THEORY OF ALL CHAPTERS

Basic Accounting Terms

➢ Evolution of Accounting: The three phases:

⚫ The first phase could be tracked three centuries ago when Kautilya wrote a book called 'Arthashastra'.

⚫ The second phase included the concept of double entry system of book-keeping.

⚫ The third phase emerged with 'Management Accounting' in the 20th century.

➢ Business Transactions : Business Transaction is an economic activity that changes the position of the business
financially.

➢ Event : The result or the consequence of a transaction is called event.

⚫ The following are the examples of Events :

◼ When the goods bought for ` 30,000 are sold for ` 32,000, the profit of ` 2,000 is the event.

◼ Computation of capital, cash in hand, etc. are events.

⚫ In other words, we can say that an event is what a transaction does for the business entity.

➢ Voucher : A document that provides the authorisation and allows the transaction to be recorded in the books of
accounts.

⚫ Every business transaction has a separate voucher.

⚫ It varies from entity to entity.

⚫ Each voucher is uniquely numbered.

➢ Trade Debtors : Debtors are the persons or firms to whom goods are sold for credit.

➢ Trade Creditors : Creditors are the persons or firms from whom the goods are purchased on credit

➢ Purchases : The goods bought for selling it and in which the business deals in.

⚫ In case of manufacturing firm, the goods will be raw materials.

⚫ In case of trading firm, the goods will be the manufactured goods bought to sale. For example, furniture will
be a good for the furniture seller.

⚫ Goods purchased other than those to be resold are assets.

⚫ It includes both cash and credit purchases.

➢ Sales : The transaction which transfers the ownership of the goods or services to the customer for a price.

⚫ It involves transfer of ownership.

⚫ It is used for the sale of goods only and not of assets.

⚫ It includes both cash and credit sales.

➢ Assets : “Assets are valuable resources owned by a business which are acquired at a measurable money cost.”

–Prof. R.N.
Anthony
⚫ Tangible Assets : The assets that can be seen and touched, e.g., Land, Building, Computers, etc.
 ⚫ Intangible Assets : The assets that cannot be seen and touched but improves the working of the business, e.g.,
Goodwill, Patents, Copyright, etc.

⚫ Current Assets : Current Assets are the assets which can be converted into cash within a year, e.g., Cash
in hand, Cash at Bank, Debtors, etc.

⚫ Fictitious or Nominal Assets : The assets that cannot derive any future benefit and cannot be realised in cash.

⚫ Wasting Assets : The assets that are consumed after being used, e.g. Oil wells.

⚫ Fixed Assets : These are long-term and will likely provide benefits to a company for more than one year, such
as real estate, land or major machinery.

➢ Liability : Liability is a non-recurring amount that the firm owes to outsiders.

⚫ Internal Liability : It includes the capital that the proprietor or the partners have infused into the business.

⚫ External Liability : The liability that the business entity must pay to the outsiders.

⚫ Non-current liabilities : When the period for the payment of liability is relatively long.

⚫ Current Liabilities : The liabilities which need to be paid in the short span of time.

⚫ Contingent Liabilities : The liabilities that may occur depending on happening of certain events.

➢ Stock : The value of goods purchased but not sold is stock.

➢ Inventory :
⚫ Inventory of Raw Material : It is the unused goods purchased as raw materials to produce another goods.

⚫ Inventory of Work-in-progress : It is the unused semi-finished goods which must go for further process of
manufacturing.

⚫ Inventory of Finished Goods : The finished goods that are yet to be sold.

⚫ Inventory of Stock-in-trade : It includes the value of goods purchased for resale.

➢ Profit : It is the situation when the revenue is more than the expenses in any accounting period.

⚫ It increases the capital invested by the proprietor.

⚫ It needs to be paid back to the owner.

➢ Loss : It is the situation when the expenses are more than the revenue in any accounting period.

⚫ It decreases the capital invested.

⚫ They are not incurred to generate revenues.

⚫ Loss due to fire, theft or accident are some examples of losses.

➢ Expenses : “Expense is the cost to use things or services for the purpose of generating revenue.”

–Finney and
Miller
⚫ They are incurred to generate revenue.

⚫ It includes : Cost of goods sold, depreciation and expenses like rent, wages, salaries, etc.

➢ Expenditure : The expenses incurred to acquire assets are called expenditure.

⚫ They are payments done for future benefits.

➢ Revenue : The amount received from any recurring accounting transaction is called revenue.

⚫ It includes :

◼ Sale of goods or services.

◼ Receipt of rent, commission, interest, etc

 ➢ Income : The surplus of revenue over expense is called Income.

Income = Revenue – Expense

⚫ It is different from revenue as it is revenue minus the expenses incurred.

⚫ Revenue includes the income generated.

⚫ It gives the financial position of the business.

➢ Drawings : The amount withdrawn or the value of goods taken by the proprietor or partner for personal use is
called drawings.

⚫ It decreases the capital.

⚫ It is like the payment made to the owner.

➢ Capital : The amount invested by the proprietor or a partner in the business is called capital.

Capital = Assets – Liabilities

➢ It is also called the Owner ’s Equity or Net Worth or Net Assets.

➢ It is the amount that the business owes to the owner.

➢ Entry : The recording of a business transaction.

➢ Bad Debts : Irrecoverable amount from the debtors.

➢ Entity : The economic unit formed to earn profit.

➢ Investment : The introduction of new funds either to start or in an existing entity.

➢ Goods & Services Tax : GST is the merged indirect tax introduced in 2017.

Accounting Equation
➢ Uses of accounting equations:
➢ Accounting Equation: It states that the assets are always equal to the sum of capital and liabilities.

Assets = Capital + Liabilities

⚫ It helps in the preparation of balance sheet.

⚫ It ensures the accuracy of the business transactions.

⚫ It remains balanced all the time.

➢ Debit : The left side of an account.

➢ Credit : The right side of an account

Meaning and Objectives of Accounting

➢ Meaning of Accounting : Accounting is the language of business with books of accounts being its script and
debit-credit its style i.e., the way of expressing it.

⚫ Definition of Accounting : "Accounting is the process of identifying, measuring and communicating

information to permit judgement and decisions by the users of accounts."
 ➢ Definition of Book-keeping : Book-keeping, often called record keeping, is the part of accounting that records
transactions and business events in the form of journal entries in the accounting system. In other words, book
keeping is the means by which data is entered into an accounting system.

➢ Accountancy : Accountancy is the practice of recording, classifying, and reporting of business transactions for a
business. It provides feedback to management regarding the financial results and status of an organization.

➢ Cycle of Accounting :
⚫ Identification : It means selection of transactions to be recorded. Only those transactions are recorded which
are related to the organization and considered as financial in character.

⚫ Measurement : The identified business transactions which can be quantified, estimated and measured in terms
of money can only be recorded in the books of accounts.

⚫ Recording : Economic events are recorded in a chronological order and systematic manner after having been
identified and measured in financial terms.

Communication : Communication of information is done through preparation and distribution of annual reports in
prescribed format for use by management and other internal and external users

➢ Subfields of Accounting :
⚫ Financial Accounting : It is a specific branch of accounting involving a process of recording, summarizing, and
reporting the myriad of transactions resulting from business operations over a period of time.

⚫ Cost Accounting : It is a form of managerial accounting that aims to capture a company's total cost of
production by assessing the variable costs of each step of production as well as fixed costs, such as a lease
expense.

⚫ Management Accounting : It is the practice of identifying, measuring, analyzing, interpreting, and

communicating financial information to managers for the pursuit of an organization's goals.

➢ Users of Financial Statements :

⚫ Internal Users:

◼ Investors

◼ Employees

◼ Management

◼ Owners

⚫ External Users:
◼ Potential Investors

◼ Government

◼ Lenders

◼ Competitors
 ➢ Relationship between Book-Keeping, Accounting and Accountancy:
⚫ Book-Keeping : Book-keeping is a primary and basic function in the process of accounting and concerned
with recording and maintenance of books of accounts only. It involves identification of financial transactions,
measurement, recording and classification of those transactions into respective ledger accounts.

⚫ Accounting : It is the secondary function and it starts where function of book-keeping ends. It involves
summarization of transactions, analysis and interpretation of financial results and communication of the
information to the concerned parties.

⚫ Accountancy : Accountancy refers to systematic knowledge of the principles and the techniques which are
applied in Accounting.

➢ Accounting Cycle : It is a step-by-step process of recording, classification and summarization of economic

transactions of a business.

➢ Quantitative Information : The aspects of business that can be expressed in terms of money.

Qualitative Information : The aspects of the business that cannot be expressed in monetary term.
 JOURNAL, LEDGER AND TRIAL BALANCE

Double Entry System

➢ Meaning : Double entry system means that every business transaction affects atleast two accounts.

➢ Definition of Double Entry System : "Every business transaction has a two-fold effect and that it affects two
accounts in opposite directions and if a complete record were to be made of each such transaction, it would be
necessary to debit one account and credit another account. It is this recording of the two-fold effect of every
transaction that has given rise to the term Double Entry System." – J.R. Batliboi

➢ Principles of Double Entry System :

⚫ Atleast two accounts are affected by every business transaction.

⚫ Both personal and impersonal aspects of business are recorded.

⚫ Certain specified rules are followed while recording the transactions.

⚫ Arithmetical accuracy can be detected through Trial Balance.

➢ Classification of Accounts :
⚫ Personal Accounts : Accounts related to an individual, firm, company or institute.

◼ Natural Personal Accounts : Accounts of human beings

◼ Artificial Personal Accounts : Accounts of the firm, company or bank

◼ Representative Personal Accounts : Outstanding expenses, prepaid expenses, accrued revenue and
unearned revenue

➢ Real Accounts : The accounts of the things that can be measured in monetary terms and are the property of the
business entity.

⚫ Tangible Real Accounts : Furniture A/c, Machinery A/c, Cash A/c, etc.

⚫ Intangible Real Accounts : Goodwill A/c, Patents A/c, Copyright A/c, etc.

⚫ Nominal Accounts : All the expenses and income are called nominal account, e.g., salaries paid, rent
paid, commission received, etc.

➢ When any word (as a prefix or suffix) is added to the Nominal Account, it becomes a Personal Account.
e.g., Outstanding Rent A/c, Prepaid Interest A/c, Outstanding Salaries A/c, Commission Received in Advance
A/c.

➢ Golden Rules :
⚫ Personal Account : Debit the receiver, Credit the giver.

⚫ Real Account : Debit what comes in, Credit what goes out.

⚫ Nominal Account : Debit the expenses and losses, Credit the income and gains.

➢ Stages or Parts of Double Entry System :

⚫ The transactions are recorded in Journal.

⚫ The recorded transactions are transferred to Ledger.

⚫ The balances of Ledger are summarised in Trial Balance.

⚫ Trading and Profit & Loss A/c and Balance Sheet is prepared.
 ➢ Advantages :
⚫ It is scientific as transactions are recorded as per rules.

⚫ It records all the business transactions.

⚫ Trial Balance can be used to check the arithmetical accuracy.

⚫ The gross profit and net profit can be easily calculated by preparing the Trading and Profit & Loss A/c.

⚫ Balance Sheet is useful in giving the information about the financial position of the firm.

⚫ As all the transactions effect two accounts, there is lesser possibility of fraud.

⚫ It enables the books of accounts to be used as a legal evidence.

⚫ It helps in comparative study.

⚫ It helps in decision making.

⚫ It is flexible and convenient.

Disadvantages
⚫ It is expensive.

• Proper education and practical knowledge is needed

• It is not free from errors, which cannot be detected

Books of Original Entry : Journal
➢ Meaning of Journal : Journal is a date-wise record of all the business transactions giving the details of all the debit
and credit along with the amount.

➢ Definition of Journal : The journal as originally used, is a book of prime entry in which transactions are copied
in order of date from a memorandum or waste book. The entries as they are copied are classified into debits and
credits, so as to facilitate their being correctly posted, afterwards in the ledger. – Professor Carter

➢ Advantages of Journal :
⚫ Possibility of omission reduced.

⚫ Locating a transaction is easy.

⚫ Helps in Ledger posting.

⚫ Narration after each entry gives the details of the transaction.

⚫ Allows cross-checking of data if the Trial Balance doesn’t tally.

⚫ Classification of all transactions become easy.

➢ Format of Journal :
Journal
Date Particulars Ledger Folio (L.F.) Amount (`) Dr. Amount (`) Cr.

➢ Compound Journal Entry : One entry is passed to record the transaction relating to one particular account.

For example; Ram bought goods worth ` 50,000 from Rahim and paid 50% in cash. In such a case instead of
passing two separate entries, it can be shown as a compound entry.

Date Particulars L.F. Amount (`) Dr. Amount (`) Cr.

Purchases A/c Dr. 50,000

To Cash A/c 25,000

To Rahim
25,000
(Being goods purchased from Rahim and 50% paid)

⚫ Opening entry is passed using Compound Journal Entry.

➢ Journal : The book of systematic record of day to day transactions.

➢ Ledger Folio : It records the page or folio number of the ledger where the journal posting has been made.

➢ Goods : Things bought for resale.

➢ Discount : The amount reduced normally as a percentage of the total amount while buying or selling a good.
Accounting for Goods & Services Tax
➢ Meaning of GST : Goods and Services Tax (GST) is the unified indirect tax levied on the supply of goods and
services produced in a country following the principle of ‘One Nation one Tax’.

Purchase

GOODS AND
Entertainment
Lotteries
SERVICE TAX

Sales Tax

➢ Types of GST :
⚫ Central GST (CGST)

⚫ State GST (SGST) or Union Territory GST (UTGST)

⚫ Integrated GST (IGST)

➢ Accounting Procedure :

⚫ In case of Intra State

◼ For Purchase of Goods :

Purchases A/c Dr.

Input CGST A/c Dr.

Input SGST A/c Dr.

To Bank/Creditor's A/c
(Being Goods purchased)

◼ For Sale of Goods

Bank/Debtor's A/c Dr.

To Sales A/c

To Output CGST A/c

To Output SGST A/c

(Being Goods sold)

◼ For Purchase Returns :

Creditor's A/c Dr.

To Purchase Returns A/c

To Input CGST A/c

To Input SGST A/c

(Being Purchases Returns)

◼ For Sales returns :

Sales Returns A/c Dr.
Output CGST A/c Dr.

Output SGST A/c Dr.

To Debtor's A/c
(Being Sales returns)

◼ For Purchase of Fixed Assets :

Fixed Assets A/c Dr.

Input CGST A/c Dr.

Input SGST A/c Dr.

To Bank A/c

(Being Purchase of Fixed Assets)

◼ For Expenses :
Expenses A/c Dr.

Input CGST A/c Dr.

Input SGST A/c Dr.

To Bank A/c

(Being Expenses incurred)

◼ For Income :
Bank A/c Dr.

To Income A/c

To Output CGST A/c

To Output SGST A/c

(Being Income received)

◼ For goods withdrawn by the Proprietor for personal use :

Drawings A/c Dr.

To Purchases A/c
To Input CGST A/c
To Input SGST A/c

(Being Goods taken for personal use)

◼ For goods given as free samples, loss of goods by fire or

goods stolen :
Advertisement A/c Dr.

Loss by Fire A/c Dr.

Loss by Theft A/c Dr.

To Purchases A/c
To Input CGST A/c
To Input SGST A/c
 (Being Goods distributed as free samples, goods stolen,
and goods destroyed by fire)

◼ For Payment of GST

Output CGST A/c Dr.

Output SGST A/c Dr.

To Bank A/c

(Being Balance amount of output GST deposited with the government)

⚫ In case on Inter State

◼ For Purchase of Goods :

Purchases A/c Dr.

Input IGST A/c Dr.

To Bank/Creditor's A/c

◼ For Sale of Goods :

Bank/Debtor's A/c Dr.

To Sales A/c

To Output IGST A/c

◼ For Purchase of Assets :

Asset A/c Dr.

Input IGST A/c Dr.

To Bank A/c

◼ For Expenses incurred Outside the state:

Expenses A/c Dr.

Input IGST A/c Dr.

To Bank A/c

◼ For Income earned from outside the state :

Bank A/c Dr.

To Income A/c

To Output IGST A/c

 ➢ GST : The combined indirect tax levied.

➢ CGST : The central government’s share in GST.

➢ SGST : GST levied within the state.

➢ UTGST : GST levied within the union territory.

➢ IGST : GST levied on interstate transactions.

Cash Book
➢ Sub-Division of Journal :
⚫ Cash Transactions : Recorded in Cash Book.

⚫ Credit or Non-Cash Transactions : Recorded in Purchases Book, Sales Book, Purchases Returns Book,
Sales Returns Book, Bills Receivable Book, Bills Payable Book and Journal Proper.

➢ Meaning of Cash Book : Cash book is the subsidiary book that records all the cash transactions of the business
in a systematic and simplified manner.

➢ Types of Cash Book :

⚫ Single Column Cash Book :

It records only the cash transactions and records the receipts in the left-hand debit side and payments in
the right-hand credit side.

Dr. Cash Book

Cr.
V. L. Amount V. L. Amount
Date Particulars Date Particulars
(`) (`)
No. F. No. F.

To By

⚫ Double Column Cash Book :

◼ Cash and Discount Column :

Dr. Cash Book

Cr.
Discount Discount
V. L. Cash V. L. Cash
Allowed Received
Date Particulars No. (`) Date Particulars No. (`)
F. (`) F. (`)

To By

◼ Bank and Discount Column :

 Dr. Cash Book
Cr.
Discount Discount
V. L. Bank V. L. Bank
Date Particulars No. Allowed (`) Date Particulars No. Received (`)
F. F.
(`) (`)

To By

◼ Cash and Bank Column :

Dr. Cash Book

Cr.
V. L. Cas Bank V. L. Cash Bank
Date Particulars Date Particulars
h (`) (`) (`)
No. F. No. F.
(`)

To By

⚫ Triple Column Cash Book :

It records all the transactions of cash, bank and discount allowed or received.

Dr. Cash Book

Cr.
Discount Discount
V. L. Cash Bank V. L. Cash Bank
Allowed Received
Date Particulars No. F. (`) (`) Date Particulars No. (`) (`)
(`) F. (`)

To By
 ⚫ Petty Cash Book :

It records all the cash transactions which are small and repetitive in nature.

Petty Cash Book

Dr . Cr. Analysis of Payments

Amount Cas Total Postage &

V. Wages Conveyanc Cartage Stationery Misc.
Received h Payment Courier
(`) e (`) (`) (`) (`)
(`) Book Date Particulars No. (`) (`)
Folio

➢ Contra Entries : The transactions in the double column and triple column cash books which have dual effect on
the two columns (cash and bank), that is debiting one and crediting the another. For example, depositing cash into
bank, withdrawing cash from bank for office use.

➢ Analytical Petty Cash Book : The petty cash book containing the details of all the petty transactions in separate
column. It ensures the analysis of the petty cash transactions in a classified manner.

➢ Imprest System : The system in which a fixed amount is given to the petty cashier at the beginning of a period.

⚫ Advantages of Imprest System :

◼ As a small amount is given, misappropriation of funds is not possible.

◼ It enables to control the petty cash system.

◼ The chances of misuse of cash by the petty cashier is reduced.

It reduces the liability of the cashier.

Ledger
➢ Meaning of Ledger : A book containing all accounts of a business enterprise is known as ledger and transferring
transactions from the books of original entries to their respective ledger accounts is known as posting.

➢ Definition of Ledger : "The book which contains a classified and permanent record of all the transactions of a business
is called the Ledger". – L.C. Cropper

➢ Proforma of Ledger :

Dr. Name of the Account Cr.

Amount Amount
Date Particulars J. F. Date Particulars J. F.
(`) (`)
➢ Classification of Ledger Accounts :

⚫ Under Traditional Approach :

◼ Permanent Accounts : Real and Personal Accounts

◼ Temporary Accounts : Nominal Accounts

⚫ Under Modern Approach :

◼ Permanent Accounts : Assets, Liabilities and Capital

◼ Temporary Accounts : Revenue and Expenses

➢ Rule of Posting :
⚫ All transactions relating to an account is entered at one place.

⚫ The word "To" is used in debit side and "By" is used in the credit side.

⚫ Debited accounts appear on the debit side and Credited accounts appear on the credit side.

➢ Balancing of Ledger Accounts : Balancing of an account is to total both debit and credit sides of an account and
putting the difference on that side which is shorter.

⚫ Closing of Personal Accounts :

◼ Debit Balance indicates the amount owing from.

◼ Credit Balance indicates the amount owing to.

⚫ Closing of Real Accounts :

◼ These accounts always show a debit balance.

⚫ Closing of Nominal Accounts :

◼ The balances are directly transferred to the Trading and Profit & Loss Account.

➢ Ledger Posting of Cash Book :

⚫ Single Column :

◼ The debit entries are posted to the credit side as By Cash A/c in the respective ledgers.

◼ The credit entries are posted to the debit side as To Cash A/c in the respective ledgers.

⚫ Double Column (Bank Column) :

◼ All debit entries are posted to credit side as By Bank A/c and credit entries to the debit as To Bank A/c in
respective ledgers.

◼ The Contra entries are ignored.

⚫ Triple Column (Discount Column) :

◼ Both the discount columns are totalled and transferred to the respective Ledger Accounts, i.e.,
Discount Allowed A/c and Discount Received A/c.

➢ Ledger Posting of Subsidiary Books :

⚫ Purchase Book

◼ The respective personal accounts of the creditors are credited by Purchases A/c.

◼ The total of the Purchases book is posted in the Purchases A/c by ‘Sundries from Purchase Book’.
 ⚫ Sales Book
◼ The respective personal accounts of the debtors are debited by Sales A/c.

◼ The total of the Sales book is posted in the Sales A/c by ‘Sundries from Sales Book’.

⚫ Purchase Returns/Return Outwards Book :

◼ The respective personal accounts of the creditors are debited by Purchase Returns A/c.

◼ The total of the Purchase Returns Book is posted in the Purchase Returns A/c by ‘Sundries from Purchase
Return Book’.

⚫ Sales Returns/Return Inwards Book :

◼ The respective personal accounts of the debtors are debited by Sales Returns A/c.

◼ The total of the Sales Returns Book is posted in the Sales Returns A/c by ‘Sundries from Sales Returns Book’.

➢ Ledger : The book containing the accounts in the classified way.

➢ J.F. : Journal Folio is the number that is assigned to the journal entry.

➢ Balance c/d : The balance of the account carried down from the previous accounting period.

➢ Balance b/d : The balance of the account pertaining to the present accounting period.

➢ Trial Balance : The statement of accounts used to see the arithmetic accuracy of the Ledgers.
Trial Balance
➢ Meaning : Trial balance is a statement of debit and credit balances taken out from all ledger accounts
including cash book to find the arithmetic accuracy of the Ledgers.

➢ Definition : Trial Balance is the list of debit and credit balances, taken out from ledger. It also includes the
balances of cash and bank taken from cash book. – Carter

➢ Golden Rule : “Accounting equation remains balanced all the time” and “For every business transaction there
is an equal debit and credit”.

➢ Objectives and Advantages of Trial Balance :

⚫ To ascertain arithmetical accuracy.

⚫ To facilitate detection of errors.

⚫ To summarise the Ledgers.

⚫ To facilitate preparation of financial statements.

⚫ To facilitate auditing.

➢ Limitations of Trial Balance :

⚫ Fails to assure that all transactions are recorded.

⚫ Fails to assure that it is free from all accounting errors.

⚫ It does not depict assets and liabilities separately.

⚫ It does not facilitate an analyst to analyse books of accounts.

➢ Proforma of Trial Balance :

Trial Balance as on ………………
Name of the Accounts L.F. Dr. Cr.

⚫ Balance Method of preparing Trial Balance : Under this method, debit and credit balances are to be extracted
from all ledger accounts, including cash book and shown in this schedule.

➢ Error : The mistake that occurs in the books of accounts.

➢ Closing Stock : The value of stock at the end of a financial period.

➢ Suspense Account : Account opened when the trial balance does not tally.

DEPRECIATION

➢ Meaning of Depreciation : Depreciation is the decrease in the value of an asset due to its constant use, as they have
a definite life span. In other words, it is the process of allocating a cost to the value of fixed asset according to
its life span.

➢ Definitions of Depreciation :
⚫ "Depreciation is the gradual and permanent decrease in the value of an asset from any cause." – R.N. Carter
⚫ "Depreciation may be defined as the permanent and continuing diminution in the quality, quantity or the value of
an asset." – William Pickles

➢ Features of Depreciation :
⚫ It is a decrease in the value of fixed assets.

⚫ It is permanent.

⚫ It is a gradual and continuous process.

⚫ It is a process of allocation of cost to the fixed assets over its life span.

⚫ Only the book value is decreased.

⚫ It is used only for tangible fixed assets.

⚫ It is a non-cash expense.

➢ Causes of Depreciation :
⚫ Normal physical wear and tear

⚫ Expiry of time

⚫ Expiry of legal rights

⚫ Obsolescence

⚫ Accidents

⚫ Depletion

⚫ Fall in market price

➢ Objectives of Depreciation :
⚫ To show true income

⚫ To show true financial position

⚫ To have funds for the replacement of assets

 ⚫ To ascertain true cost of production

⚫ To prevent the distribution of profit out of capital

⚫ To avoid Income Tax payment

➢ Methods of Charging Depreciation :

⚫ Fixed Instalment or Straight Line Method

⚫ Diminishing Balance or Written Down Value Method

⚫ Annuity Method

⚫ Depreciation Fund Method

⚫ Insurance Policy Method

⚫ Revaluation Method

⚫ Depletion Method

⚫ Machine Hour Rate Method

➢ Fixed Instalment or Straight Line Method : Under this method, the amount of depreciation remains the same over
the estimated useful life of the asset. It is calculated by subtracting the scrap value from the original cost and then
dividing it by the estimated life of the asset. It is also called Original Cost Method.

Depreciation = Original Cost of Asset − Estimated Scrap Value

Estimated Life of the Asset

⚫ Merits :
◼ It is simple to calculate depreciation.

◼ It ensures that the burden of depreciation is equal every year.

◼ Assets can be fully written off.

◼ Availability of information of original cost and up-to-date depreciation.

⚫ Demerits :
◼ As the depreciation on each machine is to be calculated separately, it makes it complicated.
◼ It leads to an unequal charge against income as repairs keep on increasing.

◼ There is undue pressure on later years.

◼ The method completely ignores interest factor.

◼ It is unrealistic.

◼ It is difficult to estimate the scrap value when the asset is purchased.

➢ Diminishing Balance or Written Down Value Method : Under this method, the amount of depreciation declines
as the book value of the asset reduces every year and the depreciation is charged at a fixed rate.

⚫ Merits :
◼ It is easy to calculate even if new assets are purchased.

◼ It allows equal charge against income.

◼ There is no undue pressure in later years.

◼ Balance of asset is never written off to zero.

◼ Income Tax authorities approve this method.

⚫ Demerits:
◼ Assets cannot be completely written off.

◼ The interest factor is omitted.

◼ As the rate of depreciation is not determined easily, it leads to over valuation of depreciation.
 ◼ Unlike straight line method, it is not possible to know the original cost and up-to-date depreciation.

➢ Methods of Recording Depreciation : There are two methods by which depreciation can be recorded in the
books of accounts :

⚫ Charging depreciation to Asset Account : Under this method :

◼ Depreciation is directly credited to Asset A/c.

◼ No Provision for Depreciation A/c is created.

◼ Assets appear at the written down value.

⚫ Creating Provision for Depreciation Account : Under this method :

◼ Depreciation is credited to the Provision for Depreciation A/c.

◼ Assets appear at the original cost in the ledger.

◼ When the asset is sold, the accumulated depreciation is transferred to Asset A/c with the help of the
following entry :

Provision for Depreciation A/c or Accumulated Depreciation A/c Dr.

To Asset A/c

◼ The balance of the Provision for Depreciation A/c indicates the accumulated depreciation on the assets.

➢ Repairs : The expense incurred to maintain the old asset.

➢ Overhauling : Examining the machinery for any damage.

➢ Obsolete : A machinery becomes obsolete when a new technology comes in.

➢ Scrap Value : The value that we get when an old machinery is sold.
 BILLS OF EXCHANGE

➢ Meaning : A bill of exchange is an instrument in writing containing an unconditional order, signed by the maker,
directing a certain person to pay a certain sum of money only to, or to the order of, a certain person, or to the
bearer of the instrument.

Delhi-6
31 January,

` 5,000

Specimen of a Bill of Exchange

➢ Features :

⚫ It should be in writing.

⚫ It is an order to make payment.

⚫ It is an unconditional order to make payment.

⚫ It should contain a certain amount to be paid.

⚫ It should contain a date for the payment.

⚫ The amount must be payable either to a certain person or to his order or the bearer of the bill of exchange.

⚫ It should be paid either on the expiry of a fixed period of time or on demand.

⚫ It must be signed by the maker.

⚫ It must be signed by the acceptor.

⚫ It must be appropriately stamped.

➢ Parties to a Bill of Exchange :

⚫ Drawer : She/He is the person or party who draws the bill. She/He is the seller or creditor and has to receive the
money from another person.

⚫ Drawee : She/He is the person or party on whom the bill is drawn. She/He is the debtor who has to pay the
amount to the drawer.

⚫ Payee : She/He is the person or party to whom the bill is made payable. She/He is mostly the drawer until she/
he endorses the bill on another person who has been mentioned for payment in the bill.

➢ Advantages of Bills of Exchange :

⚫ It serves as an evidence of debt.

⚫ It is valid in the eyes of law and is legally binding.

⚫ The holder of the bill can discount it before the due date.
 ⚫ A bill of exchange can be endorsed easily from one person to another.

⚫ The hassles of reminding the debtor is done away with.

⚫ As the date of payment is known, the seller can plan the cash operations.

⚫ It performs the functions of money, as it can be circulated.

⚫ It helps the drawee to get some time for payment.

➢ Promissory Note : It is the note written by the debtor himself/herself and signed and given to the seller as a
promise to pay. According to the Indian Negotiable Instrument Act, “A Promissory Note is an instrument in
writing (not being a bank note or a currency note) containing an unconditional undertaking signed by the maker
to pay a certain sum of money to, or to the order of, a certain person.”

2016, Maika Ganj,

Delhi-110 007
` 10,000.00

For M/s Aggarwal Stores

SPECIMEN OF A PROMISSORY NOTE

⚫ Features :

◼ It has to be in writing not oral.

◼ It has to be a promise to pay.

◼ The promise must be unconditional.

◼ The amount must be specified.

◼ It has to be signed by the maker.

◼ It must mention the name of the payee.

◼ It cannot be made payable to the bearer.

◼ It needs to be stamped accordingly.

 ⚫ Parties to a Promissory Note :
◼ Maker : The person who writes a promissory note and signs it.

◼ Payee : The person who will get the payment.

➢ Date of Maturity : The date on which the bill is due for the payment is termed as ‘Due Date’ or ‘Date of Maturity’.

⚫ It is the date on which the duration of the bill ends.

⚫ The three days added to the days of the period of bill are called ‘Days of Grace’.

⚫ If the due date is in the month which has no corresponding date, it will be the last day of the month.

⚫ Bill at Sight : In such bill, the date of payment is not written and so it becomes payable on the date of presenting
it.

⚫ Bill after Date : Such bills are payable at a fixed date which begins once the bill is drawn.

⚫ Bill after Sight : Such bills are payable after a fixed date after the bill is accepted.

➢ Negotiation of a Bill : When the bill is transferred to another person giving him/her the title of the bill and a right to
get the amount from the concerned parties, it is called negotiation of the bill.

⚫ Modes of Negotiation :
◼ Negotiation by delivery : In case of bill payable to bearer, negotiation is done by delivery.

◼ Negotiation by endorsement and delivery : In case of bill payable to a specific person, negotiation is done
by endorsement and delivery.

⚫ Endorsement of a Bill : When the bill is negotiated by signing the bill.

◼ The holder ’s sign needs to be at the back of the bill.

◼ The endorser is the person who transfers the bill by signing it.

◼ The endorsee is the person to whom the bill is transferred.

➢ Dishonour of the Bill : The bill of exchange is said to be dishonoured when the drawee becomes insolvent or
refuses to pay the amount of the bill.

⚫ In such a case the holder can recover the amount from any of the endorsers.

⚫ The holder needs to give a notice of dishonour to the drawer and each prior endorser.

⚫ If the holder fails to do so, she/he loses the claim.

⚫ Noting : The act of noting down the reason for dishonour by the Notary Public after she/he has presented the
bill and the acceptor has refused to pay.

⚫ Noting Charges : The fee charged by the Notary Public for the services rendered by him/her. This charge,
though borne by the holder is ultimately paid by the acceptor.

➢ Renewal of the Bill : It is an agreement between the holder and the acceptor of the bill to pay the bill on a new
date for which a new bill is drawn either in full amount or as the case may be.

⚫ In such cases, the drawer charges interest.

⚫ The entries are the same as in case of dishonour first and then the entry will be of the new bill.
➢ Accounting Treatment :

⚫ When the bill is retained by the drawer in his possession till the date of maturity.

Journal Entries in the books of

Transaction
Drawer Drawee (Acceptor)

(i) When Drawer sold goods Drawee Dr. Purchases A/c Dr.
to Drawee
To Sales A/c To Drawer

(Being goods sold on credit) (Being goods purchased on credit)

(ii) When Drawer received a Bills Receivable A/c Dr. Drawer Dr.
bill duly accepted by
To Drawee To Bills Payable A/c
Drawee
(Being acceptance given)
(Being acceptance received)

(iii) When the bill is retained by Bank A/c Dr. Bills Payable A/c Dr.
the drawer till the date of
To Bills Receivable A/c To Bank A/c
maturity and the drawee
pays the amount of bill on (Being amount of bill received on
(Being amount of bill paid on
maturity maturity)
maturity)

⚫ When the bill is discounted with the bank

Journal Entries in the books of

Transaction
Drawer Drawee (Acceptor)

(i) When Drawer discounts Bank A/c Dr.

the bill from the Bank
Discounting Charges A/c Dr.

To Bills Receivable A/c No Entry

(Being bill discounted)

(ii) When Drawee pays the Bills Payable A/c Dr.

amount of the bill on the
due date NO ENTRY To Bank/Cash A/c
(Being amount paid)

⚫ Negotiation/Endorsement of a Bill

Journal Entries in the books of

Transaction
Drawer (Endorser) Drawee (Acceptor) Endorsee

(i) If the Drawer Endorsee Dr. Bills Receivable A/c Dr.

endorsed a bill in
favour of To Bills Receivable A/c NO ENTRY To Endorser
endorsee (Being bill receivable
endorsed to endorsee) (Being bill receivable
received)
 (ii) When Drawee Bills Payable A/c Dr. Cash/Bank A/c Dr.
pays the amount To Cash/Bank A/c To Bills Receivable A/c
of the bill on the NO ENTRY
(Being amount paid on (Being amount received)
due date
due date)

⚫ When the bill is sent to the Bank for Collection

Journal Entries in the books of

Transaction

Drawer Drawee (Acceptor)

(i) When bill is sent for Bill Sent for Collection A/c Dr.
collection
To Bills Receivable A/c NO ENTRY

(Being bill sent to bank for

collection)

(ii) When the intimation of Bank A/c Dr.

actual realisation of the bill
is received To Bill Sent for Collection A/c NO ENTRY
(Being amount of bill collected by
the bank)
⚫ Retiring of a Bill under Rebate

Journal Entries in the books of

Transaction
Drawer Drawee (Acceptor)

When Drawee retires the bill Bank A/c Dr. Bills Payable A/c Dr.
before the due date
Rebate on Bill A/c Dr. To Bank A/c

To Bills Receivable A/c To Rebate on Bill A/c

(Being amount received before due
(Being amount of bill paid before the
date and rebate allowed)
due date and rebate received)

⚫ When the dishonoured bill is held by the drawer until the date of maturity
Journal Entries in the books of
Transaction
Drawer Drawee (Acceptor)

(i) When the Drawee/Acceptor Drawee Dr. Bills Payable A/c Dr.
of the bill dishonours the
bill on due date To Bills Receivable A/c To Drawer

(Being bill dishonoured or (Being bill dishonoured or

cancelled) cancelled)

(ii) When Drawer pays the Drawee Dr. Noting Charges A/c Dr.
noting charges
To Cash A/c To Drawer

(Being noting charges paid on (Being noting charges payable to

Drawee’s behalf) Drawer)

(iii) The two entries can be Drawee Dr. Bills Payable A/c Dr.
merged with the
compound entry To Bills Receivable A/c Noting Charges A/c Dr.
To Cash A/c
To Drawer
(Being bill dishonoured and noting
(Being bill dishonoured and noting
charges paid) charges paid)

⚫ When dishonoured bill is Renewed

Journal Entries in the books of

Transaction
Drawer Drawee (Acceptor)

(i) Cancellation of the Bill Drawee Dr. Bills Payable A/c Dr.

To Bills Receivable A/c To Drawer

(Being bill cancelled) (Being bill cancelled)

(ii) When Drawee pays the Cash A/c Dr. Interest A/c Dr.
interest charges
To Interest A/c To Cash A/c
(Being interest received) (Being interest paid)

(iii) When the interest charges Drawee Dr. Interest A/c Dr.
are not paid in cash
To Interest A/c To Drawer
 (Being interest receivable) (Being interest payable)

(iv) When new bill is received Bills Receivable A/c Dr. Drawer Dr.

To Drawee To Bills Payable A/c

(Being new acceptance given)
(Being new acceptance received)

⚫ When the bill discounted with bank is dishonoured

Journal Entries in the books of

Drawer Drawee (Acceptor)

Drawee (Amount of Bill + Noting charges) Dr. Bills Payable A/c Dr.

To Bank A/c Noting Charges A/c Dr.

(Being bill dishonoured and noting charges paid) To Drawer

(Being bill dishonoured and noting charges payable)

 ⚫ When the bill is endorsed to a third party is dishonoured

Journal Entries in the books of

Drawer (Endorser) Drawee (Acceptor) Endorsee

(i) Drawee Dr. Bills Payable A/c Dr. Endorser Dr.

(Amount of Bill + Noting Charges) Noting charges A/c Dr. To Bills Payable A/c
To Cash A/c
To Endorsee To Drawer
(Being bill dishonoured and
(Being bill dishonoured and the (Being bill dishonoured and noting charges paid in cash)
amount of bill paid to endorsee and noting charges payable to drawer)
noting charges receivable from
drawee)

(ii) Bills Payable A/c Dr. Bank A/c Dr.

NO ENTRY To Bank A/c To Bills Receivable A/c

(Being amount received)
(Being amount paid on the due
date)

⚫ Insolvency of the Acceptor

Journal Entries in the books of
Transaction
Drawer Drawee (Acceptor)

When part payment is made Bank A/c Dr. Drawer Dr.

Bad Debts A/c Dr. To Bank A/c

To Drawee To Deficiency A/c

(Being amount received in full (Being amount of bill paid in full

settlement) settlement)

➢ Term of the Bill : The period between the date of drawing and the due date.

➢ Honour of the Bill : When the bill is paid on the due date.

➢ Retirement of the Bill : When the bill is paid before the due date.

➢ Acceptance of the Bill : When the drawee signs the bill, indicating his acceptance of liability to pay on the due date.

➢ Noting charges : The fee charged by the Notary Public in case of dishonour of bill.