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 Accounting and Auditing
Basics of Accounting
Definitions of Accounting
• Accounting is science as well as an art.
• Some prominent definitions of accounting to help us better understand the meaning of basic accounting.
• According to the Committee of Terminology of American Institute of Certified Public Account:” Accounting is the
art of recording, classifying summarizing in a significant manner and in terms of money, transaction, and events
which are, in part at least of a financial character and interpreting the results thereof.”
• According to Bierman and Drebin:” Accounting may be defined as identifying, measuring, recording and
communicating of financial information.”
• Therefore, accounting can be defined as “the process of recording, summarizing, reporting and analyzing
required financial information relating to the economic events of an organization to the interested users
for making decisions.”

Components of Basic Accounting

1. Recording
The primary function of accounting is to make records of all transactions that the firm enters into. For the purpose of
recording, the accountant maintains a set of books. Their procedures are very systematic. Nowadays, the
computer has been deployed to automatically account for transactions as they happen.
2. Summarizing
Recording of transactions creates raw data. Pages and pages of raw data are of little use to an organization for
decision making. For this reason, the accountant classifies data into categories.
3. Reporting
Management is answerable to the investors about the company’s state of affairs. The operations that are being
financed with the money of owners, it needs to be periodically updated to them. For this reason, there are periodic
reports annually summarizing the performance of all four quarters which are sent to them.

In the form of financial statements reporting is done. To ensure that there is no misleading financial reporting, these
financial statements are also regulated by government bodies.

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4. Analyzing
• Lastly, accounting entails conducting an analysis of the result. After results have been summarized and reported,
a meaningful conclusion needs to be drawn. Management must find out its positive and negative points.
Accounting helps in doing so by means of comparison. It factors to compare profit, cash, sales, and assets, etc.
with each other to analyze the performance of the business.
• Thus accounting is a language of business. It communicates the performance of the business with various end-
users who are interested to know about the business. Accounting provides quantitative information of
financial nature to both management and other users so that they can take a proper decision about the
business.

Primary Characteristics of Accounting

• The following are the primary characteristics of accounting as follows-
• Relevance: Relevance in accounting is closely related to the concept of useful information. It means that the
information must be capable of making a difference in taking various decisions by the users. The information
gathered by users relevant for one purpose may not be necessarily relevant for other purposes. The relevant
information also reduces decision-maker’s uncertainty about future acts.
• Reliability: Reliable information is required to form judgments about the earning potential and financial position of
a business firm. Reliability differs from item to item. There are many factors affecting the reliability of information
such as uncertainties inherent in the subject-matter and accounting measurements.

Secondary Characteristics of Accounting-

The following are the secondary characteristics of accounting as follows-
• Comparability: Comparability means that the users should be able to compare the accounting information of an
enterprise of the period either with that of other periods, known as an intra-firm comparison or with the accounting
information of the other enterprises, known as an inter-firm comparison.
• Understandability: Understandability means that the information provided through the financial statements must
be presented in a manner that the users are able to understand it.

Objective of Accounting
The following are the main objectives of accounting: -
• To keep Systematic Records
The main objective of accounting is to keep a systematic record of financial transactions which helps the users to
understand the day to day transactions in a systematic manner so as to gain knowledge about overall business.
• To Protect Business Properties
Accounting provides protection to business properties from unjustified and unwarranted use. Information about the
above matters helps the proprietor in assuring that the funds of the business are not necessarily kept idle or
underutilized.
• Ascertain Profit
Another objective of accounting is that it helps in ascertaining the net profit earned or loss suffered on account of
carrying the business which is done by keeping a proper record of all books of accounts with respect to revenues
and expenses of a particular period.
• Ascertain the Financial Position
The accounting also helps the businessman to know about his financial position. This objective is served by the
Balance Sheet or Position Statement. The Balance Sheet is a statement of assets and liabilities of the business on a
particular date. It serves as a tool for ascertaining the financial health of the business.
• Facilitate Decision Making
Accounting also helps in the collection, analysis, and reporting of information at the required points of time to the
required levels of authority in order to facilitate rational decision-making.
• Information System
Another objective of accounting is that it can be defined as accounting functions as an information system for
collecting and communicating economic information about the business enterprise. This information helps the
management in taking appropriate decisions.
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Roles of Accounting
Accounting plays an important and useful role in developing the information for various types of users. The major roles
of accounting in different areas are as follows-
• Since the increased volume of business results in a large number of transactions and no businessman can remember
everything. Therefore, accounting records reduce the necessity of remembering various transactions.
• Another role of accounting records is that it should be prepared on the basis of uniform practices will enable a
business to compare results of one period with another period.
• The various different authorities have their opinion according to which, they believe that the facts contained in the
set of accounting books are maintained according to generally accepted accounting principles which will help in
better understanding for users of financial information.
• Those accounting records which are supported by proper and authenticated vouchers are good evidence in a court
of law.
• Another concerned role is that if a business is to be sold as a going concern, then the various values of different
assets which are shown by the balance sheet will help in bargaining proper price for the business.

Basic Terms of Accounting

In accounting, many technical words are commonly used. Therefore, it is essential to know their meaning, without which
knowledge of accounting subject will be incomplete. Commonly used terms such as business, purchase, purchase return,
trade etc are explained here.
1. Business
Any legal action that is done in order to earn income or profit is called business. It includes the production of goods
and services, purchase and sale of goods and services, banking, insurance, education transportation, and any other
trading activity etc.
2. Trade
Purchase and sale of goods and services in order to earn profit is called trade.
3. Profession
Any work done in order to earn profit which necessarily requires prior training and education is called a profession.
For example doctors, lawyers, engineers etc..
4. Proprietor
The person who invests capital in the business and entitled to have all profits and losses of the business is
called proprietor or owner of the business. The nature of proprietor depends upon the type or nature of the
business organization. In a sole trade business, sole trader is a proprietor, in a partnership firm, partners or
proprietor and in company shareholders are proprietors.
5. Capital
The amount of cash, goods or assets which is initially invested by proprietor while commencing business is called
capital. It is invested to earn profits. In other words, the excess of assets over liability is capital.
6. Assets
All the resources of business having economic value are called assets. These resources help the business to earn a
profit and have future value. These are important for running a business and are in the possession of businessman.
These are of two types:
a. Fixed assets
The assets which are used by business for a long time are called fixed assets or non-current assets. These are
continued to be used by the business for a period of more than one year. For example: - land ,building ,plant,
machinery ,furniture ,vehicle etc.
b. Current assets
The assets which are used up in one year or easily get converted into cash in one year are called current assets.
For example: - raw material, finished goods, debtors, cash balance and bank balance etc.

7. Liabilities
The amount which business owes to others is called its liabilities. There is a certain amount which business is under
obligation to pay. There are two types of liabilities: –
a. Long-term liabilities
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 Those liabilities which are usually payable after a period of 1 year. Long-term loans from Financial Institutions,
debentures (it is a long term debt instrument and the debenture holders are given preference over shareholders
in case of liquidation of a company) issued by companies etc.
b. Short-term liabilities
These are those which are payable within one year. For example, creditors, bank overdrafts (using this account
holder can withdraw more money than what they have in their account up to the approved limit, which has to be
paid back later on with interest) etc.
8. Drawings
The amount of cash or goods which is withdrawn by proprietor from business for its private uses is called
drawings. It reduces the capital of the business.
9. Goods
The things which are bought and sold by business are called goods. Goods, maybe raw material work in progress of
finished goods. In accounting, when goods are purchased it is written as purchases. When goods are sold it is written
as sales. It is written as a stock (of tangible items) if it remains unsold at the end of the year.
10. Purchases
Goods bought for resale are called purchases. This may be in the form of raw material or finished goods. Purchase of
assets is not called purchases because assets are not purchased for resale.
11. Sales
When purchase goods are sold in order to earn a profit are called sales. When goods are sold for cash it is called cash
sales and goods sold on credit are called credit sales.
12. Purchase return
Goods once purchased by the business, are returned back due to any reason called purchase return or return
outwards.
13. Sales return
Goods once sold to the customer when are returned back by them due to any reason then such goods are called as
sales returns or return inwards.
14. Stock
These are those goods which are left unsold in the business at the end of the year. The goods unsold at the end of the
accounting year are called closing stock. The same stock is called opening stock at the beginning of a new accounting
year.
15. Revenue
These are the amount received by a business for selling goods or services. This amount is received from day to day
business activity in the form of rent, interest, commission, discount, dividend etc.
16. Expenses
The cost which business incurs for producing goods and services or for using services is called expenses. These
include payments made for wages, salaries, freight, advertisement, rent, insurance etc. In other words, we can say
that the cost of earning revenue is an expense.
17. Expenditure
The amount which is paid for increasing the profit earning capacity of business is called expenditure. It is of long
period nature. Money spent to create capital.
18. Income
That amount which increases the capital of the business is called income. The excess of revenue over expenses is
also called income.
19. Loss
When expenses incurred are more than revenue then this excess of expenses is called loss. This reduces the capital
of the business.
20. Gain
It is a monetary receipt as a result of a business transaction. The excess of revenue over the expenses is called gain.
21. Cost
Total of direct or indirect expenses which are incurred for the production of goods and services is called cost. Like
the cost of raw material, cost of labor and cost of other services used to make the article is called its total cost.
22. Discount

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 Concession or a rebate allowed by a businessman 2 its customer is called a discount. it may be of two types: –
a. Trade discount
When a trader allows a concession to its customers on the list price, it is known as trade discount. It is not
recorded in the books. It is stated in the invoice.
b. Cash discount
When a trader allows a concession to the customer to make payment in cash or by cheque, it is known as cash
discount. It is recorded in the books. When a cash discount is allowed, the customer is required to pay the less
due amount, so it encourages the customer to pay as early as possible.
23. Debtor
The person, firm or an organization who takes goods or services on credit from the business are called debtors of
the business. In other words, the person, firm or an organization who owes money or Money’s worth to the business
is called debtor.
24. Creditors
The person, firm or an organization from whom goods or services are purchased on credit by the business are called
creditors of the business. The business owes money to them. The amount payable to creditors is a liability of the
business.
25. Receivables
The total amount which is to be received in business is called receivables.
26. Payables
The total amount which is to be paid by the business is called payables.
27. Entry
Recording of the transaction in account books is called making an entry or the record of a transaction in books is
called an entry.
28. Turnover
The total amount of cash and credit sales during a particular period is called turnover.
29. Insolvent
A person is said to be insolvent when he or she is incapable to meet all his or her liabilities. Such a person has more
liability than assets.
30. Bad debts
The amount which could not be recovered from debtors due to his insolvency or disability to pay is called bad debts.
31. Vouchers
The written document through which financial transactions are recorded in the books is called voucher.
32. Account
A list of all transactions relating to a person, property, income expenses is called into account. It is a tabular
statement containing all the transactions of the same nature at one place under a common heading in a systematic
manner.
33. Debit and credit
Every account has two sides. Left side is called the debit side and the right side is called the credit side. In short, it is
Dr. and Cr.
34. Commission
In a business activity, a remuneration is paid to the agent for his services, called commission.

Limitations of Accounting
Nine limitations of accounting are;
1. Recording only monetary items
• As per accounting principles, only the events measurable in terms of money are recorded in the books of
accounts. But events of great importance if not measurable in terms of money is not accounted for.
• For that reason, recorded accounting information fails to exhibit the exact financial position of a business
concern.
2. Time Value of Money
• Under the accounting system, money value is treated constantly.

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 • But the value of money always changes due to inflation. Under existing accounting systems accounts are
maintained considering historical cost ignoring current changed value.
• As a result, the accounts maintained fail to exhibit the exact financial position of a business concern.
3. Recommendation of alternative methods
• There exists an application of alternative methods in determining depreciation of assets and valuation of stock
etc.
• Information regarding the activities of business is expressed in a misleading way if an alternative method is used
to achieve a particular object.
4. Restrain of Accounting Principles
• Exhibited accounting information cannot always exhibit a true and fair picture of a business concern owing to
limitations of the accounting principles used.
• For example, fixed assets are shown after deducting depreciation. In the case of inflation, the value of fixed
assets shown in the accounts does not correspond to the real position.
5. Recording of past events
• Accounting past events are accounted for.
• But naturally, there is no system of recording events that may occur in the future.
6. Allocation of problem
• The allocation process is an important problem in the accounting system. The value of fixed assets is exhausted
charging depreciation for the allocated period.
• The useful life of fixed assets is fixed up hypothetically which does not stand accurately in most cases.
7. Maintaining secrecy
• Secrecy cannot be ensured for the involvement of many employees in accounting work although maintaining
secrecy is very important.
8. The tendency for secret reserves
• Often management creates secret reserves intentionally by increasing or decreasing assets and liabilities for
which the total financial picture of an organization is not reflected.
9. Importance of form over substance
• At the time of preparing accounts for a particular period emphasis is laid on form, table, etc. instead of giving
importance to an exhibition of substantial information.
• As per Company Act, preparation of the balance sheet in the prescribed form is mandatory.
• Although there are some limitations in the present accounting system, accounting in the present day world has
generally been accepted as a recognized profession.
• Efforts are on throughout the world to overcome these limitations. Economic activities of any society without
accounting are neither possible nor legal.

Process of Accounting
● Accounting is a systematic process of identifying, recording, measuring, classifying, verifying, summarizing,
interpreting and communicating financial information. It reveals profit or loss for a given period and the value and
the nature of a firm’s assets and liabilities and owners’ equity.
● In other words, accounting is a practice and body of knowledge concerned primarily with
● Method for recording transactions,
● Keeping a financial record,
● Performing internal (and external audit by the 3rd party) audit (Internal Audit is a department or an organization of
people within a company that is tasked with providing unbiased, independent reviews of systems, business
organizations, and processes.)
● Reporting and analyzing financial information to the management and
● Advising on taxation matters.

Branches of Accounting
1. Financial Accounting
• Financial Accounting is based on a systematic method of recording transactions of any business according to
the accounting principles.

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 • It is the original form of the accounting process.
• The main purpose of financial accounting is to calculate the profit or loss of a business during a period
and to provide an accurate picture of the financial position of the business as on a particular date.
• The Trial Balances, Profit & Loss Accounts and Balance Sheets of a company are based on an application of
financial accounting. (Multiple entries in various accounts will make a Ledger. Taking all the ledger balances
and presenting them in a single worksheet as on a particular date is Trial Balance. The purpose of a trial
balance is to ensure that all entries made into an organization's general ledger are properly balanced.)
• These are used by creditors, banks and financial institutions to assess the financial status of the company. There
may be internal and external users.
• Further, taxation authorities are able to calculate the tax based on these records only.
2. Cost Accounting
• Cost accounting deals with evaluating the cost of a product or service offered. It calculates the cost by
considering all factors that contribute to the production of the output, both manufacturing and administrative
factors.
• The objective of cost accounting is to help the management in fixing the prices and controlling the cost of
production.
• It also pins points any wastages, leakages and defects during manufacturing and marketing processes.
3. Management Accounting
• This branch of accounting provides information to management for better administration of the business. It
helps in making important decisions and controlling various activities of the business. The management is able
to take decisions efficiently with the help of various Management Information Systems such as Budgets,
Projected Cash Flow and Fund Flow Statements, Variance Analysis reports, Cost-Volume-Profit Analysis reports,
Break-Even-Point calculation, etc.
• Management accounting and financial accounting are not to be confused with each other. Both are different.
• Management accounting serves the needs of the management in decision makings regarding minimization
of the cost factor and enhancing of profit making. It mainly helps the internal users of the company.
• Financial accounting serves the needs of shareholders, creditors and financial institutions for ascertaining the
financial position of the company. It mainly helps the external users.
• Management accounting records are kept secret for the use of management only. They are not made public.
• Besides the above mentioned three branches of accounting, there are many other branches which are in practice
and very useful for various purposes as mentioned below:
4. AUDITING
• Auditing is a branch of accounting where an external certified public accountant known as Auditor, inspects and
certifies the accounts of a business for their accuracy and consistency. Sometimes internal auditing is also
practiced where an employee of the same company audits the accounts on the regular basis and aids the
management in keeping accurate records for audit purposes.
5. Tax Accounting
• Tax Accounting deals with taxation matters. Its functions include preparation and filing of various tax returns
and dealing with their legal implications.
• Tax accountants aid in minimizing tax payments and also help financial accountants in preparing financials for
tax reporting to various authorities. Tax accounting involves consultancy regarding the effect of taxes on
different aspects of business, minimizing tax through legal ways and also verifying consequences of tax payable
on business.

Fund Accounting
• It deals with keeping records for funds of non-profit business entities. Separate fund accounts are maintained for
separate works like welfare schemes of different nature to ensure proper utilization of funds.

Government Accounting
• It is done for Central Government (National Government) and State Government budget allocations and utilization.
Keeping records ensures proper and efficient utilization of the various budget allocations and safety of public funds.

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Forensic Accounting
• Forensic Accounting also known as legal accounting enables calculating damages or settling disputes in legal
matters. Investigations are done and calculations are carried out to evaluate the damages accurately.

Fiduciary Accounting
• It is the accounting and evaluation of a third party’s business and property maintained under the guardianship of
another person.

Types of Accounting methods

• There are two types of accounting methods: CASH AND ACCRUAL. Most small businesses can use either method.
• The cash accounting method is the simplest method. When money comes in, revenue is recorded. When money
goes out, an expense is recorded. Under this, entry is made only when cash is received or paid.
• In accrual (due) accounting, revenue is recorded when it’s earned, not when money actually comes in. A
company can perform a service and bill the client. Even if the client hasn’t paid yet, revenue is still recorded in the
books.
• Expenses are matched to revenue in accrual accounting, meaning they’re recorded at the same time as
revenue. So if a house painter has to buy paint for a job, the total income for the job and the cost of the paint are
recorded in the books at the same time. It doesn’t matter exactly when the paint was purchased. Accrual accounting
is also known as mercantile system of accounting as it is generally followed by merchants. Periodic income (cost is
matched to the corresponding revenue for the same time period when it is accrued on) is ascertained through an
accrual system of accounting. When the cost is not determined against the revenue for the same time period when it
was accrued on and the cost is carry-forwarded and when after sometime it loses its utility, then this cost is shown
as loss in the accounting.

Cash Basis Accrual Basis

Definition Record transaction only when Record transaction when it

cash is actually received or occurs, even if cash is not
paid received or paid

Example: You purchased 100 No transaction recorded Transaction recorded through

units of a product and will an accounts payable
pay for it next month. (liability) account

Accounting as a Source of Information

Accounting is regarded as the language of a business. It is used as a means of communication between a
business organization and its shareholders.
The accounting process is a source of information, it uses business data and processes it to generate relevant
information. Let us have a look.
• Accounting is the management information system of any organization and is concerned with providing necessary
information to the management, i.e it is a source of information.
• In the account, every step involves either generation or processing accounting information. It serves as a means as
well as an end of providing information to all stakeholders who need information to make a proper decision.

Accounting serves following purposes relating to generating and processing information: -

• The accounting records business transactions which is the source of generating information.
• Proper accounting system makes information more reliable.
• Accounting ensures it is a reliable source of information.
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• Accounting works as a management information system to the organization. It helps the management to manage
the organization in a proper way.
• Accounting system generates various information in the form of different accounts. These documents have to be true
and fair.
• Accounting shows the performance of any business organization. Anyone who wants to know about the progress of
an organization can only know through the use of accounting.
• Accounting provides information on activities that affect the society.
• As we all know titles in accounting are done by a person known as an accountant.
• An accountant generates accounting information by observing, screening and recognizing events and transactions in
the business.
• He measures and processes information and compile reports comprising accounting information that is
communicated to the users. Then these are interpreted and uses by management and other user groups.
• It is the responsibility of the accountant that the information provided must be relevant, adequate and reliable for
decision making.

Users of Accounting Information

• Accounting information is used by many parties for making decisions in business. All those who use accounting
information about the business to make decisions called Users. They are basically users of accounting information.
These are different parties in the business who have some stake in the business. Users have a stake in the business
in the form of
• Investment in business
• Loans to the business
• Goods sold on credit to the business
• Job in the business.
• Consumers of goods and services produced by the business etc.
• But the main purpose of all the users is that all of them want to know about the performance, progress, and working
of the business organization. The users of accounting information are divided broadly into two categories: -

1. Internal users
2. External users
Internal Users
• These are the parties who are directly involved with the management and working of the organization. They work
with the organization and have the power to influence the working of an organization. For them too, accounting is a
source of information.
• Internal uses include owners, partners, directors, managers, and employees etc. Different users need different
information from the accounting. It can be discussed in the following manner:

1. Owners/Proprietor/Partners
• They want to know about the probability of an organization. These are interested in getting a good return on
their investment. These are all interested to know how the financial position of the business organization ie It is
their responsibility to take a decision about the future policies and performance of the business according to this
data.
2. Management
• The success of the management depends on the success of an organization. The performance of the management
is evaluated according to the profits of a business.
• If the business grows, salaries of management staff will also grow. Management is also responsible to know
whether a business is able to pay its liabilities or not. The management will be interested to know if the business
is showing overall growth and performance. Their source of information, in this case, will be the accounts of the
company.
3. Employees and Workers

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 • They are interested to know whether the business is earning profits or not. If the business is in loss, then it is the
possibility that some employees may be removed from a job. These are also interested to know if they should
continue in the same organization. This will depend on the future prospect of an organization.

External Users
• All those parties and individuals who are not directly involved in the management and operation of the business
now are external users. These do not have the power to influence the working of the organization. Such users
include investors, creditors, suppliers, customers, banks, financial institutions, government, existing shareholders,
potential shareholders and suppliers of raw materials etc.
• Every different user needs a different kind of accounting information. It can be discussed in the following manner –

1. Bankers/Lenders
• These want to know interest on their loans. They will be able to get interested when the businesses are earning
profits. The financial position of the business is good then it will be able to pay back the loans.

2. Creditors
• These want their money back from the business and it depends upon the financial position of the business.

3. Customers
• These want to know the future policies of the business. If the business will continue in the future, then the
demand for customers increases.

4. Government
• Government is interested to know how the trade in an industry is doing in the country. The government
departments collect data related to revenues, sales, production, number of employees etc. of business to know
the condition of the economy. It is also interesting to know how much taxes have been paid by the business
5. Society
• The business organization uses the resources of society. Therefore, society expects the business to generate
employment for them. Therefore, society would like to know how many people are employed in the business.
• Society is also interested to know how many welfare activities are done by a business organization for them.
Societies want to know the policies of CSR (corporate social responsibility). A successful business provides a lot
of services to the people in the society like hospitals, schools, thinking water, food to school children, making
roads etc.
• Thus accounting as the language of business is used to exchange information between business and its partners.

Characteristics of Accounting information

• Relevance • Reliability • Comparability
• Understandability • Timeliness • Cost-Benefit
• Verifiability • Neutrality • Completeness

Role of Accountant
• Maintenance of books of accounts • Statutory Audit (auditing according to the laws of the country)
• Internal Audit • Budgeting • Taxation
• Investigation • Management Advisory Service • Other activities

Bookkeeping and Accounting

• Book-keeping and accounting are different from each other. Bookkeeping is an important part of accounting.
Accounting is broader than book-keeping. Accounting includes a design of accounting systems which book-keepers
use for the preparation of financial statements, audits, cost studies, income-tax statements, etc.
• It also facilitates the interpretation of accounting information for both internal and external users for business
decisions making. It requires skills and experience of an accountant.

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There is a difference between the two terms bookkeeping and accounting, let us understand what is bookkeeping and
accounting, their processes and difference between the two.
• While doing Bookkeeping, we need to follow the basic accounting concepts and accounting conventions.
• Bookkeeping is clerical in nature.
• Book-keeping is usually done by junior employees of the entity. Most of the entities nowadays use computers for
bookkeeping rather than recording them manually.
• Accounting of an entity depends on its book-keeping system.
• Book-keeping is the basis for accounting. It is because it is responsible for the proper recording of financial
transactions. Whereas, Accounting involves classification, summarizing and reporting of financial
transactions. It involves the preparation of source documents for all the financial transactions of the entity.

Process of Bookkeeping
• Identifying financial transactions
• Recording of financial transactions in Journal
• Preparation of ledger accounts
• Preparation of trial balance (found out mistakes and verifies the entries done in the ledger). if the credit and debit
side comes to be equal then the entries done in the ledger are correct.

Bookkeeping vs Accounting
Definition
• Bookkeeping is mainly related to identifying, measuring, and recording, financial transactions
• Accounting (consists of elaborate information) is the process of summarizing, interpreting, and communicating
financial transactions which were classified in the ledger account

Decision Making
• Management can't take a decision based on the data provided by bookkeeping
• Depending on the data provided by the accountants, the management can take critical business decisions
Objective
• The objective of bookkeeping is to keep the records of all financial transactions proper and systematic
• The objective of accounting is to gauge the financial situation and further communicate the information to the
relevant authorities

Preparation of Financial Statements

• Financial statements are not prepared as a part of this process (bookkeeping)
• Financial statements are prepared during the accounting process

Skills Required
• Bookkeeping doesn't require any special skill sets
• Accounting requires special skills due to its analytical and complex nature

Analysis
• The process of bookkeeping does not require any analysis
• Accounting uses bookkeeping information to analyze and interpret the data and then compiles it into reports

Types of Bookkeeping
• Basically there are two types of bookkeeping - Single entry and double entry bookkeeping
• The accounting department does preparations of a company's budgets and plans loan proposals

Bookkeepers and Accountants

• Bookkeepers are required to be accurate in their work and knowledgeable about financial topics. Bookkeepers work
is usually overseen by an accountant

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Accounting Principles
1. Accounting conventions
2. Accounting concepts
Accounting is known as the language of the business.

1. Accrual concept:
An accrual is a journal entry that is used to recognize revenues and expenses that have been earned or consumed,
respectively, and for which the related cash amounts have not yet been received or paid out.
• Accruals are needed to ensure that all revenues and expenses are recognized within the correct reporting
period, irrespective of the timing of the related cash flows.
• Without accruals, the amount of revenue, expense, and profit or loss in a period will not necessarily reflect the
actual level of economic activity within a business.
• Accruals are a key part of the closing process used to create financial statements under the accrual basis of
accounting; without accruals, financial statements are considerably less accurate.
• Under the double-entry (credit and debit side) bookkeeping system, an accrued expense is offset by a liability,
which appears in a line item in the balance sheet. If accrued revenue is recorded, it is offset by an asset, such as
unbilled service fees, which also appears as a line item in the balance sheet.
• It is most efficient to initially record most accruals as reversing entries. By doing so, the accounting software in
which they are entered will automatically cancel them in the following reporting period.
• This is a useful feature when you are expecting to issue an invoice to a customer or receive an invoice from a
supplier in the following period. For example, it is likely that a supplier invoice for $20,000 will arrive a few
days after the end of a month, but the controller wants to close the books as soon as possible.
• Accordingly, he records a $20,000 reversing entry to recognize the expense in the current month. In the next
month, the entry reverses, creating a negative $20,000 expense that is offset by the arrival and recordation of
the supplier invoice.

Accrual Examples
Examples of accruals that a business might record are:
• Expense accrual for interest. A local lender issues a loan to a business, and sends the borrower an invoice each
month, detailing the amount of interest owed. The borrower can record the interest expense in advance of invoice
receipt by recording accrued interest.
• Expense accrual for wages. An employer pays its employees once a month for the hours they have worked through
the 26th day of the month. The employer can accrue all additional wages earned from the 27th through the last day
of the month, to ensure that the full amount of the wage expense is recognized.
• Expense accrual for supplier goods and services. A supplier delivers goods at the end of the month, but is remiss
in sending the related invoice. The company accrues the estimated amount of the expense in the current month, in
advance of invoice receipt.
• Sales accrual. A services business has a number of employees working on a major project for the federal
government, which it will bill when the project has been completed. In the meantime, the company can accrue
revenue for the amount of work completed to date, even though it has not yet been billed.

Other Accrual Issues

• If a business records its transactions under the cash basis of accounting, then it does not use accruals.
Instead, it records transactions only when it either pays out or receives cash.
• The cash basis yields financial statements that are noticeably different from those created under the accrual basis,
since timing delays in the flow of cash can alter reported results. For example, a company could avoid recognizing
expenses simply by delaying its payments to suppliers.
• Alternatively, a business could pay bills early in order to recognize expenses sooner, thereby reducing its short-
term income tax liability.

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2. The conservatism principle
It is the general concept of recognizing expenses and liabilities as soon as possible when there is uncertainty about
the outcome, but to only recognize revenues and assets when they are assured of being received.
• Thus, when given a choice between several outcomes where the probabilities of occurrence are equally likely,
you should recognize that transaction resulting in the lower amount of profit, or at least the deferral of a profit.
• Similarly, if a choice of outcomes with similar probabilities of occurrence will impact the value of an asset,
recognize the transaction resulting in a lower recorded asset valuation.
• Under the conservatism principle, if there is uncertainty about incurring a loss, you should tend toward
recording the loss. Conversely, if there is uncertainty about recording a gain, you should not record the
gain.
• The conservatism principle can also be applied to recognizing estimates. For example, if the collections staff
believes that a cluster of receivables will have a 2% bad debt percentage because of historical trend lines, but
the sales staff is leaning towards a higher 5% figure because of a sudden drop in industry sales, use the 5%
figure when creating an allowance for doubtful accounts, unless there is strong evidence to the contrary.
• The conservatism principle is the foundation for the lower of cost or market rule, which states that you should
record inventory at the lower of either its acquisition cost or its current market value.
• The principle runs counter to the needs of taxing authorities, since the amount of taxable income reported tends
to be lower when this concept is actively employed; the result is less reported taxable income, and therefore
lower tax receipts.
• The conservatism principle is only a guideline. As an accountant, use your best judgment to evaluate a situation
and to record a transaction in relation to the information you have at that time. Do not use the principle to
consistently record the lowest possible profits for a company.

3. The economic (or business) entity principle

It states that the recorded activities of a business entity should be kept separate from the recorded activities of its
owner(s) and any other business entities. This means that you must maintain separate accounting records and bank
accounts for each entity, and not intermix with them the assets and liabilities of its owners or business partners.
Also, you must associate every business transaction with an entity. It is also known as separate entity concept.
• A business entity can take a variety of forms, such as a sole proprietorship, partnership, corporation, or
government agency. The business entity that experiences the most trouble with the economic entity principle is
the sole proprietorship, since the owner routinely mixes business transactions with his own personal
transactions.
• It is customary to consider a commonly-owned group of business entities to be a single entity for the purposes of
creating consolidated financial statements for the group, so the principle could be considered to apply to the
entire group as though it were a single unit.

Similar Terms
• The economic entity principle is also known as the business entity assumption, business entity principle, entity
assumption, entity principle, and economic entity assumption.
• The economic entity principle is a particular concern when businesses are just being started, for that is
when the owners are most likely to commingle their funds with those of the business.
• A typical outcome is that a trained accountant must be brought in after a business begins to grow, in order to sort
through earlier transactions and remove those that should be more appropriately linked to the owners.

4. Money Measurement Concept

• Only those transactions, which can be expressed in monetary terms, are recorded in accounting though
their quantitative records may also be kept. All business transactions should be expressed only in money.
Thus transactions, which cannot be expressed in money, will not be recorded in accounting books.
• Thus, labour-management relations, sales policy, labour unrest, effectiveness of competition etc., which are of
vital importance to business concern, do not find place in accounting.
• Another limitation of this concept makes the assumption that the money value is constant. It is contrary
to fact as there are fluctuations in the money value. For instance, a land, purchased for Rs 10,000 in 1980, may
cost four or five times in 2004. This is because of fall in money value.

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5. The going concern principle
It is the assumption that an entity will remain in business for the foreseeable future. Conversely, this means the
entity will not be forced to halt operations and liquidate its assets in the near term at what may be very low fire-sale
prices.
By making this assumption, the accountant is justified in deferring the recognition of certain expenses until a later
period, when the entity will presumably still be in business and using its assets in the most effective manner
possible.
• An entity is assumed to be a going concern in the absence of significant information to the contrary. An example
of such contrary information is an entity’s inability to meet its obligations as they come due without substantial
asset sales or debt restructurings. If such were not the case, an entity would essentially be acquiring assets with
the intention of closing its operations and reselling the assets to another party.
• If the accountant believes that an entity may no longer be a going concern, then this brings up the issue of
whether its assets are impaired, which may call for the write-down of their carrying amount to their liquidation
value. Thus, the value of an entity that is assumed to be a going concern is higher than its breakup value,
since a going concern can potentially continue to earn profits.
• The going concern concept is not clearly defined anywhere in generally accepted accounting principles, and so is
subject to a considerable amount of interpretation regarding when an entity should report it. However,
generally accepted auditing standards (GAAS) do instruct an auditor regarding the consideration of an
entity’s ability to continue as a going concern.
• The auditor evaluates an entity’s ability to continue as a going concern for a period not greater than one
year following the date of the financial statements being audited.
• The auditor considers (among other issues) the following items in deciding if there is a substantial doubt
about an entity’s ability to continue as a going concern: ---
• Negative trends in operating results, such as a series of losses
• Loan defaults by the company
• Denial of trade credit to the company by its suppliers
• Uneconomical long-term commitments to which the company is subjected
• Legal proceedings against the company
• If there is an issue, the audit firm must qualify its audit report with a statement about the problem.
• It is possible for a company to mitigate an auditor's view of its going concern status by having a third party
guarantee the debts of the business or agree to provide additional funds as needed. By doing so, the auditor is
reasonably assured that the business will remain functional during the one-year period stipulated by GAAS.

6. The matching principle

It requires that revenues and any related expenses be recognized together in the same reporting period.
Thus, if there is a cause-and-effect relationship between revenue and certain expenses, then record them at the same
time. If there is no such relationship, then charge the cost to expense at once.
This is one of the most essential concepts in accrual basis accounting, since it mandates that the entire effect of a
transaction be recorded within the same reporting period.
Here are several examples of the matching principle:
• Commission. A salesman earns a 5% commission on sales shipped and recorded in January. The commission of
$5,000 is paid in February. You should record the commission expense in January.
• Depreciation. A company acquires production equipment for $100,000 that has a projected useful life of 10
years. It should charge the cost of the equipment to depreciation expense at the rate of $10,000 per year for ten
years.
• Employee bonuses. Under a bonus plan, an employee earns a $50,000 bonus based on measurable aspects of her
performance within a year. The bonus is paid in the following year. You should record the bonus expense within
the year when the employee earned it.
• Wages. The pay period for hourly employees ends on March 28, but employees continue to earn wages through
March 31, which are paid to them on April 4. The employer should record an expense in March for those wages
earned from March 29 to March 31.

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 Eg. Matching concept
• Purchase 10 books @ 100rs. Each ---------- 1000 rs.
• Sale 5 books @ 150 ------------- rs. 750
cost ----------- 500 rs.
• : 250 rs. profit
• Recording items under the matching principle typically requires the use of an accrual entry. An example of such
an entry for a commission payment is:
Debit Credit
Commission expense 5,000
Accrued expenses 5,000

In this entry, the commission expense is charged before the cash payment to the salesperson actually occurs, along
with a liability in the same amount. In the following month, the company pays the commission, and records the
following entry:
Debit Credit

Accrued expenses 5,000

Cash 5,000

The cash balance declines as a result of paying the commission, which also eliminates the liability.
Because use of the matching principle can be labor-intensive, company controllers do not usually employ it for
immaterial items. For example, it may not make sense to create a journal entry that spreads the recognition of a $100
supplier invoice over three months, even if the underlying effect will impact all three months. Instead, such small items
are charged to expense as incurred.
• If you do not use the matching principle, then you are using the cash method of accounting, where revenue is
recorded when cash is received and expenses when they are paid.

7. Cost Concept:
• Under this concept fixed assets are recorded in the account books at the price at which they are acquired.
The price paid to acquire the assets is termed as cost and this cost is the basis for all the subsequent accounting
for the asset.
• When an asset is acquired for Rs 5,000, it is recorded in the account books at Rs 5,000 even though the
market value may be different. But the asset is shown in balance sheet year after year, at cost price minus
depreciation. This value is called book value.
• If the business pays nothing for an item it acquired, then this will not appear in the accounting records
as an asset. Thus, all such events are ignored which affect the business but have no cost, for example, a
favourable location, a good reputation with its customers, market standing etc.

8. Dual Aspect Concept (Accounting Equation Concept):

• This concept signifies that every business transaction involves a two-fold aspect:
(a) The yielding of benefit and
(b) The giving of the benefit.
For an exchange of value, two parties are required a giver and a receiver. Thus, a firm sells goods worth Rs100; the
two simultaneous implications on the seller are:
(1) Forgoing goods worth Rs 100 and
(2) Receipt of cash Rs 100.

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 • And those on the purchaser would be (1) receipt of goods for Rs 100 and (2) forgoing cash Rs 100. Every
transaction affects two accounts and entails two-fold simultaneous effect on each party. Thus a giver necessarily
implies a receiver and receiver necessarily implies a giver and each transaction affects receiving account and
giving account equally.
• Technically speaking, “for every debit, there is a credit”. Therefore, we can say that every debit must have a
corresponding credit and vice versa. This is the only system of modern account keeping.
• The underlying principle of Double Entry is very simple but wonderfully effective. “Double Entry book-
keeping is a system of accounting by which receiving and giving aspects of each transaction are recorded
at a time.”
• As such transaction affects giving account and receiving account equally, the assets of a business entity will
always be equal to its equities, i.e.,
• Total Assets = Capital + Outsiders’ liabilities
• Capital = Total Assets – Outsiders’ liabilities.
There are two types of liability:
1. Insider liability: when the owner invests in the business then the business owes that amount to the owner. The
business owes the money to the members present inside the business.
2. Outsider liability: when the business takes loans from the members or institutions not included in the business
like banks, etc
9. Accounting Period Concept:
Accounting is a continuous process in any business undertaking. Every businessman wants to know the result of his
investment and efforts at frequent intervals. Accountants choose some shorter period to measure the result.
• Therefore, one year has been, generally, accepted as the accounting period. It may be 3 months, 6 months or
2 years also.
• This period is called accounting period. Financial period chosen, in this regard, should be neither too long nor too
short. Closing day of the accounting period is known as accounting date. At this date, accountant prepares
income and position statements, shows the business operations, brings the changes of positions since the
construction of last statements. In India the accounting period is of one year (1st April-31st March).
• The financial reports prepared facilitate to make good decision, corrective measures, expansion etc.
• On the basis of income and position statement, financial position and earning capacity of one year can be
compared with another.
• Their comparison helps the business for expansion and the outsiders to draw various conclusions.
• One-year accounting period is recognized by law and the taxation is assessed annually. Reports to the outsiders are
provided on this accounting period.

10. Realization Concept:

• This concept revolves around the determination of the point of time when revenues are earned. A business
firm invests money to purchase or manufacture goods for sale. To earn profit, sales have to be made. There can
be no profit without realization of sale proceeds.
• According to realization concept, which is also known as the “revenue recognition concept”, revenue is
considered as being earned on the date on which it is realized, i.e., the date on which goods and services are
transferred to customers either for cash or for credit. “Credit transactions create debtors and the promise of
debtors to make payment is sufficient for the purpose of realizing revenue.
• The realization concept is important in ascertaining the exact profit earned during a period in a business
concern. This concept is very important as it prevents firms from inflating their profits by recording sales and
incomes that are likely to accrue.

11. Objectivity Concept:

• This concept implies that all accounting transactions should be evidenced and supported by business documents,
i.e., invoices, vouchers etc.
• The evidence substantiating the business transactions should be objective, i.e., free from the bias of the accountant
or others. These supporting documents form the basis for record of entries and of audit. Accounting record
based on documentary evidence is readily and objectively verifiable and therefore universally acceptable.

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Accounting Conventions
Accounting concepts (need to be followed) and conventions (voluntary) together known as Accounting Principles.
1. Consistency
2. Disclosure
3. Conservatism
4. Materiality

What is an Accounting Convention?

• Accounting conventions are guidelines used to help companies determine how to record certain business
transactions that have not yet been fully addressed by accounting standards.
• These procedures and principles are not legally binding but are generally accepted by accounting bodies.
• Basically, they are designed to promote consistency and help accountants overcome practical problems that can
arise when preparing financial statements.
Accounting Convention Methods
There are four main accounting conventions designed to assist accountants:
1. Conservatism: Playing it safe is both an accounting principle and convention. It tells accountants to err on the side
of caution when providing estimates for assets and liabilities. That means that when two values of a transaction
are available, the lower one should be favored. The general concept is to factor in the worst-case scenario of a
firm’s financial future.
2. Consistency: A company should apply the same accounting principles across different accounting cycles. Once it
chooses a method it is urged to stick with it in the future, unless it has a good reason to do otherwise. Without this
convention, investors ability to compare and assess how the company performs from one period to the next is made
much more challenging.
3. Full disclosure: Information considered potentially important and relevant must be revealed, regardless of whether
it is detrimental to the company.
4. Materiality: Like full disclosure, this convention urges companies to lay all their cards on the table. If an item or
event is material, in other words important, it should be disclosed. The idea here is that any information that could
influence the decision of a person looking at the financial statement must be included.
GAAP, IFRS and Ind-AS
GAAP
GAAP (Generally Accepted Accounting Principles) helps govern the world of accounting according to general rules and
guidelines. It attempts to standardize and regulate the definitions, assumptions, and methods used in
accounting across all industries. GAAP covers such topics as revenue recognition, balance sheet classification, and
materiality.
• The ultimate goal of GAAP is ensure a company's financial statements are complete, consistent, and
comparable.
• This makes it easier for investors to analyze and extract useful information from the company's financial statements,
including trend data over a period of time. It also facilitates the comparison of financial information across different
companies.
• These 10 general concepts can help you remember the main mission of GAAP:

1. Principle of Regularity:
The accountant has adhered to GAAP rules and regulations as a standard.
2. Principle of Consistency:
Accountants commit to applying the same standards throughout the reporting process to prevent errors or
discrepancies. Accountants are expected to fully disclose and explain the reasons behind any changed or updated
standards in the footnotes to the financial statements.
3. Principle of Sincerity:
The accountant strives to provide an accurate and impartial depiction of a company’s financial situation.
4. Principle of Permanence of Methods:
The procedures used in financial reporting should be consistent.

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5. Principle of Non-Compensation:
Both negatives and positives should be reported with full transparency and without the expectation of debt
compensation.
6. Principle of Prudence
Emphasizing fact-based financial data representation that is not clouded by speculation.
7. Principle of Continuity
While valuing assets, it should be assumed the business will continue to operate.
8. Principle of Periodicity
Entries should be distributed across the appropriate periods of time. For example, revenue should be reported in its
relevant accounting period.
9. Principle of Materiality / Good Faith
Accountants must strive for full disclosure in financial reports.
10. Principle of Utmost Good Faith
Derived from the Latin phrase “uberrimae fidei” used within the insurance industry. It presupposes that parties
remain honest in all transactions.
• Accounting is a language of business
• Accounting standard may be regarded as a sort of law- a guide to action, a settled ground or basis of conduct or
practice.
• The objective of setting standards is to bring about uniformity in financial reporting and to ensure consistency
and comparability in the data published by enterprise.

International Financial Reporting Standards

Commonly called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting
Standards Board (IASB).
• They constitute a standardized way of describing the company’s financial performance so that company financial
statements are understandable and comparable across international boundaries. They are particularly relevant for
companies with shares or securities listed on a public stock exchange.
• IFRS have replaced many different national accounting standards around the world but have not replaced the
separate accounting standards in the United States where US GAAP is applied.

Indian Accounting Standard (Ind-AS)

It is the Accounting standard adopted by companies in India and issued under the supervision of Accounting Standards
Board (ASB) which was constituted as a body in the year 1977.
• ASB is a committee under Institute of Chartered Accountants of India (ICAI) which consists of representatives from
government department, academicians, other professional bodies viz. ICAI, representatives from ASSOCHAM, CII,
FICCI, etc.
• The Ind AS are named and numbered in the same way as the International Financial Reporting Standards (IFRS).
• National Financial Reporting Authority (NFRA) recommend these standards to the Ministry of Corporate
Affairs (MCA). MCA has to spell out the accounting standards applicable for companies in India. As on date MCA has
notified 41 Ind AS. This shall be applied to the companies of financial year 2015-16 voluntarily and from 2016-17 on
a mandatory basis.
• Based on the international consensus, the regulators will separately notify the date of implementation of Ind-AS for
the banks, insurance companies etc. Standards for the computation of Tax has been notified as ICDS (Income
Computation and Disclosure Standards) in February 2015
• Ind-AS is in line with the International Financial Reporting Standards (IFRS)
• Ind-AS are notified under the Companies Act,2013. They converge with IFRS and are applicable to companies
• Ind-AS prescribes that every company shall value its financial assets (securities) at Fair Value whereas other assets
can be valued at historical cost or at fair value. But, whichever of the 2 are adopted, shall have to be consistently
followed.
• Historical cost is measure of value used in accounting in which the value of an asset on the balance sheet is recorded
at its original cost when acquired by the company

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• Fair Value is the price that would be received when an asset is sold or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
• Ind-AS are principle based.

A complete set of financial statements is used to give readers an overview of the financial results and condition of a
business. Financial statements shall be prepared in the form provided in new Schedule III of Companies Act,
2013.The financial statements are comprised of the follows:
• Income statement. Presents the revenues, expenses, and profits/losses generated during the reporting period. This
is usually considered the most important of the financial statements, since it presents the operating results of an
entity.
• Balance sheet. Presents the assets, liabilities, and equity of the entity as of the reporting date. Thus, the information
presented is as of a specific point in time. The report format is structured so that the total of all assets equals the
total of all liabilities and equity (known as the accounting equation). This is typically considered the second most
important financial statement, since it provides information about the liquidity and capitalization of an organization.

Difference between IFRS and Indian GAAP or Accounting standards

1. IFRS are principle based while Indian GAAP are rule based. Under the Indian laws Balance sheet is prepared
according to schedule III of the Companies Act 2013 or in the form as near thereto. It means a balance sheet item
should be detected under the prescribed head. IFRS doesn’t prescribe any form for the balance sheet.
2. IFRS are based on Fair Value Concept while Indian GAAP or Accounting Standards are based on Historical Cost
Concept.
• India had 2 options i.e. either to adopt IFRS as they are or converge the Indian Accounting Standards in line with
IFRS. It decided to converge its existing accounting standards with IFRS---Ind-AS (can’t have same laws in every
country)
• Indian GAAP issued by Council of the Institute of Chartered Accountants of India.

The Institute of Chartered Accountants of India

• The Institute of Chartered Accountants of India (ICAI) is a statutory body established by an Act of Parliament, viz.
The Chartered Accountants Act, 1949 (Act No. XXXVIII of 1949) for regulating the profession of Chartered
Accountancy in the country.
• 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, with a strong
tradition of service to the Indian economy in public interest. The affairs of the ICAI are managed by a Council in
accordance with the provisions of the Chartered Accountants Act, 1949 and the Chartered Accountants
Regulations, 1988.
• The Council constitutes of 40 members of whom 32 are elected by the Chartered Accountants and remaining 8 are
nominated by the Central Government generally representing the Comptroller and Auditor General of India,
Securities and Exchange Board of India, Ministry of Corporate Affairs, Ministry of Finance and other stakeholders.

Functions:
• To Regulate the profession of Accountancy
• Education and Examination of Chartered Accountancy Course
• Continuing Professional Education of Members
• Conducting Post Qualification Courses
• Formulation of Accounting Standards
• Prescription of Standard Auditing Procedures
• Laying down Ethical Standards
• Monitoring Quality through Peer Review
• Ensuring Standards of performance of Members
• Exercise Disciplinary Jurisdiction
• Financial Reporting Review
• Input on Policy matters to Government

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Objectives and Functions of The Accounting Standards Board
Objectives of the accounting standards board:
1. (i) to conceive of and suggest areas in which accounting standards need to be developed.
2. (ii) to formulate accounting standards with a view to assisting the council of the ICAI in evolving and establishing
accounting standards in India.
3. (iii) to examine how far the relevant international accounting standard/international financial reporting standard
(see paragraph 3 below) can be adapted while formulating the accounting standard and to adapt the same.
4. (iv) to review, at regular intervals, the accounting standards from the point of view of acceptance or changed
conditions, and, if necessary, revise the same.
5. (v) to provide, from time to time, interpretations and guidance on accounting standards.
6. (vi) to carry out such other functions relating to accounting standards.
7. The main function of the ASB is to formulate Accounting Standards so that such standards may be
established by the ICAI in India. While formulating the Accounting Standards, the ASB will take into consideration
the applicable laws, customs, usages and business environment prevailing in India.
8. The ICAI, being a full-fledged member of the International Federation of Accountants (IFAC), is expected, inter
alia, to actively promote the International Accounting Standards Board’s (IASB) pronouncements in the country with
a view to facilitate global harmonization of accounting standards.
Accordingly, while formulating the Accounting Standards, the ASB will give due consideration to International
Accounting Standards (IASs) issued by the International Accounting Standards Committee (predecessor body to
IASB) or International Financial Reporting Standards (IFRSs) issued by the IASB, as the case may be, and try to
integrate them, to the extent possible, in the light of the conditions and practices prevailing in India.
9. The Accounting Standards are issued under the authority of the Council of the ICAI. The ASB has also been
entrusted with the responsibility of propagating the Accounting Standards and of persuading the concerned parties
to adopt them in the preparation and presentation of financial statements. The ASB will provide interpretations and
guidance on issues arising from Accounting Standards.

The ASB will also review the Accounting Standards at periodical intervals and, if necessary, revise the same.
• GAAP (generally accepted accounting principles) is a collection of commonly-followed accounting rules and
standards for financial reporting. The acronym is pronounced "gap." GAAP specifications include definitions of
concepts and principles, as well as industry-specific rules.
• International Financial Reporting Standards (IFRS) is a set of accounting standards developed by an
independent, not-for-profit organization called the International Accounting Standards Board (IASB).
• Indian Accounting Standards (abbreviated as Ind-AS) in India accounting standards were issued under the
supervision and control of Accounting Standards Board (ASB), which was constituted as a body in the year 1977.
ASB is a committee under (ICAI) which consists of representatives from government department, academicians,
other professional bodies viz. icai, representatives from ASSOCHAM, CII, FICCI, etc.
• So the difference between the 3 is obvious. In simple layman terms GAAP is a collection of Accounting Generics
which give birth to IFRS International Reporting Standards which is further reduced to Indian Financial Reporting
Dynamics.
• GAAP - Grandfather, IFRS - Son, Ind AS - Grandson.
• India has not adopted IFRS Standards. India has adopted Indian Accounting Standards (Ind AS) that are based
on and substantially converged with IFRS Standards as issued by the IASB.
• Ind AS is being applied in a phased manner from 1 April 2016, beginning with companies whose net worth is equal
to or exceeding 500 crore INR.
• Comparative Ind AS information for the year ending 31 March 2016 is also required. Listed companies and others
with a net worth equal to or exceeding 250 crore INR will follow suit starting 1 April 2017.
• Banks and Insurance companies are required to comply with Ind AS beginning from 1 April 2018.
• Non-Banking Financial Corporations shall apply Ind AS in a phased manner from 1 April 2018, beginning with
NBFCs whose net worth is equal to or exceeding 500 crore INR. Comparative Ind AS information for the year ending
31 March 2018 will also be required. Listed NBFCs and NBFCs with a net worth equal to or exceeding 250 crore INR
will follow suit starting 1 April 2019.
• The companies not covered under Ind AS roadmap shall continue to apply existing Indian GAAP, however,
they can voluntarily adopt Ind AS. Once Ind AS is applied, an entity cannot switch back to Indian GAAP.

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Phases of adoption
MCA has notified a phase-wise convergence to IND AS from current accounting standards. IND AS shall be adopted by
specific classes of companies based on their Net worth and listing status. Let’s see the each of the phases in detail below:

Phase I
Mandatory applicability of IND AS to all companies from 1st April 2016, provided:
• It is a listed or unlisted company
• Its Net worth is greater than or equal to Rs. 500 crore*
*Net worth shall be checked for the previous three Financial Years (2013-14, 2014-15, and 2015-16).

Phase II
Mandatory applicability of IND AS to all companies from 1st April 2017, provided:
• It is a listed company or is in the process of being listed (as on 31.03.2016)
• Its Net worth is greater than or equal to Rs. 250 crore but less than Rs. 500 crore (for any of the below mentioned
periods).
Net worth shall be checked for the previous four Financial Years (2013-14, 2014-15, 2015-16, and 2016-17)

Phase III
Mandatory applicability of IND AS to all Banks, NBFCs, and Insurance companies from 1st April 2018, whose:
• Net worth is more than or equal to INR 500 crore with effect from 1st April 2018.
IRDA (Insurance Regulatory and Development Authority) of India shall notify the separate set of IND AS for Banks &
Insurance Companies with effect from 1st April 2018. NBFCs include core investment companies, stock brokers,
venture capitalists, etc. Net Worth shall be checked for the past 3 financial years (2015-16, 2016-17, and 2017-18)

Phase IV
All NBFCs whose Net worth is more than or equal to INR 250 crore but less than INR 500 crore shall have IND AS
mandatorily applicable to them with effect from 1st April 2019.

Accounting: A Measurement Discipline

• As it deals with monetary measurement of inputs and as a result, it provides a basis for measuring the efficiency or
performance of enterprise.
• Measurement means the assignment of numerical values to specific attributes or characteristics of selected objects
or events.
• It means that asset, liability, or change in capital must have a relevant attribute that can be expressed in monetary
units with sufficient reliability.
Generally, 4 measurement bases are usually accepted in accounting parlance.
1. Historical Cost
2. Current Cost
3. Realizable Value
4. Present Value

Historical Cost
• It means acquisition price
• The amount of cash paid to acquire the asset
• Liabilities are recorded at the amount of proceeds received in exchange of the obligation

Current Cost
• Assets are carried at the amounts of cash or cash equivalent that would have to be paid if the same or equivalent
asses were acquired currently.
• Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the
obligation currently

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Realizable Value
• As per this valuation basis, assets are recorded at the amount of cash or cash equivalent that would be realised by
selling the assets in a routine manner.
• Similarly, liabilities are recorded at their settlement values.

Present Value
• As per this concept, an asset is shown in the balance sheet at the sum of present discounted net cash inflows that the
asset is expected to generate in the normal course of business activities.
• Similarly, liabilities are disclosed at the present discounted value of future net cash outflows that are expected to be
required to satisfy the liability in normal or due course of business activities.

Meaning of Accounting: Accounting is an art to recording, classifying, summarizing, analyzing and interpreting the
business transaction of a particular accounting period for track the financial position of business. It includes only
monetary transactions.

Bookkeeping: is the work of a bookkeeper (or book-keeper), who records the day-to-day financial transactions of a
business. They usually write the daybooks (which contain records of sales, purchases, receipts, and payments), and
document each financial transaction, whether cash or credit, into the correct daybook.

Accounting Cycle

Closing Transactions
the Books

Final Journal
Account Entries

Adjusting
Journal Posting
Entries

Trial
Balance

Transactions: Exchange of any goods and services in terms of money for earning the profit. For example: Ram purchase
goods of Rs. 10,000.
Cash Transactions: All those transactions in which goods and services exchange in the form of cash. E.g. Ram purchase
goods of Rs. 10,000 in cash.
Credit Transaction: Under this all transactions included which are not in the form of cash at the time of purchase/sell.
The money will be pay later. In other word’s we can say that exchange of goods and services on credit basis.
Journal: Journal is originated by “Jour” word in French Language. It means one day. The objective of the journal is to
record the daily business transaction in chronological order. It is also called “Book of Original Entry”. Journal is based on
the double entry system.

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Types of Accounts and Golden Rules of Accounting
What is an Account?
• Account is nothing but an outline of the transactions undertaken by the business in respect of persons, their
representatives and things.
• For instance, when a business enters into transactions with suppliers or customers, both suppliers and customers
act as separate accounts.
• Similarly, businesses purchasing tangible items like plant, machinery, land, building etc. treat each of the tangibles as
individual accounts. Such accounts are related to things.
• Thus, whenever a business undertakes transactions, it must identify the accounts involved and then apply the
requisite accounting standards and golden accounting rules to record such transactions.
• Further, an account is usually represented in a T-Format. Thus, a T Account has two sides to it. The left side is known
as the debit side whereas the right side of an account is labeled as the credit side.
So, a T-Account is prepared in the following
Plant Account

Particulars (Dr) Amount Particulars (Cr) Amount

(Debit Side) (In Rupees) (Debit Side) (In Rupees)

How to Record Entries in Journal?

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1. Personal Accounts
• The accounts which relate to an individual, firm, company or an institution are called Personal
Accounts. Account of Mohan, Account of Ram, Drawings Account, Capital Account, etc. are examples of Personal
Accounts.
Rule: “Debit the receiver and Credit the giver”
• It means - Debit that person's account who receives something from the business and credit that person's
account who gives something to the business.

Objective:
• Object of preparing a personal account is to ascertain as to how much amount a personal account owes to the
business, that is, how much amount is due to be received from him and how much amount is owed to a personal
account from the business, that is, how much amount is payable to him

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• Karan purchased machinery from M/s Sharma worth Rs 10,00,000 on credit. So, this transaction involves two
accounts: a Personal Account of M/s Sharma and Machinery Account. Thus, purchasing machinery worth Rs
10,00,000 on credit means that M/s Sharma is providing the Machinery to Karan for his business. The Golden Rule of
Personal Account says, “Debit the Receiver, Credit the Giver”.
• Since M/s Sharma is the Giver in this transaction, his Personal Account will be credited with Rs 10,00,000. Whereas,
Machinery A/c would be debited with the same amount.
• Thus, this transaction will be recorded in the respective accounts as follows:
•
Machinery Account

Particulars (Dr) Amount Particulars (Cr) Amount

(in Rs) (in Rs)

To M/s Sharma 10,00,000

M/s Sharma Account

Particulars (Dr) Amount Particulars (Cr) Amount

(in Rs) (in Rs)

By Machinery 10,00,000

Representative Personal Account

• Represent a person or group of persons
• Sometimes accounts are many in no. , and of the same nature so they are added and put under one common title.
Eg. A business is not able to pay rent for its 20 shops then all landlords of these shops stand as creditors and the
amounts dues to them are added and put under one common head, known as
“Rent Outstanding Account”. It’s a personal account representing many landlords.

Other Eg.:
Salary Outstanding, Interest received in advance, rent prepaid, interest outstanding etc….
2. Real Accounts
• The accounts of all those things whose value can be measured in terms of money and which are the properties of
the business are termed as Real Accounts. Such as cash account, furniture account, machinery account, building
account, Goodwill account, etc.
Rule: “Debit what comes in Credit what goes out”
• According to this rule, whenever any property comes into the business it is debited and when it goes outside the
business it is credited.

Objective:
• These accounts represent various properties owned by a business in terms of money and indicate the financial
position of the business.
• Tangible Real Account: Land, Cash, Building Furniture etc.
• Intangible Real Accounts: Goodwill, Patent, Copyright, Trademark, etc.

3. Nominal Accounts
• These accounts include the accounts of all expenses and incomes. For example salaries paid, rent paid, discount
allowed, bad debts, Commission received, interest received discount received, etc.
Rule: “Debit the expenses and losses and Credit the income and gains”

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Objective:
• Nominal accounts are those accounts which are in name only and which do not really exist. The accounts are open
simply to explain the nature of the head for which cash has been paid in the absence of nominal accounts; it will be
very difficult for the management to know the amount paid separately on account of salary, rent, commission, etc. As
such the nominal accounts provide information regarding the following: -
(i) Amount spent on various heads in a particular period;
(ii) Income received on various heads in a particular period.

There are some other accounts in accounting as well:

• Cash Account – This account is used for keeping the records of payments done by cash, withdrawals, and deposits.
• Income Account – Purpose of this account is to keep the record of the income sources of business.
• Expense Account – This account tracks the expenditure of the business.
• Liabilities – If there is any debt or loan then that amount comes under liabilities.
• Equities – If there is an investment of the account owner or common stocks, retained earnings then these will fall
under equities.

Golden rules of accounting

• Looking at the nature of all the accounts, the accounting rules have been
devised.
• For each account there is a set of Golden Rules and hence there are three
Golden

Golden Rules:
• There are three golden rules, each of which is ascribed to one of the three
types of accounts discussed above. The golden rules are:
• For real accounts: Debit what comes in (the business), credit what goes out
(of the business)
• For personal accounts: Debit the receiver, credit the giver
• For nominal accounts: Debit all expenses and losses, credit all incomes and gains

Journal & Entries

Examples for using the golden rules:
Scenario 1: Furniture is purchased by paying in cash. Here, there are two accounts involved - Cash account and
Furniture account. Furniture and Cash are both real accounts. When you purchase furniture, furniture is coming into the
business, i.e. you shall get furniture and because you paid in cash, cash is going out of the business, i.e. you shall have

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lesser cash. Applying the golden rule for real accounts, you shall debit the Furniture account (what comes in) and
credit Cash account (what goes out).

Scenario 2:
Peter gave you a loan by transferring money in your bank account. Here, there are two accounts involved - Bank account
and Peter account. Both are personal accounts. Applying the golden rule for personal accounts, you shall debit Bank
account (the receiver) and credit Peter account (the giver)

Scenario 3:
Salary is paid by issuing a bank cheque. Here, two accounts are involved - Salary account and Bank account. Salary
account is a nominal account and Bank account is a personal account. Salary here is an expense and the bank is giving
our money to the employees. Applying the golden rule for nominal accounts, you debit the Salary account
(expenses and losses) and applying the golden rule for personal accounts, you credit the Bank account (the
giver)

Illustration
• An entity named Orange Ltd. has the following transactions.
• It deposits Rs. 10,000 into Bank
• It buys goods worth Rs. 50,000 from Apple Ltd.
• It sells goods worth Rs. 35,000 to Melon Ltd.
• It pays Rs. 12,000 as Rent for it’s premises
• It earns Rs. 3,000 as interest on a bank account.
First of all, let us identity the accounts involved in these transactions and classify them into the different types of
accounts:
Transaction Accounts involved Type of Accounts

Deposit Rs.10,000 in Bank Bank Account Personal Account

Cash Account Real Account

Purchase goods worth Rs.50,000 Purchase Account Nominal Account

from Apple Ltd. Apple Ltd. Account Personal Account

Sale of goods worth Rs. 35,000 to Sales Account Nominal Account

Melon Ltd. Melon Ltd. Account Personal Account

Pays Rs.12,000 as rent Rent Account Nominal Account

Bank Account Personal Account

Earn Rs.3,000 as interest on Bank Interest received Nominal Account

account Bank Account Personal Account

Accounts Nature of How accounts Whether Debited

Transaction
involved Accounts involved are affected or Credited
1. Cash A/c Real A/c Cash is coming in Debit
Capital A/c Personal A/c Chitra is the giver Credit

2. Furniture A/c Real A/c Furniture is coming in Debit

Cash A/c Real A/c Cash is going out Credit

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3. Purchases A/c Real A/c Goods are coming in Debit

Ram’s A/c Personal A/c Ram is the giver Credit

4. Cash A/c Real A/c Cash is coming in Debit

Sales A/c Real A/c Goods are going out Credit

5. Salary A/c Nominal A/c Salary is an expense Debit

Cash A/c Real A/c Cash is going out Credit

6. Ram’s A/c Personal A/c Ram is the receiver Debit
Cash A/c Real A/c Cash is going out Credit

7. Salary A/c Nominal A/c Salary is an expense Debit

Salary Representative Salary is payable to Rahul and

Credit
Outstanding A/c Personal A/c therefore he is our creditor.
Commission is receivable from the
Accrued Representative
8. client, therefore the client is our Debit
Commission A/c Personal A/c
debtor

Commission A/c Nominal A/c The commission is an income Credit

What is a Journal?
A journal is a detailed account that records all the financial transactions of a business, to be used for future reconciling of
and transfer to other official accounting records, such as the general ledger.

A journal states the date of a transaction, which accounts were affected, and the amounts, usually in a double-entry
bookkeeping method.

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Understanding Journals
• For accounting purposes, a journal is a physical record or digital document kept as a book, spreadsheet or data
within accounting software.
• When a business transaction is made, a bookkeeper enters the financial transaction as a journal entry.
• If the expense or income affects one or more business accounts, the journal entry will detail that as well.
• Journaling is an essential part of objective record-keeping and allows for concise review and records-transfer later
in the accounting process.
• Journals are often reviewed as part of a trade or audit process, along with the general ledger.

Journal Entries of Personal Account

It includes all the natural personal person’s account. E.g. Mohan’s account, Shyam's account.
Rule: Dr. the Receiver, Cr. the giver.
e.g. Cash Paid to Shyam Rs. 20,000. so here journal entry will be

Shyam Dr. 20,000 (Here shyam is Receiver that’s why he is Dr.)

To Cash A/c 20,000 ( Cash is paid and it shows in assets side

which show the dr. balance but now it reduces that’s why it shows in cr. side)
(For cash paid to Shyam)

Journal Entries of Real Account

Real Account: it includes all the assets account, e.g. Building A/c, Machinery a/c etc.
Rule: Debit what comes in, Cr. what goes out.
E.g. Purchase a Machinery of 50,000 then entry will be

Machinery A/c Dr. 50,000 (what comes in is Dr.)

To Cash Account 50,000 (What goes out is Cr.)
(For purchase of Machinery)

Journal Entries of Nominal Account

Nominal Account: it includes all the accounts of expenses & losses and profits & gains. E.g. Wages account, Salary
account,
Rule: Debit all Expenses and losses, Cr. all income and Gains.
E.g. Wages paid to workers Rs. 3000

Wages A/c Dr. 3000 (wages are expenses for the firm and paid for it that’s why it is dr.)

To Cash Account 3000 (Cash is reduced and goes out, that’s why cr.)

(For wages paid)

Meaning of Goods: goods refers to all those things in which a firm trades. In other words
all those items which are purchased by the firm and sell further at profit.
For trading the goods there is no goods account. Goods are shown by the sales and
purchase account.
E.g Purchase goods for cash Rs. 25000. so entry will be:
Purchase A/c Dr. 25000 (Dr. what comes in)
To cash A/c 25000 (cash reduce because of payment)
(For purchase of goods)
Some of books which are used for goods
Purchase Book, Sales Book, Purchase Returns, Sale Returns Book

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Trade Discount: a discount which is given by the seller to buyer for the purpose of
increasing the sale on a certain % on list price. There is no special journal entry of the trade
discount.
E.g. 20% trade discount on Rs. 10,000 given by the seller, so entry will be
Cash A/c Dr. 8000 (Debit what comes in)
To Sales A/c 8000 (Cr. what goes in, and Balance of sale is always Cr.)
(For sale of goods at trade discount)
Cash Discount: this type of discount is given to the debtors to collect money as soon as
possible. In other words we can say the settlement with debtors.
E.g. Shyam is a debtor with Rs. 5000 but a trader settles down at Rs. 4500. so entry will be
Cash A/c Dr. 4500 (Dr. what comes in)

Discount A/c Dr. 500 (Dr. all losses and expenses)

To Shyam 5000 (Cr. the giver)

(For cash received from Shyam and discount allowed)

Ledger & Trial Balance

Accounting Cycle Closing
Transactions: Exchange of any goods and services in terms of the Transactions
money for earning the profit. For example: Ram purchases goods of Books
Rs. 10,000.
Cash Transactions: All those transactions in which goods and
services exchange in the form of cash. E.g. Ram purchased goods of Final Journal
Rs. 10,000 in cash. Account Entries
Credit Transaction: Under this all transactions included which are
not in the form of cash at the time of purchase/sell. The money will
be paid later. In other words we can say that exchange of goods and
services on credit basis.
Adjustin
Journal: Journal is originated by “Jour” word in French Language. It g Posting
means one day. The objective of the journal is to record the daily Journal
business transaction in chronological order. It is also called “Book of Entries
Original Entry”. Journal is based on the Double entry system. Trial
Balance
Format/Performa of Journal
Date Particulars Ledger Folio Amount Amount
Dr. (Rs.) Cr. (Rs.)
1 2 3 4 5

How to Record Entries in Journal?

Journal Entries of Personal Account
It includes all the natural personal person’s account. E.g. Mohan’s account, shyam’s account.
Rule: Dr. the Receiver, Cr. the giver.
e.g. Cash Paid to Shyam Rs. 20,000. so here journal entry will be
Shyam Dr. 20,000 (Here shyam is Receiver that’s why he is Dr.)
To Cash A/c 20,000 (Cash is paid and it shows in assets side
which show the dr. balance but now it reduces that’s why it shows in cr. side)
(For cash paid to Shyam)
Journal Entries of Real Account

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Real Account: it includes all the assets account, e.g. Building A/c, Machinery a/c etc.
Rule: Debit what comes in, Cr. what goes out.
E.g. Purchase a Machinery of 50,000 than entry will be
Machinery A/c Dr. 50,000 ( what comes in is Dr.)
To Cash Account 50,000 (What goes out is Cr.)
(For purchase of Machinery)
Journal Entries of Nominal Account
Nominal Account: it includes all the accounts of expenses & losses and profits & gains. E.g. Wages account, Salary
account,
Rule: Debit all Expenses and losses, Cr. all income and Gains.
E.g. Wages paid to workers Rs. 3000
Wages A/c Dr. 3000 (wages is expenses for firm and paid it that’s why it is dr. )
To Cash Account 3000 (Cash is reduced and goes out, that’s why cr.)
(For wages paid)
Meaning of Goods: goods refers to all those things in which a firm trade. In other words, all those items which are
purchased by the firm and sell further at profit. For trading the goods there is no goods account. Goods are shown by the
sales and purchase account.
E.g purchase goods for cash Rs. 25000. so entry will be
Purchase A/c Dr. 25000 (Dr. what comes in)
To cash A/c 25000 (cash reduce because of payment)
(For purchase of goods)
Some of books which are used for goods:
Purchase Book, Sales Book, Purchase Returns, Sale Returns Book
Trade Discount: a discount which is given by the seller to buyer for the purpose of increasing the sale on a certain % on
list price. There is no special journal entry of the trade discount.
E.g. 20% trade discount on Rs. 10,000 given by the seller, so entry will be
Cash A/c Dr. 8000 (Debit what comes in)
To Sales A/c 8000 ( Cr. what goes in, and Balance of sale is always Cr.)
(For sale of goods at trade discount)
Cash Discount: this type of discount is given to the debtors to collect money as soon as possible. In other words we can
say the settlement with debtors.
E.g. Shaym is a debtor with Rs. 5000 but traders settle down in Rs. 4500. so entry will be
Cash A/c Dr. 4500 (Dr. what comes in)
Discount A/c Dr. 500 ( Dr. all losses and expenses)
To Shyam 5000 (Cr. the giver)
(For cash received from shyam and discount allowed)
Ledger: The ledger is a permanent summary of all amounts entered in supporting journals which list
individual transactions by date. In other words, we can say it is the collection of all accounts in a single book. It is also
called the Principal Book.

Performa of Ledger
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
To…. By….

E.g. On 1st feb. 2020 goods purchased Rs. 5,000. then journal entry will be
Purchase A/c Dr. 10,000 (dr. what comes in, or purchase balance is always dr.)
To Cash A/c 10,000 ( cash reduction and credit what goes out.)
(For purchase of goods)
Now how to post this entry in the ledger?

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Purchase Account
Date Particulars J.F. Amount Date Particulars J.F. Amount
2020 To Cash A/c 10,000
1st feb.
Cash Account
Date Particulars J.F. Amount Date Particulars J.F. Amount
2020 By Purchase A/c 10,000
1st feb.

• Business started by Mr. A with Cash Rs. 45,000

• Cash deposited into Bank 15,000
• Purchased goods worth Rs. 4000 Paid by Cheque 4,000
• Purchased Office equipment of Rs. 2,500
• Sold Goods for Cash Rs. 1,200
• Sold Goods to Messi Rs. 800
• Goods Return by Messi worth rs 200
• Mr. A withdraws Rs. 8000 for personal use in cash 8,000
• Paid salaries Rs. 2,500
• Paid Office Rent 1,200
• Paid Telephone Bill Rs. 2600 by cheque 2,600

DATE (2020) PARTICULARS LF DEBIT (Rs.) CREDIT (Rs.)

1 Cash A/C Dr 45,000 45,000
To Capital A/C Cr
1 Bank A/C Dr 15,000 15,000
To Cash A/C Cr
4 Purchase A/C Dr 4,000 4,000
To Bank A/C Cr
7 Office Eqip A/C Dr 2,500 2,500
To Cash A/C Cr
8 Cash A/C Dr 1,200 1,200
To Sales A/C Cr
10 Messi A/C Dr 800 800
To Sales A/C Cr
15 Sales Return A/C Dr 200 200
To Messi A/C Cr
18 Drawing A/C Dr 8,000 8,000
To Cash A/C Cr
24 Salaries A/C Dr 2,500 2,500
To Cash A/C Cr
27 Office Rent A/C Dr 1,200 1,200
To Cash A/C Cr
30 Telephone Bill A/C Dr 2,600 2,600
To Bank A/C Cr

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Cash Account
Date Particulars J.F. Amount Date Particulars J.F. Amount
To By
18. 1. Feb Capital A/c 45,000 1 Bank A/c 15,000

Sales A/c 7 Office Equipment A/c 2,500

1,200
Drawing A/c

18 Salaries A/c 8,000

Office Rent A/c

24 2,500
Balance Carried down

27 1,200

31 17,000

Total= Total=
46,200 46,200
Balance Brought down
17,000
Capital Account
Date Particulars J. Amount Date Particulars J. Amount
F. F.
To By
31 Balance Carried 45,000 1 Cash A/c 45,000
down

Total= Total=
45,000 45,000

1 Feb Balance Brought 45,000

down
Bank Account
Date Particulars J.F. Amount Date Particulars J.F. Amount
To By
1 Cash A/c 15,000 4 Purchase A/c 4,000

30 Telephone Bill A/c 2,600

Balance Carried
31 down 8,400

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 Total= Total=
15,000 15,000

1 Feb Balance Brought 8,400

down

Purchase Account

Date Particulars J.F. Amount Date Particulars J.F. Amount

4 To Bank Account 4,000 By
31 Balance Carried 4,000
down

Total= Total=4,000
4,000
Balance Brought
1 Feb down 4,000

Office Equipment Account

Date Particulars J.F. Amount Date Particulars J.F. Amount
7 To Cash Account 2,500 By
31 Balance Carried down 2,500

Total= Total=
2,500 2,500

1 Feb Balance Brought 2,500

down
Sales Account
Date Particulars J.F. Amount Date Particulars J.F. Amount
To By
31 Balance Carried 2,000 8 Cash A/c 1,200
down
10 Messi A/c 800

Total= Total=
2,000 2,000

1 Feb Balance Brought down 2,000

Messi Account
Date Particulars J.F. Amount Date Particulars J.F. Amount

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10 To Sales A/c 800 15 By Sales Return A/c 200

Balance Carried Down

31 600

Total= Total=
800 800

1 Feb Balance Brought down 600

Sales Return Account
Date Particulars J.F. Amount Date Particulars J.F. Amount
15 To Messi A/c 200 By
31 Balance Carried down 200

Total= Total= 200

200

1 Feb Balance 200

Brought
down
Drawing Account
Date Particulars J.F. Amount Date Particulars J.F. Amount
18 To Cash A/c 8,000 By
31 Balance Carried down 8,000

Total= Total=
8,000 8,000

1 Feb Balance Brought Down 8,000

Salaries Account
Date Particulars J.F. Amount Date Particulars J.F. Amount
24 To Cash Account 2,500 By
31 Balance Carried down 2,500

Total= Total=
2,500 2,500

1 Feb Balance Brought down 2,500

Office Rent Account
Date Particulars J.F. Amount Date Particulars J.F. Amount
27 To Cash Account 1,200 By
31 Balance Carried 1,200
down

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 Total= Total=
1,200 1,200

1 Feb Balance Brought 1,200

down
Telephone Bill Account
Date Particulars J.F. Amount Date Particulars J.F. Amount

30 To Bank A/c 2,600 By

31 Balance Carried 2,600
down

Total= Total=
2,600 2,600

1 Feb Balance Brought 2,600

down

Trial Balance
Trial Balance: After posting all accounts in the ledger, businessmen want to know that all the entries made were right
or not. To test the arithmetic accuracy of all entries a list is prepared that is known as Trial Balance.
It is based on a double entry system. all Dr. balance accounts are shown in the dr. side of trial balance and all cr. balance
accounts are shown in the credit side of the account. It is helpful in locating errors and comparison with other firms. In
trial balance the total of both sides should be equal.

Format of Trial Balance

Date Particulars L.F. Debit Balance Credit Balance

Cash Account 17,000

Capital Account 45,000
Bank Account 8,400
Purchase Account 4,000
Office Equipment Account 2,500
Sales Account 2,000
Messe Account 600
Sales Return Account 200
Drawings Account 8,000
Salaries Account 2,500
Office Rent Account 1,200
Telephone Bill Account 2,600

Total= 47,000 Total= 47,000

Trial Balance II
Trial Balance: After posting all accounts in the ledger, businessmen want to know that all the entries made were right
or not. To test the arithmetic accuracy of all entries a list is prepared that is known as Trial Balance.
It is based on a double entry system. All Dr. balance accounts are shown in the dr. side of trial balance and all cr. balance
accounts are shown in the credit side of the account. It is helpful in locating errors and comparison with other firms. In
trial balance the total of both sides should be equal.
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Format of Trial Balance
Date Particulars L.F. Debit Credit Balance
Balanc
e

Accounting Errors: it may be possible to occur errors during the posting of entries in journal and ledger. These types of
errors are called accounting errors. There are two types of error in trial balance.

Errors which Don’t affect the Trial Balance

1. Error of Omission: if any transaction is omitting from being recorded
in journal or ledger. There is no any affect on trial balance because no
account is dr. or cr. and omitting the same amount. Errors which do not affect
2. Error of Principle: in this, posting of an entry from journal to ledger the trail balance.
inadvertently in the correct side but violating the accounting principles.
e.g. revenue expenditure is treated as capital expenditure
For example, the installation cost of a new machine is accounted for by Errors which affect the trail
debiting the wage expense account instead of debiting the machinery balance.
account.
3. Error of Commission: Recording incorrect figures in a journal and
posting the same amount in the correct sides of ledger accounts is
called errors of commission and this does not affect the agreement of trial balance.
E.g. Goods purchased from Mohan Rs. 10,000 but entered Rs. 1000 in purchase account and Mohan’s account.
4. Compensating Errors: these types of errors compensate the effect consequently balance of trial will be equal.
e.g. A balance should be dr. in the Shyam’s account Rs. 500 but by mistake it debited Rs. 50. Another balance should
be transferred to the Mohan’s account Rs. 50 but by mistake it debited Rs. 500. Both entries are wrong in amount
but compensate each other and don’t affect the trial balance.
5. Error of Posting: These types of errors are correctly recorded in journal but wrongly posted in the account of
ledger but at the right side. So that there is no effect on the trial balance.
E.g. goods sold to Ram so made correct entries in the journal but in the ledger it is posted in the Shyam’s account.
6. Error of Recording a transaction twice in the Books: if any transaction recorded twice in the same account on
both sides, this also does not affect the trial balance.
E.g. Goods purchased from Mohan Rs. 10,000, this transaction is posted twice in the books.

Errors which affect the Trial Balance

1. Posted of Wrong Amount: in this type of error one side is entered with the wrong amount. E.g. goods purchased
from Sita Rs. 10,000 then entry will be purchased a/c Dr. and Sita Cr. but actually the entry posted in the journal is
Dr. purchase a/c Rs. 100 and Sita Cr. with Rs. 10,000. This error affects the trial balance.
2. Posting to the Wrong Side: if entry is posted on the wrong side it influences the trial balance. E.g goods sold to
Ram Rs. 5000 than entry should be Ram A/c Dr. and Sales a/c Cr. but actually a/c of Ram is credited by mistake. This
error also affects the trial balance.
3. Error of Totaling: if any subsidiary book is wrongly totaled and posted in ledger is also wrong total, consequently
trial balance is also wrong. E.g. if the total of sales books is calculated wrong by 10,000 instead of 15000. In this
situation a sales account credited by 10,000 but debtors account is debited with the right amount Rs. 15,000. This
entry also affects the trial balance.
4. Omission of Posting of one side of an entry or posting twice in any side:
e.g. Goods purchase from Ram Rs. 10,000 this entry is correctly entered in the journal but posted in ledger in only
Purchase a/c, so balance of trial balance is reduced by 10,000.
5. Error of Totaling and Balancing of Accounts: if there is any error occur in balancing and totaling of ledger, then it
affects the trial balance and does not match both sides equal. E.g. if the balance of Salary account is 30,000 but it is
wrongly calculated as 300,000.
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6. Omission to record the balance of an account in trial balance or wrongly recorded: Journal to posting in
ledger and ledger to trial balance. When entries are posted in trial balance from ledger and any amount is omitted or
wrongly entered then it affects the trial balance.

Process to Locating Errors

• At the outside casting of the trial, balance is to be checked carefully.
• Thereafter, it is to be ensured that all ledger accounts have been posted in the trial balance properly.
• It is to be ensured that all the transactions have properly been posted from journal to ledger.
• Calculation of totals of ledger accounts and balancing of ledger accounts are to be checked properly.
• Check properly half of the differentiated amount is wrongly entered in the opposite account.
• Sometimes replacement of numbers. Then divide the difference with 9, if remainder is zero, then any no. is replaced.
• Compare the current year trial balance with previous yr.
• Check properly the last year balance is carried forward properly.
• Make a suspense account.
Suspense account: A suspense account is a catch-all section of a general ledger used by
companies to record ambiguous entries that require clarification. Suspense accounts
are routinely cleared out once the nature of the suspended amounts are resolved, and
are subsequently shuffled to their correctly designated accounts.

Final Accounts
Final Accounts and Adjustments
● The Companies Act requires every company to prepare every year a Profit and Loss Account or Income and
Expenditure Account and Balance Sheet of the end of the year – Final Accounts of company including Trading
Account, Profit and Loss Account, Profit and loss Appropriation Account and Balance Sheet.
● Final accounts show both the financial position of a business along with the profitability, they are used by external
and internal parties for various purposes.
Trading account, Profit and Loss account (shows the profit and loss) and Balance Sheet (shows the financial
position of the organization) together are called final accounts.

Trading and Profit & Loss Account

For the year 31st December 2019
Dr Cr
Particulars Rs. Particulars Rs.
Opening Stock Sales
Purchase Sales Returns (-)
Purchase Returns (-) Closing Stock

Expenses Incomes

Balance Sheet
as on 31st Dec 2019

Capital+Liabilities Rs. Assets (Dr) Rs.

(Cr)
Capital
Drawings (-)

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Incomes which are debited in the ledger, can’t be shown on the debit side of the Trading and Profit & Loss Account
rather they are shown on the Assets side of the Balance Sheet.
Expenses which are credited in the ledger, can’t be shown on the credit side of the Trading and Profit & Loss Account
rather they are shown on the Capital+Liabilities side of the Balance Sheet.
Expenses at the manufacturing stage (eg: wages, etc) comes first in the priority and are shown at top (primary expenses)
whereas expenses incurred at the showroom level (eg: Salaries of salesman, etc) are second in priority and are shown at
bottom (secondary expenses) of the debit side.
Incomes at the manufacturing stage are primary incomes and thus shown at top and the incomes at the showroom level
are secondary incomes and thus shown at the bottom of the credit side.
The total of both sides of Trading and Profit & Loss Account should be equal. If income is greater than expenses then it is
profit and it is shown on the capital+liabilities side of the balance sheet and if expenses are greater than incomes then it
is loss and is shown on the assets side of the balance sheet.

Final Accounts: it includes

Trading Account
P&L Account
Balance Sheet

Trading Account: is a statement which is prepared by a business firm. It shows the gross profit of business
activities during a specific period. It gives details of total sales, total purchases and direct expenses relating to purchase
and sales.
Format of Trading Account
Trading A/c
Dr. (for the year ending…….) Cr.
Particulars Amount Particulars Amoun
t

Features of Trading Account

Trading Account has the following features:
1. It is a Nominal Account.
2. It is prepared on the last day of an accounting year.
3. It is the first stage of the Final Account of a trader and the second stage of the Final Accounts of a manufacturer.
4. Only revenue transactions are included in it. No capital item is taken into account. Capital items are included in the
Balance Sheet.
5. It has no opening balance. In the case of a manufacturing concern, it starts with the balance of the Manufacturing
Account.
6. It is debited with the cost of goods sold and all the expenses connected with the purchase of goods and credited with
sale proceeds of goods. Expenses concerning sale of goods (operating expenses) are not recorded here — these are
included in Profit or Loss Account.
7. All expenses relating to the current year — whether paid in cash or not — are taken into account. But expenses
relating to the past or next year are not included in it.
8. All revenues relating to the current year — whether received in cash or not — are taken into account. But revenues
relating to the past or next year are not included in it.
9. Its balance indicates gross profit or gross loss. Credit balance represents gross profit, while debit balance represents
gross loss.
10. Gross profit or gross loss is transferred to the Profit or Loss Account.
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Utility of Trading Account
• Knowledge of gross profit or gross loss
• Knowledge of direct expenses
• Comparison of closing stock
• Safety from loss in future
Journal entries related to Trading Account
1. Trading A/c Dr.
to all Direct expenses A/c
(For direct exp. Accounts transferred to the dr. side of trading a/c)
2. Sales A/c Dr.
Closing Stock A/c Dr.
To Trading A/c
For above Accounts transferred to the cr. side of trading a/c)
3. Sales A/c Dr.
To Sales Return A/c
(For sales return a/c transferred to sales account)
4. Trading A/c Dr.
To Profit & Loss A/c
(For Gross profit Transferred to the Cr. side of the P&L A/c)
5. P&L A/c Dr.
To Trading A/c
(For Gross loss Transferred to the dr. side of the P&L A/c

Profit and Loss Account: it is also called income statement of the firm. It gives the information of net profit or net loss.
It includes all indirect expenses including manager commission, selling and distribution, office expenses and
advertisement expenses. The gross profit of the trading account is transferred to the cr. side of P&L A/c.

Format of Profit and Loss Account

Profit and loss A/c
(For the year ending…….)
Particulars Amount Particulars Amount

Balance Sheet: is the financial statement of a company which includes assets, liabilities, equity capital, total debt, etc. at
a point in time. Balance sheet includes assets on one side, and liabilities on the other. For the balance sheet to reflect the
true picture, both heads (liabilities & assets) should tally (Assets = Liabilities + Equity). It is a snapshot of the financial
position of a company at a specified time, usually calculated after every quarter, six months or one year. Balance Sheet
has two main heads –assets and liabilities.

Format of Balance Sheet

Capital + Liabilities Amount Assets Amount

Why a firm Prepare Balance Sheet

● Knowledge of financial position
● Knowledge of all assets and liabilities
● Knowledge of capital

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● Knowledge of creditors and debtors
● Helpful in taking loan
● Helpful for the interested parties

Difference b/w Trial Balance and Balance Sheet

Trial Balance Balance Sheet

1. The objective of TB is to check the 1. The objective of BS is to know the financial

arithmetic accuracy of records. position of a firm.
2. It is prepared as per requirement. 2. It is prepared for a fixed accounting period.
3. It is not necessary to make. 3. It is necessary to make.
4. In this, no entry of closing stock. 4. There is an entry of C/S in the assets side
5. There are two sides Dr. and Cr. of BS.
6. During the preparation of trial balance no 5. There are also two sides but one is assets
need for adjustments. and other is liabilities.
7. It includes all three types of account 6. During the preparation of BS adjustments
balance. are required.
8. It is not proof in court. 7. It includes only real and personal account
balance.
8. BS can be used as a proof in court.
Final Accounts
Final accounts are a somewhat archaic bookkeeping term that refers to the final trial balance at the end of an
accounting period from which the financial statements are derived. This final trial balance includes every journal entry
used to close the books, such as:
● Wage and payroll tax accruals
● Income tax accruals
● Asset write downs
● Adjustments to reserves for returns, bad debts, and obsolete inventory
● Depreciation and amortization
● Overhead allocation
● Customer billings

Thus, final accounts can refer to the final trial balance or the financial statements upon which they are based. The
primary financial statements are the income statement, balance sheet, and statement of cash flows.
● Since final accounts refers to a company's ending account balances, which in turn are used to create financial
statements, this means that the final accounts reveal the results of the business during a period, its financial position
at the end of that period, and its sources and uses of funds during that period (which is the purpose of the financial
statements).
● A final account, or final accounting, can also be the summarized statement issued when a business transaction has
been concluded. For example, when someone leaves a hotel, they are given a final accounting of what they owe the
hotel.

Write-down
● A write-down occurs when a business reduces the carrying amount of an asset, other than through
normal depreciation and amortization (the action or process of reducing or paying off a debt with regular
payments).
● A write-down is normally done when the market value of an asset declines below its current carrying amount. The
entire amount of the write-down charge appears on the income statement, while the reduced carrying amount of the
asset appears on the balance sheet. A write-down is a non-cash expense, since there is no associated outflow of cash
when a write-down is taken.
● A write-down should be taken as soon as management is aware that the market value of an asset has fallen; they are
not supposed to delay this recognition, as often happens when a company wants to manage its earnings.

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Amortization
● Amortization is the process of incrementally charging the cost of an asset to expense over its expected period of use,
which shifts the asset from the balance sheet to the income statement. It essentially reflects the consumption of an
intangible asset over its useful life. Amortization is most commonly used for the gradual write-down of the cost of
those intangible assets that have a specific useful life. Examples of intangible assets are patents, copyrights, taxi
licenses, and trademarks. The concept also applies to such items as the discount on notes receivable and deferred
charges.
● The amortization concept is also used in lending, where an amortization schedule itemizes the beginning balance of
a loan, less the interest and principal due for payment in each period, and the ending loan balance. The amortization
schedule shows that a larger proportion of loan payments go toward paying off interest early in the term of the loan,
with this proportion declining over time as more and more of the loan's principal balance is paid off. This schedule is
quite useful for properly recording the interest and principal components of a loan payment.

Overhead allocation
● Overhead allocation is the apportionment of indirect costs to produced goods. It is required under the rules of
various accounting frameworks. In many businesses, the amount of overhead to be allocated is substantially greater
than the direct cost of goods, so the overhead allocation method can be of some importance.
● There are two types of overhead, which are administrative overhead and manufacturing overhead. Administrative
overhead includes those costs not involved in the development or production of goods or services, such as the costs
of front office administration and sales; this is essentially all overhead that is not included in manufacturing
overhead. Manufacturing overhead is all of the costs that a factory incurs, other than direct costs.
● You need to allocate the costs of manufacturing overhead to any inventory items that are classified as work-in-
process or finished goods. Overhead is not allocated to raw materials inventory, since the operations giving rise to
overhead costs only impact work-in-process and finished goods inventory

The following items are usually included in manufacturing overhead:

● Depreciation of factory equipment ● Quality control and inspection
● Factory administration expenses ● Rent, facility and equipment
● Indirect labor and production supervisory wages ● Repair expenses

● Indirect materials and supplies ● Rework labor, scrap and spoilage

● Maintenance, factory and production equipment ● Taxes related to production assets

● Officer salaries related to production ● Uncapitalized tools and equipment

● Production employees’ benefits ● Utilities

Final Account with Adjustments

Closing Stock: refers to those goods which are not sold out at the end of the accounting period. So the valuation of the
stock is at the cost or market value whichever is less. From the accounting point of view, aspects covered while
preparing the accounts are:
1. Closing Stocks as shown on the Credit Side of Trading Account
2. Closing Stocks as shown on the Asset Side of Balance Sheet (in case of C/s is shown in the balance sheet).
Closing Stock A/c Dr.
To Trading A/c
(For closing stock transferred to trading account)

Outstanding Expenses: There are certain expenses incurred but not paid. They are called outstanding expenses. So that
these expenses are liability for the firm and once recorded in the liability side and other entries will be added in the Dr.
side of P&L account with perspective item. E.g. Rent is paid for 10 months Rs. 10,000. so entry will be
Rent A/c Dr.
To Outstanding Rent A/c
(For Rent Due)

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Prepaid Expenses: refers to expenses which are paid in the current accounting period but not getting the benefit of that
is called prepaid expenses. So it is the assets for the firm and once recorded in the assets side and other entry will be
recorded in the dr. side of profit and loss account after reduction with concerned item. E.g. rent is paid advance for two
months 1000 per month.
Trading and Profit & Loss Account
For the year 31st December 2019
Dr Cr
Particulars Rs. Particulars Rs.
Opening Stock Sales
Purchase Sales Returns (-)
Purchase Returns (-) Closing Stock

Rent 12,000 12,000 Accrued 12,000 12,000

Rent 10,000 Income
Received Income 10,000
Outstanding +2,000 Received
Rent Adjustment +2,000

Expenses 12,000 12,000 Unearned 14,000

Prepaid 15,000 Income
Expenses Adjustment -2,000
Adjustment -3,000 Income 12,000 12,000
Earned
Depreciation 1,000

Interest on Capital 1,000

Expenses
Incomes

Balance Sheet
as on 31st Dec 2019

Capital+Liabilities Rs. Assets (Dr) Rs.

(Cr)
Capital
Drawings (-)
Outstanding Rent 2,000 Prepaid Expenses 3,000

Unearned Income 2,000 Accrued Income 2,000

Capital 10,000 11,000 Machinery 10,000 9,000

Interest +1,000 Depreciation -1,000
earned on
capital

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Prepaid Rent A/c Dr.
to Rent A/c
(For rent paid in advance of two months)
Accrued Income: refers to that income which is earned in the accounting year but not received at the end of accounting
period. E.g. rent received of 10 months and remaining of 2 months Rs. 2000. so the entry will be
Accrued income A/c Dr.
To Rent A/c
(For rent receivable)
It is credited to the Profit & Loss Account and shown on the asset side of the balance sheet.

Unearned Income: refers to that income which is received but not earned in the current accounting period. This income
is for next year but received in this year.
Rent A/c Dr.
To Rent received in Advance a/c
It is credited to the Profit & Loss Account and shown on the liabilities side of the balance sheet.

Depreciation: refers to continue reduction in the value of fixed assets over time period. It is expenses for the business
therefore debited to the Profit & Loss Account. It is shown on the asset side of the balance sheet by reducing the value of
depreciation from the value of fixed assets. E.g 10% depreciation on machinery, here entry will be
Depreciation a/c Dr. 1000 (Dr. all expenses and losses)
To Machinery A/c 1000 (Reduce the value of fixed assets)
(For depreciation Charged on machinery)

Interest on Capital: every trader wants fixed rate interest on capital which is employed by him in business. It is entered
once in the dr. side of P&L (because it is an expense for the business as the interest has to be paid to the owner) and
others add in the capital of the liability side. So here entry of interest of capital will be
Interest on Capital A/c Dr.
To Capital A/c
(For interest allowed on capital)

Interest on Drawing: money withdrawn by the owner in the business for his personal use is called drawing. The owner
pays the interest on drawing. It is income for business so once cr. in the P&L A/c and other is entered in the liability side
after reduction in the capital. The journal entry of this is
Drawing A/c Dr.
To Interest on drawing A/c
(For interest charged on Drawing)

Interest on Loan: interest paid on external loans. It is expenses for the firm that’s why once enter in the dr. side of P&L
a/c and others enter in the liability side of the balance sheet. The journal entry of this is
Interest on Loan A/c Dr.
To Loan A/c
(For outstanding interest on loan.)

Bad Debts: A debtor who does not pay the amount of business due to insolvent death or any other reason so this
amount is called bad debts. This is a loss for business that’s why once entered in the dr. side of profit and loss a/c and
other is shown in the assets side of the balance sheet (Less in the debtors). The journal entry of this is
Bad debts A/c Dr.
To Sundry Debtors A/c
(For Bad Debts Written off)

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Provision for Bad Debts: on the basis of previous experience a provision is made for the bad debts. This is the expenses
for business so that once enter in the dr. Side of P&L other is shown in the assets side of the balance sheet (Less in the
debtors). The journal entry of this is (in case of creditors entry will be reverse)
P&L A/c Dr.
To Provision for doubtful debts a/c
(For provision for doubtful debts created)
Manager Commission: sometimes additional commission is also distributed to the manager on extra profits. This is the
expenses for the firm so that once entered in the dr. side of profit and loss account and other is because of liability
entered in the liability side if BS. The journal entry of this is
Commission A/c Dr/
To Outstanding Commission A/c
(For commission payable to the manager)

Deferred Revenue Expenditure: those expenses which are paid in the current account period but their benefit will get
in coming years. E.g advertisement expenses Rs. 200000 and it is assumed its benefit will get in coming 5 yrs. So that
every year 40000 will be charged in the current profit. The journal entry will be
P&L A/c Dr. 40,000
To Advertisement A/c 40,000
(For 1/5th of advertisement expenses written off)
It is expenses for the firm so once entered in the Dr. side of profit and Loss account and other is assets side in the
Balance Sheet.

Dishonour of Bills Receivables: when any bill is dishonored on due date so entry will be
Debtors a/c Dr.
To Bills receivable a/c
(For bill receivable dishonored)
It is added to the debtors in assets side of BS and other is reduced in the recoverable bills in assets side of BS.

Loss due to Accident: it is also called abnormal loss because it is out of control of business. It is loss for the business of
goods so entry of this is
Loss by Accident A/c
To Purchase A/c
(For goods destroyed by accident)
Loss by Accident A/c is debited because it is a loss for the business and the Purchase A/c is credited because the goods
purchased have reduced.

Goods given away as charity/Free sample/Personal Use: when businessman gives goods as a charity so entry will be
Charity/ Free Sample/ Drawing A/c Dr.
To Purchase a/c
(For goods Given away as Charity)
Charity/Drawing A/c is debited as it is an expense and the Purchase A/c is credited because the items purchased have
reduced.

Contingent Liabilities: all expenses are related to a special event. Some of those expenses are uncertain. It is shown
outside the balance sheet.

Accounts of Non-Trading Institutions

Capital and Revenue Items
Expenditure: means spending on something. This can be a payment in cash or can also be the exchange of some
valuable item in exchange for goods or services. There are two types of expenditure namely Capital Expenditure and
Revenue Expenditure.

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Capital Expenditure: are those expenditures whose benefits are derived over a number of accounting years. There
different types of capital expenditure e.g.
1. Cash money spent on business purposes.
2. Purchasing and installation of Plants and machinery items
3. IT items and Electric power equipment
4. Permanent additions to existing fixed assets
5. Before the use of fixed assets all expenses on the assets are capital expenses.
Revenue Expenditure: are those whose complete benefits are received during the current year itself. These are the
routine expenditures that take place in the normal business. In other words, this kind of expenditure maintains fixed
assets. There are two subcategories of revenue expenditures:
Direct Expenses: These include the cost of manufacturing of raw material to turn it into a finished product. For
instance, Productive wages and salaries to workers, shipping costs, legal expenses, electricity, and water bills, fuels costs,
rent, commissions, packaging charges.
Indirect Expenses: These connect with only selling and distributing goods other than manufacturing. For example,
salaries, depreciation, machinery, items of furniture and fixing, etc.
Capital Loss: refers to a loss which is not known before it happens. In other words, we can say that this type of loss is
abnormal loss and non-recurring in nature e.g. loss by sale of fixed assets, loss by fire etc.
Revenue Loss: refers to losses which are occurred while maintaining the daily business routine activities e.g. goods sold
at loss, repair expenses of machine.
Capital Profit: refers to those profit which is not earned in normal routine, e.g. sale of old machine at profit, sale of old
furniture at profit.
Revenue Profit: refers to those profit which is earned in normal routine, e.g. sale of stock, compensation received from
state govt.
Accounts of Non-Trading Institutions
Non–Trading Institutions: Not-for-Profit Organizations are those organizations whose objective is not to earn profit
but to render services to its members and to the society. In other words, the organization’s that are used for the welfare
of the society and are set up as charitable institutions which function without any profit motive. Their main aim is to
provide service to a specific group or the public at large.

The main characteristics of such organizations are:

1. Such organizations are formed for providing service to a specific group or public at large such as education, health
care, recreation, sports and so on without any consideration of caste, creed and colour. Its sole aim is to provide
service either free of cost or at nominal cost, and not to earn profit.
2. These are organized as charitable trusts/societies and subscribers to such organizations are called members.
3. Their affairs are usually managed by an executive committee elected by its members.
4. The main sources of income
(i) subscriptions from members,
(ii) donations,
(iii) legacies,
(iv) grant-in-aid,
(v) income from investments, etc.
5. The funds raised by such organizations through various sources are credited to capital fund or general fund.
6. The surplus generated in the form of excess of income over expenditure is not distributed amongst the members. It
is simply added in the capital fund.
7. The Not-for-Profit Organizations earn their reputation on the basis of their contributions to the welfare of the
society rather than on the customers’ or owners’ satisfaction.
8. The accounting information provided by such organizations is meant for the present and potential contributors and
to meet the statutory requirement.

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Financial Statements for Non-Profit Organization

Final A/c for

NPO

Income and
Receipt and Expenditure Balance Sheet
Payment Account Account

Receipt and Payment Account: is the summary of cash and bank transactions which helps in the preparation of Income
and Expenditure Account and the Balance Sheet. Besides, it is a legal requirement as the Receipts and Payments Account
has also to be submitted to the Registrar of Societies along with the Income and Expenditure Account, and the Balance
Sheet. It is a real account.

Features of Receipt and Payment Account

1. It starts with opening balance and ends with closing balance
2. It is the summary of cash and bank transactions.
3. It includes capital as well as revenue items.
4. It follows a cash system of accounting and actual cash transactions are entered.
5. It shows cash position and excludes all non-cash items.
6. It does not take any income/expense outstanding at the beginning or at the end.

Format of Receipt and Payment Account

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Difference b/w Receipt and Payment A/c and Cash A/c
Receipt and Payment Cash Account

1. It is prepared by non-trading 1. It is prepared by trading firms.

organizations. 2. In this all receipts and payments are
2. It is not mandatory to record the receipt recorded date-wise.
and payments date-wise. 3. In this one item can be recorded more
3. In this items are recorded under a specific than one time.
head. 4. It has continued the whole year.
4. It is prepared on a fix date 5. It is based on the cash transactions
5. It is prepared on the basis of a cash book.

Income and Expenditure Account:

• Income and Expenditure Account is akin to Profit and Loss Account.
• The Not-for-Profit Organisations usually prepare the Income and Expenditure Account and a Balance Sheet with the
help of Receipt and Payment Account.
• It is concerned with only revenue items—expenses and incomes.
• It records all losses and expenses on its debit side and all incomes and gains on its credit side.
• Of the incomes and expenses of revenue nature, only the portion pertaining to the current year is shown in the
Income and Expenditure Account i.e. amount relating to the previous year or future year are excluded.
• The Income and Expenditure Account is prepared on an accrual basis with the help of Receipts and Payments
Account along with additional information regarding outstanding and prepaid expenses and depreciation etc.
Salient Features of Income and Expenditure Account
1. All revenue incomes and expenditure of the current year.
2. Adjustments of profit and loss account
3. Items of current year only.
4. Only revenue items
5. It shows the Deficit or surplus
6. Nominal Account
7. Accrual basis
Format of Income and Expenditure Account

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Difference b/w Receipt and Payment A/c and Income and Expenditure A/c
Receipt and Payment Income and Expenditure A/c
1. It is the summary of a cash book. 1. It is the same as a P & L Account.
2. Real account 2. Nominal Account
3. It is mandatory to record the opening and 3. There is no opening balance of this account.
closing balance. 4. It also includes the adjustments along with
4. It is based on a cash system. there is no entry cash transactions.
of adjustments. 5. It includes only revenue items and capital
5. It includes all receipt and payments whether it items are entered in the BS.
is capital or revenue. 6. It includes only current year income and
6. It includes all items of current, future and expenditures.
previous year. 7. All incomes are credited and all expenses are
7. In this all receipts are entered in the dr. side dr. in this account.
and all payments are recorded in the cr. side of
account.

Balance Sheet: ‘Not-for-Profit’ Organisations prepare Balance Sheet for ascertaining the financial position of the
organisation. The preparation of their Balance Sheet is on the same pattern as that of the business entities. It shows
assets and liabilities as at the end of the year. Assets are shown on the right hand side and the liabilities on the left hand
side. However, there will be a Capital Fund or General Fund in place of the Capital and the surplus or deficit as per
Income and Expenditure Account which is either added to/deducted from the capital fund, as the case may be.
It is also a common practice to add some of the capitalized items like legacies, entrance fees and life
membership fees directly in the capital fund.

Balance Sheet as on………

Liabilities Amount Assets Amount

Capital Fund cash in hand/cash at bank

Opening Balance Outstanding income
Add: Surplus or Prepaid expenses
Less: Deficit Stock of consumable items:
Add: capitalized income of the Previous Balance
current year on account of: Add: Purchase in the current period
Legacies Less: value consumed during the period
Entrance fees Previous balance
Life membership fees Add: Purchase in the current period
Closing Balance Less: Book value of the assets
Special Fund/Donations sold/disposed off
Previous balance if any Closing balance
Add: Receipt for the item during the period
Less: Exp. Paid out of fund/donation
Net Balance
Creditors for purchase
Bank overdraft
Outstanding Expenses
Income received in Advance

Important items relating to Non-Trading Institutions

Life Membership Fees: Some members prefer to pay a lump sum amount as life membership fee instead of paying
periodic subscription. Such amount is treated as capital receipt and credited directly to the capital/general fund.

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Subscriptions: Subscription is a membership fee paid by the member on annual basis. This is the main source of income
of such organizations. Subscription paid by the members is shown as receipt in the Receipt and Payment Account and as
income in the Income and Expenditure Account.
Donations: It is a sort of gift in cash or property received from some person or organisation. It appears on the receipts
side of the Receipts and Payments Account. Donation can be for specific purposes or for general purposes.
Specific Donations: If donation received is to be utilised to achieve specified purpose, it is called Specific Donation. The
specific purpose can be an extension of the existing building, construction of a new computer laboratory, creation of a
book bank, etc. Such donation is to be capitalised and shown on the liabilities side of the BS irrespective of the fact
whether the amount is big or small.
General Donations: Such donations are to be utilised to promote the general purpose of the organisation. These are
treated as revenue receipts as it is a regular source of income hence, it is taken to the income side of the Income and
Expenditure Account of the current year.
Legacies: It is the amount received as per the will of a deceased person. It appears on the receipts side of the Receipt
and Payment Account and is directly added to capital fund/general fund in the balance sheet, because it is not of
recurring nature. However, legacies of a small amount may be treated as income and shown on the income side of the
Income and Expenditure Account.
Entrance Fees: Entrance fee also known as admission fee is paid only once by the member at the time of becoming a
member. In the case of organisations like clubs and some charitable institutions, it is limited and the amount of entrance
fees is quite high. Hence, it is treated as a non-recurring item and credited directly to the capital/general fund.
Sale of old asset: Receipts from the sale of an old asset appear in the Receipts and Payments Account of the year in
which it is sold. But any gain or loss on the sale of assets is taken to the Income and Expenditure Account of the year.
For example, if an item furniture with a book value of Rs. 800 is sold for Rs. 700, this amount of Rs. 700 will be shown as
receipt in Receipts and Payments Account and Rs. 100 on the expenditure side of the Income and Expenditure Account
as a loss on sale of old asset and while showing furniture in the balance sheet Rs. 800 will be deducted from its total
book value.
Sale of Periodicals: It is an item of recurring nature and shown as the income side of the Income and Expenditure
Account.
Sale of Sports Materials: Sale of sports materials (used materials like old balls, bats, nets, etc) is the regular feature
with any Sports Club. It is usually shown as an income in the Income and Expenditure Account.
Payments of Honorarium: It is the amount paid to the person who is not the regular employee of the institution.
Payment to an artist for giving performance at the club is an example of honorarium. This payment of honorarium is
shown on the expenditure side of the Income and Expenditure Account.
Endowment Fund: It is a fund arising from a bequest or gift, the income of which is devoted for a specific purpose.
Hence, it is a capital receipt and shown on the Liabilities side of the Balance Sheet as an item of a specific purpose fund.
Government Grant: Schools, colleges, public hospitals, etc. depend upon government grants for their activities. The
recurring grants in the form of maintenance grant is treated as revenue receipt (i.e. income of the current year) and
credited to Income and Expenditure account.
• However, grants such as building grants are treated as capital receipt and transferred to the building fund account.
• It may be noted that some Not-for-Profit organizations receive cash subsidy from the government or government
agencies. This subsidy is also treated as revenue income for the year in which it is received.

Partnership Accounts
Partnership is a relation of mutual trust and faith. It is necessary that the partnership accounts be maintained in an
honest, accurate and equitable manner.
Partnership accounts should present a true and fair picture of the partnership business. For this purpose, it is necessary
to study the definition of partnership act and partnership accounts.
Definition of Partnership: Section 4 of the Indian Partnership Act, 1932, defines partnership as follows:

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“Partnership is the relation between persons who have agreed to share the profits of business carried on by all
or any of them acting for all.”
Features of Partnership
1. Two or more persons
2. Agreement between partners
3. Existence of Business and profit motive
4. Sharing of profits
5. Relationship of principal and agent
6. Business carried on by all or any of them acting for all

Partnership Deed
In order to avoid the misunderstanding and disputes, it is always the best course to have a written agreement duly
signed and registered under the act is called partnership deed. It is also called an article of partnership. It contains the
following points.
1. The name and address of the firm
2. Name and address of partners
3. The type and nature of the business the firm propose to do
4. Amount of capital to be contributed by each partner and whether the capital accounts will be fixed or fluctuating.
5. Interest on Capitals: whether interest is to be allowed on capitals. If so the rate of interest.
6. Drawing: how much amount the partners are entitled to withdraw for personal use.

Interest on Drawing: whether interest will be charged on partner’s drawing. If so, the rate of interest.

Profit Sharing Ratio: the ratio in which profits or losses are to be divided among the partners.

Salary: whether any partner will be paid salary for the work done by him. If so, how much?

Goodwill: methods of valuation of goodwill in case of admission or retirement of a partner.

Accounting Period of the Firm: the period after which the final accounts of the firm are to be prepared. Whether yearly
or half-yearly and the date on which accounts are to be closed every year.

Methods of recording of firm’s accounts and the safe custody of the books of accounts and other documents of the
firm.
Auditing: whether the firm’s books will be audited or not? if so, the mode of auditor’s appointment.
Date of Commencement of Partnership
Duration of Partnership: the period for which the partnership has been established and the mode of dissolution of
partnership.
Use of the Decision of Garner Vs Murray: whether decision in the case of Garner Vs Murray is to apply in the case of
insolvency of a partner.
Bank Accounts: whether the account in the bank will be opened in the firm's name or in some partner’s name? Who will
have the right to sign the cheque?
Rules to be followed in case of admission of a partner.
Settlement of Accounts on Retirement: the manner in which the amount due on the retirement or death of a partner
will be calculated and the manner in which it will be paid.
Settlement of Disputes: in case of dispute among the partners, how the dispute will be solved. Whether an arbitrator
will be appointed?

The importance of partnership deed: -

Having a partnership deed is not mandatory or compulsory by law but it is desirable because of the following reasons:
• It regulates the rights, duties, and liabilities of each partner.

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• It helps to avoid any misunderstanding amongst the partners because all the terms and conditions of the
partnership have been laid down beforehand in the deed.
• Any dispute amongst the partners may be settled easily as the partnership deed may be readily referred to.
Hence, it is always the best course to have a written document (partnership deed) instead of oral agreements.

Features of Partnership Business

• Partnership business should consist of at least 2 members
• Banking business partnership – Member limit is equal to or less than 10
• Non-banking business partnership – Member limit is equal to or less than 20
• Partnerships does not require any minimum capital requirement to start, as it can be started with as much capital
members want
• Partners should have mutual understanding before starting business
• Ratio of profit and loss should be decided before the signing of partnership deed
• Every active member or partner is responsible for the action of other partners or members
• Auditor is not required while registering as a partnership firm

Documents Required
• Form No. 1 (For registration under Partnership Act)
• Signed Original copy of Partnership Deed by every partner
• Affidavit that declares the interest of an individual of becoming a partner
• Property’s rental or lease agreement
All the existing partnership firms are registered under the law governing partnerships in India that comes under
Indian Partnership Act, 1932. After registering as a partnership firm, all the partners are required to sign and date
the partnership deed. This signed document needs to be witnessed by an individual above 18 years of age who shall
not be among the partners or members (excluding spouses or family members of any partner). A copy of
partnership deed should be kept with each and every partner of the firm. This deed ensures the defined roles and
responsibilities of each partner. It supports in evading unrequired misunderstanding, harassment or conflict
between the partners.

Benefits associated with a partnership firm are as follows:

• This sort of business entity is easy to start:
• Greater Borrowing Capacity
• This form of business enjoys tax savings. Here income tax is imposed after distribution of profit among partners.
There is no double tax. In the case of corporations, the income tax is imposed twice. First on a corporation's profit
and secondly, when it is disturbed to shareholders.
• If there is a key employee in the firm of partnership and he wants to leave a job, he can be given a status of partner in
the business with the mutual consultations of others partners. In this way key employees can be retained.
• When it comes to any sort of business, the most amount of time it takes to start a process is with the decision
process. The reason for this is the need to pass a resolution. However, this is one thing that a partnership firm does
not need to partake in. To that end, the decision process is fast and it is reliable.

Rules in Absence of Partnership Deed

Profit Sharing Ratio: profits and losses are to be shared equally irrespective of their capital contribution.

Interest on Capital: no interest on capitals shall be allowed to the partners. If there is provision for the interest on
capitals in the partnership deed, it will be allowed only when there is a profit.

Interest on Drawing: no interest is to be charged on drawings.

Salary to a partner: no partner is entitled to any salary or commission for taking part in running the firm’s business.
Interest on Loan: interest at the rate of 6% per annum is to be allowed on a partner’s loan to the firm. Such interest
shall be paid even if there are losses to the firm.
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Admission of a New Partner: without the consent of all existing partners no new partner can be admitted to the firm.
Each partner can participate in the conduct of business.
Each partner can inspect the books of the firm and can take a copy of the same.
Profit and Loss Appropriation Account: It is a special account that a firm prepares to show the distribution of
profits/losses among the partners or partner’s capital. the firm uses it to show the allocation and distribution of Net
Profit among the partners, reserves, and dividends. The balance of the account is transferred as the remaining profit
either to the Capital accounts or to the Current accounts of the partners.

Profit and Loss Appropriation Account

After the Profit and Loss Account, Profit and Loss Account Appropriation is prepared for the firm. In this account how
the profit or loss among the partners of the firm is distributed is shown. Through this account, all adjustments in respect
of partner’s salary, partner’s commission, interest on capital, interest on drawings, etc. are made.
It starts with the net profit/net loss as per Profit and Loss Account is transferred to this account. The journal entries for
preparation of Profit and Loss Appropriation Account and making various adjustments through it are given as follows:

Journal Entries for Distribution of Profit

1. Transfer of the balance of Profit and Loss Account to Profit and Loss Appropriation Account
If Profit and Loss Account shows a credit balance (net profit):

Profit and Loss A/c Dr.

To Profit and Loss Appropriation A/c Cr

If Profit and Loss Account shows a debit balance (net loss)

Profit and Loss Appropriation A/c Dr.

To Profit and Loss A/c Cr

2. Interest on Capital
For crediting interest on capital to partners’ capital account:

Interest on Capital A/c Dr.

To Partner’s Capital/ Current A/c(individually)

For transferring interest on capital to Profit and Loss Appropriation Account

Profit and Loss Appropriation A/c Dr.

To Interest on Capital A/c

3. Interest on Drawings
For charging interest on drawings to partners’ capital accounts

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 Partners Capital/Current A/c’s (individually) Dr.

To Interest on Drawings A/c

For transferring interest on drawings to Profit and Loss Appropriation Account:

Interest on Drawings A/c Dr.

To Profit and Loss Appropriation A/c

4. Partner’s Salary
For crediting partner’s salary to partner’s capital account:

Salary to Partner A/c Dr.

To Partner’s Capital/ Current A/c (individually)

For transferring partner’s salary to Profit and Loss Appropriation Account:

Profit and Loss Appropriation A/c Dr.

To Salary to Partner A/c

5. Partner’s Commission
For crediting the commission to a partner, to partner’s capital account:

Commission to Partner A/c Dr.

To Partner’s Capital/ Current A/c (individually)

For transferring commission paid to partners to Profit and Loss Appropriation Account.

Profit and Loss Appropriation A/c Dr.

To Commission to Partner A/c

6. The share of Profit or Loss after appropriations

If Loss:

Partner’s Capital/Current A/c’s (individually) Dr.

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 To Profit and Loss Appropriation A/c

If Profit:

Profit and Loss Appropriation A/c Dr.

To Partner’s Capital/ Current A/c’s (individually)

Format of Profit and Loss Appropriation Account

Charge Vs Appropriation
Charge Appropriation
Charge against profit means the deduction of any amount from the firm’s Appropriation of Profit is the distribution of
revenue to reach Net Profit or Loss. Profit
Hence, the Profit and Loss Account is prepared. Hence, the Profit and Loss Appropriation
Account is prepared.

Interest on Monthly Drawings

Case 1- When Drawings are made at the beginning of every month, the amount of drawing is multiplied by the
number of remaining months in the year.
For example, the drawing on 1st April, 2013 will be multiplied by 12.
If drawings of equal amounts are made on the 1st day of each month, the interest @15% rate for 6.5 months may be
calculated on the amount of total drawings for the whole year.
Average Period = (Time left after first drawing + Time left after last drawing)/ 2

Case 2- When Drawings are made at the end of every month: the interest for 5.5 months will be equal to the interest
on drawings calculated on a monthly basis.
Case 3 – When Drawings are made in the middle or at any time during the month, interest on the whole amount
will be calculated for 6 months.
Sacrificing Ratio: when existing partners surrender some of their old share in favour of one or more of other partners.
The ratio of surrender to profit sharing ratio is called sacrificing ratio. It is calculated as follows:

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Sacrificing Ratio = Old Ratio – New Ratio
Gaining Ratio: when existing partners gain some portion of other partners share of profit. The ratio of gain of profit
sharing ratio is called gaining ratio. It is calculated as follows:

Gaining Ratio = New Ratio – Old Ratio

Admission of a Partner: at the time of admission, the new partner brings his share of goodwill and capital. Old partners
sacrifice a share of their profits in his favour and thus he gets a share in the future profits of the firm. Following
adjustments are needed at the time of the admission of a new partner:
⮚ Calculation of new profit sharing ratio
⮚ Accounting treatment of goodwill
⮚ Accounting treatment of Joint Life Policy
⮚ Accounting treatment for revaluation of assets and liabilities
⮚ Accounting treatment of reserves and accumulated profits.
Sacrificing Ratio: when existing partners surrender some of their old share in favour of one or more of other partners.
The ratio of surrender of profit sharing ratio is called sacrificing ratio. It is calculated as follows:

Sacrificing Ratio = Old Ratio – New Ratio

Gaining Ratio: when existing partners gain some portion of other partners share of profit. The ratio of gain of profit
sharing ratio is called gaining ratio. It is calculated as follows:

Gaining Ratio = New Ratio – Old Ratio

Calculation of New Profit Sharing Ratio
1. When only the ratio of the new partner is given in the question, then in the absence of any other agreement, it is
presumed that the old partners will continue to share the remaining profits in the same ratio in which they were
sharing before the admission of the new partner.
2. Sometimes the new partner purchases his share of profit from the old partners equally. In such cases the new profit
sharing ratios of the old partners will be ascertained by deducting the sacrifice made by them from their existing
share of profit.
3. Sometimes the new partner purchases his share from the old partners in a particular ratio. In such cases the new
profit sharing ratio of the old partners will be calculated after deducting the sacrifice made by a partner from his
existing share of profit.
4. Sometimes the old partners surrender a particular fraction of their share in favour of the new partner. In such cases
the new partner’s share is calculated by adding the surrendered portion of share by the old partners. Old partners’
shares are calculated by deducting the surrendered share from their old shares.

Goodwill
Goodwill is an intangible asset associated with the purchase of one company by another.
Specifically, goodwill is recorded in a situation in which the purchase price is higher than the sum of the fair value of all
visible solid assets and intangible assets purchased in the acquisition and the liabilities assumed in the process.
The value of a company’s brand name, solid customer base, good customer relations, good employee relations, and any
patents or proprietary technology represent some examples of goodwill.

Goodwill Meaning in Accounting

• Goodwill arises when a company acquires another entire business. The amount of goodwill is the cost to purchase
the business minus the fair market value of the tangible assets, the intangible assets that can be identified, and the
liabilities obtained in the purchase.

How to Calculate Goodwill

• To calculate goodwill, we should take the purchase price of a company and subtract the fair market value of
identifiable assets and liabilities.

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Goodwill Formula:
Goodwill = P−(A+L)
where:
P=Purchase price of the target company
A=Fair market value of assets
L=Fair market value of liabilities

Meaning of Goodwill
• Goodwill is an intangible asset that is found in the Balance Sheet of a trading concern. The value of an enterprise’s
brand name, solid consumer base, good consumer associations, good employee associations and any patents or
proprietary technology represent some instances of goodwill.
• When computing for the partnership enterprises, the accounting treatment of goodwill in diverse scenarios is
significant:
• The retiring or deceased partner is authorized to his portion of goodwill during the death or retirement because the
goodwill has been earned by the enterprise with the hard work and perseverance of all the existing partners
• Hence, during the death/ retirement of a partner, goodwill is evaluated as per agreement among the partners the
deceased/retiring partner recompensed for his portion of goodwill by the continuing partners (who have gained due
to the accretion of the share of gain from the retiring/dead partner) in their gaining ratio
• The accounting treatment for goodwill in such a scenario relies upon whether or not goodwill already appears in the
books of the enterprise.

Types of Goodwill
There are two distinct types:
• Purchased: Purchased goodwill is the difference between the value paid for an enterprise as a going concern and
the sum of its assets less the sum of its liabilities, each item of which has been separately identified and valued.
• Inherent: It is the value of the business in excess of the fair value of its separable net assets (assets-liabilities). It is
referred to as internally generated goodwill and it arises over a period of time due to the good reputation of a
business.
• For example, if you are selling an outstanding product or providing excellent service consistently, there is a lot of
chance that goodwill rises quicker.

Goodwill Accounting Treatment

There are 3 types related to the accounting treatment of goodwill at the time of admission of a new partner:
• When the amount of goodwill is paid privately.
• When the new partner brings his share of goodwill in cash.
• When the new partner does not bring his share of goodwill in cash.

Goodwill Example
To put it in a simple term, a Company named ABC’s assets minus liabilities is $10, and a company purchases Company
ABC for $ 15, the premium value following the acquisition is $ 5. This $5 will be included on the acquirer’s balance sheet
as goodwill. It is also recorded when the purchase price of the target company is higher than the debt that is assumed.
In a real-life example, consider the PQR-Mobile company and copollo merger announced in early 2019. The deal was
valued at $35.85 billion as of March 31, 2019, per an S-4 filing. The fair value of the assets is $78.34 billion, and the fair
value of the liabilities is $45.56 billion. Thus, goodwill for the deal would be recognized as $35.85 billion – ($78.34
billion – $45.56 billion).

Factors Affecting Goodwill

• Quality of Product: Better quality of product will increase the sales and profits which will increase the value of
goodwill.
• Efficiency of Management: A well-handled interest normally enjoys the merit of more cost efficiency and
productivity, which will increase the value of goodwill.

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• Location: The better location will attract more customers resulting in an increase in sales and profits which in turn,
will result in an increase in the value of goodwill.
• Market Condition: The monopoly situation or limited competition facilitates the concern to earn more gains which
leads to the more value of goodwill
• Access to Supplies (Raw Material Etc.): If a firm has better access to supplies or assured supply of inputs then it
enjoys a better reputation than others and higher goodwill.
• Special Advantages: If a firm enjoys special advantages like patents, trademarks, brand image, or any other
exclusive benefit, then the firm enjoys a higher value of goodwill.
• External resources: After sales service, Research & Development, Effectiveness of Advertisement, the supply of
electricity, import licenses, well-known collaborators, long-term contracts for the supply of materials, trademarks,
patents, etc. certainly enjoy more value of goodwill.

Need for Valuation of Goodwill

• The difference in the profit sharing ratio (PSR) amongst the existing partners
• Admission of a new partner
• Retirement of a partner
• Death of a partner
• Dissolution of an enterprise involving the sale of the business as a trading concern
• Consolidation of partnership firms

Methods of Valuation of Goodwill

The significant methodologies of valuation are mentioned:
• Average Profits Method
• Super Profits Method
• Capitalization Method

Accounting treatment of Goodwill on the admission of a new partner

When the amount of goodwill is paid privately: no entries are required to be passed.

When the new partner brings his share of goodwill in cash. Entries will be
Cash/ Bank A/c Dr.
To premium for goodwill A/c
(the amount of goodwill brought in cash by new partner)
Premium for Goodwill A/c Dr.
To Cash/Bank
(the amount of goodwill withdrawn by the old partners)

When old Partner brings his share of goodwill/premium in cash (when Goodwill A/C is closed)
Old Partner’s Capital A/c Dr.
to goodwill A/c
(Goodwill written off in old ratio)

When the goodwill is not brought by new partners

New Partner’s Capital A/c Dr.
To old partner’s Capital A/c
(capital account of new partner dr. from his share of goodwill on his admission and capital accounts of old partners’ cr.
in their sacrificing ratio)

Revaluation of Assets and Liabilities: is done with the help of a revaluation account. This account is nominal in
nature. If there is loss due to revaluation, revaluation account is debited and if the revaluation results in a profit, the
revaluation account is credited.
For decrease in the value of assets and increase in the value of liabilities

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Revaluation A/c Dr.
to Assets A/c
to Liabilities A/c

For increases in the value of assets and decrease in the value of liabilities
Assets A/c Dr.
Liabilities A/c Dr.
To revaluation A/c Cr.

When revaluation account shows profit:

Revaluation A/c Dr.
to old partner’s Capital A/c

When revaluation account shows loss:

Old partners’ capital A/c
to revaluation A/c

Accounting treatment of Reserves and Accumulated Profits or Losses

For distributing reserves and accumulated profits:
General Reserve A/c Dr.
Reserve Funds A/c Dr.
Profit & Loss A/c Dr.
To Old partner’s Capital A/c

For Distributing Accumulated Losses Among Old Partners In Old Ratio

Old partner’s Capital A/c
To Profit & Loss A/c

For distributing surplus of specific funds.

Workmen’s Compensation Fund A/c Dr.
Investment Fluctuation Fund A/c Dr.
To Old Partner’s Capital A/c

Retirement of Partner
Retirement of Partner: a partner has the right to retire from the firm after giving due notice in advance. Old
partnership comes to an end after the retirement of a partner, but the firm continues and new partnership comes into
existence between the remaining partners.
⮚ Calculation of New Profit Sharing Ratio
⮚ Accounting treatment of goodwill
⮚ Accounting treatment of Joint Life Policy
⮚ Accounting treatment for revaluation of assets and liabilities
⮚ Accounting treatment of reserves and accumulated profits.

Calculation of New Profit Sharing Ratio

1. If the new profit sharing ratio of the remaining partners is not given in the question, it will be assumed that the
remaining partners continue to share profit and losses in the old ratio.
2. Sometimes the remaining partners purchase the share of the retiring partner in some specified proportions. In such
cases the fraction of shares purchased by them is added to their old share and the new ratio is calculated.

Adjustment of Goodwill
Continuing partner Capital A/c Dr.
to retiring Partners’ Capital A/c
(retiring partners’ share of goodwill adjusted to continuing partners in the gaining ratio)

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When goodwill account is already appearing in the books:
All partner’s Capital A/c Dr. (in old ratio)
To Goodwill A/c (goodwill existing in book)

Revaluation of Assets and Liabilities: at the time of retirement the assets and liabilities are revalued and a revaluation
account is prepared in the same way as is done in case of admission of a new partner. The only difference is that in case
of retirement any profit and loss due to revaluation is divided among all the partners, including the retiring partner,
whereas in case of admission of a new partner, the new partner does not share such profit or loss on revaluation.

For distributing reserves and accumulated profits:

General Reserve A/c Dr.
Reserve Funds A/c Dr.
Profit & Loss A/c Dr.
To all partner’s Capital A/c (in old ratio)
For Distributing Accumulated Losses Among Old Partners In Old Ratio
Old partner’s Capital A/c (in old ratio)
To Profit & Loss A/c

For distributing surplus of specific funds.

Workmen’s Compensation Fund A/c Dr.
Investment Fluctuation Fund A/c Dr.
To Old Partner’s Capital A/c (in old ratio)
Adjustment of Joint life Policy
Joint Life Policy A/c Dr. (surrendered value on the date of retirement)
To all partners capital A/c (In old ratio)

Death of Partner: on the death of a partner, the amount payable to him is to be paid to his legal representative. In this
case the account is maintained in the same way as on the retirement of a partner. Following amounts are credited to his
capital account.
• The amount standing to the credit of his capital A/c.
• His share of the increase in the value of Goodwill of the firm.
• Interest of capital, if provided in the partnership deed.
• His share of profit on the revaluation of assets and liabilities.
• His share of the undistributed profits or reserves
• His share of Life Policy
• His share of profit up to the date of his death.

The following amount will be debited to the account of the deceased partner for ascertaining the amount due to
his legal representatives:
• Drawing
• Interest on Drawing
• His share of loss on the revaluation of assets and liabilities.
• His share of undistributed loss, such as debit balance of profit and Loss Account.
• His share of the reduction in the value of goodwill.

Dissolution of Partnership: means termination of the old partnership agreement and reconstruction of the firm due to
admission, retirement and death of a partner. It may or may not result in closing down of the business as the remaining
partners may agree to carry on the business under a new agreement.
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Dissolution of Partnership Firm: means that the firm closes down its business and comes to an end. On the dissolution
of the firm, the assets of the firm are sold and liabilities are paid off and out of the remaining amount, the accounts of
partners are settled.
In case of dissolution of partnership, the firm may continue i.e. it does not mean the dissolution of the firm. But in case of
dissolution of the firm, the partnership is automatically dissolved.

Dissolution of Partnership: the partnership is deemed to have been dissolved in any of the following cases:
In case of change in profit-sharing ratio of the existing partners
In case of admission/retirement/expulsion/death/insolvency of a partner.
In case of expiry of the period of partnership.
Dissolution of Partnership Firm
Modes of Dissolution of Partnership Firm Without the intervention of the court:
1. When all partners agree to dissolve the firm. (sec. 40)
2. Compulsory Dissolution (sec. 41)
i. When all or all but one partner of the firm becomes insolvent.
ii. When business of the firm becomes unlawful.
3. On the happening of any one of the following incident: (sec. 42)
i. On the insolvency of a partner
ii. On the fulfillment of the object for which the firm was formed.
iii. On the expiry of the period for which the firm was formed.
4. When the duration of the partnership firm is not fixed and it is at will, any partner by giving notice to other partners
can dissolve the firm. (sec. 43).

By the order of the court (sec. 44): the court may, on an application by the partner, order the dissolution of the
partnership firm under the following circumstances:
⮚ When a partner has become unsound mind.
⮚ When a partner, other than the partner filing a suit, has become permanently incapable of performing his duties as a
partner.
⮚ When a partner, other than the partner filing a suit, is guilty of misconduct that may harm the partnership.
⮚ When a partner, other than the partner filing a suit, willfully or persistently commits breach of partnership
agreement.
⮚ When a partner, other than the partner filing a suit, has transferred the whole of his interests in the firm to a third
party.
⮚ When the court is satisfied that the firm cannot be carried on except at a loss.
⮚ When the court is satisfied that the dissolution is just and equitable due to some other reasons.

Accounting Procedure on Dissolution of Firm: on dissolution of firm, the following accounts are opened in the order
given below:
1. Realization account
2. Partner’s loan Account
3. Partner’s Capital Account
4. Cash or Bank Account

Realization Account: is opened for disposing of all the assets of the firm and making payment to all the creditors. It is a
nominal account and the object of such an account is to find out the profit or loss on realization of assets and payment of
liabilities. Entries are as following:

For closing Assets Account

Realization A/c Dr.
To Sundry Assets A/c
(Assets transferred to realization a/c)

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Realization A/c
Dr. Cr.
Particulars Amount (Rs.) Particulars Amount (Rs.)

To Goodwill A/c 10,000 By Creditors A/c 20,000

To Building A/c 25,000 Bills Payable A/c 10,000
To Plant A/c 25,000 Bank Loan A/c 12,000

Entry for Fictitious Assets and losses

Partners Capital A/c Dr.
To P&L A/c
To Deferred revenue Expenditure A/c
(balance of loss transferred to capital A/c)
For Provision of any assets
Provision for bad debts A/c Dr.
Provision for depreciation A/c Dr.
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Machinery Replacement Reserve A/c Dr.
Investment Fluctuation A/c Dr.
Joint Life Policy Reserve A/c Dr.
To realization A/c

For Closing Liabilities account

Sundry liabilities A/c Dr.
To realization A/c

For undistributed Profits

General Reserve A/c Dr.
Reserve Fund A/c Dr.
Contingency Reserve A/c Dr.
P & L A/c Dr.
Workmen Compensation Reserve A/c Dr.
To Partner’s Capital A/c

Entries for Realization of Assets

When assets are sold out for cash
Cash/Bank A/c Dr.
To Realization A/c

When assets are taken by one of the partner

Partners Capital A/c Dr.
To realization A/c

Entries of Payment of Liabilities

When liabilities are paid in cash:
Realization A/c Dr.
To Cash/ Bank A/c

When Partners agrees to take over some liability

Realization A/c Dr.
To partners’ Capital A/c

For payment of realization expenses:

When expenses are paid in cash:
Realization A/c Dr.
To cash/Bank A/c

When expenses of realization are paid by a partner

Realization A/c Dr.
to Partner’s Capital A/c

For closing realization account:

Realization A/c Dr.
To partner’s Capital A/c
(transfer of profit on realization to partner’s capital A/c)
Partner’s Capital A/c Dr.
To Realization A/c
(transfer of losses on realization to partner’s capital A/c)

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Partner’s Loan Account: if partners give any 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 realization account and his loan account is
prepared separately and paid off by passing the following entry:
Partner’s loan A/c
To Cash/Bank A/c
(payment of Partner’s Loan)

Partners’ Capital Account: after the transfer of profit or loss on realization, undistributed profits, reserves etc. to the
capital accounts of the partners the balance of capital account are closed in the following manner:

When a partner is required to bring cash to clear off his debit balance, the entry will be:
Cash/bank A/c Dr.
To partners capital A/c
(Required cash brought in by the partners)

When a partner is paid the credit balance of his account:

Partners’ Capital A/c Dr.
To Cash/Bank A/c
(Excess cash paid to partner)

Cash or Bank Account: opening balance of cash and bank and all the receipts are entered on the debit side of this
account and all the payments are entered on the credit 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.

Auditing
Auditing simply refers to the evaluation of business books of accounts & vouchers. It is done to make sure whether all
the financial transactions are accurately recorded. Auditing aims at finding out the errors from books of accounts of the
business.
It aims at the prevention of frauds. This examination is totally unbiased & conducted by an independent person. The
person doing auditing should be qualified for the job to perform it with accuracy. This can be performed either by
internal employees of a business or the person who are external to business.

Auditing is conducted continuously at regular intervals by the auditor. However, auditing is not mandatory for all
businesses.

Objectives of Auditing
• Accounts and Statements Verification
Evaluating the fairness & accuracy of books of accounts is the primary objective of Auditing. It checks each & every
financial transaction thoroughly. It detects and prevents any frauds in the books of accounts. The auditor is provided
with free hands to audit the books of accounts & is independent of business.
• Checking Accounting Policies
Every business or organisation needs to follow some accounting policies. Books of accounts are prepared according
to these accounting policies. If a business has an effective accounting system, its efficiency can be increased. It is the
duty of the auditor to check the accounting policies of business & express his independent opinion.
• Error and Fraud Detection
Auditing helps in easy finding of errors & frauds from the books of accounts. It is the duty of management to avoid &
check errors & frauds. However, sometimes it becomes difficult for management to find out the errors.
It is through auditing that helps managers to find out errors & frauds. After this manager take corrective steps
against these errors or frauds.
• Improves Quality of Business Processes

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 Auditing helps management in finding out the errors & frauds. Management can take corrective measures against
these errors. Steps are taken so that they are not repeated again. This way it improves the quality of business
process & improves its efficiency. Also the employees of business work properly due to the threat of auditing.
• Assurance to Investors
Auditing assures that each & every figure represented in the financial statement is correct. It helps in evaluating
every figure of business books of accounts. Financial statements after being audited are considered trustworthy by
investors. Investors are fully assured by these financial statements.
• Checking Assets and Liabilities
Auditing thoroughly evaluates the financial statements of the business. It helps in confirming the true value of assets
& liabilities of the organisation. This helps in determining true financial position of the business. After that
accordingly, proper plans can be made to achieve targets & goals.

Characteristics of Auditing
• Systematic Process
Auditing is a systematic process of examining the authenticity of the book of accounts. It follows a logical and
scientific series of steps for examining financial accounts.
• Independent Examination
It is an independent evaluation done by the body of individuals who are external to the business. These persons
have the required qualifications for conducting auditing and give their views or opinions without any biases.
• Expresses Opinion
The auditor does not only examine the accounts but also give his opinions regarding them. He expresses whether
accounts present a true and fair picture of the organization and also comply with required laws.
• Evidence
Auditing process requires collecting various financial and non-financial documents for verifying accounts. The
auditor evaluates various documents such as certificates, vouchers, questionnaires etc. for examining purpose.
• Established Criteria
In auditing, the whole examination of evidence collected is done in accordance with the established criteria or
principles. These consist of International financial reporting standards, international accounting standards, industry
practices, generally accepted accounting principles etc.

Importance of Auditing
• Detects Errors or Frauds
Auditing helps in identifying all errors or frauds in the financial books of business by examining them. Auditors
examine every financial record to verify their accuracy and discover all mistakes or frauds committed within the
organization.
• Assurance to Owners and Investors
It provides assurance to owners and investors by checking all internal workings of the organization. Business
owners will be satisfied by auditing reports that the books of accounts are properly maintained and all departments
are working efficiently. Investors to gain confidence once the accuracy of financial records is verified.
• Ensures Validation of Accounts
Auditing ensures the authenticity of all accounts by performing a detailed examination and presenting a trusted
opinion regarding them. It checks the regularity of accounts and finds out whether they follow all prescribed rules
and regulations.
• Helps in Decision Making
It supports management in decision making by providing them with crucial information regarding the organization.
Auditing is an examination process which is done by a highly qualified professional having good knowledge of
subjects like finance and accounts. They discover issues in organization workings and books of accounts and give
their opinions for resolving them.
• Independent View Point
Auditing is an independent examination of accounts which is done by auditors which are external to the
organization. Auditors properly inspect books of accounts and present their fair view without any biases or hidden
agenda.
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• Satisfies Stakeholders
It helps in gaining the confidence of all stakeholders in the organization. Auditing reports provide a transparent view
of organization operations and financial records. Financial accounts after getting audited gain more creditability and
provide satisfaction to all creditors.
• Provide Easy Access to Loans
Audit reports serve as an efficient tool for raising the required funds from banks or other financial institutions.
These reports contain accurate information regarding the business organization and depict a fair financial position.
Financial instructions easily decide the credibility of the business and take decisions regarding allocating funds to
them.
• Establishes Morale Check
Auditing enables in keeping a check over the performance and efficiency of organizations. Workers and staff work
honestly and do not try to cheat or commit fraud due to the fear of being identified under the auditing process. It
helps in avoiding all irregularities and makes all employees attentive.

Types of Auditing
• Internal Audit
An internal audit is one that is conducted within the organization by its own employees and stakeholders. It is
conducted for accessing the effectiveness of internal processes, reviewing financial information, and ensuring
whether a business is complying itself with proposed laws and regulations. Internal audit is termed as a first
checkpoint for every organization to check the authenticity of their book of accounts, operational processes, security
protocols and IT infrastructure are in line with their internal aims and external regulatory requirements.
• External Audit
External audit refers to the evaluation of books of accounts by external persons that are independent of the business
organization. External auditors are third parties like a charted accountant, IRS and a tax agency. These all have
specialized knowledge and tasked with examination of organization’s book of accounts in compliance with (GAAS)
Generally accepted auditing standards. External audit is mandatory in nature which need to be done due to
shareholder’s requirements and regulatory reasons. It provides more transparency to business state of affairs and
determine the accuracy of its accounting records. External audit is more preferred by investors and lenders for
ensuring financial health of business.
• Financial Audit
It is one of the most common type of audit which are mostly done external auditors. Financial audit is also known as
a statutory audit which evaluates the truth and fairness of financial statements of business organization. Every
business exists to generate profits and enhance wealth of their shareholders. Financial audit enables investor and
other stakeholders to ensure whether the business is going well or not so that their capital remain safe and yield
expected returns. Under it, financial transactions, procedures and balances are reviewed by auditors in order to
provide their credit opinion to lenders, investors and creditors.
• Operational Audit
Operational audit is an internal audit performed by organization voluntarily for accessing the effectiveness of its
internal operations. This audit determines whether all resources are utilized in the most efficient manner towards
the achievement of organizational objectives. It monitors activities like handling of cash, materials procurement,
equipment inventories and services of manpower working within the organization. Scope of operational audit is
broader that encompasses everything which influence attainment of goals by business.
• Compliance Audit
Compliance audit is a specific audit that is conducted to ensure whether business comply with internal and external
standards. It examines the policies and procedures of business as per the requirements of prescribed laws and
regulations. Compliance audit is most commonly conducted in educational institutions and regulated industries.
• Tax Audit
Tax audit is one which verifies the authenticity of tax returns filed by the company. These audits are conducted by
designated tax authority or government tax department. Tax auditors checks for any discrepancies in tax liabilities
of business for ensuring that there is no underpay or overpay of tax amount towards the tax authorities. It evaluates
for any possible errors on tax return of business.
• Information System Audit
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 This type of audit is conducted for examining the reliability of security systems and structures. Information system
audit is most important type of audit as most of the operations of organizations are today based on IT infrastructure.
It ensures that accurate information is delivered by system to users and no unauthorized person have access to
confidential data of organization. Information system audit may be performed as a part of internal control
assessment either as a part of internal audit or external audit.
• Environmental and Social Audit
Environmental and social audit is performed for assessing the footprints left by an organization on environment and
society around it by doing its economic activities. The main objective of this audit is to ensure that business do not
have any adverse effects on the environment.

Audit Report
Audit report refers to a formal opinion provided by auditor regarding the validity and reliability of financial statements
of organization. It is a final stage of auditing process and serve as a medium for communicating auditing results by
auditor. Auditor report may be either submitted by an internal auditor or external auditor. This report provides
reasonable assurance that financial statements comply with generally accepted accounting principles (GAAP) and are
free from any errors.
Auditor report is a key document that is mostly preferred by bank, creditors and investors for getting information about
company affairs. These peoples take their decision for lending amount to companies on the basis of audit report. A clean
auditor report represents the transparency and fairness in financial statements of company whereas an adverse report
means that financial statements have discrepancies, misrepresentations and do not comply to GAAP. Auditor by
preparing auditing report certifies the financial position and accounting records of business enterprise. They are
appointed for carrying out evaluation of accounting books by shareholders and therefore auditors work towards
protecting the rights of shareholders of company.

Format of Audit Report

The format of audit report is discussed in detail as given below: –
• Title of the report: A title of report should be proper which enables it in easily identifying. It should the name of
client which enables in distinguishing audit report from other reports.
• Name of the addressee: Addressee refers to one who appoints the auditor and to whom report of auditing is
presented. When auditor is appointed by a company then addressee are shareholders. A complete address of
addressee is needed as per the requirements of law. Shareholders are addressee in case of statutory audit whereas
in case of special audit, central government is the one.
• Introductory paragraph: The introductory paragraph denotes the opinion of auditor on financial statements that
are evaluated by him. Period of financial statements should be clearly mentioned along with dates.
• Scope: The scope defines manner in which evaluation of book of accounts has been done by auditor. An auditor in
his evaluation should consider the accounts of company, profit and loss account, cash flow statements and balance
sheet. The examination should be done in accordance with relevant law and not curtail any examination task.
• Opinion: The opinion given by auditor regarding financial statements and book of accounts of organization is free
from bias and based on information. Auditor need to give opinion regarding following: whether all financial
statements are arithmetically true and as per the figures in accounts book, whether financial statements in case of
unqualified opinion are showing fair view of result of operations and state of affairs and in case of qualified opinion
if P&L account and a balance sheet are not depicting a fair position then what are the reason for such wrong results.
• Signature: Signature refer to the manual signature of auditor that confirms the authenticity of audit report. Personal
name and signature of auditor should be provided.
• Place of signature: It denotes the location of auditor or an auditing firm where signing of report takes place.
• Date of the report: Date of report shows the date of completion of auditing work.
Types of Audit Report
There are four types of audit report which are as given below:
1. Unqualified opinion
2. Qualified opinion
3. Adverse opinion
4. Disclaimer of opinion
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Unqualified opinion: It is also termed as clean audit report which is issued by auditor when all financial statements and
books of accounts are free form any discrepancies and misrepresentations. Unqualified opinion report also assures that
all statements are prepared in compliance with standards known as generally accepted accounting principles (GAAP). It
is the best audit report that an organization can receive from an auditor.
Qualified opinion: A qualified opinion report is issued by auditor when financial statements do not comply with GAAP
but no misrepresentation of facts having higher impact are identified. Writing of qualified opinion is also same to
unqualified opinion. However, an additional paragraph describing the reason for not issuing an unqualified audit report
is included in a qualified opinion report.
Adverse opinion: Adverse opinion is the worst type of audit report that can be issued to business organization. It shows
that financial records maintained by firm do not comply with GAAP and have been grossly misrepresented. It is an
indication of fraud and sometimes it may take place by error. A company receiving this type of audit report by auditor
need to rectify its financial records and get it re-audited in order to get clean report. Lenders, investors and other
requesting parties do not generally accept this type of audit report.
Disclaimer of opinion: Disclaimer of opinion is issued where an auditor is unable to form opinion due to absence of
sufficient evidences. He may not complete an audit report and issues disclaimer of opinion which states that opinion
regarding financial status of firm cannot be determined.

Importance of audit report

Various importance of audit report for firm can be well-understand from points given below: –
• Provide independent view: Audit report presented by external auditor gives an independent view of financial
position of business. The report consists of unbiased opinion by business which assures owner and investors of true
and fair view of business affairs. External auditor will inspect the book of account without any hidden agenda and
detect all misrepresentations and fraud.
• Enhance credit rating: Another important advantage provided by audit report is that it enhances overall credit
rating of companies. Organization receiving clean audit report (unqualified opinion report) from auditor are easily
able to attract lenders and investors. Clean audit report reflects that company is adequately complying with required
laws for maintaining book of accounts and preparation of financial statements.
• Moral check: Audit report enable companies in keeping a moral check over the activities of all employees working
within it. Staff and other workers act honestly and do not steal or defraud the company as they know that all book of
account will be evaluated. Any irregularities or misrepresentations in business can be easily identified which helps
staff in being responsible at all times.
Stakeholders confidence: The financial statements of company have more credibility after getting examined by an
independent auditor. Every stakeholder of company such as banks, creditors, debenture holders, investors etc. rely
with confidence more on the audit report of business for knowing their financial position.

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