WELCOME

Money Cycle

Where does the money come from?

 Owner’s Funds
 Loans-other Peoples’ money
 Undistributed Profits

Where does the money go?

 Assets
 Fixed Assets
 Current Assets
Understanding Financial Statements
Financial statements provide information about an enterprise’s
revenues, expenses, assets, liabilities and owner’s equity. These
statements are a central feature of accounting because they are the
principal means of communicating accounting information to those
outside an enterprise.
Major financial statements are:
The Balance Sheet:
It presents an enterprises’ assets, liabilities and owner’s equity at a
particular time. It summarizes the resources of a firm and the
claims on those resources by owners and creditors of the enterprise
at the time.
The Profit and Loss Account:
It is also called the income statement. It summarizes the results of
a firm’s operations for a given period by disclosing the revenues
earned and expenses incurred. By measuring the net profit earned
by a business, it indicate its degree of operating success on a given
period.
 BALANCE SHEET

Liabilities Assets
Amounts Things owned
owed by the by the
Business Business

Sources Uses
of of
Funds Funds
BALANCE SHEET-STRUCTURE

Liabilities Assets
Owner’s Funds
450
Fixed Assets
Long-Term Loans 600
250
Current Assets
Current Liabilities
300 400

1000 1000
Balance Sheet of ABC Ltd. as at 31-3-96
(Rs.000)
Sources of Funds 1995-96
Owner’s Funds 4,50
Long Term Liabilities 2,50
Current Liabilities 3,00
Total Liabilities 10,00

Application of Funds
Fixed Assets 6,00
Current Assets 4,00
Total Assets 10,00
 BALANCE SHEET
Balance Sheet: is a statement containing the assets and liabilities of a
business on a particular date.
Liabilities: the term denotes claims against the assets of a firm.
Current Liabilities: are payable within a year; these could be:
• Accounts Payable
• Outstanding Expenses
• Bank Overdraft
• Short Term Loans
• Advance Payments received
Long Term Liabilities: are those liabilities which do not become due for
payment in one year.
Assets: are the resources acquired by a business from the funds made
available by the owners of the business or others.
 BALANCE SHEET

Current Assets: are assets held on a short term basis such as stock,
debtors, cash, and bank balance.
Fixed Assets: are those which are of permanent nature and are held
by the firm on a long term basis, such as land, buildings, plant and
machinery, furniture and fixture etc. These assets help generate revenue
and cannot be easily converted into cash.
Fictitious Assets: Formation expenses such as registration charges,
,debit balance in the P&L A/C when shown on the asset side in the case
of a joint stock co.
Contingent Liability: these are contingent upon the happening of an
event such as claims pending settlement in courts; these are shown by
way of a note in the balance sheet.
Fixed Assets

F.As. represent assets or facilities acquired for carrying on business

operations. FA’s acquired with an ‘intention to use’ and ‘not to sell’.
Land
Buildings
Plant & Equipment
Furniture & Fittings
Vehicles
Current Assets

C.As. represent facilities or assets acquired with intention for sale or

conversion into goods.
Stock
Debtors
Marketable Securities
Cash
Prepayments
CAPITAL

Share means a share in the share capital. Equity Shares are those which
are other than Preference Shares. Equity Share holders enjoy no special
privileges. Residual claimants.

Preference Shares: holders enjoy preference over ordinary shareholders

in terms of dividend, repayment of capital. They get a fixed Dividend.

Cumulative & Non-Cumulative: When dividend, remaining unpaid in any

one year, has to be carried forward and accumulated dividends are paid
before paying equity share holders. If this feature is not there, its is non-
cumulative.
CAPITAL {contd}

Authorized Capital: is the gross amount of authorized share capital

which company is authorized to issue.
Issued Capital: is that part of authorized capital which is issued to the
public.
Subscribed Capital: is that part of the issued capital which is subscribed
by the public.
Paid-up Capital: sometimes issued capital is required to be paid in
installments. The amount that is actually to be paid is known as paid-up
capital.
BALANCE SHEET of ALPHA Ltd. as at 31- 3 1999

Sources Of Funds 1998-99

Shareholder’s Funds
Ordinary Shares Rs.1,50,000
Preference shares 60,000
Reserves 70,000
Retained earnings 1,70,000
Long Term Loans
Govt. Loan 2,70,000
Current Liabilities 2,50,000
Total liabilities 9,70,000
Application Of Funds
Fixed Assets 3,90,000
Depreciation 40,000 Net 3,50,000
Current Assets 6,10,000
Debtors 2,00,000
Stock 2,70,000

CASH 40,000
Prepayments 10,000
Marketable securities 90,000
GOODWILL 10,000
Total Assets 9,70,000
Balance Sheet………………. Second Day

Credit Receipt From Debit Payment How

Whom Utilized

Liabilities Assets

Capital 4,000 Stock 20,000

Furniture 10,000
Loans 36,000
Loose Tools 2,000
Public Deposits 10,000 Loan to Mohan 5,000
Cash in Bank 10,000
Cash in hand 3,000
Total 50,000
Total 50,000
 Profit and Loss Account
The profit or loss made by a trader can be found out by comparing
the cost of goods sold with sales value.

Rs.
Purchases 30,000
Purchases returns 5,000
Sales 40,000
Sales returns 5,000

Sales 40,000
Less Sales Returns 5,000 35,000
Purchses 30,000
Less Purchases Returns 5,000 25,000

Gross Profit 10,000

 Profit and Loss Account
If a Stock of Rs. 5,000 is left unsold:

Cost of Goods sold = Net Purchases – Closing Stock

= 25,000 – 5,000
= 20,000

Gross Profit = Net Sales – COGS

= 35,000 – 20,000
= 15,000

Gross Profit = Sales – COGS

COGS = Opening Stock + Purchases – Closing Stock
Valuation of Closing Stock

Closing stock is valued on the basis of “Cost or market price which

ever is less” principle. This valuation follows the convention of
conservatism; expected losses are to be taken into account but not
expected profits.

Purchases: includes both cash and credit purchases meant for

resale.
In case, a proprietor has himself used certain goods for his personal
purposes, the value of such goods at cost will be deducted from the
purchases and included in the drawings of the proprietor.
If some goods are given by way of free samples, the value of such
goods is charged to advertisement account and deducted from
purchases.
Purchases returned are also deducted.
PROFIT & LOSS A/C of ALPHA Ltd. for the year ending 31-3-
99

Sales Rs.11,00,000
SLess Cost Of Goods Sold 8,20,000
Gross Profit 2,80,000

Less Operating Expenses 1, 30,000

Depreciation 40,000
Operating Profit [EBIT] 1,10,000
Less Interest on loan 16,200
Income tax Provision 40.300

NET INCOME [ NET PROFIT ] 53,500

 Rules of Debit and Credit - Journal
Every accounting transaction has two sides- the ‘debit’ and a ‘credit’.
These terms are used in journal entries, ledger accounts, trial
balance, trading and P&L A/c. We simply know by convention that
‘left hand side is debit’ and ‘the right hand side is credit’. There is no
specific meaning of these terms debit & credit.
Conventional Approach:
We follow certain conventions regarding ‘debit and’ credit’ these are:
a) The left hand side of every account is debit and the right hand side is
credit.
b) In case of journal and trial balance, the amount column is divided into
two parts. The left part of the amount column is ‘debit’ & the right part
is ‘credit’.
c) While passing journal entries, we use the term Dr, the short form of
Debtor against the accounts debited but don’t use the word credit
against accounts credited.
 Rules of Debit and Credit – Journal [contd]

d) All receipts are debited and all payments are credited.

e) All expenses and losses are debited but incomes and gains are
credited

The Liability side shows credit..

Accounts are classified as Personal, Real and Nominal,
as follows:

Classification of Accounts

Personal Accounts Impersonal Accounts

Natural Personal Artificial Personal Representative

Accounts Accounts Personal Accounts

Real Accounts Nominal Accounts

Tangible Real Accounts Intangible Real Accounts

Personal Accounts

There are two types of persons i.e., natural and artificial. Natural persons
are human beings, such as Ram, Mohan, John & Faisal. Artificial
Accounts are related to firms, companies, institutions, factories and
establishments, such as Ram & Sons A/c, Bank of India A/c, Janata Dal
A/c, Bata Shoe Co. A/c, Delhi Univ. A/c, Debtor’s A/c Creditor’s A/c &
Drawings A/c

Representative Personal A/cs.: represent a particular person or a

group of persons such as outstanding wages A/c; Here, instead of using
the names of workers whose wages are outstanding, we shall be crediting
O/s wages A/c which represents workers to whom wages are payable. In
this way, O/s wages, O/s salaries, Prepaid expenses, Accrued &
unearned Income are representative Personal A/cs.
Rules of Debit and Credit:
Debit the receiver.
Credit the giver.
Examples: Goods sold to Ram. Ram will be debited as receiver. If
Mahadev has given the goods, his A/c will be credited.
Bank A/c will be debited in case of deposits into the bank because Bank
will be the receiver of the deposit. If the amount is withdrawn from the
bank, the amount will be given by the bank. Hence Bank A/c will be
credited.

Impersonal A/cs.
i.e., not personal A/c such as those related to assets, losses, expenses,
income and gain. In other words, these are Real & Nominal A/cs.

Real A/cs.
Cash A/c, Building A/c, Plant A/c, Furniture A/c, Goods A/c and Machinery
A/c etc. are all real A/cs. Real A/cs are also concerned with intangible
assets,- goodwill, patents and trademarks.
Debit what comes in.
Credit what goes out.
Nominal A/cs.

These are related to income and expenditure, or gains and losses, wages
A/c, Salaries A/c, Rent A/c, Interest A/c, Discount A/c and Advertisement
A/c.
Debit all expenses or losses.
Credit all income or gain.
According to this rule, wages A/c, Salaries A/c, Insurance A/c and Interest
A/c are debited when these expenses are met. Discount A/c, Commission
A/c, Interest A/c are credited whenever these are received. In case of
payment of salaries to workers, salaries are an expense, so salaries A/c
will be debited. While receiving rent from the tenant, rent will be gain and
thus will be credited in the Rent Recd. A/c.
 JOURNAL
The word Journal is derived from the French JOUR meaning daily records.
Journal is a book of prime records for small firms. Big concerns prepare
Cash Book, Purchases Book, Sales Book and other Subsidiary Books in
addition to Journal proper. Small firms record their business transactions in
Journal and post them to the concerned ledger accounts. Big Concerns
record their transactions in subsidiary books and journal and post them
from these prime books to respective ledger accounts.
The Journal is subdivided into five columns. These columns are: Date,
Particulars, Ledger Folio, Amount (Debit), Amount (Credit) and narrations.

Format of Journal

Date Particulars Ledger Folio Amounts

Dr. Cr.
Rs. Rs.
(1) (2) (3) (4) (5)
1. Date: Year may not be repeated and only dates need be mentioned
chronologically.

2. Particulars Write the name of the A/c to be debited and also write ‘Dr’
against the A/c.The a/c to be credited is written below the account to
be debited. We don’t write ‘Cr.’ against this account. After the journal
entry, ‘Narration’ is written, just to explain the journal entry. Narration
is preceded by the words ‘Being’. ‘For’ can also be used instead of
‘Being’. Presenting journal entries as above is a convention of
Accounting. It should be honoured to establish norms of the subject
and to bring uniformity in the presentation.
3. Ledger Folio (LF.) Journal & Ledger are interrelated, and ledger
posting is based upon journal. A reference to the page no. of the
ledger is, therefore, necessary to facilitate verification.

4&5. Amount (Debit) and (Credit).

Narration: Provides a brief explanation of the transaction. It is
customary to write the narration within small brackets. After the
narration, horizontal line is drawn in particulars column only just to
separate the journal entry from the other entry.
Transaction 1: Started or commenced business with Rs. 20,000

Journal entry
Cash A/c Dr 20,000

To Capital A/c Rs. 20,000

(Being Commencement of Business

Explanation: Business (entity) has recd. cash as capital to start and

carryout activities. Cash A/c (Real A/c) is to be debited as cash has
come in (Debit what comes in and Credit what goes out). Capital A/c is
a personal A/c (the rule: Debit the receiver and Credit the giver) and has
to be credited.
Transaction 2:
Goods purchased for Rs. 5000 Or
Cash purchases Rs. 5000 Or
Goods purchases from Mohan Rs. 5000

Journal entry
Purchase A/c Dr 5000

To Cash A/c Rs. 5000

(Being Goods Purchased for Cash)

Both goods A/c & Cash A/c are Real A/cs. Goods A/c is be debited
because goods are coming into the business & Cash A/c will be credited
because it is going out of business.
Transaction 3:

Goods purchased from Mohan Rs. 3000

Or
Goods purchases from Mohan on Credit Rs. 3000

Journal entry
Purchases A/c Dr 3000

To Mohan’s A/c Rs. 3000

(Being Goods Purchased from Mohan on Credit)

Explanation: The A/cs.concerned are Goods A/c & Mohan’s A/c. Goods
A/cs, a Real A/c, will be debited because goods have come in. Mohan
A/c is personal A/c (Debit the receiver and Credit the giver)
Transaction 4:

Goods sold to Mohan Rs. 4000

Or
Goods sold to Mohan on Credit Rs. 4000

Journal entry
Mohan’s A/c Dr 4000

To Sales A/c Rs. 4000

(Being Goods Sold to Mohan)

The transaction relates to Mohan (Personal A/c) and Goods (Real A/c).
Mohan as the receiver of goods is debited & Sales A/c will be credited –
goods going out of business.
Transaction 5:

Salaries Paid Rs. 3200

Journal entry

Salaries A/c Dr 3200

To Cash A/c Rs 3200

(Being Salaries Paid)

Salaries A/c (Nominal A/c) – The rule is ‘Debit all expenses’ Salaries
being an expense, hence it will be debited. Cash A/c (Real A/c) will be
credited.
Transaction 6:

Rent received Rs. 2000

Journal entry
Cash A/c Dr 2000

To Rent A/c Rs 2000

(Being Rent Received)

Cash A/c debited (Cash recd.) Rent A/c credited – Rule is – Credit all
income.
Transaction 7:

Amount received from Mohan Rs. 990

Discount allowed Rs. 10

Journal entry
Cash A/c Dr 990

Disc. A/c Dr 10

Cash A/c debited (Cash recd.). Discount A/c (Nominal A/c) also debited
because discount is an expense.
Transaction 8:

Amount paid to Shyam Rs. 1980

Discount allowed Rs. 20

Journal entry
Shyam A/c Dr 2000

To Cash A/c Rs. 1980

Disc. A/c Rs. 20

(Being amount paid to Shyam & Disc. allowed)

In this case, the firm earned a discount. Disc. A/c (Nominal A/c) will be
credited (Credit the income)
Transaction 9:

Depreciation on Furniture Rs. 2000

Journal entry

Depreciation A/c Dr 2000

To Furniture A/c Rs. 2000

(Being Depreciation on furniture)

Depreciation A/c debited (Expenses to be debited). Furniture A/c credited

because its value amounting to Rs. 2000 has gone out of business.
Transaction 10:

Interest on Capital Rs. 1000

Journal entry
Interest on Capital A/c Dr 1000
To Capital A/c Rs. 1000

(Being Interest on Capital)

Interest on Capital is the expense of the business & hence is to be

debited, Capital A/c is a Personal A/c. There is a modified rule for
Personal A/cs (Capital A/c). ‘debit the debtor and credit the creditor’. As
the interest on capital is to be paid on capital so Capital A/c will be
creditor for it and thus credited.

Also, according to the modern approach, debit the increase in

expenses. For the Capital A/c, the rule is ‘debit the decrease and credit
the increase’. As the capital is increasing with interest on capital, as such
Capital A/c will be credited.
Transaction 11:

Outstanding Salaries Rs. 2000

Journal entry

Salaries A/c Dr 2000

To O/S Salaries A/c Rs. 2000

(Being Salaries remaining unpaid)

Salaries A/c (Nominal A/c) will be debited with expenses. Outstanding

salaries is a Personal A/c (representative of employees) & will be
credited.
Transaction 12:

Prepaid Insurance Rs. 1000

Or
Unexpired Insurance
Or
Insurance Paid in Advance
Journal entry

Prepaid Insurance A/c Dr 1000

To Insurance A/c Rs. 1000

(Being insurance paid in advance)
Prepaid Insurance A/c is a representative Personal A/c and Insurance
A/c is a Nominal A/c. Insurance Co. will be the debtor of the firm for the
amount paid in advance so Prepaid Insurance A/c will be debited. Since
insurance paid in advance is the gain for the current year. Hence it
should be credited as per the rule of Nominal A/cs – Credit the gains.
Transaction 13:

Amount withdrawn by the proprietor for

personal or private use Rs. 3000

Journal entry

Drawing A/c Dr 3000

To Cash A/c Rs. 3000

(Being amount withdrawn by the owner )

Drawing A/c is a Personal A/c & will be debited (Debit the debtor) and
Cash A/c will be credited (Cash has gone out of the business).
Transaction 14:

Goods taken by proprietor for

personal use Rs. 3000

Journal entry

Drawings A/c Dr 3000

To Purchase A/c Rs. 3000

(Being goods taken by Proprietor)

Drawings A/c will be debited by credit to Purchase A/c (goods have gone
out)
Transaction 15:

Goods given as charity Rs. 750

Journal entry

Charity A/c Dr 750

To Purchases A/c Rs. 750

(Being goods given as Charity)

Charity is a Nominal A/c, Hence charity is an expense & therefore
debited. Purchase A/c will be credited as goods have gone out of
business.
Transaction 16:

Mohan becomes insolvent. A first

and final amount of 40 paisa in a rupee
is recd. out of a loan of Rs.2000 from the official receiver

Journal entry

Cash A/c Dr 800

Bad Debts A/c Dr 1200

To Mohan Rs. 2000

(Being Mohan became bankrupt and a first & final compensation of

40 paisa per rupee recd.)

Both Cash A/c & Bad Debts A/c (Nominal A/cs will be debited-debit all
losses. Mohan is a giver and hence should be credited.
Transaction 18:

An amount previously written off as Bad Debt

has now been recovered from Mohan, the
debtor for Rs. 700.

Journal entry

Cash A/c Dr 700

To Bad Debts recovered A/c Rs. 700

(Being recovery of Bad Debt previously written off)

Bad Debts recovered A/c is a Nominal A/c. It will be credited because it is

a gain in the business.
 Certain Important Items

1. Distribution of Goods as Free Sample.

It is not a sale but an expense. Therefore Free Samples A/c will be
debited (Nominal A/c). Purchases A/c will be credited. Goods given as
charity will be valued at cost price.

Journal entry

Free Samples A/c Dr

To Purchase A/c

(Being distribution of goods as free samples)

 Certain Important Items
Loss of Goods
i) Loss of goods by theft: It is a loss (expense). Hence this is a
Nominal A/c and will be debited. Credit cannot go to Sales A/c
(Since Loss is not a sale). Loss will be credited to Purchases A/c
at cost price only.
Loss by theft A/c Dr …….
To purchase A/c …………
(Being loss by theft)
ii) Loss of goods by Fire
Loss by Fire A/c Dr ………
To Purchase A/c ………….
iii) Loss of Cash by Fire
Loss by Fire A/c Dr ………
To Cash A/c ………….
(Being loss of Cash by Fire)
 Certain Important Items
Notes:

Purchase A/c always shows Debit balances. It is debited for both cash &
Credit purchases. In the following cases goods are valued at cost.

i) Goods given as charity

ii) Goods taken by proprietor
iii) Loss of goods by Theft
iv) Free distribution of goods as sample
v) Loss of goods by fire.
 Compound Journal Entries

There may be certain transactions of the same nature on a certain

date. In these case, we prefer to pass only one entry instead of
passing two or more entries. It can be done in either of the following
ways:

i) By debiting one account and crediting two or more accounts.

ii) By crediting one account and debiting two or more accounts.
iii) By debiting two or more accounts and crediting two or more accounts.
 Compound Journal Entries

Illustration: Pass necessary journal entries in the following cases:

i) Amount recd. From Mohan Rs. 1980
Discount allowed Rs. 20
ii) Amount paid to Azhar Rs. 2920
Discount allowed Rs. 80
iii) Salaries amounting to Rs. 3000 and wages amounting to Rs. 5000
were paid on 31-12-92
Journal Entry
Cash A/c Dr 1980
Discount A/c Dr 20
To Mohan 2000
(Being amount recd. From Mohan and discount allowed)
 Compound Journal Entries

ii) Azhar Dr 3000

To Cash A/c 2920
To Discount A/c 80

(Being amount paid to Azhar and discount allowed)

iii) Salaries A/c Dr 3000
Wages A/c Dr 5000
To Cash A/c 8000
(Being payment of Salaries & Wages)
 Opening Journal Entries

Business according to going concern concept is supposed to be

carried forward indefinitely. At the end of the accounting year, different
accounts are closed but the business has to be carried on so previous
year assets and liabilities are to be brought into account of the current
year. Passing journal entry in the beginning of the current year with
the balance of assets and liabilities of the previous year is opening
journal entry. In this entry, assets accounts are debited because
assets always show debit balance. Liability and Capital account are
credited because they show credit balance
 Opening Journal Entries

Illustration: The firm of M/s Simple and Dimple had the following
balances in their different ledger accounts on January 1, 1993.
Cash Rs. 20,000
Furniture 4,000
Closing Stock 20,000
Building 60,000
Debtors 20,000
Creditors 16,000
Capital 1,08,000
Pass the opening journal entry:

Journal Entry:

Date Particulars Ledger Amounts

Folio
Dr. Cr.
Rs. Rs.
1993 Cash A/c Dr 20,000
Jan, 1 Furniture A/c Dr 4,000
Stock A/c Dr 20,000
Building A/c Dr 60,000
Debtors A/c Dr 20,000

To Creditors A/c 16,000

To Capital A/c 1,08,000

Being pervious year’s

balance brought into books