" Depreciation A/C Dr. 240

Furniture A/C 240
(Being depreciation charged on
furniture)

" Cash A/C Dr. 1,500

K A/C 1,500
(Being amount borrowed from K)
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Contents
Accounting Equations ....................................................................................................................................................... 4
Example to understand the basics of accounting equation.......................................................................................... 4
Meaning ........................................................................................................................................................................ 4
Accounting Equations
Prior to understanding an accounting equation, it is essential to know about a Balance
Sheet (in a simple T format)

Example to understand the basics of accounting equation

Kapil started a business of shoes. He invested Rs.80 lacs of his own and borrowed Rs.20 lacs
from Sunil @ 7% p.a. From this amount he bought a shop worth Rs40 lacs. He spent on
furnishing Rs.10 lacs. He bought some stock of shoes worth Rs.30 lacs and balance he
deposited in bank.

The above position can be expressed as:

BALANCE SHEET

CAPITAL & AMOUNT (Rs) ASSETS AMOUNT (Rs.)

LIABILITIES
Capital 80,00,000 Cash at Bank 20,00,000
Stock of shoes 30,00,000
Liabilities Furniture 10,00,000
(Loan from Sunil) 20,00,000 Shop premises 40,00,000
Total 1,00,00,000 1,00,00,000

Also, it can be expressed in the form of an accounting equation:

Assets = Liabilities + Capital

1,00,00,000 20,00,000 80,00,000

Meaning
Accounting Equation signifies that the assets of a business are always equal to the total of
capital and liabilities.

ASSETS = LIABILITIES + CAPITAL

A business transaction will result in the change in either of the total assets, liabilities or
capital of the firm and even after the change the assets will be again equal to the total of
capital and liabilities.

Continuing with the previous examples

Shoes of Rs.5 lacs were sold to a retailer (Ram) on credit.

Assets = Liabilities + Capital

Cash Stock Debtors Furniture Shop = Loan + Capital

20 lacs 25 lacs 5 lacs 10 lacs 40 lacs 20 lacs 80 lacs
ASSETS = LIABILITIES + CAPITAL
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 TABLE OF CONTENTS

ACCOUTING PRINCIPLES ...................................................................................... 4

Going concern concept ........................................................................................ 5
Accounting period concept .................................................................................. 5
Business entity concept ....................................................................................... 6
Money measurement concept ............................................................................. 6
Historical cost concept ......................................................................................... 7
Dual aspect concept............................................................................................. 8
Revenue recognition (Realisation) concept ......................................................... 8
Matching Concept................................................................................................ 9
Full disclosure concept ........................................................................................ 9
Accrual concept ................................................................................................... 9
Consistency ........................................................................................................ 10
Conservatism / Prudence ................................................................................... 10
Materiality ......................................................................................................... 11
Objectivity.......................................................................................................... 11

3
ACCOUTING PRINCIPLES
 Accounting principles are the uniform set of rules and guidelines that have been generally
accepted by accountants all over the world for preparing the accounting statements.

 Accounting principles are developed to ensure uniformity and easy understanding of the
accounting information
 These principles are usually called 'generally accepted accounting principles'.

 The general acceptance of an accounting principle usually depends on its usefulness,

objectiveness and feasibility.
 Accounting principles are not static and are bound to change with time in response to the
change in business practices, government policies, and needs of the users of accounting
information.

 Accounting principles are classified into two categories:

 The accountings concepts are the basic assumptions and ideas which are fundamental to
accounting practice and on the basis of which transactions are recorded and accounts are
maintained.

 Conventions are principles that are emerged out of accounting practices that are adopted
by various organizations over the period.

 From the practicability view point, it is observed that the various terms such as principles,
postulates, conventions, modifying principles, assumptions, etc. have been used
interchangeably.

4
Going concern concept
 The concept of going concern assumes that a business firm would continue to carry out its
operations indefinitely and would not be liquidated in the foreseeable future.

 This is an important assumption of accounting as it provides the very basis for showing the
value of assets and liabilities in the balance sheet.

For example,

 If machinery is purchased by a business that has the life span of 10 years then

o If a business is following the going concern concept, then it will distribute the cost of
the machinery over the next ten years.

o If the business is not following the going concern concept and assumes business will
last for this year only, then the cost of the machinery would be treated as an expense
in the year of purchase only.

 Due to the indefinite life span of the business the assets and liabilities are classified into
current and non-current in the balance sheet.

Accounting period concept

 As per the going concern concept, a business assumes indefinite life of the business.

 The true results of the business operations can be ascertained only when the business is
completely wound up.

 But the users of the financial statements need to know the performance of business at
frequent intervals.

 For this purpose, the accounting period concept requires that the entire life of the business
is divided into smaller time intervals for the measurement of the profits of the business.

 Usually the period of twelve months is taken for accounting purposes.

5
Business entity concept
 According to this concept, business is treated as a unit separate and distinct from its owners
and investors.

 For the purposes of accounting, the business and its owners are to be treated as two
separate entities.

 For example, when a person invests Rs. 1 lakh into a business, it will be treated that the
business has borrowed that much money from the owner and it will be shown as a
‘capital’ in the books of accounts of business.

Similarly, if the owner withdraws some amount from the business then it is shown as
drawings in the books of accounts of business.

 The business transactions are recorded from the business point of view and not from
the point of view of the owner.

 The personal income and expenditure of owners are kept separate from the accounts of the
business entity.

Money measurement concept

 In accounting, only those business transactions and events are recorded which can be
expressed in terms of money. In other words, a transaction which cannot be expressed
in terms of money is not recorded in the accounting books.

6
  For example, knowledge and skills of the manager of the organization are the assets for the
organizations but their measurement in monetary terms is not possible therefore, not
included in the books of account

 Another important aspect of the concept of money measurement is that the records of the
transactions are to be kept not in the physical units but in the monetary unit.

 For example, an organisation may have different assets like Rs 50,000 in cash, 500 kg of raw
material, 5 machines and 100 chairs. These assets are expressed in different units, so
cannot be added to give any meaningful information about the total worth of business.

For accounting purposes, therefore, these are shown in money terms and recorded in
rupees. In this case, the cost of raw material may be say Rs 20,000; Chair Rs 10,000;
Machine Rs 50,000. Thus, the total assets of the enterprise are valued at Rs 1,30,000.

Historical cost concept

 According to this concept an asset is ordinarily entered on the accounting records at the
price paid to acquire it.

 For example, if business entity purchases the building for Rs 5,00,000 it will be recorded
in books of accounts at this figure only. Subsequent increase or decrease in the market
value of the building will not be considered in the books of accounts.

 However cost of the asset is systematically reduced from year to year by charging
depreciation and assets are shown in the balance sheet at cost less depreciation.

 Important limitation of the historical cost basis is that it does not show the true worth of
the business.

 But in many circumstances, the cost convention is not followed. And the book value of the
assets is revalued according to the market conditions.

7
Dual aspect concept
 Financial accounting records all the transactions and events involving financial element.
Each of such transactions requires two aspects to be recorded. The recognition of these
two aspects of every transaction is known as a dual aspect analysis.

 Dual aspect concept states that every transaction has a dual effect and should therefore be
recorded at two places. In other words, every transaction affects at least two accounts. If
one account is debited, any other account must be credited.

 For example, if a firm sells goods of Rs. 10,000 on cash basis, this transaction involves two
aspects. One aspect is the delivery of goods and the other aspect is immediate receipt of
cash. Cash account will be debited with Rs 10,000 and sales account will be credited with Rs
10,000.

 The system of recording transactions based on this principle is called as ‘Double Entry
System’.

 It is because of this concept the two sides of the balance sheet will always be equal.

Assets = Capital + Liabilities

Revenue recognition (Realisation) concept

 The concept of revenue recognition requires that the revenue for a business transaction
should be included in the accounting records only when it is realised.

 Revenue is assumed to be realised when a legal right to receive it arises, i.e. the point of
time when goods have been sold or service has been rendered.

 For example, business sold goods on credit amounting Rs 20,000 on 15th February 2020 and
receive the payment for the same on 10th April 2021. Company will recognize this revenue
on 15th February rather than on the date of receipt of payment.

 Similarly, if the company receives advance payment for rendering some services in the
future. Then revenue will be recognized on the date when services are rendered rather than
on the date of receipt of advance payment.

8
Matching Concept
 Matching concept requires the revenue for a particular period to be matched with its
corresponding expenditure so as to show the true profit for the period.

 While ascertaining the profit or loss of an accounting year, we should not take the cost of all
the goods produced or purchased during that period but consider only the cost of goods
that have been sold during that year. For this purpose, the cost of unsold goods should be
deducted from the cost of the goods produced or purchased.

 This means that if you owned a store and spent money to purchase items for your
inventory, you wouldn't record that expense until you sold the items for revenue.

Full disclosure concept

 This principle state that the financial statement should be prepared in such a way that it
fairly discloses all the material information to the users, so as to help them in taking a
rational decision.

 The financial statements make a full, fair and adequate disclosure of all information which is
relevant for taking financial decisions.

 For example, the firm has to report the contingent liability at the footnote of the balance
sheet.

Accrual concept
 Under accrual concept, the effects of transactions and other events are recognised on
mercantile basis i.e., when they occur (and not when cash is received or paid)

 They are recorded in the accounting records and reported in the financial statements of the
periods to which they relate.

 For example, business records its utility bills as soon as it receives them and not when they
are paid, because the service has already been used. The company ignores the date when
the payment will be made.

9
  To ascertain true profit or loss for an accounting period and to show the true financial
position of the enterprise at the end of the accounting period are recorded whether actual
cash has been paid or received or not.

Consistency
 The convention of consistency requires that once a firm decided on certain accounting
policies and methods and has used these for some time, it should continue to follow the
same methods or procedures for all subsequent similar events and transactions.

 For example, if a firm has chosen to adopt the straight-line method of depreciation, then it
has to follow the same method consistently for the upcoming years.

 This concept allows comparisons of financial statements of the firm over a period of time.
Comparison can be possible only when accounting policies and practices followed by
enterprises are uniform and are consistent over the period of time.

 If the firm adopts different accounting principles in two accounting periods, the profit of
current period will not be comparable with profits of the preceding period.

 But the concept of consistency does not imply that firm can never change its methods and
policies. An enterprise can change its accounting policy in any of the following
circumstances:
a. To bring the books of accounts in accordance with the issued Accounting Standards.
b. To comply with the provision of law.
c. When under changed circumstances it is felt that new method will reflect more true
and fair picture.

Conservatism / Prudence
 The concept of conservatism requires that profits should not to be recorded until realised
but all losses, even those which may have a remote possibility, are to be provided for in the
books of account

 For example,
 Closing stock is valued at cost price or realisable value whichever is less
 Creating provision for doubtful debts.

10
  Due the principle of conservatism, the profit and loss of the company will disclose lower
profits in comparison to the actual profits. And the balance sheet will disclose
understatement of assets and overstatement of liabilities in comparison to actual price.

Materiality
 The concept of materiality requires that accounting should focus on material facts. Efforts
should not be wasted in recording and presenting facts, which are immaterial in the
determination of income.

 The materiality of a fact depends on its nature and the amount involved. Any fact would be
considered as material if it is reasonably believed that its knowledge would influence the
decision of informed user of financial statements.

 For example,

o Stock of erasers, pencils, scales, etc. is not shown as assets, and whatever amount of
stationery is bought in an accounting period is treated as the expense of that period,
whether consumed or not.

o An ordinary calculator costing Rs. 100 may last for ten years. However, the effort
involved in allocating its cost over the ten year period is not worth the benefit that
can be derived from this operation. The cost incurred on calculator may be treated as
the expense of the period in which it is purchased.

 It should be noted that an item material for one party may be immaterial for another. It is a
matter of judgement and scale of business.

Objectivity
 The concept of objectivity requires that accounting transaction should be recorded in an
objective manner and should not be influenced from personal bias and opinions.

 This can be possible when each of the transaction is supported by verifiable documents or
vouchers.

 For example, the transaction for the purchase of materials may be supported by the
purchase invoice.

11
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BASIC ACCOUNTING TERMS

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BASIC ACCOUNTING TERMS Page 1

 Contents
Capital ..................................................................................................................................................... 3
Drawings ................................................................................................................................................. 3
Liabilities ................................................................................................................................................. 3
Classification of liabilities................................................................................................................... 3
Distinction between business transaction and event ........................................................................... 4
Assets ...................................................................................................................................................... 4
Classification of assets ....................................................................................................................... 4
Expenditure ............................................................................................................................................ 5
Expense ................................................................................................................................................... 5
Income .................................................................................................................................................... 6
Profit ....................................................................................................................................................... 6
Gain ......................................................................................................................................................... 6
Loss ......................................................................................................................................................... 6
Terms related to trade ........................................................................................................................... 7
Distinction between stock and inventory ............................................................................................. 7
Bills receivable ........................................................................................................................................ 7
Bills payable ............................................................................................................................................ 7
Debtors ................................................................................................................................................... 7
Creditors ................................................................................................................................................. 7
Bad debts ................................................................................................................................................ 8
Insolvent ................................................................................................................................................. 8
Discount .................................................................................................................................................. 8

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 Capital: refers to the amount invested by the proprietor in a business enterprise.
Capital is also known as – Owner’s Equity /Net Worth/ Net Assets

ASSETS = LIABILITY + CAPITAL

Drawings: any cash or value of goods withdrawn by the owner for personal use or any
private payments made out of business funds.

Liabilities: It refers to the amount which the firm owes to outsiders.

Example: Unpaid wages, Creditors, etc.

Classification of liabilities
Internal: which business entity has to pay to the proprietor or owners.
External: which a business entity has to pay to outsiders.

Also classified as:

- Non- current liabilities (to be paid after more than 1 year)
- Current liabilities (to be paid within 1 year)

Case Study: Mr. X invests Rs.10000 in his business and takes a loan of Rs.25,000 from SBI
Bank for a period of 10 years. Then he buys goods worth Rs.2000 from Mr. Y on credit for 2
months.
Internal Liability: Rs.10000
External liability: Rs.25000
Non- current liability: Rs.25000
Current Liability: Rs.2000

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 Distinction between business transaction and event
A Business Transaction is an economic activity of the business that changes its financial
position.
(The change should be capable of being expressed in terms of money)
An event is the result of a transaction.
Example:
Ram purchased goods worth Rs.2 lacs and sold them for Rs.2.5 lacs. Thus, he earned a profit
of Rs.50 thousand.
Transactions - Economic activity of purchasing goods, selling goods.
Event - Profit of Rs 50,000 earned due to the transactions taking place.

Assets: Assets are valuable resources owned by businesses that are acquired at a
measurable money cost.
Example: Cash, Land, Furniture, etc.

Classification of assets
(1) Non – Current Assets:
 Held for continued use in business for producing goods and services; and
 Not meant for resale
Eg: Furniture, Land & Building.

Tangible assets - which have a physical existence. (Cash, Computer)

Intangible assets – do not have a physical existence. (Patents, Goodwill)

(2) Current assets (Floating assets/ Circulating assets)

 Meant for sale or
 Converted into cash within 1 year.
Eg: Debtors, Stock, Bills receivables
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 (3) Fictitious/ Nominal Assets:
Fictitious assets are those assets which are neither tangible assets nor intangible assets but
represent loss or expenses yet to be written off.
Eg: Debit balance of P&L, deferred revenue expenditure.

Expenditure: any disbursement of cash or transfer of property or incurring liability for the
purpose of acquiring assets, goods or services.

Expense: It is a value that has expired during the accounting period.

An expense is charged to profit and loss account.

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 Expense

Prepaid expense
Outstanding expense
It is ab expense that has been
It is an expense that has not
paid in advance and the
been paid but the benefit
benefit of which will be
thereof has already been
available in the following year
availed
or years

Income: Income is the profit earned during a period of time.

Income = Revenue - Expense

Profit: It is the excess of revenue of a business over its costs.

Gain: It is a profit of irregular or non-recurrent nature. For example, profit on the sale of a
fixed asset or investment.
Loss: A loss is excess of expenses of a period over its related revenues which may arise from
normal business activities. It decreases the owner’s equity.

Case: Following transactions were reported during an accounting reported for Mr. B’ s
business of furniture.

Transactions Term
a. Sold goods worth Rs.50, 000 to Mr X Sales
b. Theft of cash from office Loss
c. Rs.2,000 earned by selling goods Revenue
worth Rs.10,000 for Rs.12,000
d. Machinery (costing Rs.25,000) sold Gain
for Rs.28,000

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 Terms related to trade
Buying of goods in which the business deals Purchases

Purchased goods returned to the suppliers Purchase Return / Returns

Outwards
Transfer of ownership of goods or services to customers Sales
for a price

Sold goods returned by the customers Sale Return / Returns

Outwards

Distinction between stock and inventory

Stock refers to the value of goods which are purchased for reselling and which are lying
unsold at the end of the accounting period.
Inventory is a wider term which includes stock also.
Inventory includes:
1. Inventory of raw material
2. Inventory of semi-finished goods
3. Inventory of finished goods
4. Inventory of stock

Bills receivable: An accounting term for bills of exchange drawn on debtors or received by
way of endorsement from them. The amount specified in such a bill is receivable at a future
date.
Bills payable: an accounting term for bills of exchange accepted in favour of creditors. The
amount specified in such a bill is payable at a future date.
Debtors: Persons or firms to whom goods have been sold or services rendered on credit and
payment has not been received from them.
They owe some amount to the business.
Creditors: Persons or firms from whom goods have been purchased or services procured on
credit and payment has not been made to them.

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 Some amount is still owing to them.
Bad debts: the amount that has become irrecoverable from a debtor. It is debited to P&L
account as an expense.
Insolvent: a person or an enterprise which is not in a position to pay its debts.
Discount: rebate or allowance given by the seller to the buyer.
It is of 2 types:
(i) Trade discount: at a fixed percentage on the list or catalogue price of the goods.
Not recorded in the books of accounts (deducted in the invoice from the gross
value of goods)
(ii) Cash Discount: for making prompt payment.
It is always recorded in the books of accounts.

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 WHY OUR
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BASES OF ACCOUNTING
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 Contents
BASES OF ACCOUNTING ......................................................................................................................... 3
Cash Basis and Accrual Basis .............................................................................................................. 3
Examples ............................................................................................................................................. 3
Advantages and disadvantages ......................................................................................................... 4

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 BASES OF ACCOUNTING
Cash Basis and Accrual Basis
BASES OF Incomes are recorded
ACCOUNTING CASH BASIS when they are received
and expenses are
recorded when they are
paid

Incomes are recorded

ACCRUAL when they are earned or
acccrued, whether
BASIS received or not. Similarly,
expenses are recorded
when they are due,
whether paid or not.

Examples
Cases Base of Accounting
1. Received sales order in May 2017 Recorded:
Received payment in Aug 2017 May 2017 – Accrual Base
Aug 2017 – Cash Base
2. Expenses paid @ Rs. 1000 per month Recorded:
as rent for 15 months up to June 12,000 – Accrual Base
2018 15,000 – Cash Base

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 Advantages and disadvantages

Cash Accrual
Basis Basis
Advantages Advantages
1. It is very simple as 1. It shows a complete picture
adjustment enteries are not of financial transactions of the
required business
2. This basis of accounting is 2. It discloses correct profit or
suitable for those enterprises loss and also exhibits true
where most of the transactions financial position of an
are on cash basis enterprise

Disadvantages
1. It does not give a true and Disadvantages
fair view of the profit or loss
1. It is not as simple as cash
abd the financial position of an
basis
enterprise
2. A quick appraisal of the
2. It does not follow the
profit/loss is not possible
matching principle of
accounting

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 OUR COURSES
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ADMISSION OF A PARTNER

Chanchal Phore
 KEY BENEFITS OF OUR COURSES

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Contents
Reconstitution of a Partnership Firm ................................................................................................................................ 4
Admission of a partner...................................................................................................................................................... 4
New profit sharing ratio ................................................................................................................................................ 5
Sacrificing ratio ............................................................................................................................................................. 7
Goodwill ........................................................................................................................................................................ 8
Average profit method.............................................................................................................................................. 9
Super profit method ............................................................................................................................................... 10
Capitalisation method ............................................................................................................................................. 11
Accounting treatment of Goodwill on the Admission of a New Partner .................................................................... 13
Adjustment for accumulated profits and losses ......................................................................................................... 15
Revaluation of assets and reassessment of liabilities ................................................................................................. 16
Adjustment of capitals ................................................................................................................................................ 21
Reconstitution of a Partnership Firm
Any change in the partnership agreement brings to an end the existing agreement and a
new agreement comes into force.

The change in the agreement results in changes in the relationship among the partners
which amounts to reconstitution of the partnership firm.

Reconstitution of the partnership firm happens in following situations:

Admission of a new partner

Change in Profit Sharing Ratio Among the

Existing Partners

Retirement of an existing partner

Death of a Partner

Admission of a partner
A new partner is needed into the business when

 More capital is needed for expansion of business

 A competent and experienced person is needed for the efficient running of the
business
 To encourage a capable employee by taking him into the partnership.
Following are the other important points which require attention at the time of admission
of a new partner:

 New profit sharing ratio

 Sacrificing ratio
 Valuation and adjustment of goodwill
 Revaluation of assets and Reassessment of liabilities
 Distribution of accumulated profits (reserves)
 Adjustment of partners’ capitals

New profit sharing ratio

When new partner is admitted he acquires his share in profits from the old partners

Examples

Anil and Vishal are partners sharing profits in the ratio of 3:2. They admitted Sumit as a new
partner for 1/5 share in the future profits of the firm. Calculate new profit sharing ratio of
Anil, Vishal and Sumit.

Solution

Sumit’s share = 1/5

Remaining share = 1 – 1/5 = 4/5

Anil’s new share = 3/5 of 4/5 = 12/25

Vishal’s new share = 2/5 of 4/5 = 8/25

New profit sharing ratio of Anil, Vishal and Sumit will be 12:8:5.

Note: It has been assumed that the new partner acquired his share from old partners in old
ratio.
Anshu and Nitu are partners sharing profits in the ratio of 3:2. They admitted Jyoti as a new
partner for 3/10 share which she acquired 2/10 from Anshu and 1/10 from Nitu. Calculate
the new profit sharing ratio of Anshu, Nitu and Jyoti.

Solution

Jyoti’s share = 3/10

Anshu’s new share = 3/5 – 2/10 = 4/10

Nitu’s new share = 2/5 – 1/10 = 3/10

The new profit sharing ratio between Anshu, Nitu and Jyoti will be 4:3:3.

Ram and Shyam are partners in a firm sharing profits in the ratio of 3:2. They admit
Ghanshyam as a new partner. Ram sacrifices 1/4 of his share and Shyam 1/3 of his share in
favour of Ghanshyam. Calculate new profit sharing ratio of Ram, Shyam and Ghanshyam.

Solution

Ram’s old share = 3/5

Share sacrificed by Ram = 1/4 of 3/5 = 3/20

Ram’s new share = 3/5 – 3/20 = 9/20

Shyam’s old share = 2/5

Share sacrificed by Shyam = 1/3 of 2/5 = 2/15

Shyam’s new share = 2/5 – 2/15 = 4/15

Ghanshyam’s new share = Ram’s sacrifice + Shyam’s Sacrifice = 3 2 17 20 15 6New profit

sharing ratio among Ram, Shyam and Ghanshyam will be 27:16:17
Sacrificing ratio
The ratio in which the old partners agree to sacrifice their share of profit in favour of the
incoming partner is called sacrificing ratio.

Sacrificing ratio = Old share of profit – New share of profit

Example

Rohit and Mohit are partners in a firm sharing profits in the ratio of 5:3. They admit Bijoy as
a new partner for 1/7 share in the profit. The new profit sharing ratio will be 4:2:1.
Calculate the sacrificing ratio of Rohit and Mohit.

Solution

Rohit’s old share = 5/8

Rohit’s new share = 4/7

Rohit’s sacrifice = 5/8 – 4/7 = 3/56

Mohit’s old share = 3/8

Mohit’s new share = 2/7

Mohit’s sacrifice = 3/8 – 2/7 = 5/56

Sacrificing ratio among Rohit and Mohit will be 3:5.

Goodwill
Goodwill means the ‘good-name’ or the reputation earned by a firm through the hard work
and honesty of its owners. If a firm renders good service to the customers, they will be able
to earn more profits in future.

PURCHASED GOOWILL
it is the goodwill which is acquired SELF GENERATED GOODWILL
by making a payment. it is internally generated goodwill
For example, when a business is which arises from a numbere of
purchased, the excess of purchase characteristics or attributes which
consideration over its net assets is an on-going business possesses.
referred to as purchased goodwill.

METHODS OF VALUATION OF
GOODWILL

AVERAGE PROFIT SUPER PROFIT CAPITALISATION

METHOD METHOD METHOD
Average profit method
In this method, goodwill is calculated on the basis of the number of past years profits.
Average of such profits is multiplied by the agreed number of years to find out the value of
goodwill.

Value of goodwill = Average Profit * Number of Years of Purchase

For example,

Goodwill of a firm is valued at three year’s purchase of the average profits of the last five
years. The profits of each year ending 31st March are as under:

Year Profit/loss Amount (Rs)

2011 Profit 50,000
2012 Loss 20,000
2013 Profit 10,000
2014 Profit 60,000
2015 Profit 80,000

Total profits of last five years = 50,000 – 20,000 + 10,000 + 60,000 + 80,000 = 1,80,000

Average profits = 1,80,000/5 = 36,000

Goodwill = average profits * number of year’s purchased

= 36,000 * 3 = Rs. 1,08,000

Super profit method
In this method goodwill is calculated on the basis of surplus (excess) profits earned by a
firm in comparison to average profits earned by other firms. Such excess profits are called
super profits.

Normal profits = Capital invested * Normal rate of return / 100

Super profits = Actual or Average profit – Normal profit

Goodwill = Super profit * No. of years purchased

For example,

A firm’s average profits are Rs.70,000. It includes an abnormal profit of Rs.5,000. Capital
invested in the business is Rs.5,50,000 an the normal rate of return is 10%. Calculate
goodwill at four times the super profit.

Calculation of actual average profit

Average profit = 70,000

Less: Abnormal profit = 5,000

Actual average profit = 65,000

Normal profits

Capital invested * normal rate of return/100

= 5,50,000*10/100 = 55,000

Super profit

Actual average profit – Normal profit

= 65,000 – 55,000 = 10,000

Goodwill

Super profit * Number of years purchased

= 10,000 * 4 = 40,000

Capitalisation method
Under this method goodwill can be calculated in two ways:

1. By capitalising the average profits

2. By capitalising the super profits
Capitalisation of average profits method

Under this method first of all we calculate the average profits and then we assess the
capital needed for earning such average profits on the basis of normal rate of return.

Capitalised value of average profits = average profits * 100 / normal rate of return

Goodwill = capitalised value of average profits – net assets

For example,

From the figures given below, calculate goodwill according to the capitalisation of average
profits method:

Actual average profits = Rs.72,000

Normal rate of return = 10%

Assets = Rs.9,70,000

Liabilities = Rs.4,00,000

Capitalised value of average profits = 72,000 *100/10 = Rs.7,20,000

Capital employed = assets – liabilities = 9,70,000 – 4,00,000 = Rs.5,70,000

Goodwill = 7,20,000 – 5,70,000 = Rs.1,50,000

Capitalisation of super profit method

Under this method first of all we need to calculate the super profits and then we assess the
capital needed for earning such super profits on the basis of normal rate of return.

Goodwill = super profits * 100 / normal rate of return

For example,

From the figures given below, calculate goodwill according to the capitalisation of super
profits method:

Actual average profits = Rs.72,000

Normal rate of return = 10%

Assets = Rs.9,70,000

Liabilities = Rs.4,00,000

Capital employed = assets – liabilities = 9,70,000 – 4,00,000 = Rs.5,70,000

Super profits = 72,000 – 57,000(10% * 5,70,000) = Rs.15,000

Goodwill = 15,000 * 100/10 = Rs.1,50,000

Goodwill is paid to the old partners in their sacrifice ratio because the goodwill is the
amount of compensation to be paid by the new partner to the old partners for acquiring
the share of profits which they have surrendered in favour of the new partner.
Accounting treatment of Goodwill on the Admission of a
New Partner
Case Treatment
1. Amount of goodwill is paid No entries are required to be passed
privately
2. New partners brings his share
of goodwill in Cash:
(A) Goodwill is retained in the Cash/Bank A/c Dr.
business To Premium for Goodwill A/c

Premium for Goodwill A/c Dr.

(B) Goodwill is withdrawn by To old Partner’s Capital A/c
the old partners

Old Partner’s Capital A/c Dr.

To Cash/Bank A/c
(If goodwill is withdrawn by the old partners)
** in addition to above two entries

3. New partner does not bring New Partner’s Current A/c*** Dr.
his share of goodwill in cash To old Partner’s Capital A/c (in sacrificing ratio)
*** Not Capital A/c so that Capital remains intact

When Goodwill already appears in the Books

Old Partner’s Capital A/c Dr. (Goodwill written off in old ratio)

To Goodwill A/c
Hidden goodwill

Sometimes the value of goodwill is not given at the time of admission of a new partner. In
such a situation it has to be inferred from the arrangement of the capital and profit sharing
ratio.

Example

Hem and Nem are partners in a firm sharing profits in the ratio of 3:2. Their capitals were
Rs. 80,000 and Rs. 50,000 respectively. They admitted Sam on Jan. 1, 2017 as a new partner
for 1/5 share in the future profits. Sam brought Rs. 60,000 as his capital. Calculate the value
of goodwill of the firm and record necessary journal entries on Sam’s admission, if:

(a) Sam brings his share of goodwill

(b) Sam does not bring his share of goodwill.

(a) When Sam brings his share of goodwill

Bank a/c Dr. 82,000

To capital a/c 60,000

To premium for goodwill a/c 22,000

Premium for goodwill A/c Dr. 22,000

To Hem's Capital A/c 13,200

To Nem's Capital A/c 8,800

(b) Sam does not bring his share of goodwill

Bank A/c Dr. 60,000

To Sam's Capital A/c 60,000

Sam's Current A/c Dr. 22,000

To Hem's Capital A/c 13,200

To Nem's Capital A/c 8,800

Working Notes:

Value of Firm's goodwill

Sam's Capital = Rs. 60,000

Sam's Share = 1/5

Total capital of Firm = Rs. 60,000 x 5 = Rs. 3,00,000

Hem + Nem + Sam = Rs. 80,000 + Rs. 50,000 + Rs. 60,000 = Rs. 1,90,000

Goodwill of the firm = Rs. 3,00,000 - Rs. 1,90,000 = Rs. 1,10,000

Sam's Share = Rs. 1,10,000 x 1/5 = Rs. 22,000

Adjustment for accumulated profits and losses

Sometimes a firm may have accumulated profits not yet transferred to capital accounts of
the partners. These are usually in the form of general reserve, reserve and/or Profit and
Loss Account. The new partner is not entitled to have any share in such accumulated
profits. These are distributed among the partners by transferring it to their capital current
accounts in old profit sharing ratio. Similarly, if there are some accumulated losses in the
form of a debit balance of profit and loss account and/or deferred revenue expenditure
appearing in the balance sheet of the firm.

Example
Rajinder and Surinder are partners in a firm sharing profits in the ratio of 4:1. On April 15,
2017 they admit Narender as a new partner. On that date there was a balance of Rs. 20,000
in general reserve and a debit balance of Rs. 10,000 in the profit and loss account of the
firm. Pass necessary journal entries.

General reserve a/c Dr. 20,000

To Rajinder capital a/c 16,000

To Surinder capital a/c 4,000

Rajinder capital a/c Dr. 8,000

Surinder capital a/c Dr. 2,000

To profit and loss a/c 10,000

Revaluation of assets and reassessment of liabilities

 At the time of admission of a new partner, it is always desirable to ascertain whether
the assets and liabilities of the firm are shown in books at their current values.
 In case assets are understated or overstated then they are revalued. Similarly, if
liabilities are understated or overstated then they are reassessed.
 At times there may also be some unrecorded assets and liabilities of the firm. These
also have to be brought into the books of the firm.
 For all these purposes the firm has to prepare the Revaluation Account.
 The revaluation account is credited with increase in the value of each asset and
decrease in its liabilities because it is a gain and is debited with decrease in the value
of assets and increase in its liabilities is debited to revaluation account because it is a
loss.
 The unrecorded assets are credited and unrecorded liabilities are debited to the
revaluation account.
  If the revaluation account finally shows a credit balance then it indicates net gain and
if there is a debit balance then it indicates net loss, which will be transferred to the
capital accounts of the old partners in old ratio.

The journal entries recorded for revaluation of assets and reassessment of liabilities are as
follows:

(i) For increase in the value of an asset

Asset A/c Dr.

To Revaluation A/c (Gain)

(ii) For reduction in the value of an asset

Revaluation A/c Dr.

To Asset A/c (Loss)

(iii) For appreciation in the amount of a liability

Revaluation A/c Dr.

To Liability A/c (Loss)

(iv) For reduction in the amount of a liability

Liability A/c Dr.

To Revaluation A/c (Gain)

(v) For an unrecorded asset

Asset A/c Dr.

To Revaluation A/c (Gain)

(vi) For an unrecorded liability

Revaluation A/c Dr.

To Liability A/c (Loss)

(vii) For transfer of gain on Revaluation if credit balance

Revaluation A/c Dr.

To Old Partners Capital A/cs (Old ratio)

(viii) For transferring loss on revaluation

Old partner’s Capital A/cs Dr. (Old ratio)

To Revaluation A/c

Example

Following in Balance Sheet of A and B who share profits in the ratio of 3:2
On that date C is admitted into the partnership on the following terms:

1. C is to bring in Rs. 15,000 as capital and Rs. 5,000 as premium for goodwill for 1/6 share.

2. The value of stock is reduced by 10% while plant and machinery is appreciated by 10%.

3. Furniture is revalued at Rs. 9,000.

4. A provision for doubtful debts is to be created on sundry debtors at 5% and Rs. 200 is to
be provided for an outstanding electricity bill.

5. Investment worth Rs. 1,000 (not mentioned in the balance sheet) is to be taken into
account.

6. A creditor of Rs. 100 is not likely to claim his money and is to be written off.

Record journal entries and prepare revaluation account and capital account of partners.

Bank a/c Dr. 20,000

To C’s capital a/c 15,000

To goodwill a/c 5,000

Goodwill a/c Dr. 5,000

To A’s capital a/c 3,000

To B’s capital a/c 2,000

Revaluation a/c Dr. 3,100

To stock a/c 1500

To furniture a/c 1000

To provision for doubtful debt a/c 600

Plant and machinery a/c Dr. 3,000

Investment a/c Dr. 1,000

To revaluation a/c 4,000

Revaluation a/c Dr. 200

To outstanding electricity a/c 200

Sundry creditors a/c Dr. 100

Revaluation a/c 100

Revaluation a/c Dr. 800

To A’s capital a/c 480

To B’s capital a/c 320

(Source – NCERT)

Adjustment of capitals
Sometimes, at the time of admission, the partners agree that their capitals should also be
adjusted so as to be proportionate to their profit sharing ratio. In such a situation, if the
capital of the new partner is given, the same can be used as a base for calculating the new
capitals of the old partners. The capitals thus ascertained should be compared with their

old capitals after all adjustments relating to goodwill reserves and revaluation of assets and
liabilities, etc. have been made; and then the partner whose capital falls short, will bring in
the necessary amount to cover the shortage and the partner who has a surplus, will
withdraw the excess amount of capital.
Example

A and B are partners sharing profits in the ratio of 2:1. C is admitted into the firm for 1/4
share of profits. C brings in Rs. 20,000 in respect of his capital. The capitals of old partners A
and B, after all adjustments relating to goodwill, revaluation of assets and liabilities, etc.,
are Rs. 45,000 and Rs. 15,000 respectively. It is agreed that partners’ capitals should be
according to the new profit sharing ratio. Determine the new capitals of A and B and record
the necessary journal entries assuming that the partner whose capital falls short, brings in
the amount of deficiency and the partner who has an excess, withdraws the excess amount.

Assuming that the new partner acquires his share from A and B in their old profit sharing
ratio.

Total share = 1

C’s share = 1/4

Remaining share = 1 – 1/4 = 3/4

A’s new share = 3/4 * 2/3 = 2/4

B’s new share = 3/4 * 1/3 = 1/4

New profit sharing ratio = 2:1:1

C’s capital = 20,000

Total capital = 20000 * 4 = 80,000

A’s capital = 2/4 * 80,000 = 40,000

B’s capital = 1/4 * 80,000 = 20,000

The capital of A and B after all adjustments have been made, are Rs. 45,000 and Rs. 15,000
respectively. Hence, A will withdraw Rs. 5,000 (Rs. 45,000– Rs.40,000) from the firm
whereas B will contribute additional amount of Rs. 5,000 (Rs. 20,000–Rs.15,000).

Journal entries

A’s capital a/c Dr. 5,000

To cash a/c 5,000

Cash a/c Dr. 5,000

To B’s capital a/c 5,000

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 ACCOUNTING FOR
PARTNERSHIP BASIC CONCEPTS

Chanchal Phore
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Contents
Meaning ............................................................................................................................................................................ 4
Partnership Deed .............................................................................................................................................................. 4
Rules applicable in the absence of partnership deed ....................................................................................................... 5
Fixed Capital Account in Partnership ................................................................................................................................ 6
Drawings - current or capital?........................................................................................................................................... 7
Fluctuating Capital Account .............................................................................................................................................. 7
Profit and loss appropriation account .............................................................................................................................. 8
Interest on capital ............................................................................................................................................................. 9
Interest on drawings ....................................................................................................................................................... 10
Interest on Monthly drawings .................................................................................................................................... 11
When Varying Amounts are Withdrawn at Different Intervals .................................................................................. 11
When Dates of Withdrawal are not specified............................................................................................................. 12
Guarantee of Profit to a Partner ..................................................................................................................................... 12
Past adjustments............................................................................................................................................................. 13
Meaning
Partnership - Partnership is defined in Section 4 of the Indian Partnership Act, 1932 as “the
relation between persons who have agreed to share the profits of a business carried on by
all or any of them acting for all”.

Partnership Deed
Agreement to carry on a business between the partners, partnership comes into existence.
The partnership agreement can be either oral or written. The Partnership Act does not
require that the agreement must be in writing. But when the agreement is in written form, it
is called ‘Partnership Deed’. Partnership deed should be duly signed by the partners, stamped
& registered.

Partnership deed generally contains the following details:

 Names and Addresses of the firm and its main business;

 Names and Addresses of all partners;
 A contribution of the amount of capital by each partner;
 The accounting period of the firm;
 The date of commencement of partnership;
 Rules regarding an operation of Bank Accounts;
 Profit and loss sharing ratio;
 The rate of interest on capital, loan, drawings, etc;
 Mode of auditor’s appointment, if any;
 Salaries, commission, etc, if payable to any partner;
 The rights, duties, and liabilities of each partner;
 Rules to be followed in case of admission, retirement, a death of a partner; and
 Any other matter relating to the conduct of business. Normally, all the matters
affecting the relationship of partners amongst themselves are covered in partnership
deed.
Rules applicable in the absence of partnership
deed

INTEREST ON
PROFIT SHARING INTEREST ON
DRAWINGS
RATIO CAPITAL
no interest on
shared equally no interest on capital
drawings

ADMISSION OF NEW
SALARY TO PARTNER
INTEREST ON LOAN PARTNER
no partner is entitled
6% per annum with consent of all
to any salary
existing partners

Q: Arti and Anita are partners in the firm without a partnership deed with a capital of
Rs5,00,000 and Rs. 3,00,000 respectively. Arti wants to share the profits in the ratio of
capitals. Whether the claim is valid, state with a reason.

Solution: In the absence the partnership deed, profits are shared equally between the
partners, according to the Indian Partnership Act, 1932. So, the claim of Arti is not
valid to share profits in the ratio of capitals.
Fixed Capital Account in Partnership

Partner’s Capital Account – Transactions

Partner’s Current Account –
relating to bringing in and taking out
Transactions relating to appropriation
capital are considered capital natured
of profits and drawings are considered
and are recorded through the regular
current natured and are recorded
capital account. Capital accounts have a
through an account named with the
fixed balance unless capital is either
partners name suffixed with the term
withdrawn or additional capital is
current.
contributed.
Drawings - current or capital?
Regular drawings as agreed upon among partners are also treated to be transactions of
current nature and are thus recorded through the current accounts. This is on the premise
that, as the firm keeps making profits, the partners would be entitled to withdraw and use
some of the profits for their necessities.

Where there is a specific instruction to treat drawings as capital i.e., to be debited to the
capital accounts, it would have to be done accordingly.

Fluctuating Capital Account

Just as in a sole proprietorship concern, in partnership also, profits or losses, drawings,
interest on capital, interest on drawings, salary (to partners), commission, additional capital
introduced etc., may all be recorded in the capital accounts. Such capital accounts are
called Fluctuating Capital Accounts because the balances of these accounts continue to
fluctuate due to various debits and credits. Under this method, there is no need to maintain
respective current accounts because all transactions passing through current accounts are
passed through capital accounts.
Profit and loss appropriation account
It shows how the profits are appropriated or distributed among the partners. All
adjustments in respect of partner’s salary, partner’s commission, interest on capital,
interest on drawings, etc. are made through this account. It starts with the net profit/net
loss as per Profit and Loss Account.

(Source – NCERT)

Example

Amit, Babu and Charu set up a partnership firm on April 1, 2019. They contributed Rs.
50,000, Rs. 40,000 and Rs. 30,000, respectively as their capitals and agreed to share profits
and losses in the ratio of 3 : 2 :1. Amit is to be paid a salary of Rs. 1,000 per month and
Babu, a Commission of Rs. 5,000. It is also provided that interest to be allowed on capital at
6% p.a. The drawings for the year were Amit Rs. 6,000, Babu Rs. 4,000 and Charu Rs. 2,000.
Interest on drawings of Rs. 270 was charged on Amit’s drawings, Rs. 180 on Babu’s
drawings and Rs. 90, on Charu’s drawings. The net profit as per Profit and Loss Account for
the year ending March 31, 2020 was Rs. 35,660. Prepare the Profit and Loss Appropriation
Account to show the distribution of profit among the partners.
 Profit and loss appropriation account

Particulars Amount Particulars Amount

(Rs.) (Rs.)
Amit’s salary 12,000 Net profit 35,660
Babu’s commission 5,000 Interest on drawings:
Interest on capital: Amit 270
Amit 3,000 Babu 180
Babu 2,400 Charu 90 540
Charu 1,800 7,200
Share of profit
transferred to capital
accounts:
Amit 6,000
Babu 4,000
Charu 2,000
12,000

36,200 36,200

Interest on capital
Interest on capital is generally provided for in two situations:

 when the partners contribute unequal amounts of capitals but share profits equally,
and
 where the capital contribution is same but profit sharing is unequal.
Interest on capital is calculated with due allowance for any addition or withdrawal of capital
during the accounting period
Example

Saloni and Srishti are partners in a firm. Their capital accounts as on April 01. 2016 showed
a balance of Rs. 2,00,000 and Rs. 3,00,000 respectively. On July 01, 2016, Saloni introduced
additional capital of Rs. 50,000 and Srishti, Rs. 60,000. On October 01 Saloni withdrew Rs.
30,000, and on January 01, 2016 Srishti withdraw, Rs. 15,000 from their capitals. Interest is
allowed @ 8% p.a. Calculate interest payable on capital to both the partners during the
financial year 2016–2017.

For Saloni

Interest on Rs.2,00,000 for 3 months = 2,00,000 * 8 * 3/ 100 * 12 = 4,000

Add: Interest on Rs.2,50,000 for 3 months = 2,50,000 * 8 * 3/ 100 * 12 = 5,000

Add: Interest on Rs.2,20,00 for 6 months = 2,20,000 * 6 * 8/ 100 * 12 = 8,800

Total interest = 17,800

For Srishti

Interest on Rs.3,00,000 for 3 months = 3,00,000 * 8 * 3/ 100 * 12 = 6,000

Add: Interest on Rs.3,60,000 for 6 months = 3,60,000 * 8 * 6/ 100 * 12 = 14,400

Add: Interest on Rs.3,45,000 for 3 months = 3,45,000 * 8 * 3/ 100 * 12 = 6900

Total interest = 27,300

Interest on drawings
Charging interest on drawings discourages excessive amounts of drawings by the partners.
The calculation of interest on drawings under different situations is shown as here under.
Interest on Monthly drawings
Average period = (Time left after first drawing + Time left after last drawing)/2

S.No. Cases Formulae of Average Period

1. When drawings are made in (12 months + 1 month)/2 = 6.5
the beginning of every month months
2. When drawings are made at (11 months + 0 month)/2 = 5.5
the end of every month months
3. When drawings are made in (11.5 months + .5 month)/2= 6
the middle or any time during the months
month
4. When drawings of equal amount (12 months + 3 months)/2 = 7.5
are made in the beginning of each months
quarter
5. When drawings of equal amount (9 months + 0 month)/2 = 4.5
are made at the end of each months
quarter

When Varying Amounts are Withdrawn at Different

Intervals

When the partners withdraw different amounts of money at different time intervals, the
interest is calculated using the product method. Under this method, first of all the products
are computed by multiplying the each set of drawings from its duration.

The different products are added and the interest is calculated on the total of products so
arrived at for one month.

Interest on Drawings = Total of products × (Rate of interest/100) × (1/12)

When Dates of Withdrawal are not specified
When the total amount withdrawn is given but the dates of withdrawals are not specified,
it is assumed that the amount was withdrawn evenly throughout the year.

For example; Shakila withdrew Rs. 60,000 from partnership firm during the year ending
March 31, 2020 and the interest on drawings is to be charged at the rate of 8 per cent per
annum. For calculation of interest, the period would be taken as six months, which is the
average period assuming, that amount is withdrawn evenly in the middle of the month,
throughout the year. The amount of interest on drawings works out to be Rs. 2,400 as
follows:
60,000 * 8 * 6/ 100 * 12 = 2,400

Guarantee of Profit to a Partner

Sometimes a partner is admitted into the firm with a guarantee of certain minimum
amount by way of his share of profits of the firm. Such assurance may be given by all the
old partners in a certain ratio or by any of the old partners, individually to the new partner.
The minimum guaranteed amount shall be paid to such new partner when his share of
profit as per the profit sharing ratio is less than the guaranteed amount.

For example, Madhulika and Rakshita, who are partners in a firm decide to admit Kanishka
into their firm, giving her the guarantee of a minimum of Rs.25,000 as her share in firm’s
profits. The firm earned a profit of Rs.1,20,000 during the year and the agreed profit
sharing ratio between the partners is decided as 2:3:1.

Madhulika’s share in profit comes to Rs.40,000 (2/6 of Rs. 1,20,000)

Rakshita, Rs. 60,000 (3/6 of Rs. 1,20,000)
Kanishka Rs. 20,000 (1/6 of Rs. 1,20,000)
The share of Kanishka works out to be Rs.5,000 short of the guaranteed amount.
This shall be borne by the guaranteeing partners Madhulika and Rakshita in their profit
sharing ratio, which in this case is 2:3
Madhulika’s share in the deficiency comes to Rs.2,000 (2/5 of Rs. 5,000)
Rakshita’s share in the deficiency comes to Rs.3,000 (3/5 of Rs. 5000)
The total profit of the firm will be distributed among the partners as follows:
Madhulika will get Rs.38,000 (her share 40,000 minus share in deficiency Rs.2,000)
Rakshita Rs.57,000 (60,000–3,000)
Kanishka Rs. 25,000 (Rs. 20,000 + Rs. 2,000 + Rs. 3,000)

Past adjustments
Sometimes a few omissions or errors in the recording of transactions or the preparation of
summary statements are found after the final accounts have been prepared and the profits
distributed among the partners. The omission may be in respect of interest on capitals,
interest on drawings, interest on partners’ loan, partner’s salary, partner’s commission or
outstanding expenses. There may also be some changes in the provisions of partnership
deed or system of accounting having impact with retrospective effect. All these acts of
omission and commission need adjustments for correction of their impact.

The adjustments can be made either

(a) through ‘Profit and Loss Adjustment Account’, or

(b) directly in the capital accounts of the concerned partners.

Example

Rameez and Zaheer are equal partners. Their capitals as on April 01, 2015 were Rs. 50,000
and Rs. 1,00,000 respectively. After the accounts for the financial year ending March 31,
2016 have been prepared, it is discovered that interest at the rate of 6 per cent per annum,
as provided in the partnership deed has not been credited to the partners’ capital accounts
before distribution of profit.

(a) Through profit and loss adjustments account

Profit and loss adjustment a/c …. Dr 9,000

To Rameez’s capital a/c 3,000

To Zaheer’s capital a/c 6,000

Rameez’s capital a/c Dr. 4,500

Zaheer’s capital Dr. 4,500

To profit and loss adjustment a/c 9,000

(b) Directly in partner’s capital accounts

(Source – NCERT)

Rameez’s capital a/c Dr 1,500

To Zaheer’s a/c 1,500

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Contents
Meaning of accounting ratio ............................................................................................................................................. 4
Objectives of Ratio Analysis .............................................................................................................................................. 4
Advantages and disadvantages ......................................................................................................................................... 4
Classification of Ratios ...................................................................................................................................................... 5
Liquidity ratio .................................................................................................................................................................... 6
Current ratio.................................................................................................................................................................. 6
Quick/Acid Test/ Liquid Ratio ....................................................................................................................................... 7
Solvency ratios .................................................................................................................................................................. 8
Debt Equity Ratio .......................................................................................................................................................... 9
Total Assets to Debt Ratio ........................................................................................................................................... 11
Proprietary Ratio ......................................................................................................................................................... 12
Interest Coverage Ratio .............................................................................................................................................. 13
Equity ratio .................................................................................................................................................................. 14
Profitability ratios ........................................................................................................................................................... 14
Gross Profit Ratio ........................................................................................................................................................ 14
Net Profit Ratio ........................................................................................................................................................... 16
Operating Profit Ratio ................................................................................................................................................. 18
Operating Ratio ........................................................................................................................................................... 20
Return on Investment ................................................................................................................................................. 22
DuPont Formula .............................................................................................................................................................. 23
Activity/ turnover/efficiency ratios................................................................................................................................. 23
Inventory Turnover Ratios .......................................................................................................................................... 24
Asset turnover ratio .................................................................................................................................................... 25
Trade Receivables Turnover Ratio .............................................................................................................................. 25
Trade Payables Turnover Ratio ................................................................................................................................... 27
Working Capital Turnover Ratio.................................................................................................................................. 29
Meaning of accounting ratio
Relationship between two terms expressed in arithmetical terms is called as ‘ratio’.

Accounting ratios refer to the ratios which gives significant relationship between two
accounting terms. It helps in analyzing the financial statements and for comparison and
decision making.

Objectives of Ratio Analysis

- Locate weak spots in the business.
- Provide deeper analysis of the liquidity, solvency, activity and profitability of the
business.
- Provide information useful for making estimates and preparing the plans for the
future.
- Provide information for making cross-sectional analysis (for making comparison with
that of some selected firms in the same industry)
- Provide information for making time-series analysis (for making comparison of a
firm’s present ratios with its past ratios)

Advantages and disadvantages

Advantages Limitations
- Analysis of financial statements - Less effective due to price level
changes
- Simplification of Accounting Data - Limited use of a single ratio
- Helpful in Comparative Study - Window dressing
- Helpful in Forecasting - Lack of proper standards
- Estimate trends - Ignores Qualitative Factors
- Effective Control - Misleading in the Absence of
Absolute Data
Classification of Ratios

• Current Ratio
• Quick Ratio
Liquidity
Ratios

• Debt equity ratio

• Total Assets to Debt Ratio
• Proprietary Ratio
Solvency • Interest Coverage Ratio
Ratios • Equity ratio

• Inventory Turnover Ratio

• Asset turnover ratio
• Debtors/Receivables Turnover Ratio
Activity • Creditors/Payables Turnover Ratio
Ratios • Working Capital Turnover Ratio

• Gross Profit ratio

• Operating Ratio
• Operating Profit Ratio
Profitabilty • Net Profit Ratio
Ratios • Return on Investment
Liquidity ratio
Liquidity ratios are calculated to measure the short-term solvency of the business, i.e. the
firm’s ability to meet its current obligations. These are analysed by looking at the amounts
of current assets and current liabilities in the balance sheet.

Types of liquidity ratios-

Current ratio
 Current ratio is a relationship of current assets to current liabilities and is computed
to assess the short term financial position of the enterprise.
 Ideal current ratio: 2:1

Current Ratio= current assets/ current liabilities

Current assets include current investments, inventories, trade receivables (debtors and bills
receivables), cash and cash equivalents, short-term loans and advances and other current
assets such as prepaid expenses, advance tax and accrued income, etc.

Current liabilities include short-term borrowings, trade payables (creditors and bills
payables), other current liabilities and short-term provisions.

*** Items excluded from current assets:

 Loose tools, Stores and Spares

 Provision for doubtful debts is deducted from sundry trade receivables and the
amount so arrived at is taken as current asset.

Significance:

Current assets of a business must at least, be twice of its current liabilities so that even if
half the amount is realized from the current assets on time, the firm can still meet its
current liabilities in full.
Quick/Acid Test/ Liquid Ratio
Liquid assets are the assets which are either in the form of cash and cash equivalents or can
be converted into cash within a very short period.

Quick Ratio = Quick assets / Current Liabilities

Quick assets = Current assets – Inventories – Prepaid Expenses and Advance

Taxes

OR

Quick assets = Current investments + Trade Receivables (Excluding provision

for doubtful debts) + cash and cash equivalents + short term loans and
advances

*Inventory is excluded as it has to be sold before being converted into cash.

**Prepaid expenses are excluded as they are not expected to be converted into cash.

Ideal Quick Ratio: 1:1

Significance:

For every rupee of current liabilities, there should at least be one rupee of liquid assets. It is
a better test of short term financial position of a company than the current ratio as it
considers only those assets which can be easily and readily converted into cash.

Example:

From the following information, calculate Current ratio, Liquid ratio and Super quick ratio.

Items Amount Items Amount

Marketable securities 40,000 Cash & Cash equivalents 10,000
Inventories 5,000 Advance tax 8,000
Prepaid expenses 2,000 Short term loans & 4,000
Advances
Short term Borrowings 20,000 Goodwill 1,00,000
Trade Payables 2,000 Short term Provisions 3,000
Trade Receivables 2,000 Other current liabilities 5,000

Current Liabilities = Short term Borrowings + Trade Payables + Short term Provisions +
Other current liabilities

= 30,000

Current Assets = Marketable securities + Inventories + Prepaid expenses + Trade

Receivables + Cash & Cash equivalents + Advance tax + Short term loans & Advances =
71000

(a) Current ratio = Current Assets/ Current Liabilities = 71000/30000

=2.37:1 (Greater than 2:1)
(b) Quick ratio = Quick Assets / Current Liabilities = 56000/30000

= 1.87:1 (Greater than 1:1)

Quick assets = Current assets – Inventories – Prepaid expenses – Advance Tax

Solvency ratios
Solvency ratios are those ratios which show the ability of the enterprise to meet its long
term liabilities.

Many people confuse solvency ratios with liquidity ratios. Although they both measure the
ability of a company to pay off its obligations, solvency ratios focus more on the long-term
sustainability of company instead of the current liability payments.
Debt Equity Ratio
This ratio expresses the relationship between long term debts and shareholder’s funds. This
ratio indicates the proportion of funds which are acquired by long term borrowings in
comparison to shareholder’s funds.
Debt equity ratio is computed to assess long term financial soundness of the enterprise.

Debt Equity Ratio = Debt/Equity

Or
Debt Equity Ratio = Long term Debts/Shareholders funds or Net worth

Long term debt includes long term borrowings and long term provisions.
Shareholder’s funds = Share Capital + Reserves and Surplus

= Equity Share capital+ Preference Share capital + Capital Reserve + Securities Premium +
General Reserve + Balance in Statement of Profit & Loss
OR
Shareholder’s funds = Non-current assets + Working Capital- Non-current Liabilities

Working Capital = Current Assets – Current Liabilities

Ideal Ratio: 2:1

Significance:

This ratio is calculated to ascertain the soundness of the long term financial policies of the
firm. It also indicates the extent to which the enterprise depends on external funds for its
business.

Example:
Calculate Debt Equity Ratio from the following:

Items Amount
Land & Building 15,00,000
Plant & Machinery 6,00,000
Intangible Assets 1,00,000
Inventory 5,50,000
Trade Receivables 1,70,000
Trade Payables 1,20,000
Long Term Borrowings 12,00,000

Debt Equity Ratio = Debt/Equity = Long term Debts/Shareholder’s funds

Long term Debts = Long Term Borrowings = 12,00,000

Shareholder’s funds = Non-current assets + Working Capital- Non-current Liabilities

Non-Current Assets = Land & Building + Plant & Machinery + Intangible Assets
= 22,00,000

Working Capital = Current Assets – Current Liabilities

= 6,00,000

Shareholder’s funds = 22,00,0000 + 6,00,000 – 12,00,000

= 16,00,000

Debt Equity Ratio = 12,00,000/16,00,000 = 0.75:1

It implies a more financially stable business as it is less than 2:1.

Total Assets to Debt Ratio
It measures the relationship between total assets and long-term debts. It measures the
extent to which long term debts are covered by assets which indicates the margin of safety.

Total Assets to Debt Ratio = Total Assets/Long Term Debt

Total Assets = Non-Current Assets (Tangible Assets + Intangible Assets +

Non-Current Investments + Long Term Loans &
Advances) + Current Assets

Debt = Long Term Borrowings + Long Term Provisions

Example:

Calculate Total Assets to Debt Ratio from the following:

Items Amount
Land & Building 15,00,000
Plant & Machinery 6,00,000
Intangible Assets 1,00,000
Inventory 5,50,000
Trade Receivables 1,70,000
Trade Payables 1,20,000
Long Term Borrowings 12,00,000

Total Assets = Land & Building + Plant & Machinery + Intangible Assets +
Inventory + Trade Receivables = 29,20,000

Long Term Debt = 12,00,000

Total Assets to Debt Ratio = Total Assets/Long Term Debt

= 29,20,000/12,00,000

= 2.43:1

Proprietary Ratio
This ratio indicates the proportion of total assets funded by owners or shareholders.

Proprietary Ratio = Shareholder’s Funds/ Total Assets

Example:

Calculate Proprietary Ratio from the following:

Items Amount
Total debt 30,00,000
Shareholder’s funds 12,00,000
Reserves and Surplus 8,00,000
Current Assets 15,00,000
Working Capital 9,00,000

Proprietary Ratio = Equity/ Total Assets

Current Liabilities = Current Assets – Working Capital

= 6,00,000

Long term Debts = Total Debt – Current Liabilities

= 24,00,000

Total assets = Total debt + Shareholder’s funds

 = 42,00,000

Proprietary Ratio = Shareholder’s funds/ Total assets

= 12,00,000/42,00,000 = 0.285:1

*Reserves and surplus are already included in Shareholder’s funds.

Interest Coverage Ratio

This ratio is calculated by dividing the profit before charging interest and income tax (PBIT)
by fixed interest charges.

Interest Coverage Ratio = (Profit before charging Interest and Income Tax)/
Fixed Interest Charges

Fixed Interest Charges include interest on fixed (long-term) loans or debentures.

Significance
This ratio indicates how many times the interest charges are covered by the profits
available to pay interest charges.

Example:

From the following information, Calculate Interest Coverage Ratio:

Net Profit after Tax Rs.1,20,000

12% Long term Debt Rs.20,00,000

Tax Rate 40%

Net profit before tax = 120,000 × 100/60 = 2,00,000

Interest @12% on long term debt = 2,40,000

Profit before interest and tax = Rs.4,40,000

Interest Coverage Ratio = 4,40,000/2,40,000 = 1.833 times

Equity ratio
The shareholder equity ratio indicates how much of a company's assets have been
generated by issuing equity shares rather than by taking on debt.

Equity Ratio = Total Equity/ Total Assets

Profitability ratios

Profitability ratios compare income statement accounts to show a company's ability to

generate profits from its operations. Profitability ratios focus on a company's return on
investment in inventory and other assets. These ratios basically show how well companies
can achieve profits from their operations.
Investors and creditors can use profitability ratios to judge a company's return on
investment based on its relative level of resources and assets. In other words, profitability
ratios can be used to judge whether companies are making enough operational profit from
their assets.

Gross Profit Ratio

Gross margin compares the gross margin of a business to the net sales. This ratio measures
how profitably a company sells its inventory.
In other words, the gross profit ratio is essentially the percentage markup on merchandise
from its cost.

Gross Profit ratio = Gross Profit/ Net sales

Cost of goods sold = Opening stock + Purchases + Direct expenses – Closing

stock

Net sales = Gross sales minus any Returns or Refunds.

Gross Profit = Net sales - Cost of goods sold

Direct expenses are the expenses incurred directly in the production process of a product.

Indirect expenses are expenses incurred on administrative and office work of the company.

For example, labour expense is a direct expense but salary of accountant is indirect as
labour is used for production process whereas accountant is used to prepare financial
accounts for the company, which is not something it sells to the customer.

** Spare parts and Loose Tools are excluded from inventory.

Significance
Gross Profit Ratio should be adequate enough not only to cover operating expenses but
also to provide for depreciation, interest on loans, dividends and creation of reserves.

Example

Calculate the Gross Profit Ratio from the following information:

Revenue from operations Rs.4,00,000
Gross Profit 25% on cost

If Gross Profit is 25% on cost, then goods costing 100 have been sold for 125.

Gross Profit = (Revenue from operations × 25)/125

= 80,000

Gross Profit Ratio = (Gross Profit/Revenue from Operations) × 100

= 20%

Net Profit Ratio

It measures the amount of net income earned with each rupee of sales generated by
comparing the net income and net sales of a company. In other words, the net profit ratio
shows what percentage of sales are left over after all expenses are paid by the business.

Net Profit Ratio = (Net Profit / Net sales)* 100

Net profit = Gross profit - Indirect Expenses & Losses +

Indirect income

Indirect expenses & losses = Office exp. + Selling exp. + Interest on Long
term Borrowings + Accidental Losses
Significance
This ratio measures the rate of net profit earned on Revenue from Operations. It helps in
determining the overall efficiency of the business operations. An increase in the ratio over
the previous year shows improvement in the overall efficiency and profitability of the
business.

Example

From the following information, calculate Net Profit Ratio:

Items Amount (Rs.)

Opening Inventory 3,00,000
Closing Inventory 4,20,000
Purchases 14,00,000
Wages 3,70,000
Carriage Inwards 1,50,000
Administrative Exp. 84,000
Selling Exp. 36,000
Income Tax 1,00,000
Profit on sale of Fixed Assets 20,000
Revenue from Operations 24,00,000

Cost of Revenue from Operations = Opening Inventory + Purchases + Wages + Carriage

Inwards – Closing Inventory
= 18,00,000

Gross Profit = Revenue from Operations - Cost of Revenue from Operations

= 6,00,000
Net Profit = Gross Profit - Administrative Expenses - Selling Expenses –
Income Tax + Profit on sale of Fixed Assets
= 4,00,000

Net Profit Ratio = (Net Profit after Tax/ Net sales)* 100

= (4,00,000 /24,00,000) *100

= 16.67%

Operating Profit Ratio

This ratio shows the relationship between operating profit and net Revenue from
Operations.
 Operating Profit Ratio = (Operating Profit /Revenue from
Operations) * 100

Operating profit = Gross profit - Other Operating Expenses

or
Net profit (before tax) + Non-operating expenses/
losses - Non-Operating Incomes

Other operating expenses = Employee Benefit Expenses + Depreciation and

Amortization Expenses + Other expenses (i.e. Office
and Administration Expenses + Selling and
Distribution Expenses + Discount + Bad debts +
Interest on short term loans)

Relation

Operating Ratio and Operating Profit Ratio are inter-related. Total of both these ratios will
be 100. A rise in ‘Operating Ratio’ will lead to a similar amount of decline in ‘Operating
Profit Ratio’ and vice versa. For example, if Operating Ratio is 60%, it means that the
Operating Profit Ratio is 40%.
Operating Ratio

Operating ratio establishes relationship between operating costs and net sales.
Operating cost includes “direct cost of goods sold, administrative, selling and distribution
expenses, interest on working capital loans, discounts, bad debts”.
It excludes incomes and expenses, which have no relation with production or sales.
For example “interest and dividend received on investment, interest on loans and
debentures, profit or loss on sale of fixed assets”.

Operating Ratio = (Cost of Goods Sold + Operating Expenses) * 100 / Net

Sales

** Depreciation and Amortization Expenses are included in Operating Expenses.

Operating income includes Trading Commission received and Cash discount received.

Significance

It is the measurement of the efficiency and profitability of the business enterprise.

Lower the operating ratio, the better it is, as it will leave higher margin of profit on Revenue
from Operations.

Example

Calculate Operating Profit Ratio and Operating Ratio from the following information:

Items Amount
Cash revenue from operations 1,00,000
Net purchases 2,97,000
Credit Revenue from Operations 3,00,000
Carriage Inward 3,000
Administrative Expenses 40,000
Profit on Sale of Fixed Assets 10,000

Revenue from Operations = Cash revenue + Credit revenue

= 4,00,000

Cost of Revenue from Operations = Net Purchases + Carriage Inwards

= 3,00,000

Gross Profit = Revenue from Operations - Cost of Revenue from

Operations

= 1,00,000

Operating Expenses = Administrative Expenses

= 40,000

Operating Profit = Gross Profit - Operating Expenses

= 60,000

Operating Profit Ratio = (Operating Profit/ Revenue from Operations)*100

= 15%

Operating Ratio = (Cost of Goods Sold + Operating Expenses) * 100 / Net

Sales

= (3,40,000/4,00,000) *100

= 85%
Return on Investment
This ratio shows the overall profitability of the business. It is calculated by comparing the
profit earned and the capital employed to earn it.

It is also known as ‘Rate of Return’ or ‘Return on Capital Employed’ or ‘Yield on Capital’.

Return on Investment = (Net Profit before Interest, Tax and

Dividends)/Capital Employed * 100

Liabilities side approach

Capital Employed = Shareholder’s Funds + Non-Current Liabilities – Fictitious Assets

Assets side approach

Capital Employed = Non-current assets + Working capital

Example

From the following details calculate the return on investment

Share Capital : Equity (Rs.10) Rs. 4,00,000

12% Preference Rs. 1,00,000

General Reserve Rs. 1,84,000

10% Debentures Rs. 4,00,000

Current Liabilities Rs. 1,00,000

Fixed Assets Rs. 9,50,000

Current Assets Rs. 2,34,000

Profit before interest and tax = Rs. 1,50,000 + Debenture interest + Tax

= Rs. 1,50,000 + Rs. 40,000 + Rs. 50,000 = Rs.2,40,000

Capital Employed = Equity Share Capital + Preference Share Capital + Reserves +

Debentures

= Rs. 4,00,000 + Rs. 1,00,000 + Rs. 1,84,000 + Rs. 4,00,000 = Rs. 10,84,000

Return on Investment = Profit before Interest and Tax/ Capital Employed × 100 = Rs.
2,40,000/Rs. 10,84,000 × 100 = 22.14%

DuPont Formula
Return on Equity = Net Profit Margin × Assets Turnover × Equity Multiplier

= Net Profit/ Sales × Sales/Assets × Assets/Equity

Activity/ turnover/efficiency ratios

They measure how well companies utilize their assets to generate income. Efficiency ratios
often look at the time it takes companies to collect cash from customer or the time it takes
companies to convert inventory into cash—in other words, make sales. These ratios are
used by management to help improve the company as well as outside investors and
creditors looking at the operations of profitability of the company.

These ratios are known as turnover ratios as they indicate the rapidity with which the
resources available to the concern are being used to produce revenue from operations.
Inventory Turnover Ratios

It shows how effectively inventory is managed by comparing cost of goods sold with
average inventory for a period.

Inventory turnover ratio = Cost of goods sold/ average inventory

COGS = Opening stock + Purchases + Direct Expenses –

Closing Stock

Average stock = (Opening stock + Closing stock)/ 2

Significance
This measures how many times average inventory is "turned" or sold during a period.
Low turnover of inventory may be due to bad buying, obsolete inventory, etc., and is a
danger signal. High turnover is good but it must be carefully interpreted as it may be due to
buying in small lots or selling quickly at low margin to realise cash.

Example

From the following information, Calculate Inventory Turnover Ratio:

Cost of Revenue from Operations 5,40,000

Purchases 5,50,000

Direct Expenses 30,000

Opening Inventory 70,000

Cost of Revenue from Operations = Opening Inventory + Purchases + Direct Expenses –

Closing Inventory

Closing inventory = 1,10,000

Average inventory = (Opening Inventory + Closing Inventory)/2

 = 90,000

Inventory turnover ratio = cost of goods sold/ average inventory

= 5,40,000/90,000
= 6 times

Note: Cost of goods sold is also known as cost of revenue from operations.

Asset turnover ratio

The asset turnover ratio measures the efficiency of a company's assets to generate revenue
or sales.

Asset turnover ratio = Net sales / Average total assets

Average total assets = Assets in the beginning + Assets in the end / 2

Trade Receivables Turnover Ratio

It measures how many times a business can turn its accounts receivable into cash during a
period.
In other words, the accounts receivable turnover ratio measures how many times a
business can collect its average accounts receivable during the year.
This ratio shows how efficient a company is at collecting its credit sales from customers.
Higher ratios mean that companies are collecting their receivables more frequently
throughout the year.

Trade receivable turnover ratio = Net credit sales/ average Trade

receivable
Net credit sales = credit sales – sales return
Average debtors = (opening debtors + opening bills
receivable + closing debtors + closing
bills receivable)/ 2
** Doubtful debtors are not to be deducted from debtors since the purpose is to find out
days for which sales are tied up in debtors.

Average collection period is calculated after calculating debtors turnover ratio.

The formula is:

Debt collection period (number of months) = 12/ debtors turnover ratio

Debt collection period (number of days) = 365/ debtors turnover ratio

Example

From the following information, Calculate:

(i) Trade receivable turnover ratio

(ii) Average Collection Period

Total revenue operations for the year 2,00,000

Cash revenue operations for the year 40,000

Trade Receivables at the beginning 20,000

Trade Receivables at the end of the year 60,000

Credit revenue from operations = Total revenue operations for the year - Cash
revenue operations for the year

= 1,60,000
Average Trade Receivables = (Trade Receivables at the beginning +Trade Receivables at
the end of the year)/2

= 40,000

Trade receivable turnover ratio = 160,000/40,000 = 4 times

Average Collection Period = 12/ Trade receivable turnover ratio

= 12/4 = 3 months

Trade Payables Turnover Ratio

Enterprises from whom goods have been purchased are known as creditors or trade
payables. Creditors and bills payable are together called as total payables. The ratio shows
relationship between net credit purchases and average payables.

Creditor’s Turnover Ratio = Net Credit Purchases/ Average Payables

Average Payables = (Opening creditors + Opening bills payable

+ Closing creditors and Closing bills payable)/
2

Significance:

It indicates the speed with which the amount is being paid to trade payables.

The higher the ratio – The better it is – Trade Payables are being paid more quickly –
Increases credit worthiness of the firm.

Average Payment Period indicates the period which is normally taken by the firm to make
payments to its trade payables.

Average Payment Period (in days) = 365/ Creditor’s Turnover Ratio

Average Payment Period (in months) = 12/ Creditor’s Turnover Ratio

Example:

From the following information, Calculate:

(i) Trade Payables turnover ratio

(ii) Average Payment Period

Revenue from operations 5,25,00,000

Bills Payable 5,00,000

Bills Receivable 6,00,000

Total Purchases 3,15,00,000

Creditors 20,00,000

Debtors 54,00,000

Trade Payables turnover ratio = Net Credit Purchases/ Average Payables

= 3,15,00,000 / 25,00,000
= 12.6 times

Average Payment Period = 365/ Trade Payables turnover ratio

= 29 days (approx.)

Note: Since credit purchases are not mentioned, amount of total purchases has been taken.

Also average trade payables are not mentioned in the question, the ratio has been
calculated on the basis of total figures.
Working Capital Turnover Ratio
It establishes relationship between working capital and sales.
It shows the number of times a unit of rupee invested in working capital produces sales.

Working Capital Turnover Ratio = Net Sales/ Working Capital

Net Working capital = Current Assets – Current Liabilities

Example

Calculate Working Capital Turnover Ratio from the following:

Items Amount
Revenue from Operations 18,00,000
Inventory 3,60,000
Trade Receivables 1,70,000
Marketable securities 50,000
Cash and Bank 20,000
Trade Payables 1,40,000
Provision for Tax 10,000

Current Assets = Inventory + Trade Receivables + Marketable securities +

Cash and Bank

= 6,00,000
Current Liabilities = Trade Payables + Provision for Tax

= 150,000

Working Capital = Current Assets – Current Liabilities

= 4,50,000

Working Capital Turnover Ratio = Revenue from Operations/ Working Capital

= 18,00,0000/ 4,50,000
= 4 times
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NOT FOR PROFIT
ORGANIZATIONS
[Type here]

NOT-FOR-PROFIT ORGANISATIONS:

Non-profit making organization are those, which do not buy/manufacture and sell
goods and whose primary object is not to earn profit. Their object is to do good to the
society through welfare activities. Examples of non-profit organizations are clubs,
schools, colleges, Hospitals, Libraries etc.

Main features of Not-for- Profit Organisations:

- Main aim is service
- Form: set up as charitable trusts or societies and subscribers to these
organisations are called members.
- Separate entity
- Managed by elected members
- Major sources of income: (a) subscriptions from members; (b) donations etc.
- Surplus not distributed among members (added to Capital fund)

Distinction between Not for Profit Organisation and Profit Earning Organisation

FINANCIAL STATEMENTS OF NON-PROFIT ORGANISATIONS:

Financial statements include;

A) Receipt and Payment Account
[Type here]

B) Income and Expenditure Account

C) Balance Sheet

Receipt and Payment account:

It is the summarized cash book for a given accounting period.

All cash receipts during the whole year are recorded on its left hand (i.e., debit) side.
While all the cash payments during the whole year written on its right hand (i.e.,
credit) side. Its closing balance indicates cash in hand and cash at bank at the year
end.

Cash Book Receipts and Payments Account

1 It is a book of account within 1 It is an account outside the double

the double entry system. entry system.
2 Each transaction is recorded here 2 Each transaction is not recorded
separately in chronological order. separately - all the transactions are
recorded at a time at the end of
accounting year in a classified from.
3 Ledger reference is recorded here 3 No ledger reference is recorded

4 Daily cash balance can be 4 Daily cash balance cannot be

ascertained from this book. ascertained.
[Type here]

5 All concerns (non-profit seeking 5 Only non-profit seeking

and profit seeking) organizations organizations prepare it.
prepare it.
6 Whenever a cash transaction takes 6 It is prepared on the last day of the
place, it is recorded in this book. In year. In other words, it is a
other words, it is a current account. periodical account.
7 It is a must. 7 It is not indispensable - it may not
be prepared.

Income and Expenditure Account:

This is similar to Profit and Loss Account and which is prepared for finding the excess
of income over expenditures or excess of expenditures over incomes.

Notes:
1. All expenses are recorded on Debit side and all revenues on Credit side.
2. Only revenue transactions are included in it. No capital item is taken into
account.
3. All the items of income/revenue concerning current year — whether received
in cash or not—and all items of expense —whether paid in cash or not—are
taken into account.
4. Surplus or deficit of a concern is ascertained through this account. Credit
balance "indicates surplus, while debit balance indicates deficit.
5. Its balance is transferred to Capital Fund Account.
[Type here]

Difference between Income and Expenditure Account A/c and Profit and Loss A/c
[Type here]

Basis of Income and Expenditure A/c Profit and Loss A/c

Difference
1. Definition Income and expenditure Profit and loss account is
account is account which is the account which is
prepared for finding the prepared for finding net
excess of income over profit or net loss.
expenditures or excess of
expenditures over incomes.
2. Not for Income and expenditure Profit and loss account is
Profit account is prepared by not - prepared
organisation or for profit organisation whose by business whose aim is
Business aim is not to earn money. to earn money.

3. Basis of Income and expenditure Profit and loss account is

Preparation account is prepared on the prepared on the basis of
basis of receipt and payment trial balance and some
account and some other other information.
information.

4. Balance of When we compare debit and The balance of profit and

Account credit side of this account, loss account will be net
balance will be surplus profit or net loss.
or deficit.

DISTINCTION BETWEEN RECEIPTS & PAYMENT ACCOUNT and INCOME &

EXPENDITURE ACCOUNT
[Type here]

Balance Sheet:
This shows the financial position of non-profit organizations at the end of the
accounting year. It contains only capital items, grouped together as Assets and
Liabilities.
[Type here]

IMPORTANT TERMINOLOGIES:

1. Subscription:
It is the major source of revenue income of a non-profit organization. It is periodically
paid by the members of the club.
It can be calculated as:

Or it can be calculated through:

[Type here]

2. Entrance /Admission Fees:

It is the initial amount paid by new members apart from regular subscriptions.
Recurring Nature- Treated as revenue receipt and credited to Income &
Expenditure Account. (if nothing is stated, it is taken as regular)
Non-recurring Nature- Treated as Capital Receipt and shown as liabilities Side
of Balance sheet.

3. DONATION:
It is received from persons, institutions etc. in the form of money or kind.
It can be:
A) General Donation:
• Big Amount- shown on Liability side of Balance Sheet as it is non-
recurring in nature.
• Small Amount- shown on credit side of Income and Expenditure
Account as it is recurring in nature.
B) Specific Donation: (given for a specific purpose)
It is capitalized and shown on liabilities side in Balance Sheet.

4. LEGACY:
It is the amount received as per the WILL of a deceased person. It is not
recurring, hence shown on Liability side of Balance Sheet. If given for a specific
purpose, then it is added to that specific account.

5. SALE OF FIXED ASSETS

[Type here]

Sale of fixed assets should be treated as capital revenue and hence debited to
Revenue & Expenditure Account. Asset account should be credited with book
value of asset and profit and loss should be recorded in Income & Expenditure
Account.

6. USE OF CONSUMABLE ITEMS:

Every non-profit organization uses some consumable items, like, stationery,
sports materials, medicines etc. these items must be debited to Income and
Expenditure Account.

7. PAYMENT OF HONORARIUM:
The amount paid to persons who are not the employees of the institution is
called as honorarium and is debited to the Income and Expenditure Account.

8. FUNDS:
[Type here]

• Special funds are opened to maintain a record of amount received and

spent out for that special purpose.
• General or Capital fund is the difference between assets and outside
liabilities and the difference of income and expenditure is transferred to
this fund every year.

9. PURCHASE AND SALE OF NEWSPAPER:

It is recurring in nature, hence, purchase of newspaper will be debited to
Income and Expenditure Account and sale will be credited to it.

10.LIFE MEMBERSHIP FEES

Some members may pay a lump sum amount to become a life member. It is
non-recurring, hence, shown on Liabilities side of the Balance Sheet.

QUESTIONS

Q.1) Amount received from sale of old grass by a club is treated as:

[a] Capital receipt

*[b] Revenue receipt
[c] Asset
[d] None of the above

Q.2) Receipts and Payment Account generally shows:

*[a] A Debit Balance

[b] A Credit Balance
[c] Surplus or Deficit
[d] Capital Fund
[Type here]

Q.3) Consider the following statements and identify the correct ones:

1. Not for profit organizations need not maintain proper accounts.

2. Donations for specific purposes are always capitalized.
3. Not for profit organizations do not maintain any Capital Account.

[a] 1 and 2
*[b] 2 and 3
[c] 1 and 3
[d] 1, 2 and 3

Q.4) If there is a ‘Match Fund’, then match expenses and incomes are
transferred to:
[a] Income and Expenditure Account
[b] Asset side of Balance Sheet
*[c] Liability side of Balance Sheet
[d] Both Income & Expenditure A/c and to Balance Sheet

Q.5) Subscription received by a school for organizing annual function is

treated as:

*[a] Capital Receipt

[b] Revenue Receipt
[c] Asset
[d] Earned Income

Q.6) Salary paid in cash during the current year was Rs.70,000; Outstanding
salary at end was Rs.4000; Salary paid in advance last year pertaining to
the current year was Rs.3200; Paid in advance during current year for
next year was Rs.5000. The amount debited to Income & Expenditure
A/c will be:

[a] 75,800
[b] 67,800
*[c] 72,200
[d] 64,200
[Type here]

Q.7) Consider the following statements and identify the correct ones:

1. Scholarships granted to students out of funds provided by

government will be debited to Income & Expenditure A/c.
2. Receipt & Payment A/c is equivalent to profit and loss account.

[a] 1 only
[b] 2 only
[c] Both 1 and 2
*[d] Neither 1 nor 2

Q.8) Subscription received in advance during the current year is:

[a] an income
*[b] an asset
[c] a liability
[d] none of these
[Type here]
[Type here]
[Type here]
[Type here]
COMPARATIVE AND COMMON SIZE
STATEMENTS

Chanchal Phore
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Contents
Comparative statements................................................................................................................................................... 4
Comparative balance sheet .......................................................................................................................................... 4
Comparative Statement of Profit and Loss ................................................................................................................... 5
Common size statements.................................................................................................................................................. 5
Common size balance sheet ......................................................................................................................................... 6
Common size statement of profit & loss ...................................................................................................................... 6
Comparative statements
When financial statement figures of two or more years are placed side-by-side to facilitate
comparison, they are called ‘Comparative Financial Statements’.

Comparative balance sheet

COMPARATIVE BALANCE SHEET

As at 31st March 2016 and 2017

Particulars Note 31.3.2016 31.3.2017 Absolute Percentage

No. Change Change
(Increase or (Increase or
Decrease) Decrease)
A B C= B-A D= (C/A)
×100
I. Equity and Liabilities
(1) Shareholder’s funds
(2) Non-current
liabilities
(3) Current liabilities

TOTAL

II. Assets
(1) Non-Current Assets
(2) Current Assets

TOTAL
Comparative Statement of Profit and Loss

Common size statements

Common size statements are those in which individual figures are converted into
percentages to some common base.
Common size balance sheet

COMMON SIZE BALANCE SHEET

As at 31 March, 2016 and 2017

Particulars Note Absolute Amounts Percentage of Balance

No. Sheet Total
31.3.2016 31.3.2017 31.3.2016 31.3.2017
I. Equity and Liabilities
(1) Shareholder’s
funds
(2) Non-current
liabilities
(3) Current
liabilities

TOTAL 100 100

II. Assets
(1) Non-Current
Assets
(2) Current Assets

TOTAL 100 100

Common size statement of profit & loss

It is a statement in which the figure of revenue from operations is assumed to be equal to
100 and all other figures are expressed as percentage of revenue from operations.
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“HALL OF FAME”
 RBI

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300+ Students clear RBI Phase 2
48 Students got selected in RBI
SEBI
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FINANCIAL STATEMENTS OF A
COMPANY
Chanchal Phore
 KEY BENEFITS OF OUR COURSES

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are otherwise unavailable elsewhere.
It is a comprehensive guide to help you crack the
paper & secure your dream position.

We provide personal solutions all queries using a Telegram

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We curate the learning strategies of past year toppers to help

you learn from the success of the best
Contents
Meaning ............................................................................................................................................................................ 4
Nature of financial statements ......................................................................................................................................... 5
Balance sheet ................................................................................................................................................................ 5
Shareholder’s Funds:................................................................................................................................................. 7
Share application money pending allotment ............................................................................................................ 9
Non- Current Liabilities ............................................................................................................................................. 9
Current Liabilities .................................................................................................................................................... 10
Non-current assets and current assets ................................................................................................................... 12
Notes to account ......................................................................................................................................................... 13
Statement of profit and loss ....................................................................................................................................... 13
Meaning
Financial statements are the basic and formal annual reports through which the corporate
management communicates financial information to its owners and various other external
parties which include investors, tax authorities, government, employees, etc.

These include:

A) A balance sheet
B) A statement of profit and loss
C) Notes to accounts
D) Cash flow statement
Nature of financial statements
Recorded facts: The term recorded facts means recording of transactions based on
evidences in the books of accounts. For example, figures relating to cash in hand, debtors,
sales, purchases etc. are recorded facts.

Accounting concepts and conventions: These are followed while preparing financial
statements.

Personal judgments: Personal judgments also have an important bearing on financial

statements. For example, the choice of selecting a method of depreciation lies with the
management.

Balance sheet
This is new vertical format of Balance Sheet as per Schedule 3 of Companies Act 2013.
Shareholder’s Funds:

Shareholder's Funds:
Share Capital:

Reserves and Surplus:

Money received against share

warrants

A) Share capital:
The sub-categories of share capital is shown in Notes to Accounts.
Its format is as follows:

 Authorised Capital: This refers to the maximum capital that the company is
authorized to issue its share for its lifetime and this is shown in Memorandum of
Association.
  Issued Capital: This refers to the amount of Authorised Capital which is offered by
the company to the public for subscription. The remaining part is known as
‘Unissued Capital’.
 Subscribed Capital: This refers to that amount of issued capital that is subscribed
by the public.
For example: If a company has 20,000 shares of Rs.100 each, then authorized capital would
be Rs.20,00,000. If a company issues 15,000 shares then issued capital would be
Rs.15,00,000 and if public subscribes only for 10,000 shares then, subscribed capital would
be Rs.10,00,000.

Now, subscribed capital can be:

 Subscribed and fully paid up OR

 Subscribed but not fully paid
In fully paid, the whole amount is paid by the public to the company, like Rs.100 in previous
example, but in case of not fully paid up, some amount remains to be collected from the
public.

There can be some ‘Calls-in-arrear’ which refers to the amount which has been called up by
the company but is due to be paid by the public. This will be deducted from Subscribed
Capital.

There can be Shares forfeited amount which includes the amount that was paid up on the
shares that are forfeited. This amount is added to the Subscribed Capital.

B) Reserves and Surplus:

This includes all the reserves and surplus accounts. Example- Capital Reserve, Capital
Redemption Reserve, Securities Premium Reserve, Debenture Redemption Reserve etc.

C) Money received against share warrants:

A share warrant is a financial instrument issued by a public company which gives the
holder the right to acquire a certain number of equity shares specified in the instrument
at a later date.
Share application money pending allotment
If a company has received application money but date of allotment falls after the Balance
Sheet date, such application money pending allotment will be shown as:

 Share application money not refundable will be disclosed under this line item.
 Share application money refundable will be disclosed under ‘Other Current Liabilities’

Non- Current Liabilities

Non-current liabilities are those liabilities which are not current liabilities.

LONG TERM BORROWINGS

• They are payable after 12 months.

• Bonds/debentures, Long term Loans, Public Deposits

DEFERRED TAX LIABILTIES

• This arises when accounting income is more than

taxable income. It is a tax liability for future years.

OTHER LONG TERM LIABILITIES

• This includes all long term liabilties which do not

come under any other head.

LONG TERM PROVISIONS

• Provisions whose related claims are expected to be

settled beyond 12 months.
• Provison for Employee Benefits, Provision for Gratuity.
Current Liabilities
A liability is classified as current when it is:

A) Expected to be settled in company’s normal *operating cycle, or

B) Held primarily for the purpose of being traded (sale and purchase), or
C) Due to be settled within 12 months.

*Operating cycle refers to the time between the acquisition of assets for processing
and their realization in cash or cash equivalents.
In case operating cycle cannot be identified, it is assumed to have a duration of 12 months
from the date of Balance Sheet.

Current Liabilities has following sub-heads

SHORT TERM BORROWINGS

•They are payable within 12 months.
•Overdraft, Deposits, LOans from other
parties etc.

TRADE PAYABLES
•It includes 'Sundry Creditors' and 'Bills
Paybale'.

OTHER SHORT TERM LIABILITIES

•This includes all short term liabilties which
do not come under any other head.

SHORT TERM PROVISIONS

•Provisions whose related claims are
expected to be settled within 12 months.
•Provison for Doubtful Debts, etc.
 Assets

Non-current assets and current assets

Tangible assets

Intangible Assets
Fixed assets
Capital work in
progress
Non-current
investments
Intangible assets
under development
Non-Current Assets Deferred Tax asset

Long term Loans

and Advances

Other Non-current
ASSETS

assets

Current Investments

Inventories

Trade Receivables
Current Assets
Cash and Cash
equivalents

Short term loans

and advances

Other current assets

Notes to account

CONTINGENT LIABILITIES

• Liabilities which have not arisen, but may arise upon the
happening of a certain event.

Statement of profit and loss

Format of Statement of Profit and Loss is as follows

Particulars No Figures for Figures for

te the current the
No reporting previous
. period reporting
period
I. Revenue from operations

Il. Other Income

11 Total Revenue (1 + 11)

1.
 IV. Expenses :
Cost of materials consumed
Purchases of Stock-in-Trade
Changes in inventories of finished
goods, work-in progress and
Stock-in-Trade
Employee benefits expenses
Finance costs
Depreciation and amortization
expenses

Other expenses
Total expenses

v. Profit before tax (Ill-IV)

VI. Tax

VII. Profit after tax (V—VI)

 • It is revenue earned from business activities.
Revenue from
Operations

• Revenue that is not earned from business activities.

• Interest income, Dividend Income etc.
Other income

• Cost of raw materials and other materials consumed in

manufacturing the goods.
Cost of Materials • Cost of materials consumed= Opening Inventory of materials +
Consumed Purchases of materials - Closing inventory of Materials

• Opening inventory- Closing Inventory

Change in
Inventory

• It includes all interest expenses and other borrowing costs

Finance Costs
** In case of a Finance Company the following will become revenue from operations:

(i) Interest Income

(ii) Dividend Income
(iii) Net gain/loss on sale of investments
(iv) Revenue from other financial services
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REDEMPTION OF
DEBENTURES
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Contents
Meaning ............................................................................................................................................................................ 4
Sources of Finance for the Redemption of Debentures ................................................................................................... 4
Debenture redemption reserve ........................................................................................................................................ 5
Guidelines for redemption of debentures (Companies Act, 2013) .................................................................................. 5
Exceptions to the Rule of Creating DRR ............................................................................................................................ 5
Conditions of Investing 15% of the debentures maturing during the year ...................................................................... 6
Redemption of Debentures .............................................................................................................................................. 6
When debentures are issued at par and are redeemable at par ................................................................................. 6
When debentures are issued at a discount and are redeemable at par ...................................................................... 7
When debentures are issued at a premium and are redeemable at par ................................................................... 7
When debentures are issued at a par and are redeemable at a premium ............................................................... 8
When debentures are issued at a discount and are redeemable at a premium ......................................................... 8
When debentures are issued at a premium and are redeemable at a premium ........................................................ 9
Redemption by purchase in open market ...................................................................................................................... 10
Redemption of debentures by conversion ..................................................................................................................... 11
Meaning
Redemption of debentures means repayment of the amount of debentures to debenture
holders. It refers to discharge of liability on account of debentures by repaying the due
amount of debentures.

Sources of Finance for the Redemption of

Debentures
• Proceeds of fresh issue of share capital & debentures are
utilised for redeeming old debentures.
Fresh issue of • In this, financial position of the company is not adversely
shares & affected.
debentures

• No profits are set aside for redemption of debentures.

Out of Capital

• Atleast 25% of the nominal value of outstanding debentures is

transferred from Surplus in Statement of P&L to 'Debenture
Redemption Reserve A/c'.
Out of Profits
Debenture redemption reserve
Transfer to Debenture Redemption Reserve A/c reduces profits because transfer of profit
to DRR reduces the amount of profit available for dividend. It means that the profits set
aside for DRR is not available for payment as dividend but would be utilized to redeem the
debentures.

Guidelines for redemption of debentures

(Companies Act, 2013)
Creation of DRR is obligatory only for non-convertible debentures and non-convertible
portion of partly convertible debentures.

A company shall create DRR equivalent to at least 25% of the amount of debentures issued
before starting the redemption of debentures.

Exceptions to the Rule of Creating DRR

 All India Financial Institutions regulated by RBI
 Banking companies
Conditions of Investing 15% of the debentures
maturing during the year
Every company required to create DRI shall before the 30th day of April of each year,
deposit or invest, a sum which shall not be less than 15% of the amount of its debentures
maturing (to be redeemed) during the year ending on the 31st March of the next year.

The amount so deposited or invested can be utilized only for the purpose of repayment of
debentures maturing during the year

Redemption of Debentures
When debentures are issued at par and are redeemable at
par
Entries for Issue Entries for Redemption
Bank A/c 100 Debentures A/c Dr. 100
Dr. To Debenture holders A/c 100
To Debenture 100
Application & Allotment
A/c
Debenture Application 100 Debenture holders A/c Dr. 100
& Allotment A/c To Bank A/c 100
Dr. 100
To Debentures A/c
When debentures are issued at a discount and are
redeemable at par

Entries for Issue Entries for Redemption

Bank A/c 95 Debentures A/c Dr. 100
Dr. To Debenture holders A/c 100
To Debenture 95
Application & Allotment
A/c
Debenture Application Debenture holders A/c Dr. 100
& Allotment A/c 95 To Bank A/c 100
Dr.
Discount on issue of 5
Debentures A/c 100
Dr.
To Debentures A/c

When debentures are issued at a premium and are

redeemable at par

Entries for Issue Entries for Redemption

Bank A/c 105 Debentures A/c Dr. 100
Dr. To Debenture holders A/c 100
To Debenture 105
Application & Allotment
A/c
Debenture Application Debenture holders A/c Dr. 100
& Allotment A/c 105 To Bank A/c 100
Dr. 100
To Debentures A/c
To Securities 5
Premium Reserve
A/c
When debentures are issued at a par and are redeemable
at a premium

Entries for Issue Entries for Redemption

Bank A/c 100 Debentures A/c Dr. 100
Dr. Premium on Redemption of
To Debenture 100 Debentures A/c Dr. 5
Application & Allotment To Debenture holders A/c 105
A/c
Debenture Application Debenture holders A/c Dr. 105
& Allotment A/c 100 To Bank A/c 105
Dr.
Loss on issue of 5
Debentures A/c 100
Dr.
To Debentures A/c 5
To Premium on
Redemption of
Debentures A/c

When debentures are issued at a discount and are

redeemable at a premium

Entries for Issue Entries for Redemption

Bank A/c 98 Debentures A/c Dr. 100
Dr. Premium on Redemption of
To Debenture 98 Debentures A/c Dr. 5
Application & Allotment To Debenture holders A/c 105
A/c
Debenture Application Debenture holders A/c Dr. 105
& Allotment A/c 98 To Bank A/c 105
Dr.
Loss on issue of 7
Debentures A/c 100
Dr.
To Debentures A/c 5
To Premium on
Redemption of
Debentures A/c

When debentures are issued at a premium and are

redeemable at a premium

Entries for Issue Entries for Redemption

Bank A/c 106 Debentures A/c Dr. 100
Dr. Premium on Redemption of
To Debenture 106 Debentures A/c Dr. 10
Application & Allotment To Debenture holders A/c 110
A/c
Debenture Application Debenture holders A/c Dr. 110
& Allotment A/c 106 To Bank A/c 110
Dr.
Loss on issue of 10
Debentures A/c 100
Dr.
To Debentures A/c 6
To Securities
Premium Reserve A/c
To Premium on 10
Redemption of
Debentures A/c
Redemption by purchase in open market
When a company purchases its own debentures in the open market for the purpose of
immediate cancellation, the purchase and cancellation of such debentures are termed as
redemption by purchase in the open market.

On purchase of own debentures for immediate cancellation

Debentures A/c Dr.

To Bank A/c

To Profit on Redemption of Debentures A/c

On transfer of Profit on Redemption

Profit on Redemption of Debenture A/c Dr.

To Capital Reserve

In case, the debentures are purchased from the market at a price which is above the
nominal value of debenture, the excess will be debited to loss on redemption of
debentures.

The journal entry in that case will be

Debentures A/c Dr.

Loss on Redemption of Debentures A/c Dr.

To Bank A/c

Statement of profit and loss Dr.

To Loss on Redemption of Debentures A/c

Redemption of debentures by conversion
As stated earlier the debentures can also be redeemed by converting them into shares or
new debentures. If debenture holders find that the offer is beneficial to them, they will take
advantage of this offer. The new shares or debentures may be issued at par, at a discount
or at a premium.
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FINANCIAL STATEMENT
ANALYSIS
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Contents
Meaning ............................................................................................................................................................................ 4
Significance/Importance of Financial Analysis/Parties interested in financial statement analysis .................................. 4
Tools of financial statement analysis ................................................................................................................................ 5
Comparative Statements .............................................................................................................................................. 5
Common Size Statements ............................................................................................................................................. 5
Trend Analysis ............................................................................................................................................................... 6
Ratio Analysis ................................................................................................................................................................ 6
Cash Flow Analysis ........................................................................................................................................................ 6
Limitations of Financial Analysis ................................................................................................................................... 7
Meaning
Analysis of financial statements is a systematic process of critical examination of the
financial information contained in the financial statements to understand and make
decisions regarding the operations of the enterprise.

Significance/Importance of Financial
Analysis/Parties interested in financial statement
analysis

 Management

Management of a firm is always interested in the solvency, profitable structure and

the capital structure of the firm.

 Investors

They are interested in the longevity of the business enterprise and therefore, they
want to know the earning capacity of the business and its prospects for future
growth and prosperity.

 Creditors

Short term Creditors- want to know the liquidity of the business through current ratio
and quick ratio.

Long term Creditors- want to know

- Whether the company will be able to pay the interest consistently.

- Whether the company will be able to pay their debts when they fall due.

 Government
 It can judge which industry is progressing on the desired lines and which industry
needs the financial help.

 Employees

They can ascertain as to how much bonus and increase in their wages is possible
from the profits of the company. Analysis also helps the trade unions in negotiating
wages agreements.

Tools of financial statement analysis

Comparative Statements
These are the statements showing the profitability and financial position of a firm for
different periods of time in a comparative form to give an idea about the position of two or
more periods. It usually applies to the two important financial statements, namely, balance
sheet and statement of profit and loss prepared in a comparative form. The financial data
will be comparative only when same accounting principles are used in preparing these
statements. If this is not the case, the deviation in the use of accounting principles should
be mentioned as a footnote. Comparative figures indicate the trend and direction of
financial position and operating results. This analysis is also known as ‘horizontal analysis’

Common Size Statements

These are the statements which indicate the relationship of different items of a financial
statement with a common item by expressing each item as a percentage of that common
item. The percentage thus calculated can be easily compared with the results of
corresponding percentages of the previous year or of some other firms, as the numbers are
brought to common base. Such statements also allow an analyst to compare the operating
and financing characteristics of two companies of different sizes in the same industry. Thus,
common size statements are useful, both, in intra-firm comparisons over different years
and also in making inter-firm comparisons for the same year or for several years. This
analysis is also known as ‘Vertical analysis’.
Trend Analysis
It is a technique of studying the operational results and financial position over a series of
years. Using the previous years’ data of a business enterprise, trend analysis can be done to
observe the percentage changes over time in the selected data. The trend percentage is the
percentage relationship, in which each item of different years bear to the same item in the
base year. Trend analysis is important because, with its long run view, it may point to basic
changes in the nature of the business. By looking at a trend in a particular ratio, one may
find whether the ratio is falling, rising or remaining relatively constant. From this
observation, a problem is detected or the sign of good or poor management is detected.

Ratio Analysis
It describes the significant relationship which exists between various items of a balance
sheet and a statement of profit and loss of a firm. As a technique of financial analysis,
accounting ratios measure the comparative significance of the individual items of the
income and position statements. It is possible to assess the profitability, solvency and
efficiency of an enterprise through the technique of ratio analysis.

Cash Flow Analysis

It refers to the analysis of actual movement of cash into and out of an organisation. The
flow of cash into the business is called as cash inflow or positive cash flow and the flow of
cash out of the firm is called as cash outflow or a negative cash flow. The difference
between the inflow and outflow of cash is the net cash flow. Cash flow statement is
prepared to project the manner in which the cash has been received and has been utilised
during an accounting year as it shows the sources of cash receipts and also the purposes for
which payments are made. Thus, it summarises the causes for the changes in cash position
of a business enterprise between dates of two balance sheets.
Limitations of Financial Analysis

Affected by Window-dressing

Window dressing refers to the presentation of a better financial position than what it
actually is by manipulating the books of accounts. On the account of such a situation
financial analysis may give false information to the users.

Do not reflect changes in price levels

If in 2017 a furniture dealer sells set of 100 tables for Rs.15 lacs and in 2018 sells the same
set of 100 tables for Rs.18 lacs, it discloses an increase of 20% in sales, whereas , in actual,
the sales have not increased at all.

Effect of Personal Ability and Bias

In many situations, the accountant has to make a choice out of alternatives available, e.g.,
choice in the method of inventory valuation or choice in the method of depreciation.

Difficulty in Forecasting

Financial statements are a record of past events and historical facts. Due to continuous
changing business requirements, no estimate based on the analysis of historical facts can
be made for future.

Lack of Qualitative Analysis

Qualitative aspects of business units such as efficiency of management, satisfaction of

firm’s customers etc. are omitted from the books at all as these cannot be expressed in
monetary terms.
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ISSUE OF DEBENTURES
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Contents
Meaning of debentures .................................................................................................................................................... 4
Difference between shares and debentures .................................................................................................................... 4
Kinds of Debentures.......................................................................................................................................................... 5
From the Point of view of Security ............................................................................................................................... 5
From the Point of view of Tenure ................................................................................................................................. 5
From the Point of view of Convertibility ....................................................................................................................... 5
From Coupon Rate Point of view .................................................................................................................................. 5
From the view Point of Registration ............................................................................................................................. 6
Issue of debentures........................................................................................................................................................... 6
Issue of Debentures at Par ............................................................................................................................................ 6
Issue of Debentures at Premium .................................................................................................................................. 8
Issue of Debentures at Discount ................................................................................................................................... 9
Issue of Debentures for Consideration other than Cash ............................................................................................ 10
Issue of Debentures as Collateral Security ................................................................................................................. 12
Terms of issue of debentures ......................................................................................................................................... 14
Issue at par and redeemable at par ............................................................................................................................ 14
Issue at a discount and redeemable at par ................................................................................................................. 14
Issue at premium and redemption at par ................................................................................................................... 15
Issue at par and redeemable at premium................................................................................................................... 15
Issue at discount and redemption at premium .......................................................................................................... 16
Issued at a premium and redeemable at premium .................................................................................................... 16
Interest on debentures ................................................................................................................................................... 17
Meaning of debentures
A debenture is a written acknowledgement of a debt taken by the Company as these are
issued under the seal of the Company.

A Debenture Certificate contains the terms of the repayment of the principal sum at a
specified date and the terms of payment of interest at a fixed percent.

Difference between shares and debentures

Ownership: A ‘share’ represents ownership of the company whereas a debenture is only
acknowledgement of Debt. A share is a part of the owned capital whereas a debenture is a
part of borrowed capital.

Return: The return on shares is known as dividend while the return on debentures is called
interest. The rate of return on shares may vary from year to year depending upon the
profits of the company but the rate of interest on debentures is prefixed. The payment of
dividend is an appropriation of profits, whereas the payment of interest is a charge on
profits and is to be paid even if there is no profit.

Repayment: Normally, the amount of shares is not returned during the life of the company,
whereas, generally, the debentures are issued for a specified period and repayable on the
expiry of that period.

Voting Rights: Shareholders enjoy voting rights whereas debenture holders do not normally
enjoy any voting right.

Security : Shares are not secured by any charge whereas the debentures are generally
secured and carry a fixed or floating charge over the assets of the company.

Convertibility: Shares cannot be converted into debentures whereas debentures can be

converted into shares if the terms of issue so provide, and in that case these are known as
convertible debentures.
Kinds of Debentures
From the Point of view of Security
Secured Debentures: Secured debentures refer to those debentures where a charge is
created on the assets of the company for the purpose of payment in case of default.

Unsecured Debentures: Unsecured debentures do not have a specific charge on the assets
of the company.

From the Point of view of Tenure

Redeemable Debentures: Redeemable debentures are those which are payable on the
expiry of the specific period either in lump sum or in Instalments during the life time of the
company. Debentures can be redeemed either at par or at premium.

Irredeemable Debentures: Irredeemable debentures are also known as Perpetual

Debentures because the company does not give any undertaking for the repayment of
money borrowed by issuing such debentures. These debentures are repayable on the
winding-up of a company or on the expiry of a long period.

From the Point of view of Convertibility

Convertible Debentures: Debentures which are convertible into equity shares or in any
other security either at the option of the company or the debenture holders are called
convertible debentures. These debentures are either fully convertible or partly convertible.

Non-Convertible Debentures: The debentures which cannot be converted into shares or in

any other securities are called nonconvertible debentures. Most debentures issued by
companies fall in this category.

From Coupon Rate Point of view

Specific Coupon Rate Debentures: These debentures are issued with a specified rate of
interest, which is called the coupon rate.
Zero Coupon Rate Debentures: These debentures do not carry a specific rate of interest. In
order to compensate the investors, such debentures are issued at substantial discount and
the difference between the nominal value and the issue price is treated as the amount of
interest related to the duration of the debentures.

From the view Point of Registration

Registered Debentures: Registered debentures are those debentures in respect of which all
details including names, addresses and particulars of holding of the debenture holders are
entered in a register kept by the company. Such debentures can be transferred only by
executing a regular transfer deed.

Bearer Debentures: Bearer debentures are the debentures which can be transferred by way
of delivery and the company does not keep any record of the debentures Interest on
debentures is paid to a person who produces the interest coupon attached to such
debentures.

Issue of debentures
Debentures may be issued either at par, or at a premium or at a discount. There are no
restrictions on the issue of debentures at discount, whereas shares cannot be issued at
discount.

Journal entries on issue of debentures are also the same as in the case of issue of shares.

Issue of Debentures at Par

Example

Shayma Ltd. issued 5,000, 10% Debentures of Rs.100 each, at par, payable as follows: On
Application Rs.20, On Allotment Rs.20, On First Call Rs.30 and On Final Call Rs.30.

Public applied for 6000 debentures. Applications for 4500 debentures were accepted in full.
Applications for 800 debentures were allotted 500 debentures and applications for 700
debentures were rejected. Money overpaid on applications was utilized towards allotment.
Pass journal entries.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c 1,20,000
Dr.
To 10% Debenture Application A/c 1,20,000

10% Debenture Application A/c 120,000

Dr.
To 10% Debentures A/c 100,000
To 10% Debenture Allotment A/c 6,000
To Bank A/c 14,000

10% Debenture Allotment A/c 100,000

Dr.
To 10% Debentures A/c 100,000

Bank A/c 94,000

Dr.
To 10% Debenture Allotment A/c 94,000

10% Debenture First Call A/c 150,000

Dr.
To 10% Debentures A/c 150,000

Bank A/c 150,000

Dr.
To 10% Debentures First Call A/c 150,000

10% Debenture Second Call A/c 150,000

Dr.
To 10% Debentures A/c 150,000

Bank A/c 150,000

Dr.
To 10% Debentures A/c 150,000
Issue of Debentures at Premium
Example

ABC Products Ltd. issued 1000, 10% Debentures of Rs.100 each at a premium of 10%. Rs.40
is payable on application and Rs.70 (including premium) is payable on allotment.

Pass necessary journal entries.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c 4,00,000
Dr.
To 10% Debenture Application A/c 4,00,000

10% Debenture Application A/c 4,00,000

Dr.
To 10% Debentures A/c 400,000

10% Debenture Allotment A/c 700,000

Dr.
To 10% Debentures A/c 6,00,000
To Securities Premium Reserve A/c 1,00,000

Bank A/c 7,00,000

Dr.
To 10% Debenture Allotment A/c 7,00,000
Issue of Debentures at Discount

Example

Modi Ltd. issued 2500, 15% Debentures of Rs.100 each at a discount of 10% payable as
follows: Rs.25 on Application; Rs.25 on Allotment and balance on Final Call.

Applications were received for 2000 debentures and the allotment was made. Expenses on
issue of debentures amounted to Rs.8000. Directors decided to write off 1/5th of “Expenses
on Issue A/c” and “Discount on Debentures A/c” from Statement of Profit and Loss each
year.

Pass journal entries (for first year only)

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c 50,000
Dr.
To 15% Debenture Application A/c 50,000

15% Debenture Application A/c 50,000

Dr.
To 15% Debentures A/c 50,000

15% Debenture Allotment A/c 50,000

Dr. 20,000
Discount on Debentures A/c
Dr.
To 15% Debentures A/c 70,000

Bank A/c 50,000

Dr.
To 15% Debenture Allotment A/c 50,000
 15% Debenture First and Final Call A/c 80,000
Dr.
To 15% Debentures A/c 80,000

Bank A/c 80,000

Dr.
To 15% Debentures First and Final Call 80,000
A/c

Expenses on Issue A/c 8,000

Dr.
To Bank A/c 8,000

Statement of Profit & Loss 5,600

Dr.
To Discount on Debentures A/c 4,000
To Expenses on Issue A/c 1,600

Issue of Debentures for Consideration other than Cash

Particulars Entries
On purchase of assets Assets A/c Dr.
To Vendor’s A/c

Issue of debentures to vendor at par Vendor’s A/c Dr.

To Debentures A/c

Issue of debentures to vendor at Vendor’s A/c Dr.

premium To Debentures A/c
To Securities Premium Reserve
A/c

Issue of debentures to vendor at Vendor’s A/c Dr.

discount Discount on Debentures A/c Dr.
To Debentures A/c
Example

Jai Ltd. purchased a business from Veeru Ltd. for a sum of Rs.15,00,000, payable
Rs.3,00,000 by cheque and for the balance issued 9% Debentures of Rs.100 each at par.

The assets and liabilities consisted of the following:

Plant & Machinery 4,00,000

Buildings 6,00,000

Stock 5,00,000

Sundry Debtors 3,00,000

Sundry Creditors 2,00,000

Books of Jai Ltd

JOURNAL

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Plant & Machinery A/c 4,00,000
Dr.
Buildings A/c 6,00,000
Dr.
Stock A/c 5,00,000
Dr.
Sundry Debtors A/c 3,00,000
Dr.
To Sundry Creditors A/c 2,00,000

To Veeru Ltd. 15,00,000

To Capital Reserve (B/f) 1,00,000

Veeru Ltd. 3,00,000

Dr.
To Bank A/c 3,00,000
 Veeru Ltd. 12,00,000
Dr.
To 9% Debentures A/c 12,00,000

Issue of Debentures as Collateral Security

Sometimes, when a Company takes a loan from a Bank or from some other party, the
Company may have to issue debentures as a subsidiary or secondary security in addition to
the principal security.

Holders on such debentures are not entitled to any interest on these debentures.

If a default is made either in the payment of interest or in the payment of principal debt,
the lender will first realize its debt from the principal security. But if the full amount of debt
is not realized from the principal security, it may claim all the rights of a debenture holder.

There are two methods of dealing with such debentures in the books of accounts:

First method

No entry is made in the books of accounts since no liability is created by such issue.
However, on the liability side of the balance sheet, below the item of loan, a note to the
effect that it has been secured by issue of debentures as a collateral security is appended.
Second method

Journal Entries

Issue of 10,000, 9% debentures of Rs. 100 each as collateral security for bank loan of Rs.
10,00,000.

Debenture Suspense A/c Dr. 10,00,000

To 9% Debentures A/c 10,00,000

For cancellation of 9% debentures as collateral security on repayment of bank loan.

When loan is repaid the above entry will be cancelled by a reverse entry

9% Debentures A/c Dr. 10,00,000

To Debenture Suspense A/c 10,00,000

Debenture Suspense account will appear as a deduction from the debentures in notes to
accounts of long-term borrowings.
Terms of issue of debentures
Issue at par and redeemable at par
Bank A/c Dr.

To Debenture Application & Allotment A/c

(Receipt of application money)

Debenture Application & Allotment A/c Dr.

To Debentures A/c

(Allotment of debentures)

Issue at a discount and redeemable at par

Bank A/c Dr.

To Debenture Application & Allotment A/c

(Receipt of application money)

Debenture Application & Allotment A/c Dr.

Discount on Issue of Debentures A/c Dr.

To Debentures A/c

(Allotment of debentures at a discount)

Issue at premium and redemption at par
Bank A/c Dr.

To Debenture Application & Allotment A/c

(Receipt of application money)

Debenture Application & Allotment A/c Dr.

To Debentures A/c

To Securities Premium Reserve A/c

(Allotment of debentures at a premium)

Issue at par and redeemable at premium

Bank A/c Dr.

To Debenture Application & Allotment A/c

(Receipt of application money)

Debenture Application & Allotment A/c Dr.

Loss on Issue of Debentures A/c Dr. (with premium on redemption)

To Debentures A/c (with nominal value of debenture)

To Premium on Redemption of Debenture A/c (with premium on

redemption)

(Allotment of debentures at par and redeemable at a premium)

Issue at discount and redemption at premium
Bank A/c Dr.

To Debenture Application & Allotment A/c

(Receipt of application money)

Debenture Application & Allotment A/c Dr.

Loss on Issue of Debentures A/c Dr. (with discount on issue plus premium on redemption)

To Debentures A/c (with nominal value of debenture)

To Premium on Redemption of Debentures A/c (with premium on redemption)

(Allotment of debentures at a discount and redeemable at premium)

Issued at a premium and redeemable at premium

Bank A/c Dr.

To Debenture Application & Allotment A/c

(Receipt of application money)

Debenture Application & Allotment A/c Dr.

Loss on Issue of Debentures A/c Dr. (with premium on redemption)

To Debentures A/c (with nominal value of debenture)

To Securities Premium Reserve A/c (with premium on issue)

To Premium on Redemption of Debentures A/c (with premium on redemption)

Notes:

1. When debentures are redeemable at a premium, the premium payable on redemption is

debited to ‘Loss on Issue of Debentures A/c’. It may be noted that when debentures are
issued at a discount and are redeemable at a premium, the amount of discount on issue is
also debited to ‘Loss on Issue of Debentures’. It may be noted that when the debentures
are issued at a discount and are redeemable at par, the amount debited to ‘Discount on
Issue of Debentures A/c’ as usual.

2. Premium on redemption is a liability of a company payable in future.

Interest on debentures
When interest is due

Debenture Interest A/c Dr.

To Income Tax payable A/c

To Debenture holders A/c

(Amount of interest due on debenture and tax deducted at source )

For payment of interest to debenture holders

Debenture holders A/c Dr.

To Bank A/c

(Amount of interest paid to debenture holders)

On transfer debenture Interest Account to statement of Profit and Loss

Statement of Profit and Loss Dr.

To Debenture Interest A/c

(Debenture interest transferred to profit and loss A/c)

On payment of tax deducted at source to the Government

Income Tax Payable A/c Dr.

To Bank A/c

(Payment of tax deducted at source on interest on debentures)

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COMPANY ACCOUNTS – ISSUE OF
SHARES
Chanchal Phore
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Contents
Definition .......................................................................................................................................................................... 5
Characteristics of a company ............................................................................................................................................ 5
Kinds of a company ........................................................................................................................................................... 6
Company Limited by Shares .......................................................................................................................................... 6
Unlimited Company ...................................................................................................................................................... 6
Company Limited by Guarantee ................................................................................................................................... 7
Private Company ........................................................................................................................................................... 7
Public Company............................................................................................................................................................. 8
One Person Company (OPC) ......................................................................................................................................... 8
Meaning of shares............................................................................................................................................................. 8
Types of shares ................................................................................................................................................................. 9
Preference Shares ......................................................................................................................................................... 9
Equity Shares................................................................................................................................................................. 9
Share capital...................................................................................................................................................................... 9
Kinds of share capital ...................................................................................................................................................... 10
Authorized, Registered or Nominal Capital ................................................................................................................ 10
Issued Capital .............................................................................................................................................................. 10
Subscribed Capital....................................................................................................................................................... 10
Called up Capital ......................................................................................................................................................... 10
Paid-up Capital ............................................................................................................................................................ 10
Reserve Capital............................................................................................................................................................ 10
Capital Reserves .............................................................................................................................................................. 11
Distinction between reserve capital and capital reserves ............................................................................................ 11
Issue of shares - Steps ..................................................................................................................................................... 13
Issue of Prospectus ..................................................................................................................................................... 13
Receipt of Applications ............................................................................................................................................... 13
Allotment of Shares .................................................................................................................................................... 14
Entries on issue of shares................................................................................................................................................ 14
Journal Entries when shares are issued at par................................................................................................................ 16
Issue of shares at premium ............................................................................................................................................. 17
Accounting Entries for the Amount of Securities Premium ............................................................................................ 18
Issue of shares at discount .............................................................................................................................................. 20
Issue of shares for consideration other than cash .......................................................................................................... 20
Calls in arrear a/c ............................................................................................................................................................ 21
Interest on Calls in Arrear .......................................................................................................................................... 22
Calls Paid-in-Advance ...................................................................................................................................................... 22
Interest on Calls in Advance ........................................................................................................................................ 23
Under subscription of shares .......................................................................................................................................... 25
Oversubscription of shares ............................................................................................................................................. 26
Forfeiture of shares......................................................................................................................................................... 29
Entries on Forfeiture of Shares ................................................................................................................................... 29
Re-issue of forfeited shares ............................................................................................................................................ 30
Forfeiture in case of oversubscription and pro-rata allotment .................................................................................. 34
Definition
A company may be viewed as an association of person who contribute money or money’s
worth to a common inventory and use it for a common purpose. It is an artificial person
having corporate legal entity distinct from its members (shareholders) and has a common
seal used for its signature.

Characteristics of a company
Body Corporate: A company is formed according to the provisions of Law enforced from
time to time. Generally, in India, the companies are formed and registered under
Companies Law except in the case of Banking and Insurance companies for which a
separate Law is provided for.

Separate Legal Entity: A company has a separate legal entity which is distinct and separate
from its members. It can hold and deal with any type of property. It can enter into contracts
and even open a bank account in its own name.

Limited Liability: The liability of the members of the company is limited to the extent of
unpaid amount of the shares held by them. In the case of the companies limited by
guarantee, the liability of its members is limited to the extent of the guarantee given by
them in the event of the company being wound up.

Perpetual Succession: The company being an artificial person created by law continues to
exist irrespective of the changes in its membership. A company can be terminated only
through law. The death or insanity or insolvency of any member of the company in no way
affects the existence of the company. Members may come and go but the company
continues.

Common Seal: The company being an artificial person, cannot sign its name by itself.
Therefore, companies use common seal in order to authenticate the documents.

The authentication of a document, in case the company does not have a common seal, shall
be made in two ways as detailed below:

 By two directors; or
 By a director and the Company Secretary.
Transferability of Shares: The shares of a public limited company are freely transferable.
The permission of the company or the consent of any member of the company is not
necessary for the transfer of shares.

May Sue or be Sued: A company being a legal person can enter into contracts and can
enforce the contractual rights against others. It can sue and be sued in its name if there is a
breach of contract by the company

Kinds of a company

On the basis of liability of its members

Company Company
Unlimited
limited by limited by
company
shares guarantee

Company Limited by Shares

In this company, the liability of the members is limited to the extent of the nominal value of
shares held by each of them.

Unlimited Company
It is a company where there is no limit on the liability of its members. As the risk involved in
such companies is too high, these are not found in India even though permitted by the
Companies Act.
Company Limited by Guarantee
In this company, liability of the members is limited to the extent of the guarantee given by
them in the event of the winding up of the company.

The liability of its members will arise only in the event of the winding up of the company.

On the basis number of members

Private Public One person

company company company

Private Company
A private company is one which by its Article of Association

(i) Restricts the right to transfers its shares.

(ii) Limits the number of its members to two hundred (exclusive of past and present
employee)
(iii) Prohibits any invitation to the public to subscribe for any securities i.e. shares or
debentures of the company.

The name of every private company must end with the words ‘Private Limited’.
Public Company
A public company means a company which (a) is not a private company; (b) is a company
which is not a subsidiary of a private company.

DISTINCTION BETWEEN PRIVATE COMPANY AND PUBLIC COMPANY

Basis Private Company Public Company

Number of members Minimum- 2 Minimum- 7
Maximum- 200 Maximum- No limit
Invitation to public Cannot invite Can invite
Transfer of shares Restricted No restrictions
Number of Directors At least 2 At least 3
Use of word ‘Limited’ Compulsory to use the Only the word ‘Limited’ is
words ‘Private Limited’ at used at the end of its
the end of its name. name.

One Person Company (OPC)

An OPC means a private limited company with only one person as its member.

Characteristics

 Only a natural person being an Indian citizen and resident in India can form one
person company
 Its paid up share capital is not more than Rs. 50 Lakhs
 Its average annual turnover of three years does not exceed Rs. 2 Crores

Meaning of shares
Total Capital of the Company is divided into units of small denomination. Each such unit is
called ‘share’.

Example:
 If total capital of a company is Rs.1,00,000 and it is divided into 10,000 units of Rs.10
each.

Each unit of Rs.10 will be called a share.

The persons who contribute money through shares are called shareholders.

Types of shares
As per Companies Act, 2013, a Company may issue two types of shares:

(1) Preference Shares

(2) Equity shares

Preference Shares
Shares which carry the following two rights:

(i) Right to receive dividend at a fixed rate before any dividend is paid on the equity
shares.
(ii) On the winding up of the company, they have right to return of capital before that
of equity shares.

Equity Shares
Those shares which are paid dividends only when profits are left after the preference
shareholders have been paid fixed rate of dividends.

Shares which do not enjoy any preferential right in the payment of dividend or repayment
of capital, are termed as equity/ordinary shares

Share capital
Share Capital means the capital raised by a Company by the issue of shares.
Kinds of share capital
Authorized, Registered or Nominal Capital
It is the amount which is stated in the Memorandum of Association. This is the maximum
capital for which a Company is authorized to issue shares during its lifetime.

Issued Capital
It is that part of Authorized Capital which is actually offered to the public for subscription.

Subscribed Capital
It is that part of Issued Capital which has been subscribed for by the public. When the
shares offered for public subscription are subscribed fully by the public the issued capital
and subscribed capital would be the same.

Called up Capital
It means such part of Subscribed Capital, which has been called by the directors from
shareholders for payment.

Paid-up Capital
It refers to the portion of called-up capital which has been actually received from the
shareholders.

Reserve Capital
Sometimes a company, by means of special resolution, decides that the certain portion of
its uncalled shall not be called up during its existence and it would be available to the
creditors in the event of its liquidation. Such a portion of uncalled capital is termed as
‘reserved capital’.
Capital Reserves
They are the reserves which are created out of Capital profits. Capital profits which are not
earned in the normal course of business. These reserves cannot be utilized for the
distribution of dividends.

Following items give rise to Capital profits and hence, Capital reserves:

(1) Profit on sale of fixed assets

(2) Profit on revaluation of fixed assets
(3) Premium on issue of shares and debentures
(4) Profit on redemption of debentures
(5) Profit earned by a company prior to its incorporation
(6) Profit on forfeiture and re-issue of shares.

Capital Reserves are shown on the liabilities side of the Balance Sheet under the head
“Reserves and Surplus”.

Distinction between reserve capital and

capital reserves
Basis Reserve Capital Capital Reserve
Meaning & Creation It refers to that portion of It is that reserve which is
increased nominal capital created out of Capital
or uncalled share capital profits.
which shall not be called
up, except in the event of
winding up.
Necessity Not necessary Necessary
Resolution Required for its creation. Not required.
Realized or Not realized It refers to the amount It refers to the amount
which has not been which has already been
 received. received.
Disclosure in Balance Not shown in the Shown under the head,
Sheet Company’s Balance ‘Reserves and Surplus’ on
Sheet. the equity and liabilities
side of the balance sheet.
Time when it can be used Only at the time of It can be used to write off
winding up of company. Capital losses or to
declare a share bonus any
time during the life time
of a company.

Example

A company had registered capital of Rs.100,000 divided into 10,000 equity shares of Rs.10
each. It decided to issue 6000 shares for subscription. It allotted 6000 shares and called Rs.9
per share. All shareholders have duly paid the amount called, except one shareholder,
holding 500 shares who has paid only Rs.7 per share.

Balance Sheet as at ………..

Particulars Note No. Amount Amount

Current Previous Year
Year
EQUITY AND LIABILITIES 1. 53,000
Shareholder’s Funds
(a) Share Capital
Total 53,000

ASSETS
Current Assets
Cash and cash equivalents 53,000
Total 53,000
Notes to Accounts

1. Share Capital Rs. Rs.

Equity Share Capital
Authorized Share Capital 10,000 Equity shares of Rs.10 1,00,000
each
Issued share capital 6000 Equity shares of Rs.10 each 60,000
Subscribed share capital 6000 Equity shares of Rs.10 60,000
each
Called up and Paid up share capital 54,000
6000 Equity shares called up Rs.9
- Calls unpaid 500 shares @ 2 per share (1000) 53,000

Issue of shares - Steps

Issue of Prospectus
The company first issues the prospectus to the public. Prospectus is an invitation to the
public that a new company has come into existence and it needs funds for doing business. It
contains complete information about the company and the manner in which the money is
to be collected from the prospective investors.

Receipt of Applications
When prospectus is issued to the public, prospective investors intending to subscribe the
share capital of the company would make an application along with the application money
and deposit the same with a scheduled bank as specified in the prospectus. The company
has to get minimum subscription within 120 days from the date of the issue of the
prospectus. If the company fails to receive the same within the said period, the company
cannot proceed for the allotment of shares and application money should be returned
within 130 days of the date of issue of prospectus.

Allotment of Shares
If minimum subscription has been received, the company may proceed for the allotment of
shares after fulfilling certain other legal formalities.

It is to be noted that ‘minimum subscription’ of capital cannot be less than 90% of the
issued amount according to SEBI.

Entries on issue of shares

Entries on Receiving Applications

(1) On receiving application amount:

Bank A/c Dr.

To Share Application A/c

(2) Application money transferred to Share Capital:

Share Application A/c Dr.

To Share Capital A/c

Application money returned on un-allotted shares

Share Application A/c Dr.

To Bank A/c

Entries on Allotment
 (3) Amount due on Allotment

Share Allotment A/c Dr.

To Share Capital A/c

(4) On receipt of allotment money

Bank A/c Dr.

To Share Allotment A/c

Entries on First Call

(5) When shareholders are informed to pay the first call:

Share First Call A/c Dr.

To Share Capital A/c

(6) On receipt of First Call money:

Bank A/c Dr.

To Share First Call

Similarly, entries for other calls may be prepared.

Points to remember regarding the calls on shares

1. The amount on any call should not exceed 25% of the face value of
shares.
2. There must be an interval of at least one month between the making of
two calls unless otherwise provided by the articles of association of the
company.
Issue of shares (Face Value of share Rs.10)

Category Issue price Description

At par 10 Issue price = Face
Value
At premium 11 Issue price > Face
Value
At discount 9 Issue price < Face
Value

Journal Entries when shares are issued at par

ABC Ltd. invited 20,000 applications of Rs.10 each. Payments were to be made as follows –
Rs.3 on Applications; Rs.3 on Allotment; Rs.2 on First Call and Rs.2 on Final call.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c 60,000
Dr.
To Equity Share Application A/c 60,000

Equity Share Application A/c 60,000

Dr.
To Equity Share Capital A/c 60,000

Equity Share Allotment A/c 60,000

Dr.
To Equity Share Capital A/c 60,000

Bank A/c 60,000

Dr.
To Equity Share Allotment A/c 60,000
 Equity Share First Call A/c 40,000
Dr.
To Equity Share Capital A/c 40,000

Bank A/c 40,000

Dr.
To Equity Share First Call A/c 40,000

Equity Share Final Call A/c 40,000

Dr.
To Equity Share Capital A/c 40,000

Bank A/c 40,000

Dr.
To Equity Share Final Call A/c 40,000

Issue of shares at premium

The premium on issue of shares is a Capital Profit and is credited to ‘Securities Premium
Reserve Account’. It must be shown separately in the Balance Sheet on the equity and
liabilities side under the head ‘Reserves and Surplus’.

U/s 52(2) of the Companies Act, 2013, the amount of securities premium reserve may used
only for the following purposes:
 Writing off the
Writing off the expenses, Issuing fully paid bonus
preliminary expenses commission/discount shares to shareholders
of the Company allowed on issue of of the Company
share or debenture

Premium payable on
Buy Back of its own
redemption of
shares and other
redeemable preference
securities
shares/ debentures

Accounting Entries for the Amount of Securities

Premium
If amount of premium is received along with application money:

Bank A/c Dr.

To Share Application A/c

Share Application A/c Dr.

To Share Capital A/c

To Securities Premium Reserve A/c

If amount of premium is received along with allocation money:

Share Allotment A/c Dr.

To Share Capital A/c

To Securities Premium Reserve A/c

Bank A/c Dr.

To Share Allotment A/c

Example

POR Ltd. received on October 1, 2017 applications for 25,000 equity shares of Rs.100 each
to be issued at a premium of 25% payable.

On application Rs.25

On Allotment Rs.75 (including premium)

Balance amount As and when required

The shares were allotted by the Company on October20, 2017 and the allotment money
was duly received on October 31, 2017.

PQR Ltd.

JOURNAL

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 625,000
To Equity Share Application A/c 625,000

Equity Share Application A/c 625,000

Dr.
To Equity Share Capital A/c 625,000
 Equity Share Allotment A/c 18,75,000
Dr.
To Equity Share Capital A/c 12,50,000
To Securities Premium Reserve A/c 6,25,000

Bank A/c 18,75,000

Dr.
To Equity Share Allotment A/c 18,75,000

Issue of shares at discount

As per Section 53 of Companies Act 2013, Companies would no longer be permitted to
issue shares at a discount. The only shares that could be issued at a discount are sweat
equity.

Sweat equity shares

It means equity shares issued by the Company to its employees or directors

at a discount or for consideration other than cash providing know-how or
making available intellectual property rights.

Issue of shares for consideration other than cash

(1) Issue of shares to promoters

Incorporation Cost/ Formation Expenses A/c Dr.

To Share Capital A/c

 (2) Issue of shares for purchase of assets

(a) When assets are purchased from vendors:

Sundry Asset A/c Dr.

To Vendor A/c

(b) When shares are issued to vendors:

Vendor’s A/c Dr.

To Share Capital A/c

Calls in arrear a/c

When some shareholders fail to pay the amount of allotment or call when it becomes due,
it is known as calls in arrears.

There are two methods to deal with Calls in Arrear which have been explained by the
following example:

PNB Ltd. made a first call of Rs.2 per share on its 10000 shares. One shareholder (Nirav
Modi) holding 500 shares did not pay the first call but when the company made final call of
Rs.4 per share, he paid all his arrears.

Particulars Without opening Calls in By Opening Calls in Arrear A/c

Arrear A/c
On making first Share First Call A/c Dr. 20,000 Share First Call A/c Dr. 20,000
call due To Share Capital To Share Capital
20,000 20,000
On receipt of Bank A/c Dr. 19,000 Bank A/c Dr. 19,000
first call To Share First Call A/c Calls in Arrear A/c Dr. 1,000
19,000 To Share First Call A/c
20,000

On making Share Final Call A/c Dr. 40,000 Share Final Call A/c Dr. 40,000
final call due To Share Capital To Share Capital
40,000 40,000

On receipt of Bank A/c Dr. 41,000 Bank A/c Dr.

final call To Share Final A/c 41,000
40,000 To Share Final Call A/c
To Share First call A/c 40,000
1,000 To Calls in Arrear A/c
1,000

Note:

Whether the calls in Arrear/c is opened or not, the amount of calls in arrears is shown as a
deduction from the amount of subscribed but not fully paid capital on the equity and
liabilities side of the Balance Sheet. This account is closed when the amount of arrear is
received or the relevant shares are forfeited.

Interest on Calls in Arrear

The Company is authorized to charge interest on calls in arrears at a specified rate
mentioned in its articles, from the due date to the date of actual payment. But if the articles
are silent, Table F of Schedule I of the Companies Act, 2013 shall be applicable, according to
which interest shall be charged at a rate not exceeding 10% p.a.

Calls Paid-in-Advance
It is when a shareholder pays a part, or whole of the amount not yet called upon his shares
in order to save himself the trouble of paying different calls at different times.
JOURNAL ENTRIES

Particulars Entries
When amount Bank A/c Dr.
of Calls-in- To Calls in Advance A/c
Advance

On call made Share Call A/c Dr.

by the To Share Capital
directors

On receipt of Bank A/c Dr.

final call Calls in Advance A/c Dr.
To Share First call A/c

Interest on Calls in Advance

 The amount of Call in Advance is a debt of the Company and it is liable to pay interest
on Calls in Advance from the date of receipt till the date when the call is due for
payment.
 If the Articles do not contain the rate of interest, Table F of Schedule I of the
Companies Act, 2013 shall be applicable which leaves the matter to the Board of
Directors subject to a maximum rate of 12% p.a.
 It is a charge against profits.
 No dividend is payable on it as amount of Calls in Advance is not a part of share
capital.

Example
ABC Ltd. was registered with a capital of Rs.4,00,000 in equity shares of Rs.100 each. It
issued 2000 of such shares payable Rs.25 per share on application; Rs.25 on allotment;
Rs.20 on first call; and the balance as and when required.

All moneys payable on application and allotment were duly received; but when the first call
of the Rs.20 per share was made, one shareholder holding 100 shares failed to pay the
amount due and another shareholder holding 200 shares paid them in full. Record the
transactions.

JOURNAL

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 50,000
To Equity Share Application A/c 50,000

Equity Share Application A/c 50,000

Dr.
To Equity Share Capital A/c 50,000

Equity Share Allotment A/c 50,000

Dr.
To Equity Share Capital A/c 50,000

Bank A/c 50,000

Dr.
To Equity Share Allotment A/c 50,000

Equity Share First Call A/c 40,000

Dr.
To Equity Share Capital A/c 40,000

Bank A/c 44,000

Dr.
To Equity Share First Call A/c 38,000
To Calls in Advance A/c 6,000
 Calls-in-Arrear A/c Dr. 2,000
To Equity Share First Call A/c 2,000

Under subscription of shares

An issue when number of shares applied for by the public is less than the number of shares
offered by the Company.

In such a case the accounting entries are made on the basis of the number of shares applied
for.

Example

Raj Ltd. issued 20,000 equity shares of Rs.10 each at a premium of 10%. Payments were to
be made as – on Application Rs.5 (including premium); on Allotment Rs.4 and on First and
Final Call Rs.2

Applications were received for 18000 shares and all were accepted. All money was duly
received.

Pass necessary relatives in the Books of the Company.

JOURNAL

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 90,000
To Equity Share Application A/c 90,000

Equity Share Application A/c 90,000

Dr.
To Equity Share Capital A/c 72,000
 To Securities Premium Reserve A/c 18,000

Equity Share Allotment A/c 72,000

Dr.
To Equity Share Capital A/c 72,000

Bank A/c 72,000

Dr.
To Equity Share Allotment A/c 72,000

Equity Share First and Final Call A/c 36,000

Dr.
To Equity Share Capital A/c 36,000

Bank A/c 36,000

Dr.
To Equity Share First and Final Call A/c 36,000

Oversubscription of shares
Shares are said to be oversubscribed when the number of shares applied for is more than
the number of shares offered to the public for subscription.

In such case, the Board of Directors have to allot shares on Pro-rata basis which means
smaller number of shares are allotted to each applicant according to the number of shares
applied by him.

JOURNAL ENTRIES
Particulars Entries
When applicants are not Share Application A/c Dr.
allotted any shares To Bank A/c

When some applicants are Bank A/c Dr.

allotted smaller number of To Share Application A/c
shares, excess amount is (Application money received)
utilized towards amount due
on allotment Share Application A/c Dr.
To Share Capital A/c
To Share Allotment A/c
(Transfer of application money to share
capital and the excess application money
credited to share allotment account)

Share Allotment A/c Dr.

To Share Capital A/c
(Amount due on allotment)

Bank A/c Dr.

To Share Allotment A/c
(Allotment money received after adjusting
the amount already received as excess
application money

Example

Raj Ltd. invited applications for 20,000 shares of Rs.10 each payable as follows: Rs.3 on
Application, Rs.2 on Allotment, Rs.2.5 on First Call and Rs.2.5 on Second Call.

Public applied for 30,000 shares and the allotments were made as under:

To Applicants for 8000 shares……….Full

To Applicants for 16,000 shares…….12,000 shares

To Applicants for 6,000 shares………Nil

All moneys were duly received.

Pass Journal Entries.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 90,000
To Share Application A/c 90,000

Share Application A/c Dr. 90,000

To Share Capital A/c 60,000
To Share Allotment 12,000
To Bank A/c 18,000

Share Allotment A/c Dr. 40,000

To Share Capital A/c 40,000

Bank A/c 28,000

Dr.
To Share Allotment A/c 28,000

Share First Call A/c Dr. 50,000

To Share Capital A/c 50,000

Bank A/c 50,000

Dr.
To Share First Call A/c 50,000

Share Final Call A/c Dr. 50,000

To Share Capital A/c 50,000

Bank A/c 50,000

Dr.
To Share Final Call A/c 50,000
Forfeiture of shares
 When any shareholder fails to pay the amount due on allotment or on any call within
the specified period, the Directors may cancel his shares.
 Shares can be forfeited only if the Articles of Association of the Company allows them
to be forfeited.
 If no rules are given in Articles, the provisions of Table F of Schedule I of the
Companies Act, 2013 regarding forfeiture apply.
 Procedure: Defaulting shareholder must be given a minimum of 14 days’ notice
requiring him to pay the unpaid amount on his shares together with the accrued
interest thereon. If, in spite of this notice, the shareholder still does not pay the
unpaid amount on his shares, his shares may be forfeited by a resolution of the Board
of Directors.

Entries on Forfeiture of Shares

Particulars Entries
When shares are Share Capital A/c Dr.
issued at par To Share Allotment A/c
To Share Call A/c
To Share Forfeiture A/c

When shares are

issued at premium

- When Share Capital A/c Dr. (Amount called up so

forfeiture far)
takes place Securities Premium Reserve A/c Dr. (Premium not
before the received)
premium is To Share Allotment A/c (Amount not received on
received Allotment)
To Share Call A/c (Amount not received on
calls)
To Share Forfeiture A/c (Amount received on
Application and calls so far)
 - When According to Section 52 of Companies Act, 2013, if
forfeiture premium has been fully collected, it cannot be cancelled
takes place even if that share is forfeited later on.
after the
premium is
received

Re-issue of forfeited shares

Forfeited shares can be re-issued at par, at premium or at discount.

Particulars Entries
When forfeited Bank A/c Dr.
shares are To Share Capital A/c
reissued at par

When Bank A/c Dr.

forfeited To Share Capital A/c
shares are To Securities Premium Reserve A/c
reissued at
premium

When Bank A/c Dr.

forfeited Share Forfeiture A/c Dr.
shares are To Share Capital A/c
reissued at
discount
Transfer of Share Forfeiture A/c Dr.
Share To Capital Reserve A/c
Forfeiture A/c (** If all the forfeited shares are not re-issued, only that
to Capital proportion of share forfeiture account which belongs to
Reserve A/c the re-issued shares should only be transferred to Capital
Reserve A/c)

Example1. Shares issued at par

X Ltd. invited applications for 20,000 shares of Rs.10 each payable as under: Rs.3 per share
on application, Rs.3 per share on allotment; Rs.2 per share on First Call and Rs.2 per share
on Final Call.

Final Call was not made by the Company. An applicant who had been allotted 100 shares
failed to pay Allotment and First Call money due from him. His shares were forfeited after
the First Call and were immediately re-issued at Rs.8.5 per share. Make necessary journal
entries.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 60,000
To Share Application A/c 60,000

Share Application A/c Dr. 60,000

To Share Capital A/c 60,000

Share Allotment A/c Dr. 60,000

To Share Capital A/c 60,000

Bank A/c 59,700

Dr.
To Share Allotment A/c 59,700

Share First Call A/c Dr. 40,000

To Share Capital A/c 40,000

Bank A/c 39,800

Dr.
To Share First Call A/c 39,800

Share Capital A/c Dr. 800

To Share Allotment A/c 300
To Share First Call A/c 200
To Share Forfeiture A/c 300

Bank A/c 850

Dr.
To Share Capital A/c 800
 To Securities Premium Reserve A/c 50

Share Forfeiture A/c 300

To Capital Reserve A/c 300

** Final call of Rs.2 per share has not been made in the question, as such only Rs.8 have
been called up. Thus, Share Capital A/c will be debited only from Rs.8 per share at the time
of forfeiture.

Example2. When premium on forfeited shares becomes due but is not received.

Akshay Ltd. issued 5,000 shares of Rs.100 each at a premium of Rs.10 each payable as
follows:

On Application Rs.30

On Allotment Rs.40 (including premium)

On First and Final Call Rs.40

All the shares were applied for and instalments received on due dates with the exception of
the Allotment and First and Final Call on 100 shares; these shares were forfeited and re-
issued as fully paid @Rs.105 per share.

Pass necessary journal entries.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 1,50,000
To Share Application A/c 1,50,000

Share Application A/c Dr. 1,50,000

To Share Capital A/c 1,50,000

Share Allotment A/c Dr. 2,00,000

To Share Capital A/c 1,50,000
To Securities Premium Reserve A/c 50,000

Bank A/c 1,96,000

Dr.
 To Share Allotment A/c 1,96,000

Share First & Final Call A/c 2,00,000

Dr.
To Share Capital A/c 2,00,000

Bank A/c 1,96,000

Dr.
To Share First Call A/c 1,96,000

Share Capital A/c 10,000

Dr. 1,000
Securities Premium Reserve A/c
Dr.
To Share Allotment A/c 4000
To Share First Call A/c 4000
To Share Forfeiture A/c 3000

Bank A/c 10,500

Dr.
To Share Capital A/c 10,000
To Securities Premium Reserve A/c 500

Share Forfeiture A/c 3000

To Capital Reserve A/c 3000

** Allotment money on 100 forfeited shares has not been received and as the premium
was also due on allotment, thus, premium also has not been received.

Therefore, Securities Premium Reserve A/c has been debited in the entry for forfeiture of
shares.

Example3. When Premium on Forfeited Shares is Received

PQR Ltd. forfeited 1000 shares of Rs.10 each, Rs.7 called up, issued at a premium of 20% (to
be paid at the time of allotment) for non-payment of a first call of Rs.2 per share. Out of
these, 600 shares were re-issued as Rs.7 paid up for Rs.4 per share.
Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)
Share Capital A/c Dr. 7,000
To Share First Call A/c 2,000
To Share Forfeiture A/c 5,000

Bank A/c Dr. 2400

Share Forfeiture A/c Dr. 1800
To Share Capital A/c 4200

Share Forfeiture A/c Dr. 1200

To Capital Reserve A/c 1200

Working Notes:

As profit on 1000 shares = Rs.5000

Profit on 600 shares = (5000/1000) * 600 = Rs.1800

Transfer to Capital Reserve = Rs.1200

Forfeiture in case of oversubscription and pro-rata

allotment
A company offered 1,00,000 shares of Rs.10 each payable as Rs.3 on application, Rs.2.5 on
allotment, Rs.2.5 on first call and Rs.2 on the final call.

The public applied for Rs.152,000 shares. The shares were allotted on a pro-rata basis to
the applicants of 150,000 shares. All shareholders paid the allotment money excepting 1
shareholder who was allotted 200 shares. These shares were forfeited. The first call was
made thereafter. The forfeited shares were re-issued @ 9 per share, Rs.8 paid up. The final
call was not yet made.

Pass necessary journal entries.

Date Particulars L.F. Dr.(Rs.) Cr.(Rs.)

Bank A/c Dr. 456,000
To Share Application A/c 456,000
 Share Application A/c Dr. 456,000
To Share Capital A/c 3,00,000
To Share Allotment A/c 1,50,000
To Bank A/c 6,000

Share Allotment A/c Dr. 250,000

To Share Capital A/c 250,000

Bank A/c Dr. 99,800

To Share Allotment A/c 99,800

Share Capital A/c Dr. 1,100

To Share Allotment A/c 200
To Share Forfeiture A/c 900

Share First Call A/c Dr. 2,49,500

To Share Capital A/c 2,49,500

Bank A/c Dr. 2,49,500

To Share First Call A/c 2,49,500

Bank A/c Dr. 1800

To Share Capital A/c 1600
To Securities Premium Reserve A/c 200

Share Forfeiture A/c Dr. 900

To Capital Reserve A/c 900

Working Notes:

(1) Excess amount received from the holder of 200 shares on application:

The shareholder who has been allotted 200 shares must have applied for more shares.

If shares allotted were 1,00,000, shares applied for were = 1,50,000

Thus, if shares allotted were 200, shares applied for were= (150,000/100,000)*200= 300
shares

Excess application money received = 300 shares – 200 shares = 100 shares*3 = Rs.300

(2) Amount due on allotment on these shares = 200 shares* 2.5 = Rs.500
- Excess received on these shares on application = Rs.300
Amount not received on allotment Rs.200
(3) Amount received on allotment:

Total amount due on allotment 1,00,000 shares* 2.5 = 2,50,000

(-) Excess received on application = 1,50,000

(-) Amount not received on allotment = 200

Net amount received on allotment in cash 99,800

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Contents
Meaning ............................................................................................................................................................................ 4
Features ............................................................................................................................................................................ 4
Advantages........................................................................................................................................................................ 5
Disadvantages ................................................................................................................................................................... 6
Difference between double entry system and single entry system ................................................................................. 7
Ascertaining profit under the single entry system ........................................................................................................... 8
Statement of Affairs ...................................................................................................................................................... 8
Net Formula .................................................................................................................................................................. 9
Examples ....................................................................................................................................................................... 9
Meaning
Accounting records not made according to the double entry system, are known as
‘Accounts from Incomplete Records’ or ’Single Entry System of Accounting’.

Kohler defines Single Entry System as, “A system of book keeping in which as a rule only
records of cash and of personal account are maintained, it is always incomplete double
entry varying with the circumstances.”

Features

Maintenance
Non
Suitability of personal
uniformity
accounts

Maintenance Preparation of
of cash book finala accounts

Suitablility: This system is suitable for sole trader.

Non uniformity: This system may differ from firm to firm as it is a mere adjustment of
double entry system according to the requirements and convinience of the persons.

Maintenance of personal accounts: Usually under this system, only personal accounts are
maintained and real and nominal accounts are avoided. Therefore sometimes, it is defined
as a system where only personal accounts are kept.
Maintenance of cash book: Geerally, a cash book is maintained under this system.

Preparation of final accounts: In the absence of all nominal and real accounts, the final
accounts cannot be prepared.

Advantages

Simple

Less expensive

Suitable for small business

Flexible

 Simple method: Single entry system is a very simple method of recording business
transactions
 Less expensive: It is less expensive when it is compared to double entry system of
book keeping
 Suitability: It is mainly suited to small business concerns with limited number of
transactions and very few assets and liabilities. Limited companies, because of legal
provisions, cannot maintain accounting books on single entry system.
 Flexibility: The records under this system can be maintained as per the requirements
of the business.
Disadvantages

Arithmetical Correct profit and

accuracy cannot loss cannot be
be proved known

Financial position
Comparitive study
of the business
is difficult
cannot be judged

 Arithmetical accuracy cannot be proved: Trial balance cannot be prepared and hence,
arithmetical accuracy of books cannot be proved or tested. Chances of error, mischief
or fraud remaining undetected are high.
 Correct profit and loss cannot be known: Trading and profit and loss account cannot
be prepared and hence, the correct profit earned or loss incurred during the
accounting period is not known.
 Comparative study is difficult: A major defect of this system is that the financial
position of the current year cannot be compared with that of the previous year due
to incomplete information of transactions of business.
 Financial position of the business cannot be judged: Balance sheet, called statement
of affairs, under single entry system, is prepared in an unsatisfactory manner. The
assets and liabilities are not provided from the records but are put down by physical
inspection and on estimated basis. Hence, balance sheet cannot be drawn up with a
view to ascertain the correct financial position of the business on a particular date.
Thus, exact position of total net assets cannot be known.
Difference between double entry system and
single entry system

Basis Double entry system Single entry system

Both aspects Under this system, both Under this system, both
aspects of a transaction are aspects of transactions are not
recorded recorded.
Accounts Under this system, personal, Under this system, only
real and nominal accounts personal accounts and cash
are maintained. Thus, it is a book is maintained. Hence, it
complete and scientific remains an incomplete record
system of accounting of accounts
Trial balance Under this system, trial Under this system, trial
balance is prepared and balance could not be prepared
thus, the arithmetical due to incomplete system of
accuracy of the books of accounting
account is verified
Profit and loss Under this system, after a Under this system, profit and
certain period, net profit or loss account is not prepared to
net loss can be ascertained ascertain the net profit or loss.
by preparing the profit and
loss account
Financial Under this system correct Under this system, balance
position financial position of the sheet is not prepared. Only
business can be ascertained statement of affairs is
by preparing the balance prepared. The reason is that
sheet the assets and liabilities do not
stand at real amounts but at
estimated amounts
Use This system is used by This system is used by only
 almost all the businesses tiny businesses and
institutions

Ascertaining profit under the single entry system

The profit or loss in case of single entry system can be ascertained by using statement of
affairs method.

Statement of Affairs
A statement of affairs is a statement of assets and liabilities. The difference between the
amounts of two sides is taken as capital.

In this method the capital of the business in the beginning of the period is compared with
its capital at the end of the period. The difference represents profit or loss during the
period.

 If the closing capital is more than opening capital, it shows a profit for the business.
 If the closing capital is less than opening capital, the business had a loss.

Two adjustments must be borne in mind for ascertaining the profit:

1. Adjustment for capital introduced: If the proprietor brought in some additional

capital during the year, it should be deducted from the capital at the end since this
increase is not due to profit but fresh introduction of capital)
2. Adjustment for drawings: The drawings of the proprietor should be added to the
capital at the end – had the drawings not been made, the capital at the close of the
year would have been higher.
Net Formula

Profit = Closing Capital + Drawings – Additional Capital – Opening Capital

The above formula may be shown as follows in the form of statement of profit and loss:

Statement of profit and loss

Particulars Amount
Capital at the end
Add: Drawings during the year
Less: Additional capital introduced during the year
Adjusted capital at the end
Less: Capital in the beginning
Profit or loss for the year

Examples

Mohan maintains books on single entry system. He gives you the following information:

Capital on 1st April 2019 30,400

Capital on 1st April 2020 33,800

Drawings made during the year 9,600

Capital introduced on 1st April 2019 4,000

You are required to calculate the profit or loss made by Mohan

 Statement of profit or loss

For the year ended 31st March 2020

Particulars Amount
Closing capital 33,800
Add: Drawings 9,600
Less: Capital introduced (4,000)
Adjusted capital on 1st April 2020 39,400
Less: Opening capital (30,400)
Profit made during the year 9,000

Rama keeps his books under single entry system. His assets and liabilities were as under

31st March 2019 31st March 2020

Cash 1,000 900
Sundry debtors 39,000 45,000
Stock 34,000 32,000
Plant and machinery 60,000 80,000
Sundry creditors 15,000 14,900
Bills payable 5,000

During 2019-2020, he introduced Rs.10,000 as new capital. He withdrew Rs.3,000 every

month for his household expenses. Ascertain his profit for the year ended 31st march 2020

Statement of affairs

As at 31st march 2019

Particulars Amount Particulars Amount

Sundry creditors 15,000 Cash 1,000
Capital (balancing 1,19,000 Sundry debtors 39,000
figure)
Stock 34,000
Plant and machinery 60,000
1,34,000 1,34,000

Statement of affairs

As at 31st march 2020

Particulars Amount Particulars Amount

Sundry creditors 14,900 Cash 900
Bills payable 5,000 Sundry debtors 45,000
Capital (balancing 1,38,000 Stock 32,000
figure)
Plant and machinery 80,000
1,57,900 1,57,900

Statement of profit and loss

Particulars Amount
Closing capital 1,38,000
Add: Drawings (3000*12) 36,000
Less: Capital introduced (10,000)
Adjusted capital on 1st April 2020 1,64,000
Less: Opening capital (1,19,000)
Profit made during the year 45,000
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SOLE PROPRIETORSHIP

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Contents
Meaning ............................................................................................................................................................................ 4
Trading Account ................................................................................................................................................................ 4
Profit and loss account...................................................................................................................................................... 6
Balance sheet .................................................................................................................................................................... 8
Marshalling of Assets and Liabilities in Balance Sheet ................................................................................................. 8
Permanency Preference Method .............................................................................................................................. 8
Liquidity Preference Method .................................................................................................................................... 9
Classification of Assets ................................................................................................................................................ 10
Classification of Liabilities ........................................................................................................................................... 11
Meaning

Financial Statements are the summaries of the accounts of a business enterprise and shows
the profitability and financial position at the end of the accounting period.

It includes at least two basic statements:

A) Trading and & Profit and Loss Account

B) Balance Sheet

Trading Account
It is prepared for calculating the gross profit or gross loss arising out of the trading activities
of a business.

Format of a Trading Account

All expenses which relate to either purchase of raw material or manufacturing of goods are
recorded in the Trading account. All such expenses are called ‘Direct Expenses’.

Examples of direct expenses:

 Carriage or freight inwards

 Manufacturing wages
 Power and fuel
 Factory lighting
 Factory rent and rates
 Royalties
 Consumable stores

Calculation of Cost of Goods Sold:

Cost of Goods Sold = Opening stock + Net Purchases + Direct Expenses – Closing stock

Cost of Goods Sold = Sales – Gross Profit

Case:

Calculate Net Sales and Gross Profit from the following information:

Cost of Goods Sold Rs.1,00,000

Gross Profit 20% on Sales

Solution: Sales will be 1,00,000 × (100/80) = Rs.1,25,000

Gross Profit = Sales – Cost of Goods Sold

= Rs.1,25,000 – Rs.1,00,000

= Rs.25,000
Profit and loss account
Trading account only shows gross profit earned as a result of buying and selling goods.
However, there are other expenses also which must be included to get the net profit, for
this Profit and Loss Account is prepared.

All Distribution, office, selling, administrative and miscellaneous expenses like, interest on
loan, interest on capital etc. are included in Profit and Loss Account.

A Profit & Loss A/c is an account into which all gains and losses are collected, in order to
ascertain the excess of gains over the losses or vice-versa.

Name of Business
Profit and Loss Account for the year ended .....

Rs. Rs.

Trading A/C Trading A/C

Gross loss (transferred) ----- Gross profit (transferred) -----

Office and Administration

----- Interest received -----
Expenses:

Salaries ----- Rent received -----

Rent, rates, taxes ----- Discount received -----

Postage & telegrams ----- Dividend received -----

Office electric charges ----- Bad debts recovered -----

Telephone charges ----- Provision for discount on -----

 creditors

Printing and stationary ----- Miscellaneous revenue -----

Selling and Distribution Net loss - transferred to

-----
Expenses: capital A/C

Carriage outward -----

Advertisement -----

Salesmen's salaries -----

Commission -----

Insurance -----

Traveling expenses -----

Bad debts -----

Packing expenses -----

Financial and Other Expenses:

Depreciation -----

Repair -----

Audit fee -----

Interest paid -----

Commission paid -----

Bank charges -----

Legal charges -----

Net profit - transferred to

-----
capital A/C
Balance sheet

A Balance Sheet is a statement at a particular date showing on one side the trader’s
property and possessions and on the other hand the liabilities.

Balance sheet contains all the Assets and Liabilities to show the exact financial position of
the business. It is known as Balance Sheet because it shows the balances of ledger accounts
which are left open after transferring all the nominal accounts to Trading & Profit & loss
Account. Balances of all the Real and Personal Accounts are grouped together and shown in
Balance Sheet as Assets and Liabilities.

Marshalling of Assets and Liabilities in Balance Sheet

The assets and liabilities must be shown in such a manner that the financial position of the
business can be assessed through it easily and quickly. Thus an arrangement is made in
which assets and liabilities are shown in the balance sheet. Such an arrangement is called
marshalling of assets and liabilities. There are three methods of marshalling:

1. Permanency Preference Method

2. Liquidity Preference Method

Permanency Preference Method

Under this method, the assets and liabilities are shown in balance sheet in the order of their
permanence. In other words, the more permanent the assets and liabilities, the earlier they
are shown.
Balance Sheet as on....

Liabilities Assets

Fixed Liabilities: Fixed Assets:

Capital Good will

Reserves Patent
Long term loans Land
Building
Current Liabilities: Plant & Machinery
Furniture & Fixtures
Sundry creditors
Bills payable Current Assets:
Bank overdraft
Outstanding expenses Investment
Stock
Sundry debtors
Bills receivable
Prepaid expenses

Liquid Assets:

Cash at bank
Cash in hand

Liquidity Preference Method

Under this method, assets and liabilities are shown in order of their liquidity. The more
liquid the assets, the earlier are they shown.
Balance Sheet as on.....

Liabilities Assets

Current Liabilities: Liquid Assets:

Sundry creditors Cash at bank

Bills payable Cash in hand
Bank overdraft
Outstanding expenses Current Assets:

Fixed Liabilities: Investment

Stock
Capital Sundry debtors
Reserves Bills receivable
Long term loans Prepaid expenses

Fixed Assets:

Good will
Patent
Land
Building
Plant & Machinery
Furniture & Fixtures

Classification of Assets
1. Non-current Assets: Acquired for continuous use and last for many years.

Example: Furniture, Motor Vehicles etc.

2. Current Assets: Either in the form of cash or can be easily converted into cash within
1 year of the date of Balance Sheet.

Example: Accrued Income, Closing stock etc.

Classification of Liabilities
1. Non-Current/ Long-term Liabilities

Liabilities which are to be paid after 1 year or more.

Example: Debentures, Public Deposits, etc.

2. Current or Short term liabilities

Liabilities which are expected to be paid within 1 year of the date of the Balance
Sheet.

Example: Bank overdraft, Bills Payable etc.

3. Contingent Liabilities

They are liabilities which will become payable only on the happening of some
specific event, otherwise not.

Examples:

a. Liabilities for bill discounted

b. Liabilities in respect of a suit pending in a court of law
c. Liability in respect of a guarantee given for another person.

***Contingent liabilities are not shown in the Balance Sheet but as a footnote below the
Balance Sheet.

(Note: All the items of balance sheet are discussed in detail in future lectures)
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Contents
Meaning ............................................................................................................................................................................ 4
Characteristics of a bill of exchange ................................................................................................................................. 4
Parties to a bill of exchange .............................................................................................................................................. 4
Drawer........................................................................................................................................................................... 4
Drawee or Acceptor ...................................................................................................................................................... 4
Payee ............................................................................................................................................................................. 5
Contents of bill of exchange ............................................................................................................................................. 5
Promissory note ................................................................................................................................................................ 6
Parties to a Promissory Note ........................................................................................................................................ 6
Date of Maturity (Due date) and Days of Grace ............................................................................................................... 7
Discounting of bill ............................................................................................................................................................. 8
Endorsement of bill ........................................................................................................................................................... 8
Journal entries under various cases .................................................................................................................................. 9
........................................................................................................................................................................................ 10
Dishonour of Bill.............................................................................................................................................................. 10
Entries in the book of drawer ..................................................................................................................................... 10
Entries in the book of drawee ..................................................................................................................................... 11
Renewal of bill................................................................................................................................................................. 11
Retiring a Bill ................................................................................................................................................................... 12
Accommodation Bill ........................................................................................................................................................ 13
Meaning
According to Indian Negotiable Instrument Act, 1881:

A bill of exchange is an instrument in writing, an unconditional order signed by the maker

directing to pay a certain sum of money only to or to the order of a certain person or to the
bearer of the instrument.

Characteristics of a bill of exchange

 A bill of exchange must be in writing.
 It is an order to make payment.
 The order to make payment is unconditional.
 The maker of the bill of exchange must sign it.
 The payment to be made must be certain.
 The date on which payment is made must also be certain.
 The bill of exchange must be payable to a certain person.
 The amount mentioned in the bill of exchange is payable either on demand or on the
expiry of a fixed period of time.

Parties to a bill of exchange

Drawer
He is the seller or creditor entitled to receive money from someone. He writes or draws the
bill.

Drawee or Acceptor
He is the purchaser or the debtor on whom the bill is drawn and who is liable to pay the
amount mentioned in the bill. He accepts to pay the amount by writing the word
“Accepted” on the bill and then signs it.

A bill is called a draft before it is accepted.

Payee
The person to whom the payment is to be made is called payee.

The drawer of the bill himself will be the payee if he keeps the bill with him till the date of
its payment. The payee may change in the following situations:

(a) In case the drawer has got the bill discounted, the person who has discounted the bill
will become the payee;

(b) In case the bill is endorsed in favour of a creditor of the drawer, the creditor will become
the payee.

Contents of bill of exchange

1. DATE - The date on which a bill is drawn, is written on the top right corner of the bill. It
helps in determining the date of maturity of the bill.
2. Term/Tenure - Term specifies the time period for which a bill is written. It should be
specified in the body of the bill.

3. Amount - Amount in figure should be mentioned in the top left corner and amount in
words should be mentioned in body of the bill.

4. Stamp - Stamp of proper value depending upon the amount of bill must be affixed on the
bills of exchange.

5. Name of parties - The name and addresses of the drawer and the drawee should be
mentioned in the bill of exchange.

6. For Value Received – It means the bill has been issued in exchange of some
consideration.

Promissory note
According to Indian Negotiable Instrument Act, “A Promissory Note is an instrument in
writing (not being a bank note or a currency note) containing an unconditional undertaking
signed by the maker to pay a certain sum of money to, or to the order of, a certain person.”

Parties to a Promissory Note

1. Maker: He is the person who writes a promissory note and signs it.
2. Payee: He is the person who is entitled to get the payment.
There is no acceptor in case of promissory note (as the maker himself is liable to pay the
amount)
Basis Bill of exchange Promissory note
Drawer It is drawn by the creditor It is drawn by the debtor
Order or It contains an order to make It contains a promise to make
promise and payment. There can be three payment. There are only two
parties parties – the drawer, the parties to it – the drawer and the
drawee and the payee payee
Acceptance It requires acceptance by the It does not require any
drawee or someone else on his acceptance
behalf
Payee Drawer and payee can be the Drawer cannot be the payee of it
same party

Date of Maturity (Due date) and Days of Grace

The date on which the payment of the bill becomes due is called the ‘date of maturity’.

While calculating the date of maturity of the bill, it is compulsory to add three days to the
period of the bill. These three days are called Days of Grace.

Where the date of maturity is a public holiday, the instrument will become due on the
preceding business day.

Bills Description
Bill at Sight / On Payable on demand. They become due as soon as
Presentation the bill is presented for payment.
Bill after Date Period starts from the date of drawing the bill.
Bill after Sight Period starts from the date of acceptance of the
bill.
 Case:

X draws a bill on Y dated 1 March 2018. It is accepted on 15 March 2018.

Type of Bill Due date

Payable 2 months ‘after date’ 4 May 2018
At sight Payable on demand
Payable 2 months ‘after sight’ 18 May 2018

Discounting of bill
If the holder of the bill needs funds, he can approach the bank for encashment of the bill
before the due date. The bank shall makes the payment of the bill after deducting some
interest (called discount in this case). This process of encashing the bill with the bank is
called discounting the bill. The bank gets the amount from the drawee on the due date.

Endorsement of bill
The holder of the bill may transfer a bill to another person in discharge of his debt. This is
known as endorsement.
Journal entries under various cases
Dishonour of Bill
A bill of exchange is said to be dishonored when its acceptor refuses to pay the amount of
the bill to the holder of the bill on its maturity.

Noting charges: To establish beyond doubt that the bill was dishonoured, despite its due
presentation, it may preferably to be got noted by Notary Public. Noting authenticates the
fact of dishonour. For providing this service, a fees is charged by the Notary Public which is
called Noting Charges.

Entries in the book of drawer

1. When the bill is retained by the drawer till the maturity and dishonoured on due date
Debtor a/c Dr.

To bills receivable

To cash or bank a/c (noting charges if any)

2. When the bill is discounted with the bank and is dishonoured, the entry will be
Debtor a/c Dr,

To cash or bank a/c

 3. When the bill is endorsed to the endorsee and is dishonoured , the entry will be
Debtor a/c Dr.

To endorsee a/c

4. When the bill has been sent to the bank for collection and is dishonoured
Debtor a/c

To bills sent for collection a/c

To cash or bank a/c

Entries in the book of drawee

Bills Payable a/c Dr.

Noting charges a/c Dr.

To creditor a/c

Renewal of bill
Sometimes, acceptor of a bill finds unable to pay his dues on the due date. So he may
approach the drawer of the bill before the maturity date arrives, to cancel the old bill and
draw a new bill with extended date. The acceptor in this case will have to pay interest for
the extended period. Thus the cancellation of the old bill maturity in return for a new bill
for an extended period is called "renewal of a bill of exchange".
Retiring a Bill
Sometimes the acceptor of a bill of exchange desires to meet the bill before its maturity if
he has sufficient funds at his disposal. He may ask the holder of the bill to accept the
payment before the due date. If the holder agrees to his proposal, he will withdraw the bill.
Such a withdrawal is called "retirement of a bill of exchange". The holder generally allows
the acceptor a rebate or discount for the unexpired period of the bill. This rebate is an
expense for the holder and a revenue for the acceptor of the bill.

When a bill of exchange is retired by an acceptor, the following entry is made in books of
the holder:

Cash A/C...................Dr. (with actual amount of cash received)

Rebate A/C................Dr. (amount of rebate allowed)
Bill receivable A/C (full amount of bill)
In the books of acceptor, the following entry is passed:

Bill payable A/C...........Dr. (with full amount)

Cash A/C (amount actually paid)
Rebate A/C (rebate earned)

Accommodation Bill
Sometimes, in order to oblige a friend, a bill may be accepted without consideration. Such a
bill is known as ‘accommodation bill’.

Suppose A is in need of money, he approaches his friend B and asks him to give him a loan
for Rs.5,000. B also shows his inability but agrees that he will accept a bill of exchange. A
draws a bill on B which he accepts at three months. A discounts the bill with his bank and
gets the money. After three months but before the due date, A sends Rs.5,000 to B in order
to meet his acceptance. B receives amount and pays his acceptance.
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PROVISIONS AND RESERVES

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Contents
Meaning of provisions....................................................................................................................................................... 4
Examples of provisions.................................................................................................................................................. 4
Reserves ............................................................................................................................................................................ 5
Examples of reserves .................................................................................................................................................... 5
Difference between Provision and Reserves .................................................................................................................... 6
Types of Reserves.............................................................................................................................................................. 7
General Reserves .......................................................................................................................................................... 7
Specific reserves............................................................................................................................................................ 7
Revenue reserves .......................................................................................................................................................... 7
Capital reserves ............................................................................................................................................................. 8
Secret reserve ............................................................................................................................................................... 8
Meaning of provisions
There are certain expenses/losses which are related to the current accounting period but
amount of which is not known with certainty because they are not yet incurred. It is
necessary to make provision for such items for ascertaining true net profit.

Examples of provisions
• Provision for depreciation;

• Provision for bad and doubtful debts;

• Provision for taxation;

• Provision for discount on debtors; and

• Provision for repairs and renewals.

In the balance sheet, the amount of provision may be shown either:

• By way of deduction from the concerned asset on the assets side. For example, provision
for doubtful debts is shown as deduction from the amount of sundry debtors and provision
for depreciation as a deduction from the concerned fixed assets;

• On the liabilities side of the balance sheet along with current liabilities, for example
provision for taxes and provision for repairs and renewals.
Reserves
A part of the profit may be set aside and retained in the business to provide for certain
future needs like growth and expansion or to meet future contingencies such as workmen
compensation.

Unlike provisions, reserves are the appropriations of profit to strengthen the financial
position of the business. Reserve is not a charge against profit as it is not meant to cover
any known liability or expected loss in future. However, retention of profits in the form of
reserves reduces the amount of profits available for distribution among the owners of the
business. It is shown under the head Reserves and Surpluses on the liabilities side of the
balance sheet after capital.

Examples of reserves
• General reserve;

• Workmen compensation fund;

• Investment fluctuation fund;

• Capital reserve;

• Dividend equalisation reserve;

• Reserve for redemption of debenture.

Difference between Provision and Reserves
Basis of difference Provision Reserve
Basic nature Charge against profit Appropriation of profit
Purpose It is created for a known It is made for strengthening
liability or expense the financial position of the
pertaining to current business.
accounting period, the
amount of which is not
certain
Presentations in It is shown either by way of It is shown on the liabilities
balance sheet deduction from the item on side after capital amount
the asset side for which it is
created or in the liabilities
side along with current
liability
Element of Creation of provision is Generally, creation of reserve
compulsion necessary to ascertain true is at the discretion of the
and fair profit or loss in management. Reserve cannot
compliance with be created unless there are
conservatism concept profits. However, in certain
cases law has stipulated for
the creation of specific
reserves such as ‘Debenture
Redemption Reserve’
Use for the It cannot be used for It can be used for dividend
payment of dividend distribution distribution
dividend
Types of Reserves

General Reserves
When the purpose for which reserve is created is not specified, it is called General Reserve.
It is also termed as free reserve because the management can freely utilise it for any
purpose. General reserve strengthens the financial position of the business.

Specific reserves
These are created for specific purposes, example:

Dividend equalization reserve: To maintain steady rate of dividend.

Investment Fluctuation Fund: Provide for decline in the value of investments due to market
fluctuations.

Workmen Compensation Fund: It is created to provide for claims of the workers due to
accident, etc.

Debenture Redemption Reserve: Provide funds for Redemption of debentures.

Revenue reserves
These reserves are made out of profits which are earned from day-to-day business
operations.

Examples of revenue reserves are:

 General reserve
 Workmen compensation fund
 Investment fluctuation fund
 Dividend equalisation reserve
 Debenture redemption reserve
Capital reserves
Reserves made out of capital profits are known as Capital Reserves.

Capital profits may arise out of:

A) Profits on the sale of fixed assets

B) Profits on revaluation of fixed assets and liabilities.
C) Premiums received on issue of Shares or Debentures
D) Profit on purchase of running business
E) Profit prior to the incorporation of a company
F) Profit from the reissue of forfeited share
G) Profit on redemption of debentures.

Capital reserves must be used to write off Capital losses and for the issue of fully paid
bonus shares. Usually, the capital reserves are not available for distribution as cash
dividends.

Secret reserve
Secret reserve is a reserve which does not appear in the balance sheet. It may also help to
reduce the disclosed profits and also the tax liability. The secret reserve can be merged with
the profits during the lean periods to show improved profits. Management may resort to
creation of secret reserve by charging higher depreciation than required. It is termed as
‘Secret Reserve’, as it is not known to outside stakeholders. Secret reserve can also be
created by way of:

 Undervaluation of inventories/stock
 Charging capital expenditure to profit and loss account
 Making excessive provision for doubtful debts
 Showing contingent liabilities as actual liabilities
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Depreciation...................................................................................................................................................................... 4
Meaning ........................................................................................................................................................................ 4
Other related terms ...................................................................................................................................................... 5
Depletion................................................................................................................................................................... 5
Amortisation ............................................................................................................................................................. 5
Features ........................................................................................................................................................................ 5
Need, Importance or Objects of Providing Depreciation.............................................................................................. 6
Factors determining the amount of depreciation ........................................................................................................ 7
Total cost of the asset ............................................................................................................................................... 7
Estimated useful life.................................................................................................................................................. 7
Estimated useful life.................................................................................................................................................. 8
Methods of Allocating Depreciation ............................................................................................................................. 8
Straight line method ................................................................................................................................................. 8
Merits .................................................................................................................................................................. 10
Demerits .............................................................................................................................................................. 10
Written down value method................................................................................................................................... 11
Merits .................................................................................................................................................................. 13
Demerits .............................................................................................................................................................. 13
Difference Between Straight Line Method and Reducing Balance Method .................................................... 14
Methods of recording depreciation ............................................................................................................................ 15
Charging Depreciation to Asset account ................................................................................................................. 15
Accumulated depreciation account ........................................................................................................................ 16
Asset Disposal A/c ....................................................................................................................................................... 17
Depreciation
Meaning
Assets have a definite span of life after the expiry of which the assets will lose their
usefulness for the business purposes. The value of these assets keeps on declining, which is
known as depreciation.

Depreciation is the diminution in intrinsic value of the asset due to use and/ or lapse of
time.

Example: ABC Construction Ltd. Purchased a heavy machinery at Rs.10,00,000, now if he

charges this amount to the year of purchase, it will lead to distortion of matching principle
as this machinery will yield revenue in future years too. Therefore, to get the right profits,
the cost of machinery must be allocated to the years for which it will generate revenue.
This allocation of cost is known as depreciation.
Other related terms
Depletion
The term depletion is used in the context of extraction of natural resources like mines,
quarries, etc. that reduces the availability of the quantity of the material or asset.

For example, if a business enterprise is into mining business and purchases a coal mine for
Rs.10,00,000. Then the value of coal mine declines with the extraction of coal out of the
mine. This decline in the value of mine is termed as depletion.

The main difference between depletion and depreciation is that the former is concerned
with the exhaustion of economic resources, but the latter relates to the usage of an asset.

Amortisation
Amortisation refers to writing-off the cost of intangible assets like patents, copyright,
trademarks, franchises, goodwill which have utility for a specified period of time.

Features
 It is decline in the book value of fixed assets.
 It is a continuing process.
 It is an expired cost and hence must be deducted before calculating taxable profits.
 It is a non-cash expense. It does not involve any cash outflow.
Need, Importance or Objects of Providing Depreciation

Fair view of financial position

• Depreciation, if not charged, would result in assets being stated at a

higher value. As a result of this the balance sheet would not present a
true and fair view of financial position.

Avoid over-payment of Income Tax

• Depreciation charged will decrease the net profit, which will lead to
less tax payment.

Provide funds for Replacement of assets

• Depreciation charged every year to Profit and Loss account is not paid
in cash, therefore, it can be retained by the business and can be used
to replace the asset.

Compliance of legal provisions

• It is necessary to cahrge depreciation to comply withthe provisions of

the Companies Act and the Income Tax Act.
Factors determining the amount of depreciation

Total cost
of the
Asset

Estimated
useful life

Estimated Scrap
Value

Total cost of the asset

Cost will include all the expenses incurred like freight and installation charges up to the
point the asset is ready for use.

Estimated useful life

Physical life is not important - an asset may still exist physically but may not be capable of
producing goods at a reasonable goods. If, for instance, an asset can be used for twenty
years but is likely to lose its useful value within ten years, its life for the purpose of
accounting should be considered as only ten years.
Estimated useful life
Residual value is an estimated sale value of the asset at the end of its economic life to the
firm. Difference between the cost and residual or scrap value is the amount written off over
the useful life of the asset.

Amount to be written off = Cost of asset – Residual or scrap

Methods of Allocating Depreciation

Straight line method

Written Down Value Method

Straight line method

It is also known as fixed installment method and original cost method. In this method, the
number of years of use is estimated and the cost is then divided by the number of years to
give the depreciation charge each year.

The amount of depreciation will be equal each year, since depreciation is charged at fixed
rate on cost of asset. If the annual depreciation is plotted on a graph paper, it will show a
straight line, since the amount of depreciation is equal every year. This is why this method
is called straight line method.
Formula:
Depreciation charge under this method is calculated by using the following formula:

𝐂𝐨𝐬𝐭 𝐥𝐞𝐬𝐬 𝐬𝐚𝐥𝐯𝐚𝐠𝐞 𝐯𝐚𝐥𝐮𝐞

= 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧 𝐜𝐡𝐚𝐫𝐠𝐞
𝐄𝐬𝐭𝐢𝐦𝐚𝐭𝐞𝐝 𝐬𝐞𝐫𝐯𝐢𝐜𝐞 𝐥𝐢𝐟𝐞

Example:
Assume a machine was bought for Rs.500,000 and estimated salvage value of the machine
is Rs.50,000 after four years, the depreciation to be charged each year would be calculated
as follows:

𝐂𝐨𝐬𝐭 𝐥𝐞𝐬𝐬 𝐬𝐚𝐥𝐯𝐚𝐠𝐞 𝐯𝐚𝐥𝐮𝐞

= 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧 𝐜𝐡𝐚𝐫𝐠𝐞
𝐄𝐬𝐭𝐢𝐦𝐚𝐭𝐞𝐝 𝐬𝐞𝐫𝐯𝐢𝐜𝐞 𝐥𝐢𝐟𝐞

𝟓, 𝟎𝟎, 𝟎𝟎𝟎 − 𝟓𝟎, 𝟎𝟎𝟎

𝟒
=Rs.1,12,500
This amount will be charged to Profit & Loss Account for 4 consecutive years.
Merits
 It is very simple, easy to understand and apply. Simplicity makes it a popular method
in practice;
 Asset can be depreciated upto the net scrap value or zero value. Therefore, this
method makes it possible to distribute full depreciable cost over useful life of the
asset;
 Every year, same amount is charged as depreciation in profit and loss account. This
makes comparison of profits for different years easy;
 This method is suitable for those assets whose useful life can be estimated accurately
and where the use of the asset is consistent from year to year such as leasehold
buildings.
Demerits
With the passage of time, work efficiency of the asset decreases and repair and
maintenance expense increases. Hence, under this method, the total amount charged
against profit on account of depreciation and repair taken together, will not be uniform
throughout the life of the asset, rather it will keep on increasing from year to year.

Journal Entries:
Under this method depreciation is recorded as follows:

When depreciation is provided:

Depreciation Account Dr.
Asset Account Cr.
(Being depreciation charged on -@- for the year)

When depreciation is transferred to profit and loss account:

Profit and Loss Account Dr.
Depreciation Account Cr.
(Being depreciation account transferred to profit and loss
account)
 When asset is sold on expiry of its useful life:
Bank Account Dr.
Asset Account Cr.
(Being scrap of asset sold)

If profit is earned on sale of asset:

Asset Account Dr.
Profit and Loss Account Cr.
(Being profit on sale of scrap transferred to profit and loss
account)

If loss is incurred on sale of asset:

Profit and Loss Account Dr.
Asset Account Cr.
(Being loss on sale of scrap transferred to profit and loss
account)

Written down value method

Under this method, the amount of depreciation is charged every year on the Book Value of
the asset. The amount of depreciation goes on declining every year along with the declining
Book Value of the asset with constant rate of depreciation.

Suppose the cost of asset is Rs.1,000 and rate of depreciation 10% p.a.

COST OF ASSET 1,000

DEPRECIATION:
1ST YEAR: 10% OF 1,000 100

BOOK VALUE 900

 2ND YEAR: 10% OF 900 90

BOOK VALUE 810

3RD YEAR: 10% OF 810 81

BOOK VALUE 729

AND SO ON.......

Formula for the Calculation of Depreciation Rate:

r = 1 - (S/C)1/n

Where:

r = Rate of depreciation

n = Estimated useful life of asset

S = Residual value after the expiry of useful life

C = Original cost of asset

Example:

Merits
 This method is based on a more realistic assumption that the benefits from asset go
on diminishing (reducing) with the passage of time. Hence, it calls for proper
allocation of cost because higher depreciation is charged in earlier years when asset’s
utility is higher as compared to later years when it becomes less effective.
 It results into almost equal burden of depreciation and repair expenses taken
together every year on profit and loss account;
 Income Tax Act accept this method for tax purposes;
 This method is suitable for fixed assets which last for long and which require
increased repair and maintenance expenses with passage of time. It can also be used
where obsolescence rate is high.

Demerits
 As depreciation is calculated at fixed percentage of written down value, depreciable
cost of the asset cannot be fully written-off. The value of the asset can never be zero;
 It is difficult to ascertain a suitable rate of depreciation.
Difference Between Straight Line Method and Reducing
Balance Method
Straight Line Method Reducing Balance Method

1. The rate and amount of 1. The rate remains the same, but the amount of
depreciation remain the same depreciation diminishes gradually.
each year.

2. Depreciation is calculated on 2. Depreciation is calculated on the diminishing

the original cost of fixed asset balance or written down value of a fixed asset

3. At the end of its life the value 3. The value of asset is never reduced to zero at
of asset is reduced to zero or the end of its life.
scrap value.

4. The older the asset the larger 4. The amount of depreciation decreases
the cost of its repair. But the gradually, while the cost of repairs increases. So
amount of depreciation remain the total of depreciation and repairs remain
the same each year. Hence, the more or less the same each year. Hence, it
total of depreciation and causes little or no change in annual profit/loss.
repairs increases every year.
This reduces annual profit
gradually.
5. Computation of depreciation 5. Depreciation can be computed without any
under straight line method is difficulty, but it is not easy and simple.
comparatively easy and simple.
Methods of recording depreciation
Charging Depreciation to Asset account
According to this arrangement, depreciation is deducted from the depreciable cost of the
asset (credited to the asset account) and charged (or debited) to profit and loss account.
Journal entries under this recording method are as follows:

1. For recording purchase of asset (only in the year of purchase)

Asset A/c Dr. (with the cost of asset including installation, freight, etc.)

To Bank/Vendor A/c

2. Following two entries are recorded at the end of every year

(a) For deducting depreciation amount from the cost of the asset.

Depreciation A/c Dr. (with the amount of depreciation)

To Asset A/c

(b) For charging depreciation to profit and loss account.

Profit & Loss A/c Dr. (with the amount of depreciation)

To Depreciation A/c

3. Balance Sheet Treatment

When this method is used, the fixed asset appears at its net book value (i.e. cost less
depreciation charged till date) on the asset side of the balance sheet and not at its original
cost (also known as historical cost).
Accumulated depreciation account
This method is designed to accumulate the depreciation provided on an asset in a separate
account generally called ‘Provision for Depreciation’ or ‘Accumulated Depreciation’
account. By such accumulation of depreciation the asset account need not be disturbed in
any way and it continues to be shown at its original cost over the successive years of its
useful life.

The following journal entries are recorded under this method:

1. For recording purchase of asset (only in the year of purchase)

Asset A/c Dr. (with the cost of asset including installation, expenses etc.)

To Bank/Vendor A/c (cash/credit purchase)

2. Following two journal entries are recorded at the end of each year:

(a) For crediting depreciation amount to provision for depreciation account

Depreciation A/c Dr. (with the amount of depreciation)

To Provision for depreciation A/c

(b) For charging depreciation to profit and loss account

Profit & Loss A/c Dr. (with the amount of depreciation)

To Depreciation A/c

3. Balance sheet treatment

In the balance sheet, the fixed asset continues to appear at its original cost on the asset
side. The depreciation charged till that date appears in the provision for depreciation
account, which is shown either on the “liabilities side” of the balance sheet or by way of
deduction from the original cost of the asset concerned on the asset side of the balance
sheet.
Asset Disposal A/c
When part of the asset is sold or disposed off, it is appropriate to open a new A/c called
‘Asset Disposal Account’.

Entries are as follows:

When Provision for When Provision for Depreciation A/c is

Depreciation A/c is not maintained:
maintained:
For transferring the book value For transferring Original Cost of the asset
of the asset sold sold:

Asset Disposal A/c Dr.

Asset Disposal A/c Dr.
To Asset A/c
To Asset A/c

For transferring the Accumulated

Depreciation of the asset sold:

Provision for Depreciation A/c Dr

To Asset Disposal A/c

For recording sale proceeds of For recording sale proceeds of the asset:
the asset: Bank A/c Dr.
Bank A/c Dr. To Asset Disposal A/c
To Asset Disposal A/c

For Profit on sale: For Profit on sale:

Asset Disposal A/c Asset Disposal A/c
To P & L A/c To P & L A/c
In case of loss, above entry will In case of loss, above entry will be reversed.
be reversed.
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TRIAL BALANCE AND RECTIFICATION OF
ERRORS
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Contents
Meaning of trial balance ................................................................................................................................................... 4
Format of trial balance ...................................................................................................................................................... 4
Purpose of Trial Balance ................................................................................................................................................... 4
Methods of Preparing Trial Balance.................................................................................................................................. 5
Total or Gross Trial Balance .......................................................................................................................................... 5
Balance or Net Trial Balance ......................................................................................................................................... 5
Example ......................................................................................................................................................................... 5
Types of errors ................................................................................................................................................................ 10
Errors of omission ....................................................................................................................................................... 10
Errors of commission .................................................................................................................................................. 11
Errors of principle ....................................................................................................................................................... 11
Compensating errors .................................................................................................................................................. 12
Errors affecting Trial Balance ...................................................................................................................................... 12
Errors not affecting Trial Balance................................................................................................................................ 12
Rectification of errors ..................................................................................................................................................... 14
Rectification of errors which do not affect the trial balance (Two sided errors) ....................................................... 14
Rectification of errors affecting trial balance (one sided errors)................................................................................ 16
Rectification of errors before preparation of the trial balance .............................................................................. 17
Rectification of errors after preparation of trial balance ....................................................................................... 18
Suspense account................................................................................................................................................ 18
Meaning of trial balance
A trial balance is a statement showing the balances, or total of debits and credits, of all the
accounts in the ledger with a view to verify the arithmetical accuracy of posting into the
ledger accounts.

Format of trial balance

Purpose of Trial Balance

1. To check the equality of debits and credits - an arithmetical or mathematical test of
accuracy.
2. To help in preparation of final accounts.
3. To locate errors.
4. To obtain a summary of ledger accounts.
If the trial balance agrees we may reasonably assume that the books are correct. On the
other hand, if it does not agree, it indicates that the books are not correct - there are
mistakes somewhere. There are however, a few types of errors which the trial balance
cannot detect. In other words, the trial balance will agree in spite of the existence of those
errors.

Methods of Preparing Trial Balance

There are two methods for the preparation of trial balance. These methods are:

1. Total or gross trial balance

2. Balance or net trial balance

Total or Gross Trial Balance

Under this method the two sides of all the ledger accounts are totaled up. The total of
debit side and credit side of each account is then placed on "debit amount" column and
"credit amount" column respectively of a list. Finally the two columns are added separately
to see whether they agree of not.

Balance or Net Trial Balance

Under this method, first of all the balances of all ledger accounts are drawn. Thereafter,
the debit balances and credit balances are recorded in "debit amount" and "credit amount"
column respectively and the two columns are added separately to see whether they agree
or not.

Example
Enter the following transactions in journal and post them into the ledger and also prepare a
trial balance.

2018
Jan. 1 Mr. X started business with cash Rs.80,000 and furniture Rs.20,000.
Jan. 2 Purchased goods on credit worth Rs.30,000 from Y.
Jan. 3 Sold goods for cash Rs.16,000.
Jan. 4 Sold goods on credit to S for Rs.10,000
Jan. 8 Cash received from S Rs.9,800 in full settlement of his account.

Solution:

Journal

Date Particulars L.F DR. Cr.

2018 Amount (Rs.) Amount (Rs.)
Jan.
Cash A/C 80,000
1
Furniture A/C 20,000
Capital A/C 1,00,000
(Owner invested cash and furniture)

Jan.
Purchases Account 30,000
2
Y 30,000
(Bought goods on credit)

Jan.
Cash A/C 16,000
3
Sales A/C 16,000
(Sold goods for cash)

Jan.
S A/C 10,000
4
Sales A/C 10,000
(Sold goods on credit)

Jan.
Cash A/C 9,800
8
Discount A/C 200
S A/C 10,000
(Cash received and discount allowed)
 Ledger

Cash Account

Date Particulars JF Amount Date Particulars JF Amount

Jan 1 Capital a/c 80,000 Jan 31 Balance 1,05,800
c/d
Jan 3 Sales a/c 16,000
Jan 8 S a/c 9,800
1,05,800 1,05,800

Feb 1 Balance 1,05,800

b/d

Furniture Account

Date Particulars JF Amount Date Particulars JF Amount

Jan 1 Capital a/c 20,000 Jan 31 Balance 20,000
c/d
20,000 20,000

Feb 1 Balance 20,000

b/d

Capital Account

Date Particulars JF Amount Date Particulars JF Amount

Jan 31 Balance 1,00,000 Jan 1 Cash a/c 80,000
c/d
Jan 1 Furniture 20,000
a/c
 1,00,000 1,00,000

Feb 1 Balance 1,00,000

b/d

Purchases Account

Date Particulars JF Amount Date Particulars JF Amount

Jan 2 Y a/c 30,000 Jan 31 Balance 30,000
c/d
30,000 30,000

Feb 1 Balance 30,000

b/d

Y Account (No.13)

Date Particulars JF Amount Date Particulars JF Amount

Jan 31 Balance 30,000 Jan 2 Purchases 30,000
c/d a/c
30,000 30,000

Feb 1 Balance 30,000

b/d

Sales Account

Date Particulars JF Amount Date Particulars JF Amount

Jan 31 Balance 40,000 Jan 3 Cash a/c 16,000
c/d
Jan 4 S a/c 10,000
 40,000 40,000

Feb 1 Balance 40,000

b/d

S Account

Date Particulars JF Amount Date Particulars JF Amount

Jan 4 Sales a/c 10,000 Jan 8 Cash a/c 9,800
Jan 8 Discount 200
a/c
10,000 10,000

Discount Account (No.19)

Date Particulars JF Amount Date Particulars JF Amount

Jan 8 S a/c 200 Jan 31 Balance 200
c/d
200 200

Feb 1 Balance 200

b/d

Trial Balance (Balances method)

A/C
S. No. Account Name Debit Credit
No.
1 Cash Account 105,800
2 Furniture Account 20,000
 3 Capital Account -- 100,000
4 Purchases Account 30,000
5 Y Account -- 30,000
6 Sales Account -- 26,000
7 S Account -- --
8 Discount Account 200 --
Total 156,000 1,56,000

Note: If an account shows zero balance, it is not necessary to record it in trial balance.

Types of errors

Types of errors

Errors of Errors of Errors of Compensating

omission commission principle errors

Errors of omission
The errors of omission may be committed at the time of recording the transaction in the
books of original entry or while posting to the ledger. These can be of two types:

(i) error of complete omission

(ii) error of partial omission

When a transaction is completely omitted from recording in the books of original record, it
is an error of complete omission. For example, credit sales to Mohan Rs. 10,000, not
entered in the sales book. When the recording of transaction is partly omitted from the
books, it is an error of partial omission. If in the above example, credit sales had been duly
recorded in the sales book but the posting from sales book to Mohan’s account has not
been made, it would be an error of partial omission.

Errors of commission
These are the errors which are committed due to wrong posting of transactions, wrong
totaling or wrong balancing of the accounts, wrong casting of the subsidiary books, or
wrong recording of amount in the books of original entry, etc.

For example: Raj Hans Traders paid Rs.25,000 to Preetpal Traders (a supplier of goods). This
transaction was correctly recorded in the cashbook. But while posting to the ledger,
Preetpal’s account was debited with Rs.2,500 only. This constitutes an error of commission.

Such an error by definition is of clerical nature and most of the errors of commission affect
in the trial balance.

Errors of principle
Accounting entries are recorded as per the generally accepted accounting principles. If any
of these principles are violated or ignored, errors resulting from such violation are known as
errors of principle.

An error of principle may occur due to incorrect classification of expenditure or receipt

between capital and revenue.

Examples:

 Amount spent on additions to the buildings should be treated as capital expenditure

and must be debited to the asset account. Instead, if this amount is debited to
maintenance and repairs account, it has been treated as a revenue expense. This is
an error of principle.
 If a credit purchase of machinery is recorded in purchases book instead of journal
proper or rent paid to the landlord is recorded in the cash book as payment to
landlord, these errors of principle. These errors do not affect the trial balance.
Compensating errors
When two or more errors are committed in such a way that the net effect of these errors
on the debits and credits of accounts is nil, such errors are called compensating errors.

Example: Shyam’s account was debited with Rs.100 instead of Rs.1000 while Ram’s account
was debited with Rs.1000 instead of Rs.100. Thus, Shyam’s account which was debited by
Rs.900 less was compensated by another error in Ram’s account, whose account was
debited excess of Rs.900.

From another point of view, errors may be divided into two categories:

Errors affecting Trial Balance

1. Posting only one aspect of the journal entry in the ledger
2. Posting a journal entry on the wrong side of an account
3. Wrong totalling of the subsidiary books
4. Posting the correct amount in one account and wrong amount in another account
5. Wrong totalling or balancing of the ledger account
6. Omission in writing the balance of an account in the trial balance
7. Writing balance in the wrong column of trial balance
8. Totalling the trial balance wrongly

Errors not affecting Trial Balance

1. Errors of complete omission
Transaction remains altogether unrecorded either in Journal or in Subsidiary books.

2. Compensating Errors
Effect of one error is neutralized by the effect of some other error.
 3. Errors of Principle
Some fundamental principle of accounting is violated while recording a transaction.

Suppose on the purchase of a typewriter, office expenses account is debited, the trial
balance will still agree

4. Errors of Posting in wrong account

While posting from the books of original entry, posting is made to a wrong account but on
the correct side.

5. Recording both the aspects of a transaction twice in the books of accounts

Case study (for errors)

Mr. Roy is a furniture dealer. Some of the transactions undertaken through the year are as
follows:

Transactions Errors Affect Trial

Balance
Total of purchase book was added Rs Error of commission Yes
2,000 in excess due to wrong calculations

Dining table was sold to Ram. Error of commission Yes

Ram’s A/c was credited by Rs 20,000.

Rs 10,000 spent on repairs of old Error of Principle No

machinery debited to Machinery A/c

Sold study table to Shyam for Rs 15,000 Errors of Omission No

but was omitted to be recorded in the
books.
Rs 5,000 received from Rahul was posted Error of commission Yes
on the credit side of Rahul’s A/c twice but
correctly entered in Cash Book

Purchased wood from Mr X for Rs 10,000. Error of commission Yes

Credited Mr X with Rs 1000

Sold a bed for Rs 40,000 but cash A/c was Error of omission Yes
not debited

Purcahse book was overcast by Rs 1,000 Compensating Errors No

and Purchase Returns book was overcast
by Rs 1,000

Sale of table to Meena for Rs 5000 has Errors of Commission No

been entered in the Journal as Rs 500

Rectification of errors
From the point of view of rectification, the errors may be classified into the following two
categories:

(a) errors which do not affect the trial balance.

(b) errors which affect the trial balance.

Rectification of errors which do not affect the trial balance

(Two sided errors)
These errors are committed in two or more accounts. Such errors are also known as two
sided errors. They can be rectified by recording a journal entry giving the correct debit and
credit to the concerned accounts.
Examples of such errors are – complete omission to record an entry in the books of original
entry; wrong recording of transactions in the book of accounts; complete omission of
posting to the wrong account on the correct side, and errors of principle.

Such errors are rectified by passing a rectifying entry.

The procedure for rectification for such errors is explained with the help of following
examples:

(a) Credit sales to Mohan Rs. 10,000 were not recorded in the sales book. This is an error
of complete omission. Its affect is that Mohan’s account has not been debited and
Sales account has not been credited. Accordingly, recording usual entry for credit
sales will rectify the error.
Mohan’s a/c Dr. 10,000

To sales a/c 10,000

(b) Credit sales to Mohan Rs. 10,000 were recorded as Rs. 1,000 in the sales book. This is
an error of commission.
Wrong entry Mohan’s a/c 1000
To sales a/c 1000

Correct entry Mohan’s a/c 10000

should have been To sales a/c 10000

Rectifying entry Mohan’s a/c 9000

To sales a/c 9000

(c) Credit sales to Mohan Rs.10,000 were recorded as Rs. 12,000. This is an error of
commission.
Wrong entry Mohan’s a/c 12000
To sales a/c 12000

Correct entry Mohan’s a/c 10000

 should have been To sales a/c 10000

Rectifying entry Sales a/c 2000

To Mohan’s a/c 2000

(d) Credit sales to Mohan Rs.10,000 was correctly recorded in the sales book but was
posted to Ram’s account.
Wrong entry Ram’s a/c 10000
To sales a/c 10000

Correct entry Mohan’s a/c 10000

should have been To sales a/c 10000

Rectifying entry Mohan’s a/c 10000

To Ram’s a/c 10000

(e) Rent paid Rs.2,000 was wrongly shown as payment to landlord in the cash book
Wrong entry Landlord a/c 2000
To cash a/c 2000

Correct entry Rent a/c 2000

should have been To cash a/c 2000

Rectifying entry Rent a/c 2000

To landlord a/c 2000

Rectification of errors affecting trial balance (one sided

errors)
The errors which affect only one account can be rectified by giving an explanatory note in
the account affected or by recording a journal entry with the help of the Suspense Account.
Rectification of errors before preparation of the trial balance
If the one sided errors come into notice before preparing the trial balance, they should be
rectified by debiting the concerned account for short debit or excess credit and by crediting
the concerned account for short credit or excess debit.

Examples:

Shyam’s account was credited short by Rs.190. This will be rectified by an additional entry
for Rs.190 on the credit side of his account as follows:

(Source – NCERT)

The purchases book was undercast by Rs.1,000. The effect of this entry is on purchases
account (debit side) where the total of purchases book is posted

(Source – NCERT)
Rectification of errors after preparation of trial balance
One sided errors will be rectified by passing the journal entry either debiting or crediting
the suspense account.

Suspense account
Sometimes, in spite of best efforts some errors are not located and due to which Trial
Balance does not tally. In such a situation, to avoid delay in preparing the Final Accounts,
the difference in the Trial Balance is placed to a newly opened account known as ‘Suspense
Account’ and the Trial Balance tallies.

Later, when errors are detected, rectification entries are passed. When all the errors are
rectified, the account will close.

But if suspense account shows balance, it will be shown on the Asset side of the Balance
sheet if it has debit balance and if it has credit balance, then it is shown on Liabilities side.

Examples

Credit sales to Mohan Rs.10,000 were not posted to his account. This is an error of partial
omission committed while posting entries of the sales book.

Wrong entry Mohan’s a/c Nil

To sales a/c 10000

Correct entry Mohan’s a/c 10000

should have been To sales a/c 10000

Rectifying entry Mohan’s a/c 10000

To suspense a/c 10000

Purchases book overcast by Rs.1,000

Suspense a/c 1,000

To purchases a/c 1,000

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Contents
Subsidiary books ............................................................................................................................................................... 4
Purchase book ............................................................................................................................................................... 4
Purchase return book.................................................................................................................................................... 6
Sales book ..................................................................................................................................................................... 7
Sales return book .......................................................................................................................................................... 8
Journal proper ............................................................................................................................................................... 9
Subsidiary books

CASH BOOK PURCHASE BOOK

• All transactions relating to cash • This book records credit
receipts and cash payments are purchases.
entered in this book

SALES BOOK PURCHASE RETURN OR

• This book records credit sales. RETURN OUTWARD BOOK
• When goods previously
purchased on credit are
returned to the suppliers, such
returns are added to this book

SALES RETURN OR JOURNAL PROPER

RETURN INWARD BOOK • This book records transactions
• When goods previously sold on which are not entered in
credit are returned by the previous mentioned books
customers, such returns are
added to this book

Purchase book
All credit purchases of goods are recorded in the purchases journal whereas cash purchases
are recorded in the cash book. Other purchases such as purchases of office equipment,
furniture, building, are recoded in the journal proper if purchased on credit or in the cash
book if purchased for cash. The source documents for recording entries in the book are
invoices or bills received by the firm from the supplies of the goods.

The format of the purchases journal

Date Invoice no. Name of supplier L.F. Amount

The monthly total of the purchases book is posted to the debit of purchases account in the
ledger. Individual supplier’s accounts may be posted daily.

Books of Kanika Electronics

Purchase Book

Date Invoice no. Name of supplier L.F. Amount

2017
Aug 04 3250 Neema Electronics 1,82,000
Aug 10 3260 Pawan electronics 31,050
Aug 18 4256 Northern Electronics 3,06,250
Aug 26 3294 Neema Electronics 54,000
Aug 29 3281 Pawan Electronics 38,700
Aug 31 6,12,000

(Source – NCERT)
(Source – NCERT)

Purchase return book

In this book, purchases return of goods are recorded. Sometimes goods purchased are
returned to the supplier for various reasons such as the goods are not of the required
quality, or are defective, etc. For every return, a debit note (in duplicate) is prepared and
the original one is sent to the supplier for making necessary entries in his book. The supplier
may also prepare a note, which is called the credit note.
 Books of Kanika Electronics

Purchase Return Book

Date Debit note Name of supplier L.F. Amount

no.

Neema Electronics 13,200

(Source – NCERT)

Sales book
All credit sales of merchandise are recorded in the sales journal. Cash sales are recorded in
the cash book. The format of the sales journal is similar to that of the purchases journal
explained earlier. The source document for recording entries in the sales journal are sales
invoice or bill issued by the firm to the customers.

Date Invoice no. Name of customer L.F. Amount

2017
Apr 6 178 Raman traders 4,850
Apr 09 180 Nutan Enterprises 21,000
Apr 28 209 Raman traders 85,000
Apr 30 1,10,850
(Source – NCERT)

Sales return book

This journal is used to record return of goods by customers to them on credit.

Date Credit no. Name of customer L.F. Amount

Raman traders 2,100

(Source – NCERT)

Journal proper
Entries recorded in journal proper are:

Opening Entry: In order to open new set of books in the beginning of new accounting year
and record therein opening balances of assets, liabilities and capital, the opening entry is
made in the journal.

Adjustment Entries: In order to update ledger account on accrual basis, such entries are
made at the end of the accounting period. Such as Rent outstanding, Prepaid insurance,
Depreciation and Commission received in advance.

Rectification entries: To rectify errors in recording transactions in the books of original

entry and their posting to ledger accounts this journal is used.

Transfer entries: Drawing account is transferred to capital account at the end of the
accounting year. Expenses accounts and revenue accounts which are not balanced at the
time of balancing are opened to record specific transactions. Accounts relating to operation
of business such as Sales, Purchases, Opening Stock, Income, Gains and Expenses, etc., and
drawing are closed at the end of the year and their Total/balances are transferred to
Trading and Profit and Loss account by recording the journal entries. These are also called
closing entries.

Other entries: In addition to the above mentioned entries, recording of the following
transaction is done in the journal proper:

 Purchase/sale of items on credit other than goods.

 Goods withdrawn by the owner for personal use.
 Goods distributed as samples for sales promotion.
 Endorsement and dishonour of bills of exchange.
 Transaction in respect of consignment and joint venture, etc.
 Loss of goods by fire/theft/spoilage.
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Contents
BANK RECONCILIATION STATEMENT ................................................................................................................................ 4
Meaning ........................................................................................................................................................................ 4
Reasons of difference between cash book and pass book balances ............................................................................ 5
Difference caused by Time Gap in recording transactions ....................................................................................... 5
Cheques issued but not yet presented for payment ............................................................................................ 5
Cheques paid into the bank but not yet collected ................................................................................................ 5
Direct debits made by the bank on behalf of the customer ................................................................................. 5
Amounts directly deposited in the bank account ................................................................................................. 6
Interest and dividends collected by the bank ....................................................................................................... 6
Direct payments made by the bank on behalf of the customers ......................................................................... 6
Dishonour of a bill discounted with a bank .......................................................................................................... 6
Differences caused by Errors Committed in Recording Transactions ....................................................................... 7
Errors committed in recording transaction by the firm ........................................................................................ 7
Errors committed in recording transactions by the bank ..................................................................................... 7
Procedure of preparing a bank reconciliation statement ............................................................................................. 8
By debit balance of Bank Column of Cash Book ....................................................................................................... 8
By debit balance (Overdraft) of Pass Book ............................................................................................................... 9
By credit balance (favourable) of Pass Book ............................................................................................................. 9
Example ....................................................................................................................................................................... 10
BANK RECONCILIATION STATEMENT

Meaning
A bank reconciliation statement is a statement is a statement prepared on a particular date
to reconcile the bank balance as per the cash book with the balance as per the bank pass
book by showing reasons for differences between the two.

As the transactions relating to deposits and withdrawals made during a period are recorded
in both cash book and the pass book, the balances shown by the two records at the end of a
period should normally agree. But, sometimes the two balances differ. If the two balances
differ, it becomes necessary to know the reasons for the difference. A statement showing
the reasons or causes of differences is prepared. This statement is known as a bank
reconciliation statement.
Reasons of difference between cash book and pass book
balances
Difference caused by Time Gap in recording transactions

Cheques issued but not yet presented for payment

When cheques are issued by the firm to suppliers or creditors of the firm, these are
immediately entered on the credit side of the cash book. However, the receiving party may
not present the cheque to the bank for payment immediately. The bank will debit the firm’s
account only when these cheques are actually paid by the bank. Hence, there is a time lag
between the issue of a cheque and its presentation to the bank which may cause the
difference between the two balances.

Cheques paid into the bank but not yet collected

When firm receives cheques from its customers (debtors), they are immediately recorded
in the debit side of the cash book. This increases the bank balance as per the cash book.
However, the bank credits the customer account only when the amount of cheques are
actually realised. The clearing of cheques generally takes few days especially in case of
outstation cheques or when the cheques are paid-in at a bank branch other than the one at
which the account of the firm is maintained. This leads to a cause of difference between the
bank balance shown by the cash book and the balance shown by the bank passbook.

Direct debits made by the bank on behalf of the customer

Sometimes, the bank deducts amount for various services from the account without the
firm’s knowledge. The firm comes to know about it only when the bank statement arrives.
Examples of such deductions include: cheque collection charges, incidental charges,
interest on overdraft, unpaid cheques deducted by the bank – i.e., stopped or bounced, etc.
As a result, the balance as per passbook will be less than the balance as per cash book.
Amounts directly deposited in the bank account
There are instances when debtors (customers) directly deposits money into firm’s bank
account. But, the firm does not receive the intimation from any source till it receives the
bank statement. In this case, the bank records the receipts in the firm’s account at the bank
but the same is not recorded in the firm’s cash book. As a result, the balance shown in the
bank passbook will be more than the balance shown in the firm’s cash book.

Interest and dividends collected by the bank

When the bank collects interest and dividend on behalf of the customer, then these are
immediately credited to the customer’s account. But the firm will know about these
transactions and record the same in the cash book only when it receives a bank statement.
Till then the balances as per the cash book and passbook will differ.

Direct payments made by the bank on behalf of the customers

Sometimes the customers give standing instructions to the bank to make some payment
regularly on stated days to the third parties. For example, telephone bills, insurance
premium, rent, taxes, etc. are directly paid by the bank on behalf of the customer and
debited to the account. As a result, the balance as per the bank passbook would be less
than the one shown in the cash book.

Dishonour of a bill discounted with a bank

If the bank is not able to receive payment on bill discounted by it, it will debit the
customer’s account together with any charges that I may have incurred. The customer will
naturally record the entry only when he peruses the pass book.
Differences caused by Errors Committed in Recording
Transactions

Errors committed Errors committed

in recording in recording
transactions by the transactions by the
firm bank

Errors committed in recording transaction by the firm

Omission or wrong recording of transactions relating to cheques issued, cheques deposited
and wrong totalling, etc., committed by the firm while recording entries in the cash book
cause difference between cash book and passbook balance.

Errors committed in recording transactions by the bank

Omission or wrong recording of transactions relating to cheques deposited and wrong
totalling, etc., committed by the bank while posting entries in the passbook also cause
differences between passbook and cash book balance.
Procedure of preparing a bank reconciliation statement

By debit balance of Bank Column of Cash Book

If there is a debit balance in Bank Column of Cash book then, it will be added to Bank
Reconciliation Statement.

Items to be added: Items to be deducted:

1. Cheques issued but not yet presented 1. Cheques sent to the bank for
for payment collection but not yet credited by the
2. Credit made by the bank for interest bank
3. Amount directly deposited by 2. Dishonour of a bill discounted with the
customers in bank bank
4. Interest and dividend collected by the 3. Direct payment made by the bank on
bank behalf of the customers
5. Cheques paid into bank but omitted to 4. Debits made by the bank for
be recorded in cash book commission, bank charges etc.
5. Cheques issued but omitted to be
recorded in the cash book.
By debit balance (Overdraft) of Pass Book

If there is Debit balance of Pass Book, the starting balance will be written in minus items
and all the other items will be reversed.

Items to be added: Items to be deducted:

1. Cheques sent to the bank for 1. Cheques issued but not yet presented
collection but not yet credited by the for payment
bank 2. Credit made by the bank for interest
2. Dishounour of a bill discounted with 3. Amount directly deposited by
the bank customers in bank
3. Direct payment made by the bank on 4. Interest and dividend collected by the
behalf of the customers bank
4. Debits made by the bank for 5. Cheques paid into bank but omitted to
commission, bank charges etc. be recorded in cash book
5. Cheques issued but omitted to be
recorded in the cash book.

By credit balance (favourable) of Pass Book

If there is credit balance of Pass Book, the starting balance will be written in Plus items and
all items will be written in same columns as in overdraft balance of pass book.
Example
From the following particulars of Mr. Vinod, prepare bank reconciliation statement as on
March 31, 2017.

1. Bank balance as per cash book Rs.50,000.

2. Cheques issued but not presented for payment Rs.6,000.

3. The bank had directly collected dividend of Rs.8,000 and credited to bank account but
was not entered in the cash book.

4. Bank charges of Rs.400 were not entered in the cash book.

5. A cheque for Rs.6,000 was deposited but not collected by the bank.

Solution

Particulars Plus items (Rs.) Minus items

(Rs.)
Balance as per cash book 50,000
Cheques issued but not presented for 6,000
payment
Dividends collected by the bank 8,000
Cheque deposited but not credited by the 6,000
bank
Bank charges debited by bank 400
Balance as per pass book 57,600
64,000 64,000
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CASH BOOK
Chanchal Phore
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Contents
CASH BOOK ....................................................................................................................................................................... 4
Special Journals ............................................................................................................................................................. 4
Cash book (A Subsidiary and Principal Book) ................................................................................................................ 5
TYPES OF CASH BOOKS ..................................................................................................................................................... 5
Single Column Cash Book .............................................................................................................................................. 5
Format of single column cash book .......................................................................................................................... 6
Posting in single column cash book .......................................................................................................................... 6
Balancing of single column cash book ...................................................................................................................... 6
Example ..................................................................................................................................................................... 7
Double Column Cash Book ............................................................................................................................................ 9
Format of double cash book ..................................................................................................................................... 9
Contra Entry .............................................................................................................................................................. 9
Example ................................................................................................................................................................... 10
Three column cash book ............................................................................................................................................ 12
Format of triple column cash book ......................................................................................................................... 12
Petty Cash ....................................................................................................................................................................... 12
Imprest system of petty cash book ............................................................................................................................. 13
Example ....................................................................................................................................................................... 13
Solution:.................................................................................................................................................................. 14
CASH BOOK
Special Journals
If the size of business is small, then it is possible to enter every transaction in Journal only,
but if the size of business is large, it is no longer possible to enter every transaction in one
book only. Therefore, Journal is divided into sub-parts, known as Special Journals.

Therefore, following subsidiary books are prepared:

CASH BOOK PURCHASE BOOK

• All transactions relating to cash • This book records credit
receipts and cash payments are purchases.
entered in this book

SALES BOOK PURCHASE RETURN OR

• This book records credit sales. RETURN OUTWARD BOOK
• When goods previously
purchased on credit are
returned to the suppliers, such
returns are added to this book

SALES RETURN OR JOURNAL PROPER

RETURN INWARD BOOK • This book records transactions
• When goods previously sold on which are not entered in
credit are returned by the previous mentioned books
customers, such returns are
added to this book
Cash book (A Subsidiary and Principal Book)
It plays a dual role. It is both a book of original entry as well as a book of final entry. All cash
transactions are primarily recorded in it as soon as they take place; so it is a journal (a book
of original entry/subsidiary book). On the other hand, the cash aspect of all cash
transactions is finally recorded in the Cash Book (no posting in Ledger); so a Cash Book is
also a Ledger (a book of final entry/Principal Book)

When a cashbook is maintained, transactions of cash are not recorded in

the journal, and no separate account for cash or bank is required in the
ledger.

TYPES OF CASH BOOKS

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

It does not record:

1. Non-cash transactions
2. Cheques received or given
3. Cash discount allowed or received
Format of single column cash book

(Source – NCERT)

1. Date: Date for the transaction is written

2. Particulars: The name of the account under which the cash has been received or
payment has been made is written. Cash book starts with the opening balance of
cash written on the receipts side as “To balance b/d”. A new business will not have
an opening balance.
3. Ledger Folio (L.F.): It records the page number in the ledger where the amount has
been posted in the account.
4. Amount: The amounts received are written on the debit side and the amounts paid
are written on the credit side.

Posting in single column cash book

The left side of the cash book shows the receipts of the cash whereas the right side of the
cash book shows all the payments made in cash. The accounts appearing on then debit side
for the cash book are credited in the respective ledger accounts because cash has been
received in respect of them. Similarly, all the account names appearing on the credit side of
the cash book are debited as cash/cheque has been paid in respect of them.

Balancing of single column cash book

A cash book is balanced like any other account. The receipts column is always bigger than
the payments column. The difference is written on the credit side as ‘By balance c/d’.
Example
Enter the following transactions in the cash book of Mr. Jamil:
2018. Rs.
Jan. 1 Mr. Jamil started business with cash 2,00,000
Jan. 3 Bought goods for cash 1,40,000
Jan. 5 Paid for stationary 2,000
Jan. 7 Sold goods for cash 80,000
Jan. 10 Paid for trade expenses 2,000
Jan. 11 Sold goods for cash 20,000
Jan. 14 Received cash from Mr. Asif 10,000
Jan. 15 Paid cash to Mr. Qadir 20,000
Jan. 18 Withdrew cash for personal use 6,000
Jan. 22 Bought goods for cash 40,000
Jan. 25 Sold goods for cash 90,000
Jan. 27 Paid for electricity bill 4,000
Jan. 31 Paid salary 10,000
Jan. 31 Paid rent 3,000
Solution:

Single Column Cash Book of Mr. Jamil

Date Particulars V.N L.F Amount Date Particulars V. L. Amount

. . (Rs.) N. F. (Rs.)
2018 2018
Jan. Capital A/C 200,000 Jan. Purchases A/C 140,000
1 3
Jan.7 Sates A/C 80,000 Jan. Stationery A/C 2,000
5
Jan. Sales A/C 20,000 Jan. Trade expenses 2,000
11 10
Jan. Mr. Asif A/C 10,000 Jan. Mr. Qadir A/C 20,000
14 15
Jan. Sales A/c 90,000 Jan. Drawing A/C 6,000
25 18
Jan. Purchase A/C 40,000
22
Jan. Electricity A/C 4,000
27
Jan. Salary A/C 10,000
31
Jan. Rent A/C 3,000
31
Jan. Balance c/d 173,000
31

4,00,00 4,00,00

Feb. Balance b/d 173,000

1
Double Column Cash Book
In this cash book, there are two columns on each side, one column for recording cash
transactions and the other column for recording bank transactions.

Format of double cash book

(Source – NCERT)

Contra Entry
In any account we can only have one half of a double entry. An account cannot be debited
and credited at the same time. For example, when we sell goods for cash, cash received will
be recorded on the debit side of Cash Book and the goods sold will be posted on the credit
side of Sales Account.

But in Double Column Cash Book, we have two accounts, Cash A/c and the Bank A/c, so it is
possible to have both a debit entry and a credit entry at the same time. For example, cash
of Rs.5,000 is deposited into the bank. In this transaction both Bank A/c and Cash A/c are
involved and they will be recorded on both sides of Double Column Cash Book i.e. on the
debit side in bank column and on the credit side in cash column.

Thus a transaction in which Cash A/c and Bank A/c are involved, is recorded on both the
sides of Double Column Cash Book, it is called "contra entry".

In recording such a transaction the letter "C", is written in 'L.F' column because both
aspects of the transactions are recorded and there is no need to post them into the ledger.
Example
Enter the following transactions in a double column cash book/two column cash book.

2018 Rs.
March 1 Cash in hand 80,000
March 1 Bank Balance 120,000
March 3 Received a cheque from Osman 24,000
March 4 Deposited Osman's cheque with bank --
March 8 Withdrawn from bank for business use 20,000
March 10 Goods sold for cash 30,000
March 15 Goods bought for cash 80,000
March 18 Goods sold for cash 60,000
March 20 Paid Rahim by cheque 26,000
March 30 Deposited into bank 16,000
March 31 Paid salary in cash 10,000
March 31 Paid rent by cheque 6,000
Solution:

Double Column Cash Book

Date Particulars V L/ Cash Rs. Bank Rs. Date Particulars V L/ Cash Rs. Bank Rs.
/ F / F
N N
2018 2018
Mar. Balance b/d 80,000 120,000 Mar. Bank A/c C 24,000
1 4
3 Osman A/c 24,000 8 Cash A/c C 20,000

4 Cash A/c C 24,000 15 Purchase 80,000

A/c

8 Bank A/c C 20,000 18 Cash A/c C 16,000

10 Sales A/c 30,000 20 Rahim A/c 26,000

18 Sales A/c 60,000 31 Salary A/c 10,000

30 Cash A/c C 16,000 31 Rent A/c 6,000

31 Balance c/d 84,000 108,000
214,000 160,000 214,000 160,000

Apr 1 Balance b/d 84,000 108,000

Three column cash book
The triple column cash book (also referred to as three column cash book) is the most
exhaustive form of cash book which has three money columns on both receipt (Dr) and
payment (Cr) sides to record transactions involving cash, bank and discounts. A triple
column cash book is usually maintained by large firms which make and receive payments in
cash as well as by bank and which frequently receive and allow cash discounts

Format of triple column cash book

Discount: The amount of discount allowed is recorded on debit side and the amount of
discount received is recorded on credit side in discount column. The totals of debit column
and credit column are posted to discount allowed account and discount received account
respectively.

Note: All other columns are similar to the double column cash book.

Petty Cash
It is another Cash Book which is maintained, generally, in large business concerns to reduce
the burden of 'Main Cash Book', in which numerous transactions involving petty (small)
amounts are recorded. For this purpose, a Petty Cashier is appointed by the Chief Cashier.
The Chief Cashier advances a sum of money to the Petty Cashier to enable him to meet
petty expenses for a fixed period. The Petty Cashier will record this amount on the Debit
Side of the Petty Cash Book while the Chief Cashier will record the same amount on the
Credit Side of the Main Cash Book.
Imprest system of petty cash book
Under this system, a definite sum, say Rs.2,000 is given to the petty cashier at the beginning
of a certain period. This amount is called imprest amount. The petty cashier goes on making
all small payments out of this imprest amount and when he has spent the substantial
portion of the imprest amount say Rs.1,780, he gets reimbursement of the amount spent
from the head cashier. Thus, he again has the full imprest amount in the beginning of the
next period. The reimbursement may be made on a weekly, fortnightly or monthly basis,
depending on the frequency of small payments.

The balance of the Petty Cash Book will be shown on the asset side of balance sheet as
"Cash in hand" at the end of the year.

Example
From the following particulars prepare a Petty Cash Book under Imprest System.

2018

Jan. 1. Received from the Chief Cashier as imprest cash Rs.400.

Jan. 2. Paid Taxi hire Rs.20.
Jan. 3. Paid postage Rs.28 and stationery Rs.60.
Jan. 4. Purchased stationery Rs.48.
Jan. 5. Paid telegram charges Rs.28 and bus fare Rs.4.
Jan. 6. Bought postage stamps Rs.96.
Jan. 7. Paid Rs.72 for repairs of typewriter.
Solution:

Petty Cash Book

Amount Date Particulars V. Total Traveling Postag Station Office Misc.

Received No Rs. Expenses es Rs. ery Rs. Expenses Expenses
Rs. . Rs. Rs. Rs.
400 2018 Cash Received
Jun.
1
Jun. Taxi hire A/c 20 20
2
Jun. Postage A/c 28 28
3
Jun. Stationery A/c 60 60
3
Jun. Stationery A/c 48 48
4
Jun. Telegram A/c 28 28
5
Jun. Bus fare A/c 4 4
5
Jun. Postage A/c 96 96
6
Jun. Repairs A/c 72 72
7

356 24 152 108 72

Balance c/d 44

400 400

44 Jun. Balance b/d

8
356 Cash received
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LEDGER
[Type here]

LEDGER
The journal provides a complete listing of the daily transactions of a business, but it does not
provide information about a specific account in one place. For example, to know how much cash
balance we have, the accounting clerk would have to check all the journal entries in which cash is
involved which is very difficult. To avoid this difficulty, the debit and credit of journalized
transactions are transferred to ledger accounts. Thus all the changes for a single account are located
in one place - in a ledger account. This makes it easy to determine the current balance of any
account.

Standard Form of Ledger Account:

To understand clearly as to how to write the accounts in ledger, the standard form of an account is
given below with two separate transactions:
Date Particulars J.R Amount Date Particulars J.R Amount
2005 2005
Dec. 17 Cash A/C 1,200 Dec. 17 Purchases A/C 2,000

Posting Procedure:

Transferring information i.e. entries from journal to ledger accounts is called posting. The procedure
of posting from journal to ledger is as follows:

1. Locate the ledger account from the first debit in the journal entry.
2. Record the date in the date column on the debit side of the account. The date is the date of
transaction rather than the date of the posting.
3. Record the name of the opposite account (account credited in entry) in the particular (also
known as reference column, description column etc.) column.
4. Record the page number of the journal in the journal reference (J.R) column from where the
entry is being posted.
5. Record the amount of the debit in the "amount column"
6. Locate the ledger account for the first credit in the journal and follow the same procedure.

Balancing An Account:

The difference between the two sides of an account is its balance. The balance is written on the
lesser side to make the two sides equal. The process of equalizing the two sides of an account is
known as balancing.

The rules for balancing an account are stated as below:

1. Add up the amount columns of both the sides of an account and write the totals in a
separate slip of paper.
2. Find out the difference of the two totals.
3. Write down the difference on the lesser side of the account.
[Type here]

4. Now total up both the sides and write the totals and draw double lines under them.
5. Again write the difference on the opposite side below the double line.

If the debit side of an account is heavier, its balance is known as debit balance. and if the credit side
of an account is heavier its balance is known as credit balance. If the two sides are equal, that
account will show zero balance. The rules for determining the balance is as follows:

Total debit More than total credit = Debit balance

Total credit More than total debit = Credit balance
Total debit Total credit = Nil balance

It may be noted that at the time of balancing an account debit balance is placed on the credit side
and credit balance on debit site. This balance is known as closing balance. What is closing balance in
this year, is the opening balance of the next year.

Example:

Enter the following transactions in journal and post them into ledger:

2018
Jan. 1 Mr. Javed started business with cash Rs.100,000
2 He purchased furniture for Rs.20,000
3 He purchased goods for Rs.60,000
5 He sold goods for cash Rs.80,000
6 He paid salaries Rs.10,000

Solution:

Journal

Date Particular L.F Amount Amount

2018
Jan. Cash A/C .....................................................Dr. 9 100,000
1 Capital 11 100,000
(Being capital brought in)
2 Furniture 13 20,000
A/C.................................................Dr. 9 20,000
[Type here]

Cash A/C
(Being furniture purchased for cash)
3 Purchases A/C...............................................Dr. 15 60,000
Cash A/C 9 60,000
(Goods purchased for cash)
5 Cash A/C......................................................Dr. 9 80,000
Sales A/C 17 80,000
(Sold goods for cash)
6 Salaries A/C..................................................Dr. 19 10,000
Cash A/C Return 9 10,000
(Salaries paid)

Ledger

Cash Account (No.9)

Date Particular J.R Amount Date Particulars J.R Amount

20018 2018
Jan.1 Capital A/C 1 100,000 Jan.2 Furniture A/C 1 20,000
Jan.5 Sales A/C 1 80,000 Jan.3 Purchases A/C 1 60,000
Jan.6 Salaries A/C 1 10,000
Balance c/d 90,000
Total 180,000 Total 180,000

Capital Account (No.11)

Date Particular J.R Amount Date Particulars J.R Amount

2018 2018
Jan.6 Balance c/d 100,000 Jan.1 Cash A/C 1 100,000
Total 100,000 Total 100,000

Furniture Account (No.13)

Date Particular J.R Amount Date Particulars J.R Amount

2018 2018
Jan.2 Cash A/C 1 20,000 Jan.6 Balance c/d 20,000
Total 20,000 Total 20,000

Purchases Account (No.15)

Date Particular J.R Amount Date Particulars J.R Amount

[Type here]

2018 2018
Jan.3 Cash A/C 1 60,000 Jan.6 Balance c/d 60,000
Total 60,000 Total 60,000

Sales Account (17)

Date Particular J.R Amount Date Particulars J.R Amount

2018 2018
Jan.6 Balance c/d 80,000 Jan.5 Cash A/C 1 80,000
Total 80,000 Total 80,000

Salaries Account (19)

Date Particular J.R Amount Date Particulars J.R Amount

2018 2018
Jan.6 Cash A/C 1 10,000 Jan.6 Balance c/d 10,000
Total 10,000 Total 10,000

DISTINCTION BETWEEN BOOKS OF ORIGINAL ENTRY AND LEDGER

Basis Books of original entry Ledger

Recording of transactions Transactions are entered for the Transactions are entered in
first time in these books, they Journal or Subsidiary Books are
are also referred to as books of later transferred to the Ledger.
primary entry. Thus, ledger is also called a
They are also referred to as book of final entry.
books of primary entry.
Narrations Narrations are recorded. Narrations are not recorded.
Order of transactions Transactions are entered in Transactions are entered in
chronological order. analytical order.
Final Accounts Final accounts can’t be Final accounts can be prepared
prepared with the help of books with the help of Ledger
of original entry. balances.
Accuracy Accuracy of these books can’t Accuracy of the Ledger
be tested. Accounts is tested by preparing
a Trial Balance.
Process of recording Journalising Posting
entries

CLOSING OF ACCOUNTS
[Type here]

1. Personal Accounts
If a personal account shows a debit balance, it indicates the amount owing from him.
On the contrary, if a personal account shows a credit balance, it indicates the amount owing
to him.

2. Real Accounts
Method of closing the Cash A/c and the accounts of all other assets is the same as that of
personal accounts. When balanced, these will always show debit balances.

3. Nominal Accounts
These accounts do not require balancing. As the main purpose of opening such accounts is
to ascertain the net profit or loss of the firm, all such accounts are transferred to the trading
and profit and loss account of the firm at the end of the financial period.

QUESTIONS

Q.1) The total of purchase returns book will be posted to the:

[a] Debit of purchases A/c

[b] Credit of purchases A/c
[c] Debit side of Purchase Returns A/c
*[d] Credit side of Purchases Return A/c

Q.2) Which of the following is known as “Principal Book of Accounting”?

*[a] Ledger
[b] Journal
[c] Trial Balance
[d] Balance Sheet

Q.3) Purchased goods from Mohan of Rs 40,000 at 20% trade discount. Posting will be
made in Manoj A/c:
[a] Debit side Rs 40,000
[b] Credit side Rs 40,000
*[c] Debit side Rs 32,000
[d] Credit side Rs 32,000
[Type here]

Q.4) Which of the following has a debit balance?

[a] Bank loan

[b] Income received in advance
*[c] Prepaid insurance premium
[d] Creditors for goods

Q.5) Journal and ledger record transactions in

*[a] A chronological order and analytical order respectively

[b] An analytical order and chronological order respectively
[c] A chronological order only
[d] An analytical order only

Q.6) At the end of the accounting year all the nominal accounts of ledger book are:

[a] Balanced but not transferred to profit and loss account.

[b] Not balanced and their balance is not transferred to the profit and loss account.
[c] Balanced and the balance is transferred to the balance sheet.
*[d] Not balanced and their balance is transferred to the profit and loss account.

Q.7) The technique of finding the net balance of account after considering the totals of
both debits and credits appearing in the account is known as:

[a] Posting
*[b] Balancing of account
[c] Accuracy test
[d] None of the above

Q.8) Consider the following statements and identify the correct ones:

1. The balance of an account is always known by the side which is in excess.

2. Asset accounts may have either debit or credit balance.
3. L.F. in the journal is filled at the time of posting.

[a] 1 and 2
[b] 2 and 3
*[c] 1 and 3
[d] 1, 2 and 3

Q.9) Proprietor of the business withdrew goods from business for private use. It will be
posted to the:
[Type here]

[a] Credit of drawings A/c

[b] Debit of Purchases A/c
*[c] Credit of Purchases A/c
[d] None of the above

Q.10) Received Rs 8,000 from Ram in full settlement of Rs 10,000. Posting of Rs 2,000 will
be made to the:
[a] Debit side of Ram’s A/c
[b] Credit side of Ram’s A/c
*[c] Debit side of Discount A/c
[d] Credit side of Discount A/c
[Type here]
[Type here]
[Type here]
JOURNAL
Chanchal Phore
 KEY BENEFITS OF OUR COURSES

Our course structure includes a lot of perks that

are otherwise unavailable elsewhere.
It is a comprehensive guide to help you crack the
paper & secure your dream position.

We provide personal solutions all queries using a Telegram

group wherein Anuj Jindal himself will clarify your doubts.

We curate the learning strategies of past year toppers to help

you learn from the success of the best
Contents
Journal ............................................................................................................................................................................... 4
Meaning ........................................................................................................................................................................ 4
Format of Journal .......................................................................................................................................................... 4
Date ........................................................................................................................................................................... 4
Particulars or Details Column.................................................................................................................................... 5
Ledger Folio (L.F) ....................................................................................................................................................... 5
Amount ..................................................................................................................................................................... 5
Rules for Journalizing .................................................................................................................................................... 5
Simple Entry and Compound Entry ............................................................................................................................... 6
Example of Simple Entry ........................................................................................................................................... 6
Example of Compound Entry .................................................................................................................................... 7
Personal Books and Business Books ............................................................................................................................. 7
Capital Account ......................................................................................................................................................... 7
Drawings ................................................................................................................................................................... 8
Entries of some specific transactions............................................................................................................................ 9
Cash Discount ............................................................................................................................................................ 9
Trade Discount .......................................................................................................................................................... 9
Bad Debts .................................................................................................................................................................. 9
Bad Debts Recovered .............................................................................................................................................. 10
Outstanding Expenses ............................................................................................................................................. 10
Prepaid Expenses .................................................................................................................................................... 10
Depreciation............................................................................................................................................................ 10
Accrued Income ...................................................................................................................................................... 11
Income received in advance ................................................................................................................................... 11
Purchase and sale of fixed asset ............................................................................................................................. 11
Expenditure on installation of Machinery .............................................................................................................. 12
Transactions related to goods................................................................................................................................. 12
Opening Entry ............................................................................................................................................................. 13
Example of Journal ...................................................................................................................................................... 14
Journal
Meaning
The books in which transactions are recorded for the first time from a source document are
called ‘Book of Original Entry’.

Journal is one of the basic books of original entry in which transactions are originally
recorded in a chronological order according to the principles of double entry system.

After Journal, transactions are entered in Ledger.

The process of recording a transaction in a journal is known as

journalising

The transfer of journal entry to a ledger account is called posting

Format of Journal
Date Particulars L.F Amount Amount

Account to be debited XXX

.............................Dr. XXX
Account to be credited
(Narration)

The various columns of journal are explained in details below:

Date
This column is used to write the date of the business transaction. Different date formats are
used in different countries. Different formats of date are: 15.03.2001, 03.15.2011, 15
March 2021 etc.
Particulars or Details Column
In this column the names of the two connected accounts are written in two consecutive
lines - in the first line the name of account debited and in the second line the name of
account credited.

The world "Dr." is used at the end of the name of account debited. It is not necessary to
place the word "Cr." after the name of the credited account, because if one account is Dr. It
follows that the other account must be Cr.

Ledger Folio (L.F)

In this column, the number of the ledger page is written to which the amount is posted

Amount
The debit amount is written in the first "amount" column against the name of account
debited and the credit amount in the second "amount" column against the name of
account credited.

All the columns, except the Ledger Folio column are completed at the time
of journalising. The Ledger Folio column is filled in at the time of posting.

Rules for Journalizing

How a transaction is recorded in journal, is discussed below:

Suppose the transaction is:

Purchased furniture from Mr. A on 10.01.20 for Rs.16,000, for cash

Here furniture accounting is debited and cash account is credited.

Date Particulars L.F Amount Amount

10.01.20 Furniture A/c .............................Dr. 16,000

Cash A/c 16,000
(Being the furniture purchased
against the cash)

Simple Entry and Compound Entry

Simple entry - Every transaction effects two accounts - one is debited and another account
is credited. Thus in recording a transaction in a journal one account is debited and another
account is credited. This type of entry is called simple entry.

Compound entry - The entry in which more than one account is debited or more than one
account is credited, is known as compound entry. Three or more accounts are connected
with a compound entry.

Example of Simple Entry

For example, on 10.04.20 we bought furniture from S. The entry is:

Date Particulars L.F Amount Amount

10.04.20 Furniture A/C .............................Dr. 10,000

S A/C 10,000
(Being furniture purchased on
credit)
Example of Compound Entry
For example on 16.05.20 we paid Rs. 1,000 on account of salaries and Rs.600 on account of
rent. For this the entry will be:

Date Particulars L.F Amount Amount

16.05.20 Salary A/C .............................Dr. 1,000

Rent A/C 600
Cash A/C 10,000
(Being salaries and rent)

Here two accounts have been debited and the entry involves three accounts. Hence, it is
a compound entry.

Personal Books and Business Books

It should be noted here that no private transactions of the proprietor can be recorded in
the books of business. On the other hand, no transactions of the business can be recorded
in the books of its proprietor. But the transactions in between proprietor and business must
be recorded in the books of both the proprietor and business. If these rules are not strictly
followed, the books of account will fail to disclose the true result of business.

We are concerned with the books of business, not with the private books of proprietor.
Transactions between the business and its proprietor are recorded in the following two
accounts:

Capital Account
The money with which proprietor starts his business is called capital. When proprietor
brings capital in the business, it is recorded in capital A/C. Capital account is in fact the
personal account of the proprietor. So, it is a personal account. The proprietor has given the
benefit to the business through introduction of capital. So proprietor's account A/C, i.e.
capital account will be credited. From the view point of bookkeeping the introduction of
capital to the business by proprietor means that the proprietor lends the money to his
business and the business becomes indebted to him. The proprietor is regarded as a special
or internal creditor to the business.

Example: Mr. R started a business with Rs.20,000

Date Particulars L.F Amount Amount

16.05.20 Cash A/C .............................Dr. 20,000

Capital A/C 20,000
(Being capital brought in)

Drawings
If the proprietor draws any money or takes goods from his business for his personal use, it
will be recorded in drawings A/C. Drawings A/C is the personal account of the proprietor, so
it is classified as the personal account. Proprietor receives benefit, when he withdraws
money or goods from business. So the proprietor's account i.e. drawing is debited.

Example:

Date Particulars L.F Amount Amount

16.05.20 Drawings A/C .............................Dr. 2,000

Cash A/C 2,000
(Being amount withdrawn by
proprietor)
Entries of some specific transactions
Cash Discount
The manufacturers and whole sellers frequently grant cash discount to their debtors who
will pay their debts before due date for goods purchased by them on credit. The seller
regards it a "cash discount" or "sale discount" or "discount allowed". The buyer calls the
discount as "purchase discount" or "discount received".

Trade Discount
This discount is allowed by wholesaler or manufacturer to the retailer at a fixed percentage
on the listed price of goods. It is allowed when goods are manufactured in bulk. No
separate entry is passed for the trade discount, as it is deducted from the invoice of the
goods.

If both trade discount and cash discount are allowed, first trade discount is
allowed and thereafter, cash discount is allowed.

Bad Debts
When the goods are sold on credit to a customer, and if the amount becomes
irrecoverable, the amount is called as bad debts. For recording it, bad debts is debited and
customer account is credited.

Bad Debts A/c Dr.

To debtor’s personal A/c

Bad Debts Recovered
Sometimes, it happens if the bad debts previously written off are subsequently recovered.
In such case:

Cash A/c Dr.

To Bad Debts Recovered A/c

Outstanding Expenses
Sometimes, there are some expenses which are yet to be paid at the end of the accounting
period, they are called as Outstanding Expenses

Expenses A/c Dr.

To Outstanding expenses A/c

Prepaid Expenses
These are those expenses which are related to the next accounting year but paid in advance
during the current year.

Prepaid Expenses A/c Dr.

To Expenses A/c

Depreciation
It is the gradual decrease in the value of an asset due to wear and tear and passage of time.

Depreciation A/c Dr.

To Asset A/c
Accrued Income
The income which has been earned but not yet received is called accrued income.

Accrued income/c Dr.

To income A/c

Income received in advance

Income received but not earned during the accounting period is called income received in
advance.

Income A/c Dr.

To income received in advance A/c

Purchase and sale of fixed asset

Fixed asset includes land, building, plant, machinery, furniture etc. When fixed asset is
purchased, the asset account is debited. It is not debited to purchases account as fixed
asset is not for the purpose of sales. Similarly, when fixed asset is sold, it is credited to asset
account and not sales account.

 On purchase of asset for cash

Asset A/c Dr.
To cash A/c

 On purchase of asset on credit

Asset A/c Dr.
To suppliers A/c

 On sale of asset for cash

Cash A/c Dr.
To assets A/c
  On sale of asset on credit
Purchaser A/c Dr.
To assets A/c

Expenditure on installation of Machinery

Any expenditure incurred on the carriage and installation of machinery is treated as capital
expenditure and included in the cost of the machinery.

Asset A/c Dr.

To cash A/c

Transactions related to goods

Drawings of Goods
Drawings A/c Dr.

To Purchases A/c

Goods given away as charity

Charity A/c Dr.

To Purchases A/c

Goods distributed as samples

Advertisement expenses A/c Dr.

To Purchases A/c
Loss of Goods by theft or fire
Loss by Theft A/c Dr.

Loss by Fire A/c Dr.

To Purchases A/c

In case goods were insured

Insurance Company A/c Dr.

To Loss by Theft or Fire A/c

If full claimed amount is received

Bank A/c Dr.

To Insurance Company A/c

When stock is not insured

Profit and Loss A/c Dr.

To loss by theft/fire A/c

Opening Entry
Business firms close their books of accounts at the end of each year and start a new set of
books in the beginning of each new year. The first entry in journal is to record the closing
balances of individual assets and liabilities of the previous year. These balances become the
opening balances of the new year. The entry passed to record the closing balances of the
previous year is called the opening entry.

While passing the opening entry all the assets are debited and capital and liabilities are
credited. If capital is not given, total liabilities are deducted from total assets.
Example of Journal
Journalise the following transactions:

2020

Feb. 3 X commenced business with a capital of Rs.15,000

05 Purchased good Rs.6,000

07 Purchased goods on credit from S & Co. Rs.3,000

10 Purchased furniture Rs.2,400

11 Sold goods Rs.3,900

15 Sold goods on credit to D Rs.2,250

20 Paid salaries Rs.960

25 Received commission Rs.75

26 Returned goods to S & Co. Rs.600.

27 Returned goods by D Rs.450

28 Received from D Rs.1,500

Paid to S & Co. Rs.1,800

X withdrew from business Rs.900
Charged depreciation on Rs.240
Borrowed from K Rs.1,500
Solution:

Journal

Date Particular L.F Amount Amount

2020

Feb. Cash A/C Dr. 15,000

3 Capital 15,000
(Being capital brought in)

5 Purchases A/C Dr. 6,000

Cash A/C 6,000
(Being goods purchased for cash)

7 Purchases A/C Dr. 3,000

S & Co. A/C 3,000
(Being goods purchased form S & Co on
credit)

10 Furniture A/C Dr. 2,400

Cash A/C 2,400
(Being furniture purchased for cash)

11 Cash A/C Dr. 3,900

Sales A/C 3,900
(Being goods sold for cash)

15 D Bros. A/C Dr. 2,250

Sales A/C 2,250
(Being goods sold on credit to D)

20 Salaries A/C Dr. 960

Cash A/C 960
 (Being salaries paid)

25 Cash A/C Dr. 75

Commission A/C 75
(Being commission received)

26 S & Co. A/C Dr. 600

Purchases A/C Return 600
(Being goods returned to S & co.)

27 Sales Returns A/C Dr. 450

D Bros. A/C 450
(Being goods returned by D Bros.)

28 Cash A/C Dr. 1,500

D Bros. A/C 1,500
(Being amount received from D Bros.)

" S & Co. A/C Dr. 1,800

Cash A/C 1,800
(Being amount paid to S & Co.)

" Drawings A/C Dr. 900

Cash A/C 900
(Being amount paid to S & Co.)

" Depreciation A/C Dr. 240

Furniture A/C 240
(Being depreciation charged on
furniture)

" Cash A/C Dr. 1,500

K A/C 1,500
(Being amount borrowed from K)
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