Official Guide to Financial Accounting using TallyPrime: Managing your Business Just Got Simpler

CHAPTER 1

Fundamentals of Accounting

LEARNING OBJECTIVES

Introduction to Accounting

Concepts of Accounting

Recording of Business Transactions

Preparation of Trial Balance, Trading Account, Profit and Loss Account, and Balance Sheet.

Types of Subsidiary Books

Depreciation Methods and Preparation of schedule.

Introduction and advantages of Computerised accounting.

Meaning of Accounting

Terminologies used in Accounting

Double Entry System of Accounting

Golden Rules of Accounting

1.1 INTRODUCTION

A Commercial Professional or Industrial activity, driven by an individual or a group of individuals engaging in producing and selling goods and services for profit is known as Business.

An organization that is formed to operate some type of service or commercial activities for profit or for non-profit.

For Example: Proprietorship, Partnership, Limited Liability Partnership, Private Limited Company, Public Limited Company, Co-operative societies, NGO etc.

Types of Business Sector

Producing raw materials: These are the business sectors which are involved in the production and extraction of the raw materials.

Trading: The business of buying and selling commodities & products.

Manufacturing: The process of converting raw materials, components, or parts into finished goods that meet a customer’s expectations

Service: An enterprise of professional or team of experts that deliver work or aid in completing a task for the benefit of its customers. A type of economic activity that is intangible. Examples of a service business are consultancy and profession services rendered by Chartered Accountants, Tax Consultants, Doctors, Engineers, Recreation, Health care, Transportation etc.

It becomes essential for a business owner to keep a record of the business income and expenditure, to find answers to numerous questions, a few of which are:

What is the total value of business assets?

Whether the business is earning profits or incurring a loss?

How much do third parties owe the business?

How much does the business owe to third parties?

Should a specific operation be withdrawn?

Can the business be expanded?

These answers can be occurred by, studying the financial information of the business operations. Therefore, accounting is an integral part of the business.

Accounting is the practice of maintaining precise records of the financial dealings of a business. It involves identifying business transactions, recording them, and summarising the same in such a way that important financial information can be communicated to the stakeholders of the business. Accounting is also called the language of business/finance.

The Common Stakeholders of typical business concern

Owners: The stakeholders are the owners of an organization.

Employees: These people are employed for wages or salary.

Investors (existing and potential): These investors can be owners or outside vendors who typically have a right to know the accurate and timely information such as regular financial statements.

Suppliers: These are the people or businesses who sell goods to your business and rely on you for revenue from the sale of those goods.

Customers: These are the people who buy business products.

Communities: These are stakeholders which are considered as business function by another set of stakeholders (Suppliers, customer employees).

Government authorities: These are the authorities which collect taxes from the company and its employees.

1.1.1 Meaning of Accounting

Accounting is a process of identifying, systematic recording, summarizing, analyzing, and interpretation of financial reports of a business.

Phases of the Accounting Cycle

The following chart will depict the different phases/process of the accounting cycle as shown in Chart 1.1.

Chart 1.1: Accounting Cycle

Explanation of the Chart

Understanding the transaction: The details of transaction like date, debit and credit amount etc.

Journal Entry: In this process, we will record the business transaction by debiting and crediting the different account.

Ledger Posting: In this process, we will transfer the transactions which were recorded in the journal to its corresponding ledger accounts.

Trial Balance: In this process, we will determine the list of all the general ledger accounts into debit and credit account column totals that are equally contained in the ledger of a business. The purpose of producing a Trial Balance is to ensure the entries in the company’s book keeping system are mathematically correct.

Profit & Loss Account: In this process, we will determine the net profit/loss of a business that occurs during the accounting period.

Balance Sheet: In this process, we will determine the summary of the financial balances of a business or an organization.

In the case of manual accounting, all six activities are carried out manually by accountants. But in case of accounting software, out of these above given six activities, only two activities are performed manually. i.e.

Understanding the Transactions

Voucher Entry

Remaining four activities, i.e. Ledger Posting, Trial Balance, Profit & Loss Account & Balance Sheet are performed by the accounting software automatically.

1.2 TERMINOLOGIES USED IN ACCOUNTING

Basic accounting terms are most important for Accounting beginners or an individual. The commonly used accounting terms in the business are :

Capital

The amount of money or money’s worth introduced into the business by owner is called capital.

Transaction

A Transaction is a business activity that involves the transfer of money or money’s worth between two accounts. A transaction can be of two types :

Cash transaction: A cash transaction is one where the money is immediately received or paid in the form of cash.

Credit transaction: A credit transaction is one where the money is paid later, but the benefits are enjoyed immediately.

Assets

Any item of economic value owned by an individual or corporation especially, which could be converted into cash.

Liability

The Liabilities are whatever the entity owes to outsiders. So, it includes loans, the amount payable to creditors, etc.

Drawings

Money or money worth, which is withdrawn by an individual (business owner) or corporation from a business for his personal use.

Bad debts

When a debtor becomes insolvent the trader will not be able to realize in part or full amount due from the customer. Part or full amount will remain unrealized. The unrealized amount is called bad debts. Bad debts are irrecoverable receivable.

Purchases

A purchase is the number of goods bought by a business for further use or for reselling. Goods purchased with immediate payment of cash are called cash purchases. Goods purchased on credit are called credit purchases.

Purchase returns

Goods that have been purchased but are returned to the seller before consumption due to reasons like poor quality and damage are called purchase returns.

Sales

Sales refer to the number of goods sold by businesses. Sales made against immediate payment of cash are called cash sales. Sales on credit are called credit sales.

Sales returns

The goods that are sold but returned by the buyer before consumption due to poor quality and damage, are called sales returns.

Debtor

A Debtor is a person who receives benefits from the business immediately but is obligated to pay for the same in future.

Creditor

A person who provides benefit without receiving immediate payment for the same, and who will claim the payment in future, is called a creditor.

Stock

Unsold goods, raw material, etc., that lie with the business are collectively known as stock.

Revenue

The earnings of a business through its business activities and operations is called revenue.

1.3 CONCEPTS OF ACCOUNTING

Accounting Concepts are those basic assumptions and conditions on which accounting is based.

Business Entity Concept

The business concept is also known as the separate entity concept. It is assumed that business has a separate and distinct entity from its owner who owns it. Thus, the transactions related to business needs to be recorded in the books of Accounts.

The types of Business Entities are:

Sole Proprietorship: A sole proprietorship, is also known as the sole trader or simply a proprietorship, is a type of business entity that is owned and run by an individual.

Partnership: A business organization in which two or more individuals manage and operate the business. Both owners are equally and personally liable for the debts from the business.

Private Limited Company: It is a type of privately held small/medium business entity, in which owner liability is limited to their shares, the firm is limited to having 200 or fewer shareholders, and shares are prohibited from being publicly traded.

Public Limited Company: The standard legal designation of a company which has offered shares to the general public and has limited liability. A Public limited company’s stock can be acquired by anyone and holders are only limited to potentially lose the amount paid for the share

Corporation: It is a type of legal entity which is separate and distinct from its owners.

Limited Liability Partnership (LLP): A hybrid legal entity that has both the characteristics of a corporation and a partnership. An LLP provides its owners with corporate-like protection against personal liability. It is, however, usually treated as a non-corporate business organization for tax purposes.

Going Concern Concept

The going concern concept is also known as continuity concept. In this concept, the assumption is made that every business is carried on continuing for an indefinite period. It will not be dissolved in near future.

Money Measurement Concept (Monetary Expression)

It implies in accounting entries to record is made of only those transactions or events, which can be measured and expressed in terms of money.

Cost Concept

The cost concept is also called a Historical cost concept. According to this concept the assets which are acquired by a concern are recorded in the books of accounts at cost price. The cost of acquisition is related to the past; hence it is known as the historical cost concept.

Dual Aspect Concept

This concept states that every financial transaction has two aspects: one where the business receives a benefit, and the other where it provides a benefit. Therefore, every transaction should be recorded in such a way that its effect is reflected in two places in a business’ books of accounts. This concept forms the basis for the Double Entry System of Accounting.

Accounting Period Concept

The Accounting period concept can also be called a Periodicity concept. Life of the business is indefinite, thus indefinite period is divided into periodic intervals each interval is known as the accounting period. At the end of each accounting period, financial statements i.e, Balance sheet and Profit and Loss account are prepared to know the financial position of the business.

Revenue Realisation Concept

According to this concept, revenue is considered as the income earned on the date when it is received. As per this concept, unearned or unrealised revenue is not considered. This concept is vital for determining income pertaining to an accounting period. It reduces the possibilities of inflating incomes and profits.

Accrual Concept

This concept requires that income or expenditure are recorded when they become receivable or payable rather than when they are collected or paid i.e., transactions are recorded based on income earned or expense incurred irrespective of actual receipt or payment.

Matching Concept

As per this concept, the revenue earned and the cost incurred to earn such revenue, need to belong to the same period, and hence they need to be ‘matched’. This will help ascertain the result of the business operations. This concept serves as the basis for calculating accurate profit earned during a period.

Verifiable and Objective Evidence Concept

This concept requires that all financial transactions be supported by documentary evidence. Such evidence should be easy to verify and provide unbiased proof of transaction.

Note: The cash basis of accounting is a method wherein revenue is recognised when it is received, rather than when it is earned. Expenses are booked when they are actually paid, rather than when incurred. This method is usually not used by businesses and is, therefore, used only in selected situations such as for micro-businesses.

1.4 DOUBLE ENTRY SYSTEM OF ACCOUNTING

Every business transaction has a two-fold effect, wherein two accounts are affected in opposite directions. Thus, if a complete record were to be made of each such transaction, it is necessary to debit one account and credit another account. Recording of this twofold effect of every transaction is called the Double Entry System of Accounting.

As explained in the Dual Aspect Concept, every financial transaction has two aspects: one where the business receives a benefit, and the other where it provides benefit. Therefore, every transaction should be recorded in such a way that its effect is reflected in two places in a business’ Books of Accounts. The receiving aspect is termed the ‘Debit’ aspect. The giving aspect is termed the ‘Credit’ aspect. Therefore, every business transaction will influence two accounts; one will be debited, whereas the other will be credited.

The double entry mode format is shown in Table 1.1.

Table 1.1

1.4.1 Uses of Debit and Credit

Every transaction involves two aspects – give and take. In the double entry system of accounting, every transaction is recorded in at least two accounts. While recording transactions, the total amount debited and credited must be equal. In accounting, the terms debit (abbreviated as Dr.) and credit (abbreviated as Cr.) indicate whether the transactions are to be recorded on the left or right of the account.

1.4.2 Rules of Debit and Credit

The following table summarises the rules applicable to different kinds of accounts is shown in Table 1.2.

Table 1.2

The 5 Elements of Financial Statement

Chart 1.2: Financial Statements

Illustration 1: Application of Rules of Debit and Credit

Objective: Recording transactions using debit and credit rules for the business

As on 1st April 2020, Suman commenced the business with ₹15,00,000 by Cheque of Citi Bank vide cheque number 540102.

This transaction increases the capital as well as the Bank balance. Increase in assets is debited and the Increase in capital is credited. Therefore, record the transaction with a debit to Bank account and credit to Suman’s capital account.

Table 1.3

1.5 GOLDEN RULES OF ACCOUNTING

An ‘account’ is a statement of transactions relating to one of the two aspects of a business transaction. Based on the aspect being recorded, an account can be ‘debited’ or ‘credited’.

To understand the Golden Rules of Accounting we must understand the types of accounts. The Accounts are classified based on the three categories of business transactions:

Transactions involving individuals or other business entities.

Transactions involving assets, goods, cash.

Transactions involving incomes, expenses, losses and gains.

In effect, there are Three Types of Accounts maintained for transactions as shown in Chart 1.3.

Personal Account.

Real Account.

Nominal Account.

Chart 1.3: Golden rules of Accounting

Let’s understand what each type of account means:

Personal Accounts: These are relating to individuals, a group of individuals, firms and institutions.

They are of three types:

Natural person accounts: It represents the accounts of real persons of business deal with. The proprietor’s account, the accounts of suppliers and customers are some examples of natural person accounts.

Artificial person accounts: It represents the accounts of firms, the business deals with. The accounts of limited companies or banks that are not real persons are examples of artificial person accounts.

Representative personal account: It represents to persons or a group. It is different compared to natural and artificial person accounts.

For Example: Mr. Manoj (Individual account), Citi Bank (an Institution’s account), Naveen & Sagar (a Partnership firm) i.e, Customer and Supplier.

The Golden rule for Personal Account is :

Debit the Receiver

Credit the Giver

For Example: Daksh Enterprises Pvt. Ltd. paid ₹ 54,000 to Roshan Electricals Pvt. Ltd. by ICICI Bank vide cheque no 462001, for the credit purchase made earlier. (Passing entry in the books of Daksh Enterprises Pvt Ltd)

Step: 1 Identify the 2 ledgers involved in the transaction:

Being the Roshan Electricals Pvt. Ltd. Received the amount through ICICI Bank. These two ledgers involved in the transaction.

Roshan Electricals Pvt. Ltd.

ICICI Bank

Step: 2 Identify the category they belong to:

Roshan Electricals Pvt. Ltd. – It is related to a company. Hence it is classified under the Personal Account.

ICICI Bank – It is an institutional account. Hence it is classified under the Personal Account.

Step: 3 Apply the Rule:

The Rule can be applied two ways-

Rule of Debit and Credit

Table 1.4

Golden Rule of Account

Table 1.5

Real Accounts: These are relating to the property or assets and cash belonging to a business concern.

They are of two types:

Tangible Real accounts: The things that can be touched, measured, sold or purchased. Examples of tangible real accounts are furniture account, plant and machinery account, and cash account.

Intangible Real accounts: The things that cannot be touched in the physical sense but can be measured in terms of money value. Goodwill, trademark, and patents, copyrights are examples of intangible real accounts.

For Example: Land and Building (assets), Cash-in-hand (asset),, Goodwill, etc.

The Golden rule for Real Account is :

Debit What comes in

Credit What goes out

For Example: Daksh Enterprises Pvt. Ltd. purchased furniture of ₹9,000 for cash.

Step: 1 Identify the 2 ledgers involved in the transaction:

Being furniture purchased in a Cash. These two ledgers involved in the transaction.

Furniture Account

Cash Account

Step: 2 Identify the category they belong to:

Furniture – It is a tangible asset of a business the value can be measured in terms of money. Hence it is classified under Real Account.

Cash - It is a tangible Asset and payment is made by Cash. Hence it is classified under the Real Account.

Step: 3 Apply the Rule:

The Rule can be applied two ways-

Rule of Debit and Credit

Table 1.6

Golden Rule of Account

Table 1.7

Nominal Accounts: These are relating to the incomes, expenses, losses and gains of a business concern. Without nominal accounts, it is difficult for management to find out where the money was spent. The net result of all the nominal accounts helps the management to find out the profit earned, or loss incurred by the business.

For Example: Rent, salary, telephone expenses, discount allowed, discount received, etc.

The Golden rule for Nominal Account is :

Debit All Expenses and Losses

Credit All Incomes and Gains

For Example: Daksh Enterprises Pvt. Ltd. purchased goods worth ₹ 7,000 for cash.

Step: 1 Identify the 2 ledgers involved in the transaction:

Being goods Purchased through Cash. These two ledgers involved in the transaction.

Purchase Account

Cash Account

Step: 2 Identify the category they belong to:

Purchase – The purchase is the cost of buying goods for sale in the ordinary course of the business. Hence it is a kind of expense. So, it is classified under the Nominal Account.

Cash - It is a tangible Asset and payment is made by Cash. Hence it is classified under the Real Account.

Step: 3 Apply the Rule:

The Rule can be applied two ways-

Rule of Debit and Credit

Table 1.8

Golden Rule of Account

Table 1.9

All business transaction must be accounted- These business transactions should be accounted in Journal entries by applying the Golden Rule of Accounting. In the next section, let us learn the posting of transactions in the Journal Entry.

1.6 RECORDING OF BUSINESS TRANSACTIONS

A transaction is an event or happening that changes an organisation’s financial position and/or its earnings. For example, when you sell goods for cash, your cash balance increases, and your stock reduces. Such a transaction involves the reciprocal exchange of two things, receipt of cash and delivery of stock.

Hence, the transaction involves the aspect of ‘give and take’. Receipt of the cash involves the take aspect and delivery of stock is a give aspect. Thus, business transactions are exchanges of economic consideration between parties and have two-fold effects that are recorded in at least two accounts.

As explained earlier, business transactions are usually evidenced by appropriate documents such as cash memo, invoice, sales bill, pay-in-slip, cheque, salary slip, and so on. A document which provides evidence of the transactions is called the source document or voucher.

1.6.1 Journalising Transactions

Journal is a daybook or a daily record wherein the transactions are recorded in chronological order, i.e. as and when they take place. The act of recording a transaction in the journal is called journalising.

In real accounting systems, transactions recorded in source documents are analysed and recorded for the first time in a journal, which is also known as the book of original entry. This practice provides a complete record of each transaction in one place, apart from linking the debits and credits for each transaction. After the debits and credits for each transaction are entered in the journal, they are transferred to the individual accounts. The process of recording transactions in the journal is called journalising. Once the journalising process is complete, the journal entry provides a complete and useful description of the event’s effect on the organisation.

The format of Journal as shown in Table 1.10

Table 1.10

Explanation about the table

Date: This column contains the date of the transaction.

Particulars: In the particular’s column contains the name of the account which will be debited and name of the account which will be credited. It is also supported by an explanation called narration.

Ledger Folio (L.F): In the Ledger Folio (L.F.) column, the page number of the ledger, where the transaction is posted is recorded

Debit (Dr.): The debit column is meant to record the amount against the account to be debited.

Credit (Cr.): The credit column is meant to record the amount against the account to be credited.

Note: All the columns are filled in at the time of entering the transaction except for the column of ledger folio. This is filled at the time of posting of the transaction to ‘ledger’.

As explained earlier, a journal is a daybook or a daily record wherein the transactions are recorded in chronological order, i.e. as and when they take place. The act of recording a transaction in the journal is called journalising.

They are two types of Journal Entries namely:

Simple Journal Entry: A journal entry in which one account is debited and one account is credited.

Example: As on 15th April 2020, Purchased goods from Eureka Enterprises on credit ₹60,000

Table 1.11

In the journal entry we have debited one account i.e., Purchase Account and Credited one account i.e., Eureka Enterprises Account.

Compound Journal Entry: A journal entry in which more than one debit account, more than one credit account or more than one of both debit and credit accounts are involved in the transactions on the same date relating to one account or one particular nature of the account is termed as Compound Entry.

Instead of recording several Journal entries, we can record the transaction which involves more than one debit or credit in a single journal entry called Compound Journal Entry.

Example: As on 30th April 2020, made a payment of ₹50,000 towards -Telephone Bill ₹20,000 Stationery Expenses ₹20,000, and Travelling Expenses ₹10,000 by cheque.

Table 1.12

In the above entry, we have debited three Accounts (Telephone bill, Stationery Expenses and Travelling Expenses) and credited one Account that is Citi Bank Account. A compound entry can be recorded in any one of the following manners:

Debit multiple accounts and Credit one account

Debit multiple accounts and Credit multiple accounts

Debit one account and Credit multiple accounts

Posting Journal entries for April 2020

Dhanalaxmi Enterprises furnishes the following information regarding transactions for April 2020. Journalise the transactions:

Table 1.13

Posting Journal entries in the books of Dhanalaxmi Enterprises for April Month 2020.

Table 1.14

Note: Ledger posting is not explained in this chapter, because the same will be explained in the further chapter, we will demonstrate how ledger posting is automated in TallyPrime.

1.7 TRIAL BALANCE

The trial balance is a statement showing the balances or total of debits and credits of all the accounts in the ledger, intending to verify the arithmetical accuracy of posting to the ledger accounts. It is an important statement in the accounting process as it shows the final position of all accounts and helps in preparing the final statements.

Format of a Trial Balance is shown in Table 1.15

Table 1.15

Illustration 2: Preparation of Trial Balance

Objective: Preparation of a Trial Balance

From the following ledger balances extracted from the books of MC Enterprises, prepare the Trial Balance as on 31.03.2021.

Table 1.16

Solution Trial Balance as on 31st March 2021

Table 1.17

1.8 FINANCIAL STATEMENTS

Stakeholders need to know the business’ position at the end of each financial year. Financial statements serve a significant purpose to users of accounting information, in knowing about the profitability and the financial position of the organisation.

Financial statements normally include:

Trading and Profit & Loss Account

Balance Sheet

1.8.1 Trading Account

A trading account merely indicates the result of buying and selling of goods, i.e. the gross profit or gross loss on trading, without considering administration, selling and financial expenses incurred in running the business

The format of Trading Account is shown in Table 1.18

Table 1.18

Note: Gross Profit is brought forward on the Credit side (Income side of the Profit and Loss Account). In case the company has incurred Gross Loss, then the same will be brought forward on the debit side (Expenses side of the profit and loss account). View the template of Profit and Loss Account in P&L section.)

Debit Side Items

The value of opening stocks of goods (The stock of goods with which the business was started).

Net purchase made during the year (i.e., purchases – purchase returns).

Direct expenses if any.

Gross Profit

Credit Side Items

Total sales made during the period less the value of returns, i.e., net sales.

The value of the closing stock of goods.

Gross Loss

Prepare the Trading Account for the year ended 31.03.2021 from the following particulars.

Preparation of Trading Account

Table 1.19

Trading Account as on 31-3-2021

Table 1.20

1.8.2 Profit & Loss Account

The profit and loss account helps to ascertain the net profit earned or net loss incurred during a particular period. This helps the company in monitoring and controlling the costs incurred and in improving its efficiency. In other words, the profit and loss statement shows the performance of the company in terms of profits or losses over a specified period.

The Net Profit is expressed as:

Net Profit = (Gross Profit + Other Income) – (Selling and Administrative Expenses + Depreciation + Interest + Taxes+ Other Expenses)

The format of Profit & Loss Account is shown in Table 1.21

Table 1.21

Explanation of a few important items in the format

Office and Maintenance Expenses

Salaries: This refers to the salaries paid to office staff.

Rent and taxes: Rent and taxes refer to municipal taxes and the rent paid for the office building.

Insurance: This refers to the premium paid for insuring buildings, machinery, stock, and so on against risks.

Office lighting and heating: This refers to lighting and heating expenses incurred in providing lighting and heating for the office.

Printing and stationery: This indicates the printing and stationery expenses incurred in the office.

Repairs and renewals: This refers to repair charges incurred for repairing the properties of the business.

Depreciation: This refers to the wear and tear, i.e. the reduction in the value of an asset, resulting out of its use.

Selling and Distribution Expenses

Carriage outwards or Freight outwards: It refers to the transportation expenses incurred in carrying the goods to the market for sale.

Bad debts: It refers to the debts that are considered to be irrecoverable.

Commission paid: This is the commission paid to the salesmen and distributors for their services.

Financial Expenses

Discount on sales or Discount allowed: This indicates the cash discount allowed to the debtors for the prompt payment made by them.

Interest paid: This refers to the interest paid on loans.

Incomes

Non-trading incomes: It refers to all incomes other than trading incomes, such as rent received, the commission received, interest received, and so on.

Note: Personal expenses such as life insurance premium, income tax, and so on, incurred by the business owner should not be included in the profit and loss account. Such expenses are treated as drawings, which has to be deducted from the capital.

Preparation of Profit and Loss account

Referring to Table 1.22, Prepare the Profit and Loss account as on 31-3-2021.

Table 1.22

Profit & Loss Account for the year ending on 31st March 2021

Table 1.23

1.8.3 Balance Sheet

The Balance Sheet is a statement that summarises the assets and liabilities of a business. The excess of assets over liabilities is the net worth of a business. The balance sheet provides information that helps in assessing:

A company’s long-term financial strength and performance

A company’s efficiency in day-to-day working capital management

A company’s asset portfolio

A key element of the Profit and Loss Account, and one that distinguishes it from the Balance Sheet, is that the amounts shown on the statement represent transactions over a period of Time, while the items represented on the balance sheet show information as on a specific date.

All revenue and expense accounts are closed once the profit and loss account is prepared. The Revenue and Expenses accounts will not have an opening balance for the next accounting period.

Types of Assets and Liabilities included in a Balance Sheet

Assets are defined as any item of economic value owned by an individual or corporation, provided it can be measured in terms of money. In other words, assets are the properties owned by an organisation and the debts (i.e. amounts) due to an organisation from other parties.

Examples are cash, securities, accounts receivable, inventory, office equipment, and other properties. On a balance sheet, assets are equal to the sum of liabilities, common stock, preferred stock, and retained earnings.

From an accounting perspective, assets are divided into the following categories namely current assets (cash and other liquid items), long-term assets (real estate, plant, equipment), prepaid and deferred assets (expenditures for future costs such as insurance, rent, interest), and intangible assets (trademarks, patents, copyrights, goodwill).

Current assets, circulating, floating, or fluctuating assets: These refer to cash or other temporary assets which can be converted into cash in a short period.

Examples are cash in hand, cash at bank, bills receivable, and other liquid items.

Liquid assets: Liquid assets are the current assets which are either in the form of cash or can be converted into cash immediately without incurring high losses.

Examples are cash in hand, cash at bank, and sundry debtors.

Investments: This refers to the amount invested by the business on government bonds, on shares and debentures of companies to earn interest and dividends. Investments may be for short-term or long-term. Short-term investments are grouped with current assets and long-term investments are shown as a separate item.

Fixed assets: These are the assets held by a business organisation for its use, and not for sale. These are relatively permanent.

Examples are buildings, furniture, and machinery.

Wasting assets: Wasting assets are the fixed assets lost through use or exhausted.

Examples are mines and quarries.

Intangible assets: Intangible assets are the fixed assets which do not have a physical existence, i.e. it cannot be seen or touched, but the possession of which yields benefit to the business or the possessor.

Examples are copyright, patent, and goodwill.

Fictitious assets: Fictitious assets are the debit balances, i.e. expenses and losses, carried forward from one accounting period to another. These are fictitious and not represented by any tangible or concrete property.

Examples are heavy advertisement expenses not written off and preliminary expenses.

The Format of Balance Sheet is shown in Table 1.24

Table 1.24

Illustration 3: Preparation of Balance Sheet

Objective: Preparation of Balance Sheet

Prepare the Balance Sheet as on 31-03-2021, from the given particulars.

Table 1.25

Table 1.26

1.9 SUBSIDIARY BOOKS & CONTROL ACCOUNTS

Business transactions are first recorded in the journal and then posted to ledger accounts. Small businesses usually record all their transactions in a single journal. In large organisations, the journal is sub-divided into special journals, also known as day books or subsidiary books.

A special journal facilitates the division of labour in accounting work and enables you to record transactions of a similar nature. Repetitive business transactions can be easily recorded in special journals.

For example, all cash transactions may be recorded in one book, all credit sales transactions in another book, and so on. Transactions that cannot be recorded in any special journal are recorded in the journal proper.

This section deals with the following special books.

Cash Book

Petty Cash Book

Purchases book

Purchases Return (Return outwards) book

Sales Book

Sales Return (Return inwards) book

Journal Proper

1.9.1 Cash Book

The Cashbook is an accounting book which records cash receipts and disbursements. It is opened with cash and bank balance at the beginning of the period. The entries are balanced monthly. Cashbook, also known as the book of original entry, is maintained by all organisations, big or small, profit or not-for-profit. It serves the purpose of both journals as well as the ledger (cash) account. When a cash book is maintained, transactions of cash are not recorded in the journal and no separate account for cash or bank is required in the ledger.

1.9.1.1 Single Column Cash Book

Single Column Cashbook has amount column on each side. All cash receipts are recorded on the debit side and all cash payments on the credit side, this book is nothing but a Cash Account and there is no need to open separate cash account in the ledger.

The format of a Single Column Cash Book is shown in Table 1.27

Table 1.27

1.9.1.2 Double Column Cash Book

A double column cash book contains two columns of amounts on each side of the cash book. Three types of columns are :

Cash and discount columns

Cash and bank columns

Bank and discount columns

In many organisations, as far as possible, all receipts and payments are affected by the bank.

Cash/cheque is deposited in a bank account by filling a form called the pay-in-slip. This slip contains a counterfoil to be returned to the customer (depositor) with the signature of the cashier as a receipt.

To withdraw money, banks issue blank cheque books to account holders, Cheques are generally crossed in practice. The payment of a crossed cheque is affected only through a bank account.

The format of a Double Column Cash Book is shown in Table 1.28

Table 1.28

Note: In double column cash book bank column is added.

1.9.1.3 Three Column Cash Book

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

The format of a Three Column Cash Book is shown in Table 1.29

Table 1.29

1.9.2 Petty Cash Book

Miscellaneous expenses such as conveyance, cartage, postage, telegrams, and so on are common to every organisation. These are generally repetitive, and it would burden the cashier to record all these payments in the main cash book. Further, the cash book would become very bulky. Hence, large organisations usually appoint a petty cashier and maintain a separate cash book to record such transactions. Such a cash book is called a petty cash book.

Note: The petty cashier follows the Imprest system. Under this system, a definite sum, say ₹5,000/-, is given to the petty cashier at the beginning of a certain period. This amount is called the imprest amount. The petty cashier makes all small payments out of this imprest amount. When he has spent a substantial portion of the imprest amount, say ₹4,380, he gets reimbursement from the head cashier

1.9.3 Purchase (Journal) Book

A purchase (journal) book is used to record all credit purchases of goods used in the normal course of business. Other purchases such as the purchases of office equipment, furniture, and building are recorded in the journal proper if purchased on credit, or in the cash book if purchased for cash. Invoices or bills received from suppliers of goods are the source documents to record entries in the book. Entries are made with the net amount of the invoice. Details of the invoice such as trade discount need not be recorded in this book.

1.9.4 Purchases Return (Journal) Book

Goods purchased are sometimes returned to the supplier for reasons such as poor quality, defects and so on. Entries regarding the purchases return of goods are recorded in the purchases return book. For every return, the trader prepares a debit note (in duplicate) to inform the supplier that his account has been debited to the extent of the goods returned or for the allowance claimed. The original is then sent to the supplier to enable him to make the necessary entries in his book. The source document to record entries in the purchases return journal is generally a debit note.

A debit note contains the name of the party (to whom the goods have been returned), details of the goods returned and the reason for returning the goods. Each debit note has a serial number and date.

1.9.5 Sales (Journal) Book

The sales journal is a book maintained to record all credit sales of merchandise. The format of the sales journal is similar to that of the purchases journal explained earlier. Sales invoices or bills, issued by the firm to its customers, are the source documents to record entries in the sales journal.

For each sale, two or more copies of a sales invoice are prepared. The bookkeeper makes entries in the sales journal from a copy of the sales invoice. In the sales journal, one additional column may be added to record GST recovered from the customer and to be paid to the government within the stipulated time. At the end of each month, the amount column is totalled and posted to the credit of sales account in the ledger. Posting to the debit side of individual customer accounts may be made daily.

1.9.6 Sales Return (Journal) Book

Sales return (journal) book is used to keep a record of the goods returned by customers. The trader prepares a statement, known as a credit note when goods are taken back from the customers or an allowance is granted to a customer. A credit note informs the customer that his account has been credited for the goods returned or for the allowance granted.

1.9.7 Journal Proper

The Journal proper is a book maintained to record transactions that cannot be recorded in any of the special journals. It is also known as the modern journal or journal residual.

A journal proper generally records the following entries:

Entries regarding dishonour of cheques

Credit purchases and sale of things other than goods

Entries of goods withdrawn by the owner for personal use

Loss of goods by fire, theft and so on

Transactions concerning consignment and joint ventures

1.9.8 Control Accounts

Control Accounts also termed as Controlling Accounts, are accounts prepared to keep the general ledgers like Asset Account (Accounts Receivable, Accounts Payable, Inventory) nice and clean. It contains the summary Balances which can be used in the Financial Statements.

Control Accounts Balance are updated for a particular period; from here the balances are transferred to Balance Sheet and Profit & Loss account.

1.10 DEPRECIATION

Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, the passage of time or obsolescence through technology and market changes.

Depreciation is allocated to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset.

In accounting, depreciation is allocating or assigning of the cost of an asset (other than land).

Examples of depreciable assets are plant and machinery, furniture, buildings, computers, trucks, vans, equipment, etc. Moreover, depreciation is the allocation of ‘depreciable amount’, which is the historical cost, or other amount substituted for a historical cost less estimated salvage value.

In accounting terms depreciation refers to two aspects those are :

The actual decrease in the value of an asset i.e, a decrease in the value of factory equipment each year as it used and wear and tears.

The allocation in accounting statements of the original cost of the assets to periods in which the assets are used.

Depreciation is thus the decrease in the value of assets and the method used to reallocate, or write down the cost of a tangible asset (such as equipment) over its useful life span.

1.10.1 Methods for Depreciation

There are several methods for calculating depreciation, generally based on either the passage of time or the level of activity (or use) of the asset.

The list of Depreciation methods as follows :

Straight-line depreciation

Diminishing balance method

Annuity depreciation

Sum-of-years-digits method

Units-of-production depreciation method

Group depreciation method

Composite depreciation method

Straight-line Depreciation Method: It is the simplest and most often used method. In this method, the company estimates the residual value of the asset at the end of the period during which it will be used to generate revenues. The company will then charge the same amount to depreciation each year over that period until the value shown for the asset has reduced from the original cost to the salvage value.{\displaystyle {\mbox{annual depreciation expense}}={{\mbox{cost of fixed asset}}-{\mbox{residual value}} \over {\mbox{useful life of asset}}(years)}}

The formula to calculate depreciation on Straight Line Method:

Annual Depreciation Expense = Cost of a fixed asset - Residual value / Useful life of the asset (Years)

Book Value = Original Cost − Accumulated Depreciation. Book value at the end of year becomes book value at the beginning of next year. The asset is depreciated until the book value equals scrap value.

Diminishing Balance Method: When using the double-declining-balance method, the salvage value is not considered in determining the annual depreciation, but the book value of the asset being depreciated is never brought below its salvage value, regardless of the method used. Depreciation ceases when either the salvage value or the end of the asset’s useful life is reached.

Annuity Depreciation: This method is not based on time, but a level of Annuity. This could be miles driven for a vehicle, or a cycle count for a machine. When the asset is acquired, its life is estimated in terms of this level of activity.

Sum-of-years-digits Method: It is a depreciation method that results in a more accelerated write-off than the straight-line method, and typically also more accelerated than the declining balance method. Under this method, the annual depreciation is determined by multiplying the depreciable cost by a schedule of fractions.

Sum of the years’ digits method of depreciation is one of the accelerated depreciation techniques which are based on the assumption that assets are generally more productive when they are new, and their productivity decreases as they become old. The formula to calculate depreciation under SYD method is:

The formula to calculate depreciation on Sum-of-years Method:

SYD Depreciation = Depreciable Base value X (Remaining useful life/Sum of the year’s digits)

Depreciable Base = Cost − Salvage Value

Units-of-production Depreciation Method: This is the useful life of the asset is expressed in terms of the total number of units expected to be produced:

The formula to calculate depreciation:

Annual Depreciation Expense = Cost of fixed asset - Residual value X Actual production / Estimated total production.

Group depreciation method: It is the method used for depreciating multiple-asset accounts using a similar depreciation method. The assets must be similar and have approximately the same useful lives.

Composite depreciation method: It is applied to a collection of assets that are not similar and have different service lives. For example, computers and printers are not similar, but both are part of the office equipment. Depreciation on all assets is determined by using the straight-line depreciation method.

1.10.2 Preparation of Depreciation schedule

A company may use different depreciation methods for different types of assets. All businesses keep a depreciation schedule for their assets showing all the relevant details about each asset. Here is the basic information that shows up on a depreciation schedule:

Description: The type of asset and any other identifying information about the fixed asset. For a truck, the description may include the make and model of the truck and its license plate number.

Cost: The purchase price of the asset plus any other spending that should be added to the asset’s cost. Although most additions to purchase price take place when the company acquires the asset, the fixed asset cost can be added to after the fact if material renovations are performed.

Life: How long the company estimates it will use the fixed asset.

Method: The method of depreciation the company uses for the fixed asset.

Salvage value: The estimated value of the fixed asset when the company gets rid of or replaces it.

Date purchased: The day the asset was purchased.

Current depreciation: The depreciation expense booked in the current period.

Accumulated depreciation: The total amount of depreciation expensed from the day the company placed the fixed asset in service to the date of the financial report.

NetBook value: The difference between the fixed asset cost and its accumulated depreciation.

Depending on the size of the company, the depreciation schedule may also have the fixed asset’s identifying number, the location where the fixed asset is kept, property tax information, and many more facts about the asset.

1.11 COMPUTERISED ACCOUNTING

With the advent of computers in India, people started developing software for various needs. Accounting activity was one of the most important activities which desperately needed automation for the following reasons.

Minimum accuracy level required is 100%

Accounting activity consumes a lot of time and energy.

Timely delivery of Financial Statements and Reports

Ratio Analysis

Accounting software is aimed at ensuring 100% arithmetical accuracy saving time and energy to a great extent and ensuring timely delivery of Financial Statements and Reports.

Computerised Accounting is a system that automatically carries out Mechanical Activities in the accounting process. Accounting being the backbone of any