Accounting: An Introduction

➢ Koutilya, a minister of Chandragupta, wrote the book named ‘Arthashasthra.’

➢ The book ‘Summa de Arithmetica, Geometria, Proportion at Proportionality’ (Review
of Arithmetic and Geometric proportions), written by Fra Luca Bartolomeo de
Pacioli in Venice (1494).
➢ He was an Italian mathematician and a Franciscan Friar (member of a religious order
founded by St. Francis of Assisi).
➢ His book is considered as the first book on double entry bookkeeping.
➢ In this book, he used Debit (Dr.) and Credit (Cr.).
➢ Debit comes from the Italian debito which comes from the Latin debita and debeo
which means owed to the proprietor.
➢ Credit comes from the Italian credito which comes from the Latin ‘credo’ which means
trust or belief in the proprietor or owed by the proprietor.
➢ Luca Pacioli is regarded as the Father of Accounting or Father of Double Entry System
or Father of Book Keeping at international level.
➢ Shri Kalyan Subramani Aiyar (K. S. AIYAR) (1859-1940) is known as the father of
Accountancy in India.

Accounting: It is the process of recording financial transactions related to an organisation

or entity.

Book keeping
➢ It refers to recording of day-to-day business transactions in the books of accounts.
➢ It involves identification of transactions of financial nature, recording them in the
books of accounts and classifying them into the ledger accounts.
➢ From broader point of view, it is part of accounting.
➢ From narrow point of view, accounting starts when book keeping ends.
Business/Economic Events: Economic event is a happening of consequence of
transactions which are measurable in monetary terms.
Transaction: It is an act which brings change to account balances.
Identification: It means determining which transactions are to be recorded.
Measurement: It means quantification of the business transactions into financial terms by
using monetary unit.
Recording: It means entering business transactions in the books of account in monetary
terms and in a chronological order. Recoding is made in the primary books of accounts.
Classifying: It is the process of grouping transactions or entries of one nature at one place.
Classification is done in the main book of account known as the ledger.
Summarising: It means presenting the classified data in a summarized manner which is
understandable and useful for user.
Analysis and interpretation: It involve finding out vital information from the books of
accounts. For example, to know about the earning capacity and financial position of
organisation.
Communication: It refers to regularly communicate the desired information to the users
of accounts, through accounting reports.
Organisation: It refers to an enterprise, whether for profit or not-for profit motive.

Interested Users of Information:

➢ Internal users: Chief Executive Officer, Chief Financial Officer, Vice President,
Business Unit Managers, Plant Managers, Store Managers, Line Supervisors, etc.
➢ External users: Present and potential Investors (shareholders), Creditors (Banks and
other Financial Institutions, Debenture holders and other Lenders), Tax Authorities,
Regulatory Agencies (Department of Company Affairs, Registrar of Companies,
SEBI), Labour Unions, Trade Associations, Stock Exchange, and Customers, etc.
Accounting as a Source of Information: Accounting provides information for making
economic decisions. It serves the users who rely on financial statements as their principal
source of information.

Branches of Accounting:
➢ Financial accounting: It is related with keeping a systematic record of financial
transactions and, preparation and presentation of financial reports.
➢ Cost accounting: It is related with analyzing the expenditure for ascertaining the cost
of various products manufactured or services rendered by the firm.
➢ Management accounting: It is related with using the relevant information mainly
from financial accounting and cost accounting and helping the management in
budgeting, taking pricing decisions, capital expenditure decisions and so on.

Qualitative Characteristics of Accounting Information

➢ Reliability: accounting information should be free from error and bias.
➢ Relevance: accounting information should be according to user’s need.
➢ Understandability: accounting information should be understood in the same sense as
it is prepared and conveyed to the users.
➢ Comparability: accounting reports must belong to a common period and use common
unit of measurement and format of reporting.

Objectives of Accounting
➢ Maintenance of Records of Business Transactions
➢ Calculation of Profit and Loss
➢ Depiction of Financial Position
➢ Providing Accounting Information to its Users

Basic Terms in Accounting

➢ Entity: a reality that has a definite individual existence.
➢ Business entity: specifically, identifiable business enterprise.
➢ Assets: economic resources of an enterprise that can be usefully expressed in monetary
terms.
➢ Liabilities: obligations or debts that an enterprise must pay at some time in the future.
➢ Capital: amount invested by the owner in his/her firm.
➢ Revenues: the amount earned by selling products or providing services to customers.
➢ Expenses: costs incurred by a business in the process of earning revenue.
➢ Expenditure: spending money for some benefit or property received.
o Revenue Expenditure – benefits within 1 year only. Examples: Expenditure
on stationery and raw material etc.
o Capital Expenditure –benefits for long period. Examples: Expenditure made
on purchase of building, furniture for office etc.
➢ Profit: the excess of revenues of a period over its related expenses during an
accounting year.
➢ Gain: profit that arises from events or transactions which are incidental to business.
➢ Loss: the excess of expenses of a period over its related revenues.
➢ Discount: the deduction in the price of the goods sold.
o Trade Discount – offered to increase sale.
o Cash Discount – offered to collect cash soon.
➢ Voucher: the documentary evidence in support of a transaction.
➢ Goods: the products in which the business unit is dealing.
➢ Drawings: withdrawal of money or goods by the owner from the business for personal
use.
➢ Purchases: procuring goods for resale with or without processing.
➢ Stock (inventory): a measure of something on hand-goods, spares, and other items in
a business.
➢ Debtors: persons or other entities who owe to an enterprise an amount for buying
goods and services on credit.
➢ Creditors: persons or other entities who must be paid by an enterprise an amount for
providing the enterprise goods and services on credit.

Theoretical Framework of Accounting (GAAP, Principles, Standards):

GAAP: Generally Accepted Accounting Principles (GAAP) are basic accounting

principles and guidelines. These principles provide the framework for accounting
profession to ensure that financial reporting is transparent and comparable.
GAAP Includes Basic accounting principles and Accounting Standards issued by the
accounting body of the country.

Accounting Principles: Accounting principles are the general guidelines that accountants
follow while reporting financial data.
1. Accounting Concepts: Accounting concept refers to the basic assumptions which
work as the basis of recording of business transactions and preparing accounts.
2. Accounting Conventions: The term “Accounting Conventions” refer to the customs
or traditions which are used as a guide in the preparation of accounting reports and
statements.

Major Principles of Accounting:

Accrual principle: Accounting transactions should be recorded in the accounting period
when they occur, rather than in the period when there are cash flows associated with them.
Conservatism/prudence principle: This principle provides for probable expenses and
losses, but record revenues only when they are sure to occur.
Consistency principle: Once adopt an accounting principle or method, continue to use it
until a demonstrably better principle or method is found.
Cost concept: The fixed assets of a business are recorded on the basis of their original cost
in the first year of accounting. Subsequently, these assets are recorded deducting
depreciation.
Dual aspect concept: For every credit, a corresponding debit is made.
Full disclosure: Reveal all information which are of material value to creditors and
debtors.
Going concern concept: A business is expected to continue for a long time and carry out
its commitments and obligations.
Matching principle: While recording revenue, record all related expenses at the same
time.
Materiality: All material facts should be recorded in accounting. Accountants should
record important data and leave out insignificant information.
Money measurement concept: Only business transactions that can be expressed in terms
of money are recorded in accounting.
Revenue recognition principle/Realisation concept: Revenue is recognised only when it
is earned.
Separate entity principle: The transactions of a business should be kept separate from
those of its owners and other businesses.
Time period principle: The business should report the results of its operations over a
standard period.

Fundamental Accounting Assumptions:

➢ Going Concern, Consistency and Accrual Assumption (GCA) are considered
Fundamental Accounting Assumptions.
➢ If nothing has been mentioned in financial statements regarding GCA, it is assumed
that they have been followed in preparation of financial statements.
➢ However, if any of the three assumptions is not followed in preparation of financial
statements, clarification in this regard should be specifically disclosed.
Accounting standards: Accounting standards are common set of principles, standards,
and procedures that define the basis of financial accounting policies and practices. In India,
Accounting Standards are issued under the supervision of Accounting Standards Board
(ASB). ASB was constituted in the year 1977. ASB is a committee under Institute of
Chartered Accountants of India (ICAI). It consists of representatives from government
department, academicians, other professional bodies. The Institute of Chartered
Accountants of India (ICAI) is a statutory body established by an Act of Parliament, The
Chartered Accountants Act, 1949. The Institute, functions under the administrative control
of the Ministry of Corporate Affairs, Government of India. The ICAI is the second largest
professional body of Chartered Accountants in the world.

The National Financial Reporting Authority (NFRA) is a body constituted under the
provisions of Section 132 of the Companies Act, 2013. NFRA is an independent regulator
set up to oversee the auditing profession and the Indian Accounting Standards.

Mandatory Accounting Standards of ICAI (as on 1 July 2017):

AS 1 Disclosure of Accounting Policies: deals with the disclosure of significant
accounting policies which are followed in preparing and presenting financial statements.
AS 2 Valuation of Inventories: deals with the determination of value at which inventories
are carried in the financial statements.
AS 3 Cash Flow Statements: deals with the provision of information about the historical
changes in cash and cash equivalents of an enterprise.
AS 4 Contingencies and Events Occurring After Balance Sheet Date: deals with the
treatment of contingencies and events occurring after the balance sheet date.
AS 5 Net profit or Loss for the period, Prior Period Items and Changes in Accounting
Policies: deals with presenting profit or loss from ordinary activities, extraordinary items
and prior period items in the Statement of Profit and Loss.
AS 6 Depreciation Accounting: Withdrawn and merged with AS 10.
AS 7 Construction Contracts: deals with the accounting for construction contracts in the
financial statements of contractors.
AS 9 Revenue Recognition: deals with the bases for recognition of revenue in the
Statement of Profit and Loss of an enterprise.
AS 10 Property, Plant and Equipment: deals with the accounting treatment for Property,
Plant and Equipment.
AS 11 The Effects of Changes in Foreign Exchange Rates: lays down principles of
accounting for foreign currency transactions and foreign operations.
AS 12 Government Grants: deals with accounting for government grants.
AS 13 Accounting for Investments: deals with accounting for investments in the financial
statements of enterprises and related disclosure requirements.
AS 14 Accounting for Amalgamations: deals with accounting for amalgamations and the
treatment of any resultant goodwill or reserves.
AS 15 Employee Benefits: prescribe the accounting treatment and disclosure for
employee benefits in the books of employer except employee share-based payments.
AS 16 Borrowing Costs: deals with accounting for borrowing costs.
AS 17 Segment Reporting: deals with reporting financial information, about the different
types of segments i.e. products and services an enterprise produces and the different
geographical areas in which it operates.
AS 18 Related Party Disclosures: deals with reporting related party relationships and
transactions between a reporting enterprise and its related parties.
AS 19 Leases: prescribes, for lessees and lessors, the appropriate accounting policies and
disclosures in relation to finance leases and operating leases.
AS 20 Earnings Per Share: prescribes principles for the determination and presentation
of earnings per share.
AS 21 Consolidated Financial Statements: lays down principles and procedures for
preparation and presentation of consolidated financial statements.
AS 22 Accounting for Taxes on Income: prescribes accounting treatment of taxes on
income.
AS 23 Accounting for Investments in Associates: deals with accounting for investments
in associates in the preparation and presentation of Consolidated Financial Statements
(CFS) by an investor.
AS 24 Discontinuing Operations: establishes principles for reporting information about
discontinuing operations.
AS 25 Interim Financial Reporting: prescribe the minimum content of an interim
financial report.
AS 26 Intangible Assets: prescribes the accounting treatment for intangible assets.
AS 27 Financial Reporting of Interests in Joint Ventures: set out principles and
procedures for accounting for interests in joint ventures.
AS 28 Impairment of Assets: deals with impairment of all assets unless specifically
excluded from the scope of the Standard.
AS 29 Provisions, Contingent Liabilities and Contingent Assets: appropriate
recognition criteria and measurement bases are applied to provisions, contingent liabilities
and contingent assets.

ICAI has announced on 15 Nov., 2016 that the following standards stands withdrawn:
➢ ‘AS 30- Financial Instruments: Recognition and Measurement’,
➢ ‘AS 31- Financial Instruments: Presentation’,
➢ ‘AS 32- Financial Instruments: Disclosures’

IFRS:

➢ In 2001 the International Accounting Standards Board (IASB) replaced the IASC.
➢ During its first meeting the new Board adopted existing IAS (International
Accounting Standards).
➢ The IASB has continued to develop standards calling the new standards
"International Financial Reporting Standards" (IFRS).

Existing IFRS List:

IFRS 1 First-time Adoption of IFRS 2 Share-based Payment
International Financial Reporting IFRS 3 Business Combinations
Standards IFRS 4 Insurance Contracts
IFRS 5 Non-current Assets Held for Sale IAS 12 Income Taxes
and Discontinued Operations IAS 16 Property, Plant and Equipment
IFRS 6 Exploration for and Evaluation of IAS 17 Leases
Mineral Resources IAS 18 Revenue
IFRS 7 Financial Instruments: IAS 19 Employee Benefits
Disclosures IAS 20 Accounting for Government
IFRS 8 Operating Segments Grants and Disclosure of Government
IFRS 9 Financial Instruments Assistance
IFRS 10 Consolidated Financial IAS 21 The Effects of Changes in
Statements Foreign Exchange Rates
IFRS 11 Joint Arrangements IAS 23 Borrowing Costs
IFRS 12 Disclosure of Interests in Other IAS 24 Related Party Disclosures
Entities IAS 26 Accounting and Reporting by
IFRS 13 Fair Value Measurement Retirement Benefit Plans
IFRS 14 Regulatory Deferral Accounts IAS 27 Separate Financial Statements
IFRS 15 Revenue from Contracts with IAS 28 Investments in Associates and
Customers Joint Ventures
IFRS 16 Leases IAS 29 Financial Reporting in
IFRS 17 Insurance Contracts (replaced Hyperinflationary Economies
IFRS 4-issued Date March 2022) IAS 32 Financial Instruments:
IAS 1 Presentation of Financial Presentation
Statements IAS 33 Earnings per Share
IAS 2 Inventories IAS 34 Interim Financial Reporting
IAS 7 Statement of Cash Flows IAS 36 Impairment of Assets
IAS 8 Accounting Policies, Changes in IAS 37 Provisions, Contingent Liabilities
Accounting Estimates and Errors and Contingent Assets
IAS 10 Events after the Reporting Period IAS 38 Intangible Assets
IAS 11 Construction Contracts
IAS 39 Financial Instruments: IAS 40 Investment Property
Recognition and Measurement IAS 41 Agriculture

Ind-AS: Ind-AS are a set of accounting standards notified under the Companies Act, 2013
that converge with IFRS. Ind-AS are applicable to companies: listed on stock exchanges
of India, Having net worth of Rs. 250 crore or more, and their holding, subsidiary, associate
and joint venture companies. The Ind AS are named and numbered in the same way as the
International Financial Reporting Standards (IFRS). The underlying assumptions in Ind-
AS are Going Concern Assumption and Accrual Assumption.

INDIAN ACCOUNTING STANDARDS (IND-AS) AS ON 01.04.2020

Ind AS 101 First-time Adoption of Ind AS 112 Disclosure of Interests in
Indian Accounting Standards Other Entities
Ind AS 102 Share-based Payment Ind AS 113 Fair Value Measurement
Ind AS 103 Business Combinations Ind AS 114 Regulatory Deferral
Ind AS 104 Insurance Contracts Accounts
Ind AS 105 Non-current Assets Held Ind AS 115 Revenue from Contracts
for Sale and Discontinued Operations with Customers
Ind AS 106 Exploration for and Ind AS 116 Leases
Evaluation of Mineral Resources Ind AS 1 Presentation of Financial
Ind AS 107 Financial Instruments Statements
Disclosures Ind AS 2 Inventories
Ind AS 108 Operating Segments Ind AS 7 Statement of Cash Flows
Ind AS 109 Financial Instruments Ind AS 8 Accounting Policies,
Ind AS 110 Consolidated Financial Changes in Accounting Estimates and
Statements Errors
Ind AS 111 Joint Arrangements Ind AS 10 Events after the reporting
period
Ind AS 12 Income Taxes Ind AS 29 Financial Reporting in
Ind AS 16 Property, Plant and Hyperinflationary Economies
Equipment Ind AS 32 Financial Instruments
Ind AS 19 Employee Benefits Presentation
Ind AS 20 Accounting for Ind AS 33 Earnings per Share
Government Grants and Disclosure of Ind AS 34 Interim Financial
Government Assistance Reporting
Ind AS 21 The Effects of Changes in Ind AS 36 Impairment of Assets
Foreign Exchange Rates Ind AS 37 Provisions, Contingent
Ind AS 23 Borrowing Costs Liabilities and Contingent Assets
Ind AS 24 Related Party Disclosures Ind AS 38 Intangible Assets
Ind AS 27 Separate Financial Ind AS 40 Investment Property
Statements Ind AS 41 Agriculture
Ind AS 28 Investments in Associates
and Joint Ventures

ACCOUNTING: BASIS, PROCESS, VOUCHERS, ACCOUNTING EQUATION:

Cash and Accrual Basis of Accounting:
1. Cash basis: Under this method we record revenues when cash is received, and expenses
when they are paid. This method is simple to use.
2. Accrual basis: Under this method we record revenues when they are earned and
expenses when they are incurred.
3. Hybrid: Under this method revenues are recorded on cash basis and expenses are
recorded on accrual basis.

Systems of Accounting:
1. Double entry system:
➢ based on the principle of “Dual Aspect”
 ➢ every transaction has two effects, viz. receiving of a benefit and giving of a benefit
➢ every debit must have a corresponding credit
➢ accurate and more reliable as the possibilities of frauds and mis-appropriations are
minimized
➢ can be implemented by big as well as small organisations
2. Single entry system:
➢ not a complete system of maintaining records of financial transactions
➢ does not record two-fold effect of each and every transaction
➢ usually personal accounts and cash book are maintained under this system
➢ accounts maintained under this system are incomplete and unsystematic.
➢ followed by small business firms as it is very simple and flexible
Process of Accounting: Process of
Accounting includes the steps of
identifying and measuring the
business transactions, recording,
classifying, summarising, analysing &
interpreting and finally
communicating it to the interested
users of accounting information.

Voucher: A document which

provides evidence of the transactions is called the Source Document or a Voucher.

➢ A transaction with one debit and one credit is a simple transaction and the accounting
vouchers prepared for such transaction is known as transaction Voucher.
➢ Voucher which records a transaction that entails multiple debits and one credit or
multiple credits and one debit is called compound voucher. Compound voucher may
be Debit Voucher or Credit Voucher.
Voucher which records multiple debits and multiple credits are called Complex Voucher
or Journal Voucher.

Accounting Equation/Balance Sheet Equation:

➢ The accounting equation or balance sheet equation, denotes the relationship between
the assets, liabilities, and capital.
➢ The Accounting Equation is based on the double entry accounting, which says that
every transaction has two aspects, debit and credit.
➢ The equation involves: Assets (Total Equity), Liabilities (Creditor's Equity) and
Capital (Owner's Equity).
➢ Accounting equation shows that the assets of a business are always equal to the total
of its liabilities and capital.
Original Accounting Equation: Assets = Liabilities + Capital
Derived Accounting Equations:
o Liabilities = Assets – Capital
o Capital = Assets – Liabilities

Classification of Accounts:
A. Traditional approach or English Approach
B. Modern Approach or American Approach or Accounting Equation Approach
Traditional approach or English Approach
Types of Accounts Concept
Personal Account Related to persons or organisations
Ex. Ram’s A/c, Bata Ltd. A/c, Outstanding Salary A/c, etc.
Natural Personal – Ram’s Account
Artificial Personal – Bata Ltd.’s Account
Representative Personal – Debtors Account, Out. Exp.
 Real Account Cash, Money and Assets
Ex. Cash A/c, Machine A/c, Goodwill A/c, etc.
Tangible - Machine
Intangible - Goodwill
Nominal Account All income and expenses
Ex. Rent A/c, Salary A/c, Purchases A/c, Discount A/c, etc.

Rules of Debit and Credit: Traditional approach or English Approach

Types of Accounts Rule
Personal Account Dr. the Receiver and Cr. the giver
Real Account Dr. what comes in and Cr. what goes out
Nominal Account Dr. all expenses and losses and Cr. all income and gains
Modern Approach
Types of Accounts Concept and Examples
Asset Items have some money worth, or may fetch some income in
future
Ex. Cash, Debtors, Plant, etc.
Expense Amounts incurred to get some benefit
Ex. Rent Paid, Discount Allowed etc.
Capital Owner’s monetary contribution
Ex. Capital, Drawings, Current
Labilities Dues payable in future
Ex. Bank Loan Payable, Outstanding Expenses, etc.
Income/Revenue Amounts earned
Ex. Commission Received, Rent Received, etc.
Rules of Debit and Credit: Modern Approach
Dr. Increase Cr. Decrease Dr. Decrease Cr. Increase

Asset, Expenses Capital, Liabilities, Income

Books of Original Entry: The book in which the transaction is recorded for the first time
is called journal or book of original entry. The process of recording transactions in journal
is called journalising. The process of transferring journal entry to individual accounts is
called posting. Journal is called the Book of Original Entry and the Ledger is called the
Principal Book of entry. Journal is subdivided into several books of original entry as
follows:
➢ Journal Proper
➢ Cash book
➢ Other day books:
Purchases (journal) book
Sales (journal) book
Purchase Returns (journal) book
Sale Returns (journal) book
Bills Receivable (journal) book
Bills Payable (journal) book

Classification of Ledger Accounts

1. Permanent accounts–
➢ All permanent accounts are balanced and carried forward to the next accounting period.
➢ All assets, liabilities and capital accounts are permanent accounts
➢ All permanent accounts appear in the balance sheet.
2. Temporary accounts –
➢ temporary accounts are closed at the end of the accounting period by transferring them
to the trading and profit and loss account.
➢ all revenue and expense accounts are temporary accounts

Posting from Journal to Ledger: Posting is the process of transferring the entries from
the books of original entry (journal) to the ledger.

Cash Book
➢ Cash book is a book in which all transactions relating to cash receipts and cash
payments are recorded.
➢ This is a very popular book and is maintained by all organisations, big or small, profit
or not-for-profit.
➢ It serves the purpose of both journal as well as the ledger (cash) account.
➢ 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 Book

➢ Single Column Cash Book
➢ Double Column Cash Book
➢ Triple Column Cash Book
➢ Petty Cash Book
Format of Single Column Cash Book
Dr. Cash Book Cr.
Date Particulars L.F. Rs. Date Particulars L.F. Rs
 Format of Double Column Cash Book
Dr. Cash Book Cr.
Date Particulars L.F. Cash Bank Date Particulars L.F. Cash Bank

Triple Column Cash Book: In this type of cash book, there are three columns of amount
on each side of the cash book one for Discount, Cash and Bank.

Format of Triple Column Cash Book

Dr. Cash Book Cr.
Date Particulars L.F. Disc. Cash Bank Date Particulars L.F. Dis. Cash Bank

Petty Cash Book: Small payments such as conveyance, cartage, postage, telegrams and
other expenses are collectively recorded under miscellaneous expenses.

Petty Cash Book

Amt. Date Particulars V.N. Amt. Analysis of Payments
Rec. Paid
Rs. 2020 Rs. Postage Telephone Conveyance Statio Misc.
Jan. nery

➢ The petty cashier works on the Imprest system.

Debit Note: Debit note is a document evidencing a debit to be raised against a party for
reasons other than sale on credit.
Name of the Firm Issuing the Note………………
No.
Address of the Firm
Date of Issue
Debit Note
Against: Supplier’s Name
Goods returned as per delivery
Amount in Rs.
Challan No.
(Details of goods returned)
(Rs…………………only)
Signature of the Manager with date

Credit Note: Credit note is prepared, when a party is to be given a credit for reasons other
than credit purchase.
Name of the Firm Issuing the Note…………….
No.
Address of the Firm
Date of Issue
Credit Note
Against: Customer’s Name
Goods returned by the customer
Amount in Rs.
Challan No.
(Details of goods returned)
 (Rs…………………only)
Signature of the Manager with date

Journal Proper
The transactions, which do not find place in special journals, are recorded in Journal Proper
or Journal Residual. Generally, following types of entries are recorded in journal:
➢ Opening Entry
➢ Adjustment Entries
➢ Rectification entries
➢ Transfer entries
➢ Discount received or discount allowed
➢ 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.

Financial statements: These are the written statements that provide financial information
such as financial performance and financial position of an organisation. Most common
financial statements are Trading and Profit & Loss Account (Income Statement or
Statement of Profit and Loss) and Balance Sheet (Position Statement or Statement of
Financial Position)
 Trading and Profit & Loss Account
Dr. (for the year ended…………….) Cr.
Particulars Amount Particulars Amount

Balance Sheet
(as at …………….)
Liabilities Amount Assets Amount

Preparation of Financial Statements: These are prepared usually at the end of accounting
year on the basis of Trial Balance. Nominal accounts are closed and transferred to Trading
and Profit & Loss Account. Real and Personal accounts are shown in the Balance Sheet.

Capital and Revenue Items: Revenue items form part of the trading and profit and loss
account. Capital items are shown in balance sheet.
Expenditure: Money spent for some purpose in order to get benefits is called expenditure.
The benefit of an expenditure may extend up to one accounting year or more than one year.
• If the benefit of expenditure extends up to one accounting period, it is termed as
revenue expenditure. Examples of revenue expenditure are salaries, rent, discount, etc.
• If the benefit of expenditure extends more than one accounting period, it is termed as
capital expenditure. Examples of capital expenditure are purchase of furniture,
construction building, extension of fixed assets, acquiring patents, etc.
Distinction between capital expenditure and revenue expenditure
Capital Expenditure Revenue Expenditure
Increases earning capacity Maintain the earning capacity
Acquire fixed assets for operation Day-to-day conduct of business
Non-recurring by nature Generally recurring expenditure
Benefits more than one accounting year Benefits one accounting year
Recorded in balance sheet (after Transferred to trading and profit and loss
deducting depreciation) account
Debited to trading and profit and loss Debited to trading and profit and loss
account in life time, by way of account in the year of occurrence
depreciation

Deferred Revenue Expenditure: Revenue expenditures, which are likely to give benefit
for more than one accounting period, are termed as deferred revenue expenditure. The
treatment of deferred revenue expenditure is same as of capital expenditure. They are also
written-off over their expected period of benefit.

Receipts
Capital Receipts: If a receipt incurs an obligation to return the money or is in the form of
a sale of fixed asset, it is termed as capital receipt. Examples are taking bank loan, money
invested by owner and sale of old fixed assets, etc.

Revenue Receipts: If a receipt does not incur an obligation to return the money or is not
in the form of a sale of fixed asset, it is termed as revenue receipt. Examples are sales made
by the firm and interest on investment received, etc.

Preparation of Trading and Profit and Loss Account and Balance Sheet:
➢ Trading Account is prepared to show gross profit or gross loss.
➢ Profit and Loss Account is prepared to show net profit or net loss
 ➢ Balance Sheet is prepared to show financial position.

Relevant Items in Trading and Profit and Loss Account:

Items on the debit side
➢ Opening stock ➢ Salaries
➢ Purchases less returns ➢ Rent paid
➢ Wages ➢ Commission paid
➢ Carriage inwards/Freight inwards ➢ Repairs
➢ Fuel/Water/Power/Gas ➢ Miscellaneous expenses
➢ Packaging material and Packing
charges

Items on the credit side

➢ Sales less returns ➢ interest received
➢ rent received ➢ discount received
➢ dividend received ➢ commission received

Trading Account:
It ascertains the result from basic operational activities of the business.
Gross Profit = Sales – Cost of Goods Sold
Gross Profit = Sales – (Opening Stock + Purchases + Direct Expenses – Closing Stock)
Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses – Closing Stock

Ex. Prepare Trading Account from the following information of a business:

Trial Balance (Amount in
Rs.)
Opening Stock 10,000 Sales 55,000
Purchases 30,000 Capital 2,00,000
Direct Expenses 5,000
 Building 2,10,000
Closing Stock is Rs. 6,000.

Solution:
Trading Account
Dr. (for the year ended…………….) Cr.
Particulars Amount Particulars Amount
To Opening Stock 10,000 By Sales 55,000
To Purchases 30,000 By Closing Stock 6,000
To Direct Expenses 5,000
To G/P 16,000
61,000 61,000

Operating Profit (EBIT)

Operating profit = Gross Profit – Operating Expenses; or
Operating profit = Net Profit + Non-Operating Expenses – Non-Operating Incomes

Net Profit
Net Profit = Gross Profit + Non-Operating Income – Indirect Expenses (Operating and
Non-Operating)
Or Net Profit = Operating Profit + Non-Operating Income – Non-Operating

Ex. Prepare Trading and Profit & Loss Account from the following information of a
business:
Trial Balance (Amount in
Rs.)
 Opening Stock 10,000 Sales 55,000
Purchases 30,000 Capital 2,08,000
Direct Expenses 5,000 Non-operating Income 2,000
Building 2,10,000
Operating Expenses 6,000
Non-Operating Expenses 4,000
Closing Stock is Rs. 6,0000.

Solution:
Trading and Profit & Loss Account
Dr. (for the year ended…………….) Cr.
Particulars Amount Particulars Amount
To Opening Stock 10,000 By Sales 55,000
To Purchases 30,000 By Closing Stock 6,000
To Direct Expenses 5,000
To G/P 16,000
61,000 61,000
To Operating Expenses 6,000 By G/P 16,000
To Operating Profit 10,000
16,000 16000
To Non- Operating Expenses 4,000 By Operating Profit 10,000
To Net Profit 8,000 By Non- Operating 2,000
Income
12,000 12,000
Balance Sheet: It is a statement prepared for showing the financial position of the business
summarising its assets and liabilities at a given date.
Preparing Balance Sheet: There is no prescribed form of Balance sheet, for a proprietary
and partnership firms. However, for Companies, Schedule III Part I of the Companies Act
2013 prescribes the format and the order in which the assets and liabilities of a company
should be shown.

Balance Sheet
(as at …………….)
Liabilities Amount Assets Amount
Current Liabilities Current Assets
Non-Current Liabilities Non-Current Assets
Capital
Add: NP
Less: Drawings

Marshalling and Grouping of Assets and Liabilities:

• Arrangement of assets and liabilities in a particular order is known as Marshalling. The
assets and liabilities are arranged either in the order of liquidity or permanence.
• Grouping the assets and liabilities items under different heads in balance sheet is called
grouping.

Final Accounts – Adjustments: Adjustments are made at the end of accounting year to
adjust incomes or expenses, received or paid in advance and income or expenses accrued
but not received or paid. The purpose of making various adjustments is to ensure that the
final accounts reveal the true profit or loss and the true financial position of the business.

Items which usually need adjustments

➢ Closing Stock ➢ Outstanding Expenses
 ➢ Prepaid/Unexpired Expenses ➢ Bad-Debts
➢ Accrued Income ➢ Provision for Bad and Doubtful
➢ Income Received in Advance Debts
➢ Depreciation ➢ Provision for Discount on Debtors

Accounting treatment of accounting adjustment: Adjustments can be understood with

the following examples.

Ex. 1 Closing stock: When closing stock is given outside the trial balance, it is shown in
the credit side of trading account and in the assets side of the balance sheet.

Trial Balance
Particulars Rs. Particulars Rs.
Opening Stock 1,000 Int. Received 4,000
Purchases 6,000 Sales 15,000
Wages 2,000 Capital 33,000
Salary 3,000 Creditors 4,000
Cash 10,000
Furniture 30,000 Adjustment: Closing Stock Rs.
Debtors 4,000 2,000

Total 56,000 Total 56,000

Solution:
 Trading and Profit & Loss Account
Dr. (for the year ended…………….)
Cr.
Particulars Amount Particulars Amount
To Opening Stock 1,000 By Sales 15,000
To Purchase 6,000 By Closing Stock 2,000
To Wages 2,000
To G/P 8,000
17,000 17,000
To Salary 3,000 By G/P 8,000
To N/P 9,000 By Interest 4,000
12,000
Balance Sheet 12,000

(as at …………….)
Liabilities Amount Assets Amount
Capital 33,000 Cash 10,000
Add: N.P. 9,000 42,000 Furniture 30,000
Creditors 4,000 Debtors 4,000
Stock 2,000
46,000 46,000

Ex. 2 Closing stock: When closing stock is given in the trial balance, it is not shown in
the Trading Account as it is already adjusted with purchases. It is shown in the assets
side of the balance sheet.
 Trial Balance
Particulars Rs. Particulars Rs.
Opening Stock 1,000 Int. Received 4,000
Purchases 4,000 Sales 15,000
Closing Stock 2,000
Wages 2,000 Capital 33,000
Salary 3,000 Creditors 4,000
Cash 10,000
Furniture 30,000
Debtors 4,000
Total 56,000 Total 56,000

Trading and Profit & Loss Account

Dr. (for the year ended…………….) Cr.
Particulars Amount Particulars Amount
To Opening Stock 1,000 By Sales 15,000
To Purchase 4,000
To Wages 2,000
To G/P 8,000
15,000 15,000
To Salary 3,000 By G/P 8,000
To N/P 9,000 By Interest 4,000
12,000 12,000

Balance Sheet
(as at ……….)
Liabilities Amount Assets Amount
Capital 33,000 Cash 10,000
Add: N.P. 9,000 42,000 Furniture 30,000
Creditors 4,000 Debtors 4,000
Stock 2,000
46,000 46,000
Ex. 3. Outstanding Expenses: Outstanding expenses are shown in Dr. side of trading
and profit and loss account and shown in the liability side of the balance sheet.

Trial Balance Adjustment:

Particulars Rs. Particulars Rs.
1. Closing Stock Rs. 2,000
Opening Stock 1,000 Int. Received 4,000
Purchases 6,000 Sales 15,000 2. Outstanding Wages Rs. 500
Wages 2,000 Capital 33,000
Salary 3,000 Creditors 4,000
Cash 10,000
Furniture 30,000
Debtors 4,000
Total 56,000 Total 56,000

Trading and Profit & Loss Account

Dr. (for the year ended…………….) Cr.
Particulars Amount Particulars Amount
To Opening Stock 1,000 By Sales 15,000
To Purchase 6,000 By Closing Stock 2,000
To Wages 2,000
Add: Out. Wages 500
To G/P 7,500
17,000 17,000
To Salary 3,000 By G/P 7,500
To N/P 8,500 By Interest 4,000
11,500 11,500
 Balance Sheet
(as at …………….)
Liabilities Amount Assets Amount
Capital 33,000 Cash 10,000
Add: N.P. 8,500 41,500 Furniture 30,000
Out. Wages 500 Stock 2,000
Creditors 4,000 Debtors 4,000
46,000 46,000

Ex. 4 Prepaid Expenses: Prepaid expenses are shown as an asset in the asset side of
balance sheet. If these are included in the current year expenses in the trial balance then
the amount of prepaid expenses is deducted from the related expenses so that only current
Trial Balance year related expenses have their
Particulars Rs. Particulars Rs.
impact in the trading and profit and
Opening Stock 1,000 Int. Received 4,000
loss account.
Purchases 6,000 Sales 15,000
Wages 2,000 Capital 33,000 Adjustment:

Salary 3,000 Creditors 4,000 1. Closing Stock Rs. 2,000

Cash 10,000
2. Outstanding Wages Rs. 500
Furniture 30,000
3. Prepaid Wages Rs. 100
Debtors 4,000
Total 56,000 Total 56,000
 Trading and Profit & Loss Account
Dr. (for the year ended…………….) Cr.
Particulars Amount Particulars Amount
To Opening Stock 1,000 By Sales 15,000
To Purchase 6,000 By Closing Stock 2,000
To Wages 2,000
Add: Out. 500
Less: Prep. 100 2,400
To G/P 7,600
17,000 17,000
To Salary 3,000 By G/P 7,600
To N/P 8,600 By Interest 4,000
11,600 11,600

Balance Sheet
(as at …………….)
Liabilities Amount Assets Amount
Capital 33,000 Cash 10,000
Add: N.P. 8,600 41,600 Furniture 30,000
Outstanding Wages 500 Stock 2,000
Creditors 4,000 Debtors 4,000
Prepaid Wages 100
46,100 46,100
Ex. 5 Accrued Income: Accrued income is shown in the credit side of Profit and Loss
Account and shown as an asset in the asset side of balance sheet.

Trial Balance Adjustment:

Particulars Rs. Particulars Rs.
1. Closing Stock Rs. 2,000
Opening Stock 1,000 Int. Received 4,000
Purchases 6,000 Sales 15,000 2. Outstanding Wages Rs. 500
Wages 2,000 Capital 33,000 3. Prepaid Wages Rs. 100
Salary 3,000 Creditors 4,000 4. Accrued Interest Rs. 400
Cash 10,000
Furniture 30,000
Debtors 4,000
Total 56,000 Total 56,000
Trading and Profit & Loss Account
Dr. (for the year ended…………….) Cr.
Particulars Amount Particulars Amount
To Opening Stock 1,000 By Sales 15,000
To Purchase 6,000 By Closing Stock 2,000
To Wages 2,000
Add: Out. 500
Less: Prep. 100 2,400
To G/P 7,600
17,000 17,000
To Salary 3,000 By G/P 7,600
To N/P 9,000 By Interest 4,000
Add: Accrued Int. 400
12,000 12,000
 Balance Sheet
(as at …………….)
Liabilities Amount Assets Amount
Capital 33,000 Cash 10,000
Add: N.P. 9,000 42,000 Furniture 30,000
Outstanding Wages 500 Stock 2,000
Creditors 4,000 Debtors 4,000
Prepaid Wages 100
Accrued Interest 400
46,500 46,500

Ex. 6 Income Received in Advance: Income Received in Advance is shown in the liability
side of the balance sheet, till the time it is not earned. It is not the income of the current
year and if it is included in related income of the year, the advance income is deducted so
that it may have no impact on current year’s profit or loss.
 Particulars Rs. Particulars Rs. Adjustment:
Opening Stock 1,000 Int. Received 4,000
1. Closing Stock Rs. 2,000
Purchases 6,000 Sales 15,000
Wages 2,000 Capital 33,000 2. Outstanding Wages Rs. 500
Salary 3,000 Creditors 4,000 3. Prepaid Wages Rs. 100
Cash 10,000 4. Accrued Interest Rs. 400
Furniture 30,000 5. Interest received in advance Rs.
Debtors 4,000
300
Total 56,000 Total 56,000

Trading and Profit & Loss Account

Dr. (for the year ended…………….) Cr.
Particulars Amount Particulars Amount
To Opening Stock 1,000 By Sales 15,000
To Purchase 6,000 By Closing Stock 2,000
To Wages 2,000
Add: Out. 500
Less: Prep. 100 2,400
To G/P 7,600
17,000 17,000
To Salary 3,000 By G/P 7,600
To N/P 8,700 By Interest 4000
Add: Accrued 400
Less: Advance 300 4,100
11,700 11,700
 Balance Sheet
(as at …………….)
Liabilities Amount Assets Amount
Capital 33,000 Cash 10,000
Add: N.P. 8,700 41,700 Furniture 30,000
Outstanding Wages 500 Stock 2,000
Creditors 4,000 Debtors 4,000
Int. Received in Advance 300 Prepaid Wages 100
Accrued Interest 400
46,500 46,500

Ex. 7 Depreciation: Depreciation is an expense and hence it is shown in the Dr. side of
Trading and Profit & Loss Account and it is deducted from the related asset.

Particulars Rs. Particulars Rs. Adjustment:

Opening Stock 1,000 Int. Received 4,000
1. Closing Stock Rs. 2,000
Purchases 6,000 Sales 15,000
2. Outstanding Wages Rs. 500
Wages 2,000 Capital 33,000
3. Prepaid Wages Rs. 100
Salary 3,000 Creditors 4,000
4. Accrued Interest Rs. 400
Cash 10,000
5. Interest received in advance Rs.
Furniture 30,000
300
Debtors 4,000
6. Depreciate furniture @ 10%.
Total 56,000 Total 56,000

Trading and Profit & Loss Account

 Dr. (for the year ended…………….) Cr.
Particulars Amount Particulars Amount
To Opening Stock 1,000 By Sales 15,000
To Purchase 6,000 By Closing Stock 2,000
To Wages 2,000
Add: Out. 500
Less: Prep. 100 2,400
To G/P 7,600
17,000 17,000
To Salary 3,000 By G/P 7,600
To Depreciation 3,000 By Interest 4000
Add: Accrued 400
To N/P 5,700 Less: Adv. 300 4,100
11,700 11,700

Balance Sheet
(as at …………….)
Liabilities Amount Assets Amount
Capital 33,000 Cash 10,000
Add: N.P. 5,700 38,700 Furniture (30,000 – 3,000) 27,000
Outstanding Wages 500 Stock 2,000
Creditors 4,000 Debtors 4,000
Int. Received in Advance 300 Prepaid Wages 100
Accrued Interest 400

43,500 43,500
Ex. 8 Bad Debt, Provision for Bad and Doubtful Debts, Provision for Discount on
Debtors:

Bad Debts in the trial balance: Bad debts given in the trial balance are shown in the
debit side of the trading and profit and loss account.

Further Bad Debts (given outside the trial balance): Further bad debts are the additional
bad debts and these are also shown in the debit side of the trading and profit and loss
account. These are also deducted from the debtors as this amount cannot be recovered.

Provision for Bad and Doubtful Debts: It is considered loss to the business hence the
amount of provision required to be made (excess of new provision required over old
provision existed in the books) during the current year is shown in the debit side of the
trading and profit and loss account. Amount of provision for Bad and Doubtful Debts is
calculated on debtors after deducting further bad debts if any. The amount of new provision
is shown in the liability side of the balance sheet or it can be shown as a deduction from
the debtors.

Provision for Discount on Debtors: It is also a loss to the business hence the amount of
provision required to be made for discount on debtors during the current year is shown in
the debit side of the trading and profit and loss account. The provision for discount on
debtors is calculated on the good debtors i.e. debtors after deducting provision for bad and
doubtful debts. The amount of provision for discount on debtors is shown in the liability
side of the balance sheet or it can be shown as a deduction from the debtors.
 Trial Balance Adjustment: 1. Closing Stock Rs.
Particulars Rs. Particulars Rs. 2,000
Opening Stock 1,000 Int. Received 4,000 2. Outstanding Wages Rs. 500
Purchases 6,000 Sales 15,000 3. Prepaid Wages Rs. 100
Wages 2,000 Capital 33,000 4. Accrued Interest Rs. 400
Salary 3,000 Creditors 4,000
5. Interest received in advance Rs.
Cash 10,000
300
Furniture 30,000
6. Depreciate furniture @ 10%.
Debtors 3,600
7. Write off further bad debts Rs. 600
Bad Debts 400
8. Make a provision for bad and
Total 56,000 Total 56,000
doubtful debts @5%.
9. Make a provision for discount on debtors @10%.

Trading and Profit & Loss Account

Dr. (for the year ended…………….) Cr.
Particulars Amount Particulars Amount
To Opening Stock 1,000 By Sales 15,000
To Purchase 6,000 By Closing Stock 2,000
To Wages 2,000
Add: Out. 500
Less: Prep. 100 2,400
To G/P 7,600
17,000 17,000
To Salary 3,000 By G/P 7,600
To Depreciation 3,000 By Interest 4000
To B. Debt 400 Add: Accrued 400
Add: F.B.D. 600 Less: Adv. 300 4,100
Add: Prov. 150 1,150
To Prov. for Disc. 285
To N/P 4,265
11,700 11,700

Balance Sheet (as at …………….)

 Liabilities Amount Assets Amount
Capital 33,000 Cash 10,000
Add: N.P. 4,265 37,265 Furniture 27,000
Outstanding Wages 500 Stock 2,000
Creditors 4,000 Debtors (3600-600-150-285) 2,565
Int. Received in Advance 300 Prepaid Wages 100
Accrued Interest 400
42,065 42,065