The Accounting Story

7/30/2019 The Accounting Story

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THE ACCOUNTING STORY

CHAPTERS

CHAPTERS TOPICS PAGE

NOS

1 ACCOUNTING CONCEPTS 3-43

2 THE JOURNAL BOOK 44-55

3 OTHER SUBSIDIARY BOOKS 56-

4 THE LEDGER

5 THE TRIAL BALANCE

6 THE BANK RECONCILIATION STATEMENT

7 THE FINAL ACCOUNTS


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CHAPTER ONE

ACCOUNTING CONCEPTS

CONTENTS

Sr No Particulars Page

No

1 THE ACCOUNTING STORY 4

2 LESSON NO 1-WHAT IS A BUSINESS TRANSACTION 8

3 THE ACCOUNTING STORY- continued 9

4 LESSON NO 2-THE ACCOUNTING EQUATION 12


6 LESSON NO 3-BOOKS OF ACCOUNTS 17


8 LESSON NO 4-DEFINITION OF ACCOUNTANCY 21


10 LESSON NO 5-EFFECTS OF BUSINESS TRANSACTIONS 23


12 LESSON NO 6-CLASSIFICATION OF BUSINESS

TRANSACTIONS

26

13 THE ACCOUNTING STORY.. continued 27

14 LESSON NO 7-PRINCIPLES AND RULES OF ACCOUNTANCY 28


16 LESSON NO 8-SOME ACCOUNTING TERMINOLOGIES 33

17 ILLUSTRATIONS 35


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Ram had turned 24 today. He had just majored in Marketing from one of

Punes numerous management institutes.

His father, Hari Kale, had promised him an unique present for this birthday.

Hari was pretty well off, being the General Manager of Marketing in a

multinational company in India.

Ram planned to start a business enterprise- initially trading, then eventually a

manufacturing one. But today was for enjoying the party organized by his

family.

The party went on well past midnight. Ram had forgotten all about his

fathers birthday present.

After the festivities were over Hari and he were relaxing alone in their

drawing room when he remembered his fathers promise.

Dad, when are you giving me your unique present?

Ah, Ram. I was just wondering when you would ask. I have been able to

save a considerable amount of money up to now, part of which I can give

you-maybe up to Rs 1 crore, that will be my birthday present but there are

some conditions which you will have to agree to.

Ram was totally flabbergasted ! One Crore!! He had not expected

this!

Conditions-anything what you say, Dad, just name them. I am a MBA, it

should be easy for me to fulfill all your conditions.

Hari could not help smiling.


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Hey hold on, buddy, you are excited because I have promised you a crore but

first listen to my conditions.

OK, Dad, spell them out.

I know you want to start a business but I am not sure whether you are

capable of making a success of it. I know you are good at marketing and I

know that you have worked hard at it, but to run a business, just having

knowledge of marketing is not enough.

Then what, Dad?

How much do you know of Accounting and Finance?

Why? Whats this got to do with your conditions?

Ram, just answer my question.

Dad, I think that I have a fairly good knowledge of Finance but I am not very

sure about Accounting.

You mean to tell me that without knowledge of Accounting, you have a good

knowledge of Finance?

Why? Why do you require knowledge of Accounting to understand Finance?

Dad, you very well know that I did my MBA after my engineering degree. I

was never good at accounting but because today Financial Theories are more

dominated by economists than accountants, it is more statistically and

mathematically oriented than accounting wise. Therefore I had lesser

difficulty there.

Ram, I dont agree with you. You know I met a guy some 10 years back and

we got to talking about finance because he was a finance guy and I was

having some problems in understanding some finance reports. He is a

Chartered Accountant but he also teaches Accounts and Finance. Name

Vijay Korke-Professor Vijay Korke.


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He said that you just cannot understand finance without having a basic

knowledge of accounting and he proved it to me subsequently. He said that

all financial theories-statistical, economic, mathematical or otherwise werebased on financial information.

This financial information is recorded and structured in the required formats

by accounting methods and techniques. Therefore, unless one has a good

knowledge of the basics of Accounting, it can lead to wrong financial

decisions.

He taught me some basics, enough for my job of marketing-but you want to

run a business which involves everything, money, purchases, manufacturing,marketing, people-if you do not know basic accounting, where will you be?

So, condition number one, first you go to him and persuade him to teach you

the basics of accounting and finance, I give you a max of three months for

accounting and three for finance. Call it revision but you will have to get his

certificate, for me to consider loosening my purse strings!!. So, agreed to

condition one?

Ram thought for some time.

OK Dad, so what are the other conditions?

Other conditions baad me bataunga !!! Pehle yeh to kar lo!

Here is his cell number. Phone him and take his appointment.

Next day, Ram met Prof Vijay at his house at Baner in Pune city.

Hi, so you are Ram. Haris son eh!

Yes sir.

You are a MBA and still you want to learn the basics of accounts from me?

Well, sir, dad says that you will be able to make me appreciate the

importance of accounting in finance and marketing.


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And you obviously do not share his opinion!!

No I am not sure but I sure do require to revise my concepts of accounting.

OK we will find out soon enough what you know about it.

Tell me Ram, you want to start a business, right?

Yes sir.

Why?

Why? Because I think it will help me to increase my wealth.

Wow-spoken just like a MBA!! So what do you mean by your wealth?

Hmmm. I suppose it means what I own-my properties.

And how would you increase your properties?

By doing business, obviously!

Oh, we have a wise guy here! OK, Ill play along. Tell me, Ram, what is the

definition of business? Tell me in your own words.

Well, business involves buying or selling goods or services in order to

increase your wealth.

Not bad! However let me give you my definition of business, OK?

A business is a series of relationships entered into for the prime purpose of

increasing the monetary worth of each party to the relationship, by

conducting business transactions.

Therefore, Ram, in Lesson no 1, let us define a Business

Transaction.


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LESSON NO 1

WHAT IS A BUSINESS TRANSACTION

An act of exchange-

a. of things or services

b. between two or more parties

is called a transaction.

Transactions may be monetary or non-monetary i.e., they may involve

money or no money respectively.

Transactions which do not involve an exchange of money or money's worth

directly or indirectly or in more simple terms,

which do not result -immediately or in the future -into either an inflow or

outflow of cash,

are called Non-Monetary, Non-Business Transactions

Transactions involving money or money's worth

which result into either an inflow or outflow of cash-

immediately or in the future-

and which are not personal in nature,

are called Business Transactions

Examples of Business Transactions:

payment of money to buy goods which are intended to be resold for a

profit,

a sale of the same goods without receiving any money immediately but

would receive money at a later date,

receipt of moneys on sale of these goods,

In the above context, the word personal concerns any inflows and outflows of

cash which result into a personal benefit e.g., a money gift received during

marriage or paying money for buying articles for personal consumption or

spending money to buy a train ticket for personal travel----all these type of

transactions are personal in nature and are not concerned with the business!


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THE ACCOUNTING STORY-continued

So Ram, are you now clear about Business Transactions!

This is the first step to become a Bean Counter which you MBA guys call us

accountants.

Sir, I dont want to become a Bean Counter, but I would certainly like to get a

feel of accounts not because I want to make it my career, but to help me run

my business efficiently.

Right, it is presumed that you are interested in learning all about Accountancy

for this reason so as to understand and record business transactions-and not

personal ones.

Ram, you mentioned sometime earlier that you want to do business for

increasing your wealth, i.e., increasing the worth of your properties. Correct?

Yes, sir.

That means these business properties are your Assets because they are

worth something to you in monetary terms?

Yes, sir.

That means that you own these business properties, correct?

Of course, Sir.

Do you agree that you as the proprietor of your business and your

business are two different persons?

Yes, Sir

Why?

Because the proprietor invests his money into the business as opposed to his

own personal investment-and he expects the business to use this money for

making profit which ultimately belongs to the proprietor. Therefore the

proprietor and his business are two different persons.


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Then all these properties of the business are owned by whom - by the

proprietor or the business?

Ram thought for sometime.

I guess, the business.

Therefore the business which is at present holding these properties as its

assets, is it liable to the proprietor for the same?

Yes, it is I know this! The proprietor has invested his money in the business

and therefore once the business is closed, if at all, then it will have to return

the money back to the proprietor. What it purchases from these moneys

ultimately belongs to the proprietor. But since it is holding these assets in its

name, it becomes liable to return them to the proprietor either in the sameform or by converting into their monetary value, as and when the proprietor

wants his money back.

Wow!! Ram, tumne toh sixer mara! OK, what this means is that the business

is liable to the proprietor because he has provided the money for these

assets, right?

Yes, sir.

It also means that the business has assets and also has an equal liability-

towards the proprietor, isnt it? It also means that the proprietor has whatcan be termed as Property Rights over the assets of the business?

Sir, as you so easily put it, now I am beginning to understand the meaning of

the Accounting Equation!!

So you are aware of the Accounting Equation-OK, so let us discuss this in

detail in our lesson no 2 tomorrow at 10a.m sharp.

Next day, Vijay had just finished his bath when the doorbell rang. It was

Ram.

Arre, you are very early today? Its just 8.30 am!

Sir, I could not sleep last night-some questions were going round in my mind

and I wanted the answers immediately so I came early. I hope you dont

mind, do you Sir?

No-no, come on in-said Vijay.

Whats the problem? he asked.


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Sir, you mentioned yesterday that all business transactions result immediately

or in the future, either into an inflow or outflow of cash. But suppose A owes

me Rs 1000/- and he does not pay me anything-it does not result into a cashoutflow or inflow-then is it a business transaction?

When A took the money, he had promised to pay you back-it is assumed that

he had borrowed this money for a business purpose. Therefore according to

my definition it was a business transaction, because it had resulted into a

cash outflow . That is one business transaction.

Now I presume that your question is about the fact that A is not going to pay

you back and therefore, is it a business transaction? If A does not pay you

the Rs 1000/- then it is lost for you which we term in Accounting terms as a

loss.

Therefore this is a business transaction, because it has resulted into a

reduction or loss of an inflow of cash due from A and you have lost Rs

1000!!!. If A had paid you as promised, it would have resulted into an inflow

of cash, wouldnt it?

But my dear chap-you have leapt forward-these types of business

transactions we will deal with later-not now.

Let us go forward in a more structured way and start with Lesson No 2 on

The Accounting Equation.


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LESSON NO 2

THE ACCOUNTING EQUATION

All businesses necessarily start with Property and Property Rights.

What then is this Property? Property can be Tangible or Intangible.

Tangible Property can be felt and seen, and which has monetary value to

the owner of that Property like Buildings, Shares in Companies, Furniture,

Machinery, Cash, Inventory, etc . Intangibles also have monetary value but

cannot be felt or seen like patent rights, business goodwill, software

programs, customer debts etc.

This Property is created by providing resources or money to the business.

These resources can be provided by the owners contribution and/or by

borrowing these resources from someone who is willing to lend the same.Therefore at any given time the business properties are equal to the total

amount of moneys brought into the business by the owners and by the

lenders, who obtain the Rights in the Property.

BUSINESS PROPERTY = RIGHTS IN THE BUSINESS PROPERTY.

This is called the Accounting Equation

Whenever there is an increase in Business Property, there would be an

increase in the Property Rights and vice versa.

These Property Rights belong jointly to the owners of the business and the

lenders to the business in the proportion of the resources provided by each,

and as the value of property increases or decreases these rights also

automatically increase or decrease in value but not necessarily in the same

proportion for each resource provider-we will detail this out a little later.


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Therefore Business Property = Owners Funds + Lenders Funds

Therefore Owners Funds = Business Property Lenders Funds

Therefore Lenders Funds = Business Property - Owners Funds

In the Business environment, Owners Funds is called Capital, Business

Property is called Assets, and Lenders Funds is called Liabilities.

Therefore Assets = Capital + Liabilities

Capital = Assets Liabilities

Liabilities = Assets Capital

Business Transactions therefore result into either a change in the

values of Capital, Assets or Liabilities.

Let us look at a few Business Transactions and see how they affectthe above Accounting equations:

Sr No Particulars-

Effects

Total

Assets

Rs

Total

Capital

Rs

Total

Liabilities

Rs

Total

Capital +

Liabilities

Rs

1 If Assets are =

Rs 500000

Then Capital +

Liabilities = Rs

500000.

500000 300000 200000 500000

2 If Capital = Rs

300000 then

Liabilities =

Rs 500000 minus

Rs 300000 = Rs

200000

500000 300000 200000 500000


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Sr No Particulars-

Effects

Total

Assets

Rs

Total

Capital

Rs

Total

Liabilities

Rs

Total

Capital +

Liabilities

Rs

3 Suppose some

assets valued at Rs

150000 in the Total

Assets of Rs

500000 given

above, are sold for

Rs 200000 which isreceived in cash,

then

500000

-150000

(assets

sold)

+200000

(cashreceived)

=550000

300000

+50000

(Profit on

Sale of

Asset-

belongs

to Owner)

=350000

200000 550000

4 Suppose further

Plant & Machinery is

purchased for Rs

150000 by making

payment in Cash,

then

550000

+150000

(Machiner

y)

150000

(Cash)

=550000

350000 200000 550000

5 Suppose instead of

payment in cash ,

the payment is to be

made at a later date

to the Supplier of

the Machinery - M/s

A, then

550000 +

150000

(Machiner

y)

=700000

350000 200000 +

150000

(M/s A)

=350000

700000


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Book-Keeping and Accountancy is the technique of recording these changes

in such a manner that the businessman is made aware of the results of his

business transactions in the following way:

Whether they have resulted into an increase or decrease in his Capital, i.e.,

whether he has made a profit or loss, and

What is his financial worth-i.e., what is the amount of Capital, Assets and

Liabilities of his business.

Such recordings of the business transactions are done in the Books of

Accounts maintained by him. Therefore we now come to the Books of

Accounts.

Vijay Sir, I think I am now beginning to understand the importance of

Accounting. But Sir, lets continue tomorrow-I want to do a little more

practice on my own to cement this understanding of the Accounting Equation.

Yes, Ram, do that- meet me again at 4 p.m. tomorrow.

OK, Sir, no problem!!

Next day, at 4 p.m. sharp Ram turned up.

So Ram, any problems now with the Accounting Equation?

No sir, none at all.

Good, then we can proceed with the Books of Accounts.

But sir, why do we have to learn about this- With the extent of

computerization we have today, does anybody have to know how to write or

maintain books of accounts?

No doubt Ram that there are numerous software programs available today

which automatically record all the business transactions in the required Books

of Accounts.

Therefore the topics relating to the maintenance of the books of accounts

would be purely academic as they are automatically formatted by the

software.


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However knowledge of the same may be necessary for a proper

understanding of the Accounting Technique because the same technique and

method of maintaining the books of accounts is followed in the computerizedaccounting packages.

Moreover the entries to record the actual debits and credits to the required

accounts are still to be entered manually into the package by the User and

therefore he has to have knowledge of accounting.

What is debit and credit we shall go into later.

It is also compulsory as per the various laws of our country for certain

business enterprises to maintain them but-but-but, absolutely necessary for

all businessmen to maintain them.Books of Accounts can be maintained manually or in a computer but the

formats are similar.

So on to Lesson no 3- Books of Accounts.


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LESSON NO 3

BOOKS OF ACCOUNTS

Recording of business transactions is called 'Book-Keeping' and the way or

technique or say rules for recording them is called 'Accountancy'.

Therefore in Book-Keeping and Accountancy, we are only concerned withmonetary business transactions. If a transaction has no financial character it

will not be recorded in the Books of Accounts.

From time immemorial human beings have kept some sort of a record of

things done or to be done, in some form or the other. Some have kept it in

their minds, some have written it down in their personal diaries or a notebook

or on scraps of paper and so on and so forth. Some have been very

organized and have kept proper accessible records and some have not

bothered to keep any track at all!

It was this need which gave rise to recording of dealings concerning money in

a more organized manner, and the records in which such dealings were

written down were called the 'Books of Accounts'.

The method of writing and recording these business transactions in

these books is the subject of 'Book-Keeping and Accountancy'.

The human mind is a great storehouse of data. But it suffers from a major

shortcoming- of easy, immediate and at will recall and retrieval of the

information stored in it!!

Therefore it becomes necessary to record the required data in a proper andaccessible manner. It becomes more important when any business dealing is

to be recorded because neglect in this case could result into a monetary loss.

Therefore Book Keeping & Accountancy is mainly concerned with the

recording of business dealings or what accountants call as 'business

transactions'.


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Objectives and importance of maintaining Books of Accounts

Objectives:

It is not possible for any businessman to remember all his business

transactions.

Books of Accounts serve as a permanent record of the business dealings and

they can be produced as evidence of a business transaction whenever and

where-ever required.

A businessman can know what he owes to others and what others owe to

him.Maintenance of Books of Accounts enables him to ascertain his trading

results, i.e., profits earned or losses sustained by his business, and to also

know the financial position of his business on a particular day. It also assists

him to meet the requirements of certain laws.

Importance And Utility Of Book-Keeping:

In the absence of book keeping it would be difficult to conduct business

successfully. Whether the business is profitable or not would be difficult toascertain.

A businessman would not be able to ascertain the total amount of his capital,

i.e., how much of his money has been invested into his business.

The businessman can arrive at certain conclusions by scrutinizing or checking the

accounts of the business and thereby be able to take decisions to control the

activities of the business i.e., it is the source of the Management Information

Systems of a business concern.

Required for the correct assessment of Income-tax, Sales-tax, Customs Duty,etc,.

If a legal action is required to be taken against any customer for recovery of debt

due from him, the books of accounts or its extracts are required to be produced

in the Courts as evidence.

In cases of Insolvency or Bankruptcy, the Courts may refuse or suspend the

discharge of an insolvent who cannot produce his books of accounts.


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For ascertaining the value of business in the case of admission of a partner or

amalgamation or sale of business.

Maintenance of books of accounts has been made compulsory in respect of

companies by the Indian Companies Act, 1956 and by various Laws of all the

countries in the World.


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Ram, I am sure you now understand that the Books of Accounts have to

maintained not only to record the business transactions but also for various

other reasons which were detailed out in our Lesson no 3. Do you have any

problems?

No Sir, I do not have any problems.

Good, now if you remember in the beginning of Lesson no 3, I had

differentiated between Book-Keeping and Accountancy as follows.

Recording of business transactions is called 'Book-Keeping' and the way or

technique or say rules for recording them is called 'Accountancy.

Therefore the maintenance of the various Books of Accounts falls under

Book-Keeping.

So now to Lesson No 4 Definition of Accountancy-a small but interestinglesson.


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LESSON NO 4

DEFINITION OF ACCOUNTANCY

The term Accountancy relates to the formulation of the principles or rules to

be followed in the recording of business transactions.

Is Accountancy a Science or an Art ??? Neither !!

Though Accountancy follows rules based on common sense and logic, the

results of applying these Rules could lead to disparate and different results,

all termed as correct eg., depending on the method used for valuing the cost

of the products dealt in by the business, the profit of the business can be

varied and all such profit figures could be taken as correct!!! However

scientific results are unique for a given set of circumstances, hence

Accountancy cannot be called a Science.

At the same time it is not abstract and is based on logical and objective

principles rather than subjective ones i.e.,. results cannot be based on thewhims, fancies and talents of a particular person, and therefore it cannot

be called an Art.

Therefore it is something unique and should be viewed as such by

the student.


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Now that you are aware about the meaning of Accountancy and the fact that

it is based on the logic of business transactions, Ram, let us consider the

effects of business transactions.

What do you mean by this , Sir?-Ram was a little puzzled by this.

Ha! You will see the logic of it when we go to the next lesson-Lesson No 5.


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LESSON NO 5

EFFECTS OF BUSINESS TRANSACTIONS

To understand how the Principles and Rules of Accountancy were formulated

we have to first evaluate the effects of Business Transactions.

Every businessman enters into a business transaction with a profit motive.

This means that his objective in starting and continuing his business is to

have more money than what he first had when he started his business. It is

possible that he may end up with less and that would mean that he has made

a loss, but that would definitely not be his intention or objective!

All business transactions have some effect on the cash flow of the business.

That would mean that cash will be either added or reduced, either

immediately or in the future, because of the business transaction.

What I mean by cash here, is the cash lying physically in the business.

Cash held by its bankers in its bank account or invested in such a way that it

can be encashed ( converted into cash) immediately whenever it wants it, aretermed as Investments. These are also called cash equivalents.

These cash inflows and outflows are of two types---Temporary and Permanent.

A temporary cash inflow would mean that cash has been received today which

will have to be returned in the future while a permanent inflow would imply that

the cash which has been received , permanently belongs to the business and

does not have to be returned.

Similarly with cash outflows-a temporary cash outflow would imply that though

cash is going out now it will come back into the business at a later date.However with a permanent cash outflow we do not expect it to come back.

What does this mean for the business??

Whenever a business transaction results into a temporary inflow of

cash, a Liability gets created.

Since the business has to return it in the future what has been temporarily

received today, it would mean that it owes this money to the person who has


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given it. A simple definition of liability is the amount owed by the business to

others.

Conversely when we pay back what we owe, which will result into a permanent

cash outflow, the liability which was created by the temporary cash inflow will

get extinguished.

When there is a permanent inflow it means that the business has

received Revenues or Income.

This means the cash received is not to be given back and therefore it belongs

permanently to the business.

This money adds to the Owners Capital which the business had originally

received from the owner, and therefore adds to the profit which it is making.

Whenever a business transaction results into a temporary outflow of

cash it results into the creation of an Asset.

A simple example is that of furniture purchased by paying cash. Here there is an

outflow of cash but furniture has been received in its stead. It is possible to sell

that piece of furniture in the future and recover the cash gone out (assuming for

the moment that the same amount can be recovered). That means that this

type of cash outflow has resulted into a receipt of some article having the same

cash (or monetary) value! Assets are articles which have a value which can beconverted to cash.

Conversely when the asset is sold, which will result into a permanent cash inflow,

the asset which was created by the temporary cash outflow will get liquidated.

Whenever a business transaction results into a permanent outflow of

cash, it results into an Expense or Loss.

This means that this cash outflow will not be received back and therefore it has

gone out permanently from the business.

This money reduces the Owners Capital which was originally received from theowner, and therefore reduces the profit of the business.

Based on the above we have now grouped our basic cash business transactions

into liabilities, incomes, assets, expenses, sale/liquidation of an asset and

repayment of a liability.


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A Chart is given below to illustrate the above:

Serial No Type of Cash Flow Meaning Effect

1 Temporary Inflow Cash comes into the

business which it will

have to give back in

the future

Creates a Liability

(Does not affect

Owners Capital

unless it has been

received from the

Owner)

2 Temporary Outflow Cash goes out of the

business which can be

received back in the

future

Creates an Asset

(Does not affect

Owners Capital)

3 Permanent Inflow Cash comes into the

business which it does

not have to give back

in the future

Creates Income

(Adds to the Owners

Capital)

4 Permanent Inflow Cash comes into the

business as a result of

sale or liquidation of

an Asset

Asset gets liquidated-

goes out of the

business

(Does not affectOwners Capital

unless more or less

cash is received than

what was originally

paid for the Asset)

5 Permanent Outflow Cash goes out of the

business which will

not be received back

in the future

Incurs Expenses

(Reduces from

Owners Capital)

6 Permanent Outflow Cash goes out for

repayment of Liability

Liability is

extinguished

(Does not affect

Owners Capital

unless paid to the

Owner)


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However there are also other business transactions which do not immediately

result into either a cash inflow or outflow but would result into such, in the

future. How then will we determine their effects?This requires a little more application of business logic.

Suppose we buy Furniture from M/s A & Co for Rs 25000 but we decide to pay A

& Co after 15 days. Now in this case there is neither an inflow nor outflow of

cash. But let us first suppose that we paid A & Co the money which then would

be considered a temporary outflow of cash. This would result into the creation of

an asset for us called Furniture. However it is assumed that this cash is then

returned by A & Co to us with a condition that it should be paid back within 15

days. This results into a Liability as this would be a temporary inflow of cash.

This means that this business transaction is an example of a simultaneoustemporary outflow and temporary inflow of cash which has resulted into both an

Asset and a Liability.

All business transactions in which the cash flow does not take place immediately

result either into an Asset and a Liability as above or an Expense and a Liability

or an Asset and an Income.

We will now make use of these basic groups of Assets, Liabilities, Incomes and

Expenses to decide the rules for entering the business transactions into the

Books of Accounts.

What we have now discussed, is the first rule of evaluating a business

transaction i.e.,

How to determine the Type of a Business Transaction!!!


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Ram was surprised.

Sir, do you mean that it is the cash inflow or outflow which determines the

type of business transaction?

Why, dont you agree? As mentioned earlier, every business transaction

results into a cash inflow or outflow, so we make use of these cash flows to

determine a very important rule-the type of the business transaction. Do you

not agree that there is logic in the way we have formulated this rule?

Of course, Sir, it definitely has perfect logic, but all my friends who were

Commerce graduates have never explained this logic to me whenever I had

difficulties in understanding Accountancy during my MBA days!

Forget about them-do you agree with me on this?

Yes, Sir, perfectly as far as the basic cash inflows and outflows are concerned

but I am still a bit hazy on the non-cash flow transactions. Could you please

clarify?

Yes, that logic takes a little more time to understand. But once you have

properly understood it, you will have less difficulty in understanding what

follows. So let me illustrate this logic a little further for you.

Suppose you are a trader in pens. A customer comes to you to buy 1000

pens from you and you offer to sell him the same @ Rs 10/- per pen i.e., a

total of Rs 10,000/-. Now he pays you in cash. Therefore for you it is a cash

inflow and because you have given him 1000 pens in return, you will not

have to return this money to him, therefore for you it is a permanent cash

inflow which has generated income or revenue for you of Rs 10,000.

But then the customer makes a request to you to give back the money to him

and promises to pay back after 15 days and you accept for whatever reasons

he gives you for this request in the interest of your business because he is a

regular customer and you trust his promise, and you give back the Rs 10,000,

then this will be a cash outflow for you which will be a temporary one since

you are going to receive it back after 15 days. This temporary cash outflow

will create an Asset for you in the form of owing by your customer.

Therefore in this transaction, there is zero net cash flow but both an income

has been generated and an asset has been created, isnt it? You agree that

this is a business transaction because as per the definition of such given


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earlier there is an exchange of pens and promise to pay for the same and

money will flow in the future?

Yes, I suppose so.

Why do you suppose-are you not sure?

No, no what you say is very logical but it takes some getting used to!!

That is what you should understand-the logic behind a business

transaction which determines the nature of the business transaction

and recognizes its type so as to determine which of the groups it

relates to i.e., whether it creates an Asset or Liability or an Expense

or Income or a combination of these. Unless you can recognize this,

it would be difficult for you to properly account for the transactionin your Books of Accounts however expert you may be in

understanding the other rules of Accountancy which follow.

Most of my management students who have graduated in Commerce have

not understood this very vital and important fact and therefore have

problems in accounting.

I will give you another example below:

A, a businessman, contracts with a cleaning service, B & Co to clean his

business offices for a sum of Rs 5000/- and after it has done the same toAs satisfaction, to pay the contracted amount after 15 days of submission

of B & Cos Bill. Which type of transaction is this for A and which groups

has it generated?

The answer would be that this a zero cash flow type of business

transaction and that it generates an Expense and a Liability. How, Ram?

Well Sir, no cash has passed so it is a zero cash flow transaction. However

if A had paid B & Co immediately after receiving the Bill, it would have

been a Permanent Cash Outflow resulting into an Expense for him. But if

B& Co returns this money back in return of a promise from A to pay it

back after 15 days then it will be a Temporary Cash Inflow creating a

liability. This will therefore cancel out both the outflow and inflow of cash

since they are of equal amounts making it a net zero cash flow and what

will remain is the Expense and Liability for A.

Wow!! Ram, you have passed the logic test. I am sure you will think of

more such types of business transactions and arrive correctly at the

groups generated by it.


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I have given above and in the Lesson no 5 above three examples to

determine the groups of non-cash flow transactions.

This topic is very very important, Ram, for the proper understanding of

how to account for business transactions in the Books of Accounts.

Because if you do not know how, though you may apply all the other rules

of Accountancy correctly, you may account for the transaction incorrectly.

Now let us proceed ahead- these groups which we have identified will

now have to be classified further. Why? That will be explained in our

next lesson no 6-Classification of Business Transactions.


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LESSON NO 6

CLASSIFICATION OF BUSINESS TRANSACTIONS

This is the second rule to evaluate a business transaction-How to determine

in which classification a business transaction falls, based on its Type and

Groups.

Basically therefore all initial business transactions result into liabilities,

assets, incomes and expenses and all other transactions flowing from

these initial business transactions are either a sale or liquidation of an

asset or repayment of a liability as also a combination of the four

groups as explained earlier.

Liabilities are basically classified further as Personal transactions

because moneys are owed to persons maybe individuals or another business

firm or to the Government or to any other Statutory Authority etc..

Assets can either be articles and things of monetary value or persons who

owe the business some moneys. Therefore Assets are further classified aseither Real or Personal. Real is an accounting term depicting something

real belonging to the business, having monetary value. Cash is the basic Real

Asset and is always classified as such.

Incomes and Expenses are classified further into what is called Nominal

transactions i.e., they have value which adds or reduces the Owners

Capital.

Therefore Business Transactions for the purpose of accounting ( this is now

hereafter the word which we will use to substitute recording) the same in

the Books of Accounts can be a mixture of the following classifications.

Personal: Relating to personal dealings i.e., transactions involving monetary

dealings with various persons like individuals, other business concerns,

financial institutions, banks etc. Therefore all such persons to whom moneys

are owed or those from whom money is owed , are classified as Personal-i.e.,

all liabilities and some types of assets.

Real: Relating to buying and selling or transfer of an asset, not personal in

nature.

Nominal: Relating to the payment of an expense or receipt of an income.


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Ram, these two Rules-one for determining the Type and Groups, and the other

for determining the Classification, form the basis for the third Rule which

determines the Accounting Entry in the Books of Accounts-which is explained in

the next Lesson No 7- Principles and Rules of Accountancy.


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LESSON NO 7

PRINCIPLES AND RULES OF ACCOUNTANCY

Every business transaction results into an exchange of money or money's worth.

Exchange means the act of giving or taking one thing in return for another.

Thus every such transaction results into two equivalent opposite effects like the

famous Newtons Law of Physics viz., 'every action has an equal and opposite

reaction'.

These two equivalent and opposite effects are recorded in the Books of

Accounts. From the above it is quite clear that every business transaction is

concerned with at least two accounts. Hence if any transaction is to be recorded

completely, it has to be recorded in such a manner that both the opposite sides

or effects are equalized.

Thus the Double Entry Book Keeping System of Accounting is based onthe "Dual Aspect" of each transaction. Every transaction has a double or two fold

effect, which is termed as 'debit' and 'credit'.

The recording of a transaction involves debiting one or more accounts affected

and crediting one or more different accounts with an equivalent amount. It is

therefore very clear that "every debit has a corresponding credit and vice-versa",

and therefore the system is known as the Double Entry System of Book-Keeping.

Based on the classifications arrived at earlier:

a. Business transactions are analyzed to find out which classifications arebeing affected and

b. Then after applying the Rules for passing Accounting Entries (i.e., what

to debit and what to credit) for each such classification,

c. to determine which account or accounts are to be debited and which are

to be credited.


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But what is an Account ? :-An account (short form is a/c) is a summarized

record or a statement of all the business transactions (during a particular period,

generally a year) relating to a particular person or institute, or to a particularproperty or things, or to a particular item of an expenditure or income. In order

to keep a full record of all the transactions the business has to keep:

a. An account of each person, firm, institute with whom it deals.

b. An account of each property or an article.

c. An account of each type (head) of expense or income.

The Rules for each Class of Accounts are as follows:

For Personal Accounts :-

DEBIT THE RECEIVER, AND

CREDIT THE GIVER.

Whenever any person receives any Property from the business, he becomes a

Debtor of the business and his account is therefore debited. Whenever the

business receives any Property from another person, that person becomes a

Creditor of the business, i.e., he has given to the business and therefore his

account is credited. This is related to the temporary cash outflows and inflows.

Whenever the Debtors pays the money due, he is the giver and therefore his

Account will be credited. This is related to the permanent cash flow received

due to the liquidation of a personal asset.

For Real Accounts :-

DEBIT WHAT COMES IN, AND

CREDIT WHAT GOES OUT.

Whenever Cash or any Property is bought, it comes into the business it

increases the value of the total Properties held, and its account is therefore

debited. This is related to the temporary cash outflows. Whenever a Property

goes out of the business because of it being sold/transferred/exchanged, it

reduces the value of the total Properties held and its account is thereforecredited. This is related to the permanent cash inflow received due to sale of the

asset.

For Nominal Accounts :-

DEBIT EXPENSES AND LOSSES,

CREDIT INCOMES AND PROFITS

Whenever a business makes an expense or a loss, it results into a reduction of

the Capital Fund of the business and therefore that expense or loss account is


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debited. If an income or gains result because of a business transaction, it results

into an increase in the Capital Fund of the business and therefore the income or

gain account is credited. This is related to the permanent cash outflows andinflows. Now applying the stated rules, how do we pass an Accounting

Entry ? Let us take an example-

On 1st January 2007, A brings in Rs 35000 in cash as his Capital in the business

called A & Co. Pass an entry in the books of A & Co.

The two equal and opposite sides of this transaction are -----Cash and As Capital

In this business, cash of Rs 35000 has come in. Cash is an Asset having money

value and it has come into the business. This is an a/c having the Real

classification and the rule for that classification is-Debit what comes in, Creditwhat goes out.

Since in this case, Cash has come in, Cash a/c is debited.

Capital means moneys received from the owner/s for conducting the business

operations. This money would have to be returned back to the owners as and

when he requires or when the business closes down. Therefore the receipt from

A is a temporary inflow and is therefore a liability. It is also an a/c having

Personal classification -the rule for this classification is Debit the Receiver and

Credit the Giver.

Therefore since A is the giver, his a/c will be credited. Instead of his

individual a/c , his Capital a/c is credited because he is the Owner.

So the Journal Entry is as follows:

Date Particulars LF Debit

Amount in

Rs

Credit

Amount in

Rs

01-01-07 Cash a/c Dr 35000.00

To As Capital a/c 35000.00


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Therefore each side of the business transaction has to be analyzed to determine

its classification and then using the rules for each such classification, decide

which a/c to debit and which to credit.

Therefore it can be seen that the basic knowledge required for

accounting a business transaction is as follows:

a. Understanding and recognizing the dual i.e., the two fold effect

of the business transaction by the Cash Flow and Non-Cash Flow

Evaluation Methods,

b. Determining the Accounts affected by the business transaction,

c. Finding out the Classifications of the accounts involved in the

business transaction,

d. Applying the rules of Debit and Credit to the Accounts based on

their classification,

e. Passing the Accounting Entry.

Everything else in this subject of Accountancy follows this knowledge

and therefore it should be properly understood,++++++++ before we

go on to :

a. Where and How to make the Accounting Entries, in such a way

that we are absolutely sure that we have entered all the effects

of our business transactions in the proper and required manner.

b. How to present the information available in the Books of

Accounts for the proper evaluation and understanding of the

results of the business-whether the business has made a profit or

loss- how much cash we have-how much Assets we have-how

much money we owe to others how much money is owed by

others to us and so on and so forth.


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So now, Ram, we have, on the basis of the Type, Classification and the dual

aspect of a Business Transaction, formulated the most important and basically

the main Rule or say, the basic theory of Accountancy, and that is,

What to Debit and What to Credit???

This is the only Rule which you have to memorize or mug up. Everything which

you will learn further in Accountancy is based on the logical use and extension of

these Rules.

Therefore before you proceed further, check the two Illustrations at the end of

Lesson No 8 and then go to vikrofinacs.com on your internet , log in and solve at

least two different Problems concerning the Concepts of Accounts, in the

System, within the hours allotted to you .

Then come back to me, Ram, after three days and if you have any further

questions, then we will discuss further otherwise we will proceed to the next

Chapter.

Also in the meanwhile, go through the next Lesson No 8- Some Accounting

Terminologies- so that you become familiar with Accounting Terms.


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LESSON NO 8

SOME ACCOUNTING TERMINOLOGIES

Cash Transaction:-A business transaction in which cash is paid or received

immediately.

Credit Transaction:- A business transaction in which cash is not paid or

received immediately at the time of a transaction but it is paid or received at alater date.

Goods:- The term goods refers to merchandise, commodities, articles or things

which a business deals with i.e., either trades or manufactures.

Purchases & Sales:- Purchases and Sales are synonymous with Goods and are

used to indicate purchases and sales of goods. When goods come in due to

purchases for business purposes, the correct account affected is the Purchases

Account and not the Goods account. Similarly when goods go out due to a sale,

the account affected is the Sales Account.Stock:- It means goods which had been purchased earlier and lying unsold in

the business on any given date. Stock at the beginning of the trading year is

termed as Opening Stock. Stock at the end of the trading year is termed as

Closing Stock.

Debtor:-A person who owes money to the business becomes a debtor of the

business. e.g., A Customer who bought goods from the business and still owes

money on that account.

Creditor:- A person to whom a business owes money is a creditor of the

business. A creditor could be a Supplier from whom goods are purchased and

not yet paid for.

Debt:- The money due from a debtor.

Bad Debts:- The debts which cannot be recovered in money or moneys worth

are termed as bad debts.

Assets:- Total possessions of and debts due to the business such as building,

furniture,stocks, sundry debtors etc.


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Fixed Assets:- Assets purchased by the business for its own use and for

producing goods and not for resale, such as Buildings, Machinery, Motor car etc.

Liabilities:- Amounts payable by the business to its proprietors & other

persons, like creditors, banks, financiers etc.

Capital:- Whatever money or money's worth the proprietor brings into his

business from his private or personal estate, is his capital in the business.

Drawings:- Money or goods or other items of the business either withdrawn or

used by the proprietor for his private and personal purpose, is the drawings of

the proprietor.

Discount:- Discount means an allowance in the purchase price, given by the

seller to the purchaser. There are two types of discount viz., Trade Discount andCash Discount. A Trade Discount is is an allowance given on the catalogue or

stated price of goods. This discount is allowed at the time of purchase/sale of

goods. Trade Discount does not appear in the Books of Accounts separately." A

Cash Discount is allowed to trade debtors to induce them to pay their dues

within or before the time limit given. If payment is not so made the debtors do

not get this discount. As this discount is dependant upon the payment of cash

in time, it is required to be recorded separately in the books of accounts.

Books of Accounts:- It means suitably ruled account books in which business

transactions are recorded. Main books of accounts are Journal and Ledger.

An Accounting Entry:- An Accounting Entry means recording a transaction in

the Journal or Ledger. Thus this term may mean journal entry or ledger entry.

Turnover:- Turnover means the total sales (cash and credit) of the business

during a given business accounting period.

Voucher:- Any document which is a written evidence in support of a business

transaction is called a voucher.

Cheque:- A Cheque is an unconditional order in writing, drawn on a specified

banker ,signed by the drawer directing the banker to pay on demand, a certain

sum of money to or to the order of a person named therein or to the bearer

and which does not order any act to be done in addition to payment of money.

Bank Current Account:- It is a running account of a customer of the bank

and he is at liberty to pay into or withdraw from this account the amount

required by him from time to time.


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ILLUSTRATIONS

Illustration 1. Enter Account Type, Classification, Applicable Rule and Side for

the transactions of A & Co, given below: :-

1. A & Co receives cash from A, the proprietor.2. It receives goods from B on credit terms.

3. A deposits a cheque of his personal bank a/c into A & Cos bank account.4. Sold goods on cash to C allowing trade discount5. Withdraws cash from the bank.

Answer:

Tran

No

Account

Head

Account

Group

Classifica

tion

Applicable Rule Side

1 Cash Asset Real Debit What Comes In Dr

1 As Capital Liability Personal Credit The Giver Cr

2 Purchases Expense Nominal Debit

Expenses/Losses

Dr

2 B Liability Personal Credit The Giver Cr

3 Bank Asset Personal Debit The Receiver Dr

3 As Capital Liability Personal Credit The Giver Cr


4 Sales Income Nominal Credit Incomes/Gains Cr


5 Bank Asset Personal Credit The Giver Cr


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Justifications for the above Answers are given below:

Transaction 11. This is a temporary inflow as cash is brought in by A as his Capital which

would have to be returned whenever he requires or when the business

closes down or winds up. This therefore creates a liability of A & Co

towards A.

2. 2 accounts are therefore affected-Cash & A Capital.

3. Since A brings in cash into the business, cash a/c which is an asset and is

classified as real, is debited as the applicable rule is - debit what comes in.

4. Since A has given the cash, As Capital a/c (Capital- because A is the

owner) which is a liability of the business, is credited since itsclassification is personal and the applicable rule is - credit the giver-.

Transaction 2

1. This is a case of both inflow and outflow or non-cash flow. This creates

both an assumed permanent cash outflow incurring an expense (for goods

purchased) and an assumed temporary cash inflow (from B) creating a

liability.

2. Therefore 2 accounts-Purchases and B are created.

3. Normally when goods are purchased for trading or manufacturing

purposes, it creates a revenue asset since it should have been considered

a temporary cash outflow which will be received back when they are sold.

However it becomes difficult to keep an exact track of how much and

which of the goods purchased were sold during an accounting period.

Therefore when goods intended for trading or manufacturing are

purchased, it is considered as a permanent cash outflow and an Account

Head named as 'Purchases' is debited, having nominal classification and

the applicable rule is 'debit expenses'.

4. Purchases of goods in such cases are therefore considered as expenses

and at the end of the accounting period they are matched with the sales

made from the goods purchased to arrive at the profitability of the

business by deducting the expense (Purchases) from the income (Sales).

5. The profit made on the sale of the same i.e., the amount received over

and above the amount paid for the purchase of the goods will be a

permanent inflow and which will be accounted for as the profit of the

business.

6. The goods are given on credit by B.


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7. B is a liability a/c having personal classification and the applicable rule is '

Credit the Giver' and therefore B a/c is credited with the total amount of

the goods purchased.

Transaction 3

1. This is also a case of both inflow and outflow or non-cash flow since this is

a cheque receipt and therefore requires the services of a third party

(bank) to collect the money on A & Cos behalf. This creates both an

assumed temporary cash inflow from A creating a liability (As Capital) and

an assumed temporary outflow to the Bank creating a personal asset since

the money on the cheque is collected/received by the Bank directly on A &

Cos behalf. The Bank has to return this money to A & Co when it requiresor to pay someone on As behalf and on its instructions, out of the amount

A has given it from time to time. Therefore the amount of such money

lying with its Bank will be A & Cos Personal Asset.

2. Therefore two accounts-Bank and As Capital are affected.

3. Bank is a Personal a/c and since it receives the money on A & Cos behalf,

the applicable rule is-Debit the Receiver. Therefore the Bank a/c will be

debited.

4. A is the giver and there his Capital a/c (since he is the owner) will be

credited as per the applicable rule-Credit the Giver.

Transaction 4

1. This is a permanent cash inflow creating an income. Cash has been

received from C for goods sold to him by A & Co which will not be

returned to C because he has received equivalent goods in return from A

& Co.

2. Therefore Cash and Sales (Income Head) are affected.

3. Since Cash is received, it means it has come into the business and since it

has a Real classification, the applicable rule is-debit what comes in and

therefore Cash a/c is debited.

4. The trade discount allowed to C, reduces the Sales amount and amount

due from C and therefore the profit made on selling the same. Therefore

it is not necessary to account for it separately.

5. Normally when goods are sold,it results into a liquidation of a revenue

asset and it should have been considered as a repayment of a temporary

cash outflow made earlier and therefore goods a/c should have been

credited as the goods are going out.


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6. However it becomes difficult to keep an exact track of how much and

which of the goods purchased were sold during an accounting period.

Therefore when goods intended for trading are sold, it is considered as apermanent cash inflow which is considered as an income and an Account

Head named as 'Sales' is credited, having nominal classification and the

applicable rule is 'credit income'.

Transaction 5

1. This is a case of liquidation of a personal asset i.e., return by the Bank as

required by A & Co, of a past temporary cash outflow.

2. Therefore Cash and Bank a/cs are affected.

3. When cash is withdrawn the bank, cash comes in and then applying therelevant rule for its Real classification-Debit what comes in, Cash a/c is

debited.

4. Bank is the giver of the cash withdrawn, and having a personal

classification, it is therefore credited, the applicable rule being credit the

receiver. It is a personal asset of the business to the extent of the balance

in it of the money deposited into it by the business.


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Illustration 2. Abhijit starts a retail business in Pune called as Baner Consumer

Electronica (BCE) for trading in electronic items like TVs, Refrigerators and

Washing Machines. From the transactions given below enter Account Heads,

Group, Classification, Applicable Rule & Side:-

1. Abhijit opens a bank account in the name of his business- -with theCanara Bank, Baner Road Branch with his personal cash.

2. He also deposits his personal cheque into the bank .3. BCE pays Rent Deposit to Mr. Shrivastava, the landlord of the shop leased

out to it for its retail business,. It also pays the advance rent for the firstmonth. Both payments were made by two cheques drawn on BCEs bank.

4. BCE also pays to Pune Office Equipments Co a cheques of differentamounts for purchase of various furniture & fittings and OfficeEquipments.

5. It withdraws cash from its bank a/c.6. It pays in cash to a carpenter for some customized furniture fittings.7. It purchases the first lot of its electronic goods from its Principals-M/s

Whirlpool India, by issuing a cheque on its bank. It also obtains TVs oncredit for 30 days from M/s Vijay Traders.

8. It incurs expenses in cash for stationery and other office expenses.9. It sells Washing Machines and TVs and receives payment partly by

cheques and partly in cash.


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Answer:

TranNo

AccountHead

AccountGroup

Classification

Applicable Rule Side

1 Canara Bank Asset Personal Debit the Receiver Dr

1 Abhijit Capital Liability Personal Credit the Giver Cr


2 Abhijit Capital Liability Personal Credit the Giver Cr

3 Rent Deposit Asset Personal Debit the Receiver Dr

3 Canara Bank Asset Personal Credit the Giver Cr

4 Rent Expense Nominal Debit Expenses/Losses Dr


5 Furniture &

Fittings

Asset Real Debit what comes in Dr

5 Office Equipments Asset Real Debit what comes in Dr


6 Cash Asset Real Debit what comes in Dr


7 Purchases Expense Nominal Debit Expenses/Losses Dr


7 Purchases Expense Nominal Debit Expenses/Losses Dr

7 Vijay Traders Liability Personal Credit the Giver Cr

8 Stationery

Expenses

Expense Nominal Debit Expenses/Losses Dr

8 Office Expenses Expense Nominal Debit Expenses/Losses Dr

8 Cash Asset Real Credit what goes out Cr

9 Cash Asset Real Debit what comes in Dr


9 Sales Income Personal Credit the Giver Cr

Work out the justifications yourselves.

You can check them in vikrofinacs.com if you so wish-under Accounts Concepts

Chapter Problem No 5.


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CHAPTER TWO

THE JOURNAL

CONTENTS


No


2LESSON NO 1- THE JOURNAL BOOK

8


4 ILLUSTRATION 12


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Ram came back 3 days after attending the Lesson on Principles of Accountancy.

Sir, I have solved all the problems on Accounting Concepts and now I am ready

for the next Chapter.

You are sure you have understood it in its entirety?

Yes, the justifications for every transaction in the Problems were very clear and

I had no difficulty in understanding them. I did have to attempt each problem at

least twice-in one problem, thrice-before I got them all right.

You have done well now we can without any delay get on with the next

Chapter. It deals with the Journal which is called the Prime Book of Entry.

It was so called because the accounting entries of all business transactions of the

business were first entered into this Account Book.

Nowadays this book has been divided into different Books of Accounts. We shall

have a look at them later. But for now we will assume that there is only one

Book of Prime Entry (it means First Entry ) and that all Business Transactions

have to be first accounted for in this Book.

Accounting for a transaction means evaluating a Business for its Dual Aspects,

for Group, for Classification and then deciding which account or accounts to debit

and credit such that the total of the accounts debited will be equal to the total of

the accounts credited.

Sir. Sir, you are going too fast for me!!

Prof Vijay laughed loudly and said-Isnt this what you did when you solved the

Accounting Concepts Problems?

Yes , and so I did.

Then why the confusion-I just said you have to do that and then enter in the

Journal. OK, we will go straight away to the Topic and then you will

understand-So Lesson No 1-The Journal.


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LESSON NO 1

THE JOURNAL BOOK

In order to avoid omission of any transaction or to avoid any error in the entry

recording that transaction, it is necessary to immediately record it in the Books of

Accounts. One of the books of accounts in which an entry is first made is known

as the Journal Book.

Journal means a Day Book or a daily record. The Journal is a subsidiary book in

which all day to day transactions of a business are recorded as and when they

take place in a chronological order, in a debit and credit form and in a systematic

manner.

The act of recording a transaction in the Journal in the form required, is called

Journalizing.

FORMAT OF THE JOURNAL

Date Particulars LF Debit

Amount in

Rs

Credit

Amount in

Rs

01-01-07 Cash a/c Dr 35000.00

To As Capital a/c 35000.00

(Being the amount

received from A as his

Capital)


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The Method:

Find out the accounts involved in a transaction. There will be at least two

accounts concerned.

Ascertain the class of each of the accounts concerned and then apply the rules of

debit and credit to the class identified. On the basis of the relevant rule, debit or

credit the said account. The name of the account/s to be debited is written first

under the 'Particulars' column, and the name of the account/s to be credited is to

be written on the second line.

The word "Dr" is written after the name of the account to be debited whereas

the name of the account to be credited is to be preceded by the word "To".

The amount involved in the transaction is written under the 'Dr' and 'Cr' columnsagainst the names of debit and credit accounts respectively.

A brief explanation of the entry is given in brackets just below the entry. It is

called the 'Narration'.

LF in the Journal is the reference to the page number of the concerned Account

in the ledger. It facilitates easy reference.

The date of the transaction is written in the column 'Date'.

In simple entries there is only one debit and one credit for every transaction. But

there may be certain transactions in which there may be more than one debit

entry or more than one credit entry. However the total of debit amounts should

equalize the total of credit amounts.

The Journal is necessary for the following reasons:

a. A complete record of each transaction is available at one place.

b. As the transactions are recorded date-wise it facilitates quick and easy

reference to any transaction, whenever necessary.

c. Narration of the entry helps to understand the transaction recorded.d. Cross Checking between journal and ledger is facilitated.

e. Courts of Law consider journal entries as a proof of a transaction.

Some Useful Tips for passing (recording) Journal Entries

a. Any amount withdrawn by the proprietor for personal use or for payment

of his private expenses or any business asset used by the proprietor for

his private purposes is called as Drawings of the Proprietor.


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b. When it is not mentioned specifically whether purchase or sale is on cash

or credit and party's name is mentioned it is presumed to be a credit

transaction. If partys name is not mentioned then it is presumed to be acash transaction (not cheque).

c. Trade discount does not appear in the books of accounts. The purchases

or sales are reduced by the amount of Trade Discount and only the net

amount is recorded.

d. Goods distributed as free samples are treated as Advertisement Expenses.

e. In the Business Entitys Books of Accounts, there will never be its own

account, since obviously the Business Entity cannot enter into a business

transaction with itself, because for a transaction to be recognized as a

business transaction, there has to be more than one person different fromeach other as parties to the transaction. However in my experience as an

examiner, many students show the business entitys account in its own

books!!

ILLUSTRATION:

Journalize the following business transactions in the Journal of Hasmukhlal

Salunkhe & Bros:

Sr No Date Particulars

1 1-1-12 Withdrew cash Rs 75,000 from the bank, out of the Rs6,79,435 available in it.

2 1-1-12 Paid Rs 19,250 as salary by cheque to Hari Ram, Head

Supervisor of the business, after deducting Rs 750 as

income tax on the same.

3 1-1-12 Paid Rs 46,730 as salary to subordinate staff members in

cash

4 2-1-12 Received a cheque from Gandhi Mfg Co of Rs 1,56,395 for

credit sales made to it earlier

5 2-1-12 Sold goods to Fergusson Wholesalers Ltd of Rs 6,57,980 and

received payment immediately by cheque

6 3-1-12 Purchased goods from Wankhede Distributors of Rs

8,34,650 payable after 30 days

7 3-1-12 Paid Rs 2,361 in cash as tempo charges for bringing the

above goods to Hasmukhlals godown.


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8 3-1-12 Paid in cash Rs 835 as unloading charges of the above

goods

9 4-1-12 Paid by cheque to the Income-Tax Dept the amount of Rs

750 earlier deducted from the Head Supervisors salary

10 4-1-12 Paid to Chagan Chaiwala in cash Rs 1925 being the tea

charges for Dec 11

11 5-1-12 Incurred xerox charges of Rs 249 from Satpute Copiers. All

amounts of xeroxing work done by Satpute in every month

are payable by the 7th of next month and are accounted as

expenses when actually paid.

12 7-1-12 Paid Rs 7451 by cheque to Satpute Copiers being the

amount of xerox charges for the month of Dec 11

13 8-1-12 Paid cash of Rs 1835 for purchase of office stationery

14 9-1-12 Paid Rs 10,000 to the Proprietor Hasmukh in cash for

personal purposes

15 10-1-12 Sold goods to an employee for Rs 1545 to be accounted for

as a Salary Advance for the month.


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3-1-12 Purchases a/c Dr

To Wankhede Distributors a/c

(Being the credit purchasesfrom the latter)

8,34,650.00

8,34,650.00

3-1-12 Carriage Inward a/c Dr

To Cash a/c

(Being the cash paid for tempo

charges for inward goods)

2,361.00

2,361.00

3-1-12 Hamali charges a/c Dr

To Cash a/c

(Being the unloading charges

for goods received)

835.00

835.00

4-1-12 I-Tax on Salaries a/c Dr

To Bank a/c

(Being the cheque paid to the

I-Tax Dept on a/c of tax

deducted from salary)

750.00

750.00

4-1-12 Miscellaneous Exps a/c Dr

To Cash a/c

(Being the cash paid to Chagan

Chaiwalla for tea charges for

Dec 11)

1925.00

1925.00

5-1-12 --No entry to be done--

7-1-12 Xerox Charges a/c Dr

To Bank a/c

(Being the cheque paid to

Satpute Copiers for Xerox chgs

for Dec 11)

7451.00

7451.00


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8-1-12 Stationery Expenses a/c Dr

To Cash a/c

(Being the cash paid for officestationery)

1835.00

1835.00

9-1-12 Hasmukh Drawings a/c Dr

To Cash a/c

(Being the cash withdrawn by

Hasmukh for his personal

purposes)

10,000.00

10,000.00

10-1-12 Salary Advance a/c Dr

To Sales

( Being the goods sold to an

employee to be treated as a

Salary Advance)

1545.00

1545.00

Justifications for all the entries above are available in Problem No 5 of Journal in

vikrofinacs.com


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THE ACCOUNTING STORY- continued

Now do you understand, dear Ram, what this Journal is all about?

Yes, but I think I require to solve the Problems in vikrofinacs.com to understand

completely.

In this subject, where the Theory is not much, you have to solve the maximum

problems-at least four in each topic covering different business transactions. So

go ahead and solve them and come back after two days.

OK, Sir, no problem.


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CHAPTER THREE

THE LEDGER

CONTENTS


No


2LESSON NO 1- THE LEDGER ACCOUNT

8


4 LESSON NO 2- POSTING INTO THE LEDGER

5LESSON NO 3- BALANCING OF A LEDGER ACCOUNT

12


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Now we come to the Main Book of Account-The Ledger.

The Journal is the Prime Book and the Ledger is the Main Book. This prime book,

the Journal is divided further depending on the transactions involving some

Accounts regularly, like Cash (Cash Book), Bank (Bank Book), Sales (Sales Book),

Purchases (Purchase Book) etc., This we shall see in details in the next Chapter.

These Subsidiary Books are part of the Journal, but we find that they have

characteristics of the Ledger also. Therefore we will first familiar ourselves with the

Ledger and then understand that further. OK, Ram?

Yes, Sir.

Now we will try to understand the ledger by first finding out in the 1st Lesson-all

about the Ledger Account.


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LESSON NO 1

THE LEDGER ACCOUNT

The Ledger is the Principal Book of Account and it contains all the accounts of a

business. An account is a record of all dealings and transactions in respect of any

particular person, a particular thing or a particular item of expenditure or income.

All the transactions are recorded first in the Journal and if necessary in the other

subsidiary books and then from there they are transferred to the respective accounts in

the ledger. This is called posting to the Ledger.

The Ledger is the book wherein all transactions ultimately find their place under therespective accounts.

Therefore it is the book of final entry.

Every Account normally is opened on a new page in the Ledger. The accounting term for

a page is 'Folio'. As soon as it is opened it is entered in the alphabetical index of the

Ledger along with reference to the folio number on which it is located.

The name of the account is written in bold letters at the top center of the folio. The

folios of the Ledger as well as the Subsidiary Books should be numbered consecutivelyto facilitate reference. The left hand side of the 'T' in the account is its debit side and

the right hand side is its credit side.


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THE LEDGER

THE T FORMAT

NAME OF THE ACCOUNT

--------Debit Side---------------- -----------Credit Side--------------

THE LEDGER THE COLUMNAR FORMAT

NAME OF THE ACCOUNT

Date Particulars SBF Amt inRs

Date Particulars SBF Amt in Rs

Date Particulars SBF Debit

Amt in

Rs

Credit

Amt in

Rs

Dr/Cr Balance

Amt in Rs

This is the T format of

the Ledger-the vertical

line of the T dividing the

Debit and the Credit side


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THE ACCOUNTING STORY continued

We must understand how to enter the accounting entries made into the Journal into

the Ledger, in both the horizontal and vertical formats and then how to summarize

them in each Account.

Why? asked Ram.

Because we would want to know where our money has gone or from where it has

come in. We would like to know who owes us and to whom we owe. We would

like to know what our expenses are and what our incomes are during a particular

period .

And this we can find out from the Ledger?

You bet, and that is why it is called the Main Book of Account.

So now lets learn how to transfer the entries from the Journal into the Ledger. This

process is known in Book-Keeping as Posting into the Ledger-and that is our next

Lesson Two.


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LESSON NO 2

POSTING INTO THE LEDGER

Transferring of entries from the journal to the respective accounts in the ledger is

called Posting. Posting is to be made to the debit side of the account/s which

is/are to be debited and to the credit side of the account/s which is/are to be

credited as entered in the Journal.

While making an entry to the debit side of an account, the name of the

corresponding credit account is to be written under the column of "Particulars" and it

is to be preceded with the word "To". Whilst making an entry on the credit side of

an account the name of the corresponding account debited is written and it is

preceded by the word "By".

The date of the transaction is written under the column "date" and the amount is

written under the column "Amount". The folio No. on which the entry is made in the

Journal is to be inserted under the SBF Folio No column. Thus for the purpose of

cross references the corresponding Ledger Folio is written in the Subsidiary Book

and the Subsidiary Book folio in the Ledger.

This procedure is the same for both the T and Columnar types of Ledger Account


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THE ACCOUNTING STORY continued

After the entries have been posted into the Ledger then we have to find out whatare the balances of each of the Accounts in the Ledger.

By balancing , we summarize the effect of all the debits and credits to each account

to determine what the amount of each account is.

And how do we do that?

That is what we will now learn in Lesson No 3- Balancing of an Account.

You know Ram, I have found that the student finds this topic difficult to understandand 70% always make mistakes in balancing accounts. They try to understand it

mechanically without making a proper attempt to understand its logic.

Therefore I personally feel that it requires an elementary knowledge of Arithmetic

and a little bit of Logic.

So, understand this properly otherwise you will have a lot of problems in future.


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LESSON NO 3

BALANCING OF A LEDGER ACCOUNT

In the T format, each account in the ledger may have some entries on the debit

side and some on the credit side.

Balancing the account means finding out the difference between the two.

The procedure is to separately total the amounts on each side, write the greater

total as the total of both the sides and then subtract the smaller total from the larger

one. The difference between the two is called the Balance.

This balance is then inserted at the end of all the entries, on that side of the accountwhich has the lesser amount, writing before it as follows:

"By Balance c/d" -when inserting the difference on the credit side i.e., when the

total debit side amount is greater than the total credit side amount.

To Balance c/d" -when inserting the difference on the debit side i.e., when the

total credit side is greater than the total debit side.

Therefore by writing this balance on the side having the lesser total, it would mean

equalizing the total of the lesser side to the greater one.

This process of extracting the balance and inserting it on the lesser side of an

account is called balancing or closing of an account.

Debit Balance:-

It is therefore obvious from the above that if the balance is written on the credit

side it would mean that the debit side is greater than the credit side of the account.

Therefore this balance is called a Debit Balance even though it appears on the credit

side of the account.

Credit Balance:-

Similarly if the balance appears on the credit side of an account it means that the

credit side is greater than its debit side and therefore it is called a Credit Balance.

This method of balancing applies to the T format.

However in the Columnar format, balancing is done every time a debit entry or

credit entry is posted in the a/c, one below the other, i.e., the difference between

the debit and credit side amounts. To the balance of the earlier date, the new entry

is either added or subtracted depending on the type of the earlier balance, i.e., Debit

or Credit.


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Examples of balancing in the T and columnar formats are given below.

Balancing of Ledger- T Format

Given below is an example of a debit balance-i.e., where the debit total is more than the

credit total. This represents a Debtors a/c to whom sales have been made and moneys

received there from. The information given by the a/c is the amount of sales made to

him for the period from 12-10-06 to 30-03-07 and the moneys received from him during

that period. The balance amount which is a debit balance informs that Rs 146840.00 is

due from him and that he is a debtor to that extent as on 30-03-07, as a result of all the

business transactions concerning him during that period.

A & Cos Account (Debtors Account)

|-------------Debit Side------------------|-|-------------Credit Side---------------|

Date Particulars SBF Amt in Rs Date Particulars SBF Amt in Rs

12-10-06 To Sales 5 500000 12-11-06 By Bank 18 490000

5-11-06 To Sales 6 258978 15-11-06 By Discount 6 10000

12-12-06 To Sales 7 65890 14-01-07 By Bank 18 258978

2-2-07 To Sales 8 74250 15-02-07 By Bank 18 65890

30-3-07 To Sales 9 72590 30-03-07 By Bal c/d 146840

Total 971708 Total 971708

30-03-07 To Bal b/d 146840


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Given below is an example of a credit balance-i.e., where the credit total is more than

the debit total. Also this represents a Creditors a/c from whom purchases have been

made and moneys paid thereto. The information given by the a/c is the amount of

purchases made from him for the period from 12-10-06 to 30-03-07 and the moneys

paid to him during that period. The balance amount which is a credit balance informs

that Rs 146840.00 is due to him and that he is a creditor to that extent as on 30-03-07,

as a result of all the business transactions concerning him during that period.

A & Cos Account (Creditors Account)

|------------Debit Side---------------|-|--------------Credit Side----------------|

Date Particulars SBF Amt in Rs Date Particulars SBF Amt in Rs

12-11-06 To Bank 18 490000 12-10-06 By Purchases 7 500000

15-11-06 To Discount 6 10000 5-11-06 By Purchases 7 258978



30-03-07 To Bal c/d 146840 30-03-07 By Purchase 7 72590

Total 971708 Total 971708

30-03-07 By Bal b/d 146840


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Following are the same accounts-both the Debtors and Creditors

accounts with the same data in the columnar format of the Ledger

which is now presently utilized because it is more convenient to

program in the computerized accounting packages presently being

used.

A & Cos Account (Debtors Account)

(Columnar Format)

Date Particulars SBF Debit Amt in Rs Credit Amt in Rs Bal Type Bal Amt in Rs

12-10-06 To Sales 5 500000 Dr 500000

5-11-06 To Sales 5 258978 Dr 758978

15-11-06 By Bank 18 490000 Dr 268978

15-11-06 By Discount 6 10000 Dr 258978

12-12-06 To Sales 5 65890 Dr 324868

14-01-07 By Bank 18 258978 Dr 65890

2-02-07 To Sales 5 74250 Dr 140140

15-02-07 By Bank 18 65890 Dr 74250

30-03-07 To Sales 5 72590 Dr 146840


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A & Cos Account (Creditors Account)

(Columnar Format)

Date Particulars SBF Debit Amt in Rs Credit Amt in Rs Bal Type Bal A

The Accounting Story

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