MODULE 1PART B: FINANCIAL ACCOUNTING

1. Accounting – Definition & Meaning, Principles of Financial Accounting, Types of Accounting, Financial,
Cost & Management Accounting - Concepts and Differences,
Capital and Revenue Transactions,
Mercantile basis & Cash basis Accounting,
Journals, Ledgers, Cash Book and Trial Balance,

2. Depreciation
3. Final Accounts
4. Final Accounts of Companies,
5. Calculation and Interpretation of Ratios-
6. Cash Flow and Fund Flow Statements

Section A: Accounting is the Language of Business

1. Transaction
 Transaction is exchange of values carried out between two or more entities.
 Accounting deals with recording and compiling the financial transactions in a significant manner and interpreting
the results.
 In an accounting sense, an event can be understood as the final outcome of a business activity, that can affect the
account balances of the company if it is financial in nature.

BASIS FOR
TRANSACTION EVENT
COMPARISON

What is it? Cause Effect

Accounting record Transactions are recorded as they arise. Only those events are recorded which are
financial in nature.

Change in financial Results in change in the financial position May or may not result in change in financial
state of the company. position of the company.

Example
Alpha Ltd. is a supplier of cycles, which costs Rs. 4200 per cycle. Beta Ltd. purchases 20 cycles from Alpha Ltd. @ Rs. 5000
per cycle.
o The purchasing and selling that took place between the two business entities is a transaction, while the reduction in
stock and profit earned is an event.
⇒ All transactions are events, but all events are not transactions because to become a transaction, an event must be of
financial nature.

Types of Organization
Sole Proprietorship
Partnership [Indian Partnership Act 1932]
Companies [Companies Act 2013//Companies Act 1956]
LLP [Limited Partnership Act 2008]

**
‘Tax Audit’. As the name itself suggests, Tax audit is an examination/review of accounts of the business /profession
from income tax viewpoint.
Who will do tax audit [Section 44AB] and detail provision [section 44AD]
In case of a business, tax audit would be required if the total sales turnover or gross receipts in the business exceeds
Rs.1 crore in any previous year. Under the Income Tax Act, “Business” simply means any economic activity carried on for
earning profits. Section 2(3) has defined the business as “any trade, commerce, manufacturing activity or any adventure or
concern in the nature of trade, commerce and manufacture”.

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Organization/Proprietorship [on the basis of ownership]

ORGANISATION

non profit seeking

organisation
profit seeking
organisation

Sole Limited Liability Joint Stock

Propietorship Partnership Partnership Company

Public Limited
Private Limited Compnay
Company [Small
Company]

One Person
Company

One Person Company

 As per section 2(62) of the Companies Act, 2013, “One Person Company” means a company which has only one
person as a member.
 Types of OPC (Section 3(2)) • a company limited by shares; or • a company limited by guarantee; or • an
unlimited company.
(In case of a company, the terms shareholders and members [section 2(27)] are commonly used as synonyms,
as one can become a member of the company, except by way of holding shares. In this way, a member is a
shareholder and a shareholder is a member. The statement is true but not completely, as it is subject to certain
exceptions, i.e. a person can become the holder of shares through transfer, but is not a member, until the
transfer is entered in the register of members).

Limited liability means that on liquidation, the liability of the members of a limited liability company or limited
partnership for the debts incurred by the entity is limited to the capital they have invested (including any amount owing).
The liability of the members can be limited by shares or limited by guarantee.
1. Limited liability for the debts of the business is the main advantage that an incorporated business has over an
unincorporated business.
2. An associated advantage is that if one of the members of an incorporated business dies, his or her shares can be
transferred to someone else and the business continues, whereas an unincorporated entity has a finite life.
3. The indefinite life of an incorporated entity is possible because complementary to the concept of limited liability
for members is ‘the notion that the company is a separate “legal person” distinct from the members and the
directors’

Limited liability partnership is a body corporate. —

1. A limited liability partnership is a body corporate formed and incorporated under this Act and is a legal entity
separate from that of its partners.
2. A limited liability partnership shall have perpetual succession.
3. Any change in the partners of a limited liability partnership shall not affect the existence, rights or liabilities of the
limited liability partnership.
[Section 3 of LLP Act 2008]

A private limited company is a company which is privately held for small businesses. The liability of the members
of a Private Limited Company is limited to the amount of shares respectively held by them. Shares of Private
Limited Company cannot be publically traded.
1. Members– To start a company, a minimum number of 2 members are required and a maximum number
of 200 members as per the provisions of the Companies Act, 2013.
2. Paid up capital– It must have a minimum paid-up capital of Rs 1 lakh or such higher amount which may be
prescribed from time to time.

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 Differences Between Public Limited Company and Private Limited Company.
Public limited
Features Private limited company
company
Minimum members 7 2
Minimum directors 3 2
Maximum members Unlimited 200
Minimum capital 500000 100000
Invitation to public Yes No
Issue of prospectus Yes No
Quorum at AGM 5 Members 2 Members
Certificate for commencement of Business
Yes No
(Mandatory?)
Term used at the end of name Limited Private Limited
Cannot exceed more than 11% of Net
Managerial remuneration No restriction Profits
Listing in Stock Exchange Yes No

Section B: Accounting is the Language of Business

Meaning/Definition
 “The process of identifying, measuring and communicating economic information to permit informed
judgments and decisions by the users of accounting”.
 “Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money,
transactions and events which are, in part at least, of a financial character, and interpreting the result thereof”.
 Accounting is the process of identifying, measuring and communicating financial information about an entity
to permit informed judgments and decisions by users of the information.

Questions that Financial Accounting attempts to answer

1. How is financial information identified?
2. How is financial information measured?
3. How is financial information communicated?
4. What is an entity?
5. Who are the users of financial information about an entity?
6. What types of judgments and decisions do these users make?

Section C: Accounting is the Language of Business

a. Objectives of Financial Accounting,

i. Systematic Recording of Transaction for Providing Information to the Users for Rational
Decision-making
ii. Ascertainment of Results of Transactions [performance]
iii. Ascertain the Financial Position of Business [financial status]
iv. To Know the Solvency position [liquidity position]

Objectives of Accounting

Systematic Recording Ascertainment of Ascertainment of FinancialCommunicating

of Transactions Results Position Information to various
Users
Manufacturing, Balance Sheet
Book-keeping: Trading, Profit and
Loss Account Financial Reports
Journal, Ledger and
Trial Balance

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b. Function of Accounting
i. Measurement: Accounting measures past performance of the business entity and depicts its current
financial position.
ii. Forecasting: Accounting helps in forecasting future performance and financial position of the
enterprise using past data.
iii. Decision-making: Accounting provides relevant information to the users of accounts to aid rational
decision-making.
iv. Comparison & Evaluation: Accounting assesses performance achieved in relation to targets and
discloses information regarding accounting policies and contingent liabilities which play an
important role in predicting, comparing and evaluating the financial results.
v. Control: Accounting also identifies weaknesses of the operational system and provides feedbacks
regarding effectiveness of measures adopted to check such weaknesses.
vi. Government Regulation and Taxation: Accounting provides necessary information to the
government to exercise control on die entity as well as in collection of tax revenues.

c. The Terms

ACCOUNTANCY

ACCOUNTING

BOOK KEEPING

a. Book Keeping –
o Recording [Systematically]
o Financial statements are not part of it
o Managerial Decisions cannot be taken on the basis of this
o Crude form

b. Accounting –
o Summarizing of recorded transaction
o Language of business
o Financial statements are prepared on the basis of book keeping records
o DM is based on reports prepared.
o Three particular fields of Financial, Cost and Management accounting.

c. Accountancy – the academic discipline of Accounting

d. Meaning of different types of accounting [financial accounting, cost accounting and management
accounting]

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Financial Accounting – It covers the preparation and interpretation of financial statements and communication
to the users of accounts. It is historical in nature as it records transactions which had already been occurred.

Cost Accounting - process of accounting for cost of product [goods and services] //cost accumulation process
and Cost control.

Management Accounting – The management needs variety of information. It is concerned with internal
reporting to the managers of a business unit for decision- making.

e. Users of accounting information [information Needs].

 Investors
 Employees
 Lenders
 Suppliers and other trade creditors
 Customers
 Governments and their agencies
 Public

Section D: Generally Accepted Accounting Principles

In order to maintain uniformity and consistency in accounting records, certain rules or principles have been developed
which are generally accepted by the accounting profession. These rules are called by different names such as principles,
concepts, conventions, postulates, assumptions and modifying principles.

The term ‘principle’ has been defined by AICPA as ‘A general law or rule adopted or professed as a guide to action, a settled
ground or basis of conduct or practice’. The word ‘generally’ means ‘in a general manner’, i.e. pertaining to many persons or
cases or occasions. Thus, Generally Accepted Accounting Principles (GAAP) refers to the rules or guidelines adopted
for recording and reporting of business transactions, in order to bring uniformity in the preparation and the
presentation of financial statements.

For example, one of the important rules is to record all transactions on the basis of historical cost, which is verifiable from
the documents such as cash receipt for the money paid. This brings in objectivity in the process of recording and makes
the accounting statements more acceptable to various users.

The Generally Accepted Accounting Principles have evolved over a long period of time on the basis of past experiences, usages
or customs, statements by individuals and professional bodies and regulations by government agencies and have general
acceptability among most accounting professionals.

However, the principles of accounting are not static in nature. These are constantly influenced by changes in the legal, social
and economic environment as well as the needs of the users. These principles are also referred as concepts and conventions.

The term concept refers to the necessary assumptions and ideas which are fundamental to accounting practice, and the
term convention connotes customs or traditions as a guide to the preparation of accounting statements. In practice, the
same rules or guidelines have been described by one author as a concept, by another as a postulate and still by another as
convention. This at times becomes confusing to the learners. Instead of going into the semantics of these terms, it is
important to concentrate on the practicability of their usage. From the practicability view point, it is observed that the
various terms such as principles, postulates, conventions, modifying principles, assumptions, etc. have been used inter-
changeably and are referred to as
Basic Accounting Concepts.

Accounting Concepts and Conventions: The basic accounting concepts are referred to as the fundamental ideas or basic
assumptions underlying the theory and practice of financial accounting and are broad working rules for all accounting
activities and developed by the accounting profession.

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The important concepts have been listed as below:

Entity concept: Entity concept states that business enterprise is a separate identity apart from its owner.
Accountants should treat a business as distinct from its owner. Business transactions are recorded in the
business books of accounts and owner’s transactions in his personal books of accounts. The practice of
distinguishing the affairs of the business from the personal affairs of the owners originated only in the early
days of the double-entry book-keeping. This concept helps in keeping business affairs free from the influence
of the personal affairs of the owner. This basic concept is applied to all the organizations whether sole
proprietorship or partnership or corporate entities.
Entity concept means that the enterprise is liable to the owner for capital investment made by the owner.
Since the owner invested capital, which is also called risk capital, he has claim on the profit of the
enterprise. A portion of profit which is apportioned to the owner and is immediately payable becomes
current liability in the case of corporate entities.

Money measurement concept: As per this concept, only those transactions, which can be measured in terms of
money are recorded. Since money is the medium of exchange and the standard of economic value, this concept
requires that those transactions alone that are capable of being measured in terms of money be only to be recorded
in the books of accounts. Transactions, even if, they affect the results of the business materially, are not recorded if they
are not convertible in monetary terms. Transactions and events that cannot be expressed in terms
of money are not recorded in the business books. For example; employees of the organization are, no doubt, the assets
of the organizations but their measurement in monetary terms is not possible therefore, not included in the books
of account of the organization. Measuring unit for money is taken as the currency of the ruling country i.e., the
ruling currency of a country provides a common denomination for the value of material objects. The monetary unit
though an inelastic yardstick, remains indispensable tool of accounting.
It may be mentioned that when transactions occur across the boundary of a country, one may see many currencies.

Suppose a businessman sells goods worth Rs 50lakhs at home and he also sells goods worth of 1 lakh Euro in the
United States. What is his total sales? Rs 50 lakhs plus 1 lakh Euro.
These are not amenable to even arithmetic treatment. So transactions are to be recorded at uniform monetary unit
i.e. in one currency. Suppose EURO 1 = Rs 71.
Total Sales = Rs 50 lakhs plus 71 lakhs = Rs 121 lakhs.
Money Measurement Concept imparts the essential flexibility for measurement and interpretation of accounting
data.

This concept ignores that money is an inelastic yardstick for measurement as it is based on the implicit assumption
that purchasing power of the money is not of sufficient importance as to require adjustment. Also, many material
transactions and events are not recorded in the books of accounts just because they cannot be measured in
monetary terms. Therefore it is recognized by all the accountants that this concept has its own limitations and
inadequacies. Yet it is used for accounting purposes because it is not possible to adopt a better measurement scale.
Entity and money measurement are viewed as the basic concepts on which other procedural concepts hinge.

Going Concern concept: The financial statements are normally prepared on the assumption that an enterprise is
a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the enterprise
has neither the intention nor the need to liquidate or curtail materially the scale of its operations; if such an
intention or need exists, the financial statements may have to be prepared on a different basis and, if so, the basis
used is disclosed.
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The valuation of assets of a business entity is dependent on this assumption. Traditionally, accountants follow
historical cost in majority of the cases.

Periodicity Concept: This is also called the concept of definite accounting Period. As per ‘going concern’ concept
an indefinite life of the entity is assumed. For a business entity it causes inconvenience to measure performance
achieved by the entity in the ordinary course of business.
If a textile mill lasts for 100 years, it is not desirable to measure its performance as well as financial position only at
the end of its life.
So a small but workable fraction of time is chosen out of infinite life cycle of the business entity for measuring
performance and looking at the financial position. Generally, one-year period is taken up for performance
measurement and appraisal of financial position. However, it may also be 6 months or 9 months or 15 months.
According to this concept accounts should be prepared after every period & not at the end of the life of the entity.
Usually this period is one calendar year. We generally follow from 1st April of a year to 31st March of the immediately
following year.
Thus, for performance appraisal it is not necessary to look into the revenue and expenses of an unduly long time-
frame. This concept makes the accounting system workable and the term ‘accrual’ meaningful. If one thinks of
indefinite time-frame, nothing will accrue. There cannot be unpaid expenses and non- receipt of revenue. Accrued
expenses or accrued revenue is only with reference to a finite time-frame which is called accounting period.
Thus, the periodicity concept facilitates in:
 Comparing of financial statements of different periods
 Uniform and consistent accounting treatment for ascertaining the profit and assets of the business
 Matching periodic revenues with expenses for getting correct results of the business operations

Accrual concept: Under accrual concept, the effects of transactions and other events are recognised on mercantile
basis i.e., when they occur (and not as cash or a cash equivalent is received or paid) and they are recorded in the
accounting records and reported in the financial statements of the periods to which they relate. Financial
statements prepared on the accrual basis inform users not only of past events involving the payment and receipt
of cash but also of obligations to pay cash in the future and of resources that represent cash to be received in the
future.
To understand accrual assumption knowledge of revenues and expenses is required. Revenue is the gross inflow
of cash, receivables and other consideration arising in the course of the ordinary activities of an enterprise from sale
of goods, from rendering services and from the use by others of enterprise’s resources yielding interest, royalties
and dividends.
For example, (1) Mr. X started a cloth merchandising. He invested Rs 50,000, bought merchandise worth Rs
50,000. He sold such merchandise for Rs 60,000. Customers paid him Rs 50,000 cash and assure him to pay Rs
10,000 shortly. His revenue is Rs 60,000. It arose in the ordinary course of cloth business; Mr. X received Rs
50,000 in cash and Rs 10,000 by way of receivables.

Matching concept: In this concept, all expenses matched with the revenue of that period should only be taken into
consideration. In the financial statements of the organization if any revenue is recognized then expenses related to
earn that revenue should also be recognized.
This concept is based on accrual concept as it considers the occurrence of expenses and income and do not
concentrate on actual inflow or outflow of cash. This leads to adjustment of certain items like prepaid and
outstanding expenses, unearned or accrued incomes.
It is not necessary that every expense identify every income. Some expenses are directly related to the revenue
and some are time bound. For example: - selling expenses are directly related to sales but rent, salaries etc are
recorded on accrual basis for a particular accounting period. In other words, periodicity concept has also been
followed while applying matching concept

Historical Cost concept: By this concept, the value of an asset is to be determined on the basis of historical cost, in
other words, acquisition cost. Although there are various measurement bases, accountants traditionally prefer this
concept in the interests of objectivity. When a machine is acquired by paying Rs 5,00,000, following cost concept
the value of the machine is taken as Rs 5,00,000. It is highly objective and free from all bias. Other measurement
bases are not so objective. Current cost of an asset is not easily determinable. If the asset is purchased on
1.1.1995 and such model is not available in the market, it becomes difficult to determine which model is the
appropriate equivalent to the existing one. Similarly, unless the machine is actually sold, realisable value will give
only a hypothetical figure. Lastly, present value base is highly subjective because to know the value of the asset
one has to chase the uncertain future.

Realization concept: It closely follows the cost concept. Any change in value of an asset is to be recorded only
when the business realizes it. When an asset is recorded at its historical cost of Rs 5,00,000 and even if its current
cost is Rs 15,00,000 such change is not counted unless there is certainty that such change will materialize.
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 However, accountants follow a more conservative path. They try to cover all probable losses but do not count
any probable gain. That is to say, if accountants anticipate decrease in value they count it, but if there is increase
in value they ignore it until it is realised. Economists are highly critical about the realization concept. According to
them, this concept creates value distortion and makes accounting meaningless.

Dual aspect concept: This concept is the core of double entry book-keeping. Every transaction or event has two
aspects:
a. It increases one Asset and decreases other Asset;
b. It increases an Asset and simultaneously increases Liability;
c. It decreases one Asset, increases another Asset;
d. It decreases one Asset, decreases a Liability. Alternatively:
e. It increases one Liability, decreases other Liability;
f. It increases a Liability, increases an Asset;
g. It decreases Liability, increases other Liability;
h. It decreases Liability, decreases an Asset.

Basis of Accounting
From the point of view of the timing of recognition of revenue and costs, there can be two broad approaches to
accounting. These are:
 Cash basis; and
 Accrual basis.
Under the cash basis, entries in the book of accounts are made when cash is received or paid and not when the receipt or
payment becomes due. Let us say, for example, if office rent for the month of December 2014, is paid in January 2015,
it would be recorded in the book of account only in January 2015. Similarly, sale of goods on credit in the month of January
2015 would not be recorded in January but say in April, when the payment for the same is received. Thus, this system is
incompatible with the matching principle, which states that the revenue of a period is matched with the cost of the same
period. Though simple, this method is inappropriate for most organizations as profits calculated as a difference between
the receipts and disbursement of money for the given period rather than on happening of the transactions.
Under the accrual basis, however, revenues and costs are recognized in the period in which they occur rather when they
are paid. A distinction is made between the receipt of cash and the right to receive cash and payment of cash and legal
obligation to pay cash. Thus, under this system, the monitory effect of a transaction is considered in the period in which
they are earned rather than in the period in which cash is actually received or paid by the enterprise. This is a more
appropriate basis for the calculation of profits as
expenses are matched against revenue earned in relation thereto. For example, raw material consumed are matched
against the cost of goods sold.

d. Accounting Standards
The Generally Accepted Accounting Principles in the form of Basic Accounting Concept have been accepted by the
accounting profession to achieve uniformity and comparability in the financial statement. This is aimed at increasing the
utility of these statement to various users of the accounting information. But the difficulty is that GAAP permit a variety of
alternative treatments for the same item. For example, various methods of calculation of cost of inventory are permissible
which may be followed by different enterprises. This may cause problem to the external users of information, which
becomes inconsistent and incomparable. This necessitates brining in uniformity and consistency in the reporting of
accounting information. Recognizing this need, the Institute of Charted Accountants of India (ICAI) constituted an
Accounting Standards Board (ASB) in April, 1977 for developing Accounting Standards. The main function of ASB is to
identify areas in which
uniformity in standards is required and develop draft standards after wide discussion with representative of the
Government, public sector undertakings, industry and other organizations. ASB gives due consideration to the
International Accounting Standards as India is a member of International Account Setting Body. ASB submits the draft of
the standards to the Council of the ICAI, which finalizes them and notifies them for use in the presentation of the financial
statements. ASB also makes a periodic review of the accounting standards.

Accounting standards are written statements of uniform accounting rules and guidelines or practices for preparing the
uniform and consistent financial statements and for other disclosures affecting the user of accounting information. However,
the accounting standards cannot override the provision of applicable laws, customs, usages and business environment in the
country.

The Institute tries to persuade the accounting profession for adopting the accounting standards, so that uniformity can be
achieved in the presentation of financial statements. In the initial years the standards are of recommendatory in nature.
Once an awareness is created about the requirements of a standard, steps are taken to enforce its compliance by making
them mandatory for all companies to comply with. In case of non-compliance, the companies are required to disclose the
reasons for deviations and the financial effect, if any, arising due to such deviation.
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 e. International Financial Reporting Standards (IFRSs)
International Financial Reporting Standards (IFRSs) are globally accepted accounting standards developed by
International Accounting Standard Board (IASB). IFRS is a set of accounting standards for reporting different types of
business transactions and events in the financial statements. The objective is to facilitate international comparisons for
true and fair valuation of a business enterprise. The qualitative characteristics associated with the preparation of financial
statements are useful to the users of accounting information in making financial decisions. In an effort to narrow down the
gap in the presentation of corporate financial statements, the Ministry of Corporate Affairs, Government of India has opted
for the convergence of Indian Accounting Standards with IFRSs for bringing uniformity, comparability, transparency,
rationalization and adaptability in the field of accounting.

f. Benefits to Convergence to IFRSs

i. Easy access to global or international capital markets.
ii. Easy comparisons and transparency.
iii. True and fair valuation.
iv. Increased trust and reliance.
v. Eliminates multiple reporting.
The institute of Chartered Accountants of India (ICAI) has however clarified that the convergence with IFRSs does not
mean adoption of IFRSs in toto. As cited in IAS-1 relating to Presentation of Financial Statements ‘Financial Statements
shall not be described as complying with IFRSs unless they comply with the requirements of IFRSs’.

Section E: Framework for the Preparation and Presentation of Financial Statements in accordance with Ind AS.

A. Scope: The framework deals with;

 The objectives of Financial Statements (FS)
 Qualitative characteristics that determine the usefulness of information in FS
 Definition, recognition and measurement of elements of FS
 Concepts of Capital and Capital Maintenance
 The framework is concerned about the general purpose FS
 Complete set of FS includes;
o Balance Sheet
o Statement of profit and loss
o Statement of cash flows
o Notes, other statements and explanatory material
The framework applies to the Financial Statements of all commercial, industrial and business reporting entities

B. Objectives of FS: To provide information about the financial position, performance and cash flows of an entity

C. Underlying Assumptions
 Accrual Basis: Effects of transactions and other events are recognized when they occur
 Going Concern: Entity will continue operation for the foreseeable future
D. Qualitative Characteristics of FS
 Understandability – readily understandable
 Relevance – relevant to decision making
 Materiality – omission or misstatement could influence the economic decision
 Reliability – free from material error and bias
 Faithful representation – must represent the transactions faithfully
 Substance over form – transactions accounted and presented in their substance and economic reality
and not merely their legal form
 Neutrality – information should be free from bias
 Prudence – Prudence is the inclusion of a degree of caution in the exercise of the judgments needed in
making the estimates required under conditions of uncertainty, such that assets or income are not
overstated and liabilities or expenses are not understated.
 Completeness – information must be complete within the bounds of materiality and cost

E. Elements of Financial Statements

 elements directly related to the measurement of financial position in the balance sheet are assets, liabilities
and equity
 elements directly related to the measurement of performance in the statement of profit and loss are income
and expenses

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  The cash flow statement usually reflects elements of statement of profit and loss and changes in balance
sheet elements
[presentation of these elements in the balance sheet and the statement of profit and loss involves a process of sub-
classification]
F. Financial Position
An asset is a resource controlled by an entity as a result of past events and from which future economic benefits
are expected to flow to the entity
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits
Equity is the residual interest in the assets of an entity after deducting all its liabilities

G. Performance
Profit is frequently used as a measure of performance
The elements directly related to the measurement of profit are income and expenses.
Income is increases in economic benefits during the accounting period in the form of inflows or enhancements
of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions
from equity participants.
Expenses are decreases in economic benefits during the accounting period in the form of outflows or
depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to
distributions to equity participants

H. Concept of Capital and Capital Maintenance

A financial concept of capital is adopted by most entities in preparing their financial statements. Under a financial
concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or
equity of the entity.

Illustration
Vinod Bros. prepare accounts by using Single Entry System. They have provided the following
information at the end of the year. You are required to calculate the profit for Vinod Bros.
Capital at the end of the year…………………….. Rs.10,00,000
Capital in the beginning of the year……………..Rs.15,00,000
Drawings made during the period ……………….Rs.7,50,000
Additional capital introduced……………………. Rs.1,00,000

Illustration
Kambli maintains his account on Single Entry System. Calculate his profit on 31 st March, 2018 from
the following information:
Particulars 1 April 2017 31 March 2018

Cash in hand 6,000 2,000

Bank Balance 18,000 14,000
Furniture 8,000 8,000
Stock 4,000 12,000
Creditors 16,000 12,000
Debtors 12,000 16,000

During the year his drawings were Rs. 4,000 and additional capital invested Rs.8,000.

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Section F: ACCOUNTING PROCESS

The Accounting Process:

There are two approaches for deciding when to write on the debit side of an account and when to write on the
credit side of an account:
A. American Approach/ Modern Approach [accounting equation]
B. British Approach/ Traditional Approach/Double Entry System

1. ANALYSIS OF TRANSACTION [TRADITIONAL METHOD // ACCOUNTING EQUATION]

2. DOUBLE ENTRY SYSTEM,
a. BOOKS OF PRIME ENTRY,
b. SUBSIDIARY BOOKS and CASH BOOK (journalized ledger)
c. JOURNAL PROPER
3. LEDGER
4. TRIAL BALANCE (and ADJUSTMENT ENTRIES)

1. ANALYSIS OF TRANSACTION [TRADITIONAL METHOD and ACCOUNTING EQUATION]

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Illustration 1 and 2 [Analysis of Transaction - modern and traditional approach]

Illustration 3 [Accounting equation]

Illustration 3A [Accounting Equation]

Find the profit for the year 2018 using the Accounting equation
Particulars 31/12/2017 31/12/2018
(`) (`)
Capital 1,00,000 ?
12% Bank Loan 1,00,000 1,00,000
Trade Payables 75,000 70,000
Fixed Assets 1,25,000 1,10,000
Trade Receivables 75,000 80,000
Inventory 70,000 80,000
Cash & Bank 5,000 6,000

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Accrual Basis [Mercantile basis] and Cash Basis of Accounting
Illustration 4

Capital and Revenue Transaction [illustration 5/6/7]

Deferred Revenue Expenditures

Deferred revenue expenditures represent certain types of assets whose usefulness does not expire in the year
of their occurrence but generally expires in the near future. These type of expenditures are carried forward and
are written off in future accounting periods.
Ex: Advertisement Expenditure

Illustration 5
State whether the following are capital, revenue or deferred revenue expenditure.
i. Carriage of ` 7,500 spent on machinery purchased and installed.
ii. Heavy advertising costs of ` 20,000 spent on the launching of a company’s new product.
iii. ` 200 paid for servicing the company vehicle, including ` 50 paid for changing the oil.
iv. Construction of basement costing ` 1,95,000 at the factory premises.

Illustration 6
Classify the following items as capital or revenue expenditure:
i. An extension of railway tracks in the factory area;
ii. Wages paid to machine operators;
iii. Installation costs of new production machine;
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 iv. Materials for extension to foremen’s offices in the factory;
v. Rent paid for the factory;
vi. Payment for computer time to operate a new stores control system,
vii. Wages paid to own employees for building the foremen’s offices. Give reasons for your classification.
Illustration 7
1. State with reasons whether the following are Capital Expenditure or Revenue Expenditure:
2. Expenses incurred in connection with obtaining a licence for starting the factory were ` 10,000.
3. ` 1,000 paid for removal of stock to a new site.
4. Rings and Pistons of an engine were changed at a cost of ` 5,000 to get full efficiency.
5. ` 2,000 spent as lawyer’s fee to defend a suit claiming that the firm’s factory site belonged to the Plaintiff. The
suit was not successful.
6. ` 10,000 were spent on advertising the introduction of a new product in the market, the benefit of which will
be effective during four years.
7. A factory shed was constructed at a cost of ` 1,00,000. A sum of ` 5,000 had been incurred for the construction
of the temporary huts for storing building materials.

2. Double Entry System, Books of Prime Entry, Subsidiary Books:

Books of Prime Entry

A journal is often referred to as Book of Prime Entry or the book of original entry. In this book transactions are
recorded in their chronological order. The process of recording transaction in a journal is called as
‘Journalisation’. The entry made in this book is called a ‘journal entry’.

Functions of Journal
1. Analytical Function: Each transaction is analyzed into the debit aspect and the credit aspect. This helps
to find out how each transaction will financially affect the business.
2. Recording Function: Accountancy is a business language which helps to record the transactions the
principles.
3. Chronological Record

Illustration 8 [journal]

Subsidiary Books
Although once understood, the journal entries are easy to be written, but if transactions are too many, it may
become difficult to manage them and retrieve them as and when required. Imagine there are 25 purchase
transactions in a day. Because the journal will record all transaction chronologically the entries would be
scattered and would be impossible to retrieve at the end of the day.
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Cash Book
A Cash Book is a special journal which is used for recording all cash receipts and all cash payments. Cash Book
is a book of original entry since transactions are recorded for the first time from the source documents. The
Cash Book is larger in the sense that it is designed in the form of a Cash Account and records cash receipts on
the debit side and cash payments on the credit side. Thus, the Cash Book is both a journal and a ledger.

Types of Cash Book

There are different types of Cash Book as follows:
1. Single Column Cash Book- Single Column Cash Book has one amount column on each side. All cash
receipts
are recorded on the debit side and all cash payments on the payment side, this book is nothing but a Cash
Account and there is no need to open separate cash account in the ledger.

2. Double Column Cash Book- Cash Book with Discount Column has two amount columns, one for cash
and
other for Discount on each side. All cash receipts and cash discount allowed are recorded on the debit side
and all cash payments and discount received are recorded on the credit side.

3. Triple Column Cash Book- Triple Column Cash Book has three amount columns, one for cash,
one for Bank and one for discount, on each side. All cash receipts, deposits into book and discount
allowed are recorded on debit side and all cash payments, withdrawals from bank and discount
received are recorded on the credit side. In fact, a triple-column cash book serves the purpose of Cash
Account and Bank Account both. Thus, there is no need to create these two accounts in the ledger.

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Illustration 9 [Cash Book]

3.LEDGER ACCOUNTS
 Ledger is the main book or principal book of account.
 The entries into ledger accounts travel through the route of journal and subsidiary books.
 The ledger book contains all accounts viz. assets, liabilities, incomes or gains, expenses or losses,
owner’s capital and owner’s equity.
 The ledger is the book of final entry and hence is a permanent record.

Ledger Posting
As and when the transaction takes place, it is recorded in the journal in the form of journal entry. This entry is
posted again in the respective ledger accounts under double entry principle from the journal. This is called
ledger posting.

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 4. Trial Balance
After the transactions are posted to various ledger accounts (either from journal or from subsidiary books) and
they are balanced, the next stage is to draw up the list of all balances. We know that some ledger accounts will
show ‘debit balance’ (debit side greater than the credit side), while the other will reflect a ‘credit balance’
(credit side being higher than debit side). All account balances are listed to ensure that the total of all debit
balances equals the total of all credit balances.

Features of a Trial Balance

i. It is a list of debit and credit balances which are extracted from various ledger accounts.
ii. It is a statement of debit and credit balances.
iii. The purpose is to establish arithmetical accuracy of the transactions recorded in the Books of Accounts.
iv. It does not prove arithmetical accuracy which can be determined by audit.
v. It is not an account. It is only a statement of account.
vi. It is not a part of the final statements.
vii. It is usually prepared at the end of the accounting year but it can also be prepared anytime as and when
required like weekly, monthly, quarterly or half-yearly.
viii. It is a link between books of accounts and the Profit and Loss Account and Balance Sheet.

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COMPREHENSIVE PROBLEM
Journalise the following transactions. Show the ledger Posting and show the Trial Balance

Jun 5th : Started business with the following [from own source]
Stock of Goods 15,000; Cash 25,000; Furniture 10,000; Debtors 7,000; Machinery 8,000 & Creditors 15,000.
6th : Opened a bank account with 5,000
7th : Bought goods worth 6, 000 from Usha & Co. & paid half the amount in cash.
8th : Sold to Bee & Co. goods worth 5,000 and a cheque received for the due
14th : Sold private car for 4,000 and bought a new one for business with the proceeds plus 5,000 from office cash.
16th : Bought furniture worth 4,000 of which, those worth 1,000 are for office use and the balance for stock.
18th : Sold goods to Arial & Co. 8,000 and to Wheel & Co. 7,000
19th : Payment made to Creditors 4,500
20th : Cash received from Debtors 5,800
25th : Paid Rent by cheque 2,500
30th : Commission received 3,000

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