Chapter 1- Basics of Accounting

Learning Objectives
 Double entry system
 Meaning of Account Lecture - 1
 Types of Accounts
 Traditional Accounting Rules
 1. Double Entry System
Direct expenses means all expenses directly connected with the manufacture, purchase of goods and bringing
them to the point of sale. Direct expenses include carriage inwards, freight inwards, wages, factory lighting,
coal, water and feul, royalty on production, etc.
Notes

Similarly, sales constitute the main item of revenue for the business. The excess of sales over purchases and
direct expenses is called gross profit. If the amount of purchases including direct expenses is more than the
sales revenue, the resultant figure is gross loss. The computation of gross profit can be shown in the form of
equation as :
Gross Profit = Sales – (Purchases + Direct Expenses)
The gross profit or the gross loss is transferred to profit and loss account.

The indirect expenses are transferred to the debit side of the second part, viz. profit and loss account. All
revenue/gains other than sales are transferred to the credit side of the profit and loss account. If the total of the
credit side of the profit and loss account is more than the total of the debit side, the difference is the net profit
for the period of which it is being prepared. On the other hand, if the total of the debit side is more than the total
of the credit side, the difference is the net loss incurred by the business firm. In an equation form, it is shown as
follows :
Net Profit = Gross Profit + Other Incomes – Indirect Expenses
 Trading Account
The trading account ascertains the result from basic operational activities of the business. The basic operational
activity involves the manufacturing, purchasing and selling of goods. It is prepared to ascertain whether the selling
of goods and/or rendering of services to customers have proved profitable for
the business or not. Purchases is one of the main constituents of expenses in business organisation. Besides
purchases, the remaining expenses are divided into two categories, viz. direct expenses and indirect expenses.

Similarly, sales constitute the main item of revenue for the business. The excess of sales over purchases and direct
expenses is called gross profit. If the amount of purchases including direct expenses is more than the sales
revenue, the resultant figure is gross loss. The computation of gross profit can be shown in the form of equation as :
Gross Profit = Sales – (Purchases + Direct Expenses)
The gross profit or the gross loss is transferred to profit and loss account.
The indirect expenses are transferred to the debit side of the second part, viz. profit and loss account. All
revenue/gains other than sales are transferred to the credit side of the profit and loss account. If the total of the
credit side of the profit and loss account is more than the total of the debit side, the difference is the net profit for
the period of which it is being prepared. On the other hand, if the total of the debit side is more than the total of the
credit side, the difference is the net loss incurred by the business firm. In an equation form, it is shown as follows :
Net Profit = Gross Profit + Other Incomes – Indirect Expenses
Carriage/Freight
Inward

Insurance

Loading &
unloading
Freight/ Carriage
Inward

Power, Water,
Fuel & Gases

Wages

Packaging
material
 Matching Concept

To Purchase A/c (100 piece.) 15,00,000 By Sales A/c (90 piece.) 27,00,000

{100 15,000} {90 30,000}

Less: Closing Stock A/c 1,50,000

To Direct Expenses:-

 Freight/ Carriage
Inward By Closing Stock A/c
 Power, Water, Fuel & 1,50,000
Gases 5,50,000 {10 15,000}
 Wages (Godown Staff)
 Packaging material and
Packing charges
 factory lighting, coal By Gross Loss
To Gross Profit 8,00,000
 Office
Expenses

Showroom
Expenses
Sales Staff Salary

Rent of Showroom

Bad Debts

Cash Discount

Carriage Outward

Advertisement

Travelling Expenses
Depreciation of Delivery
Van

Salesman Commission
Rent, rates and taxes
Postage, printing and stationery
Insurance
Legal charges, audit fees
Electricity, telephone & internet
Office staff salaries
Financial Expenses
st Bank
e
nte r
I

Interest
Capital

In
te r
est

Friends
Depreciation

Maintenance

Amortisation
Abnormal Loss
 Office and Administration Expenses
 Rent, rates and taxes Other Income
 Postage, printing and
 Discount Received
stationery
To Indirect Expenses

 Insurance  Commission Received

 Legal charges, audit fees
 Electricity, telephone & Non Trading Income
internet
 Bank Interest
 Office staff salaries
 Rent Received
Selling and Distribution Expenses  Dividend from shares
 Salary (Sales Staff )  Interest on Debentures
 Rent of Showroom
 Bad Debts
 Cash Discount
 Carriage Outward
 Advertisement
 Travelling Expenses
 Depreciation of Delivery Van
 Salesman Commission
 Financial Expenses
 Interest on loan
 Interest on Capital
 Discount on bills
To Indirect Expenses

 Bank Charges

Repairs & Maintenance

 Depreciation
 Maintenance
 Amortisation Abnormal Gains
 Profit on sale of machinery
Abnormal Loss  Profit on sale of investments
 Loss on sale of machinery
 Loss by fire/ natural
calamity
 Loss on sale of Investment

To Net Profit By Net Loss

 By Sales A/c 27,00,000
{90 30,000}
To Purchase A/c 15,00,000

{100 15,000}

To Direct Expenses:-
 Freight/ Carriage
Inward
 Power, Water, Fuel &
By Closing Stock A/c 1,50,000
Gases 5,50,000
 Wages (Godown Staff) {10 15,000}
 Packaging material and
Packing charges
 factory lighting, coal

To Gross Profit
To Purchase A/c (100 piece.) 15,00,000 By Sales A/c 27,00,000

Less: Closing Stock A/c 1,50,000

To Direct Expenses:-
By Closing Stock A/c 1,50,000
 Freight/ Carriage Inward
 Power, Water, Fuel & {10 15,000}
Gases
 Wages (Godown Staff)
5,50,000
 Packaging material and
Packing charges
 factory lighting, coal

Cost
To Gross Profit 8,00,000 By Gross Loss
or Whichever
is lower
Net Realisable value
 Closing Stock Valuation

Cost
Conservatism Concept
or Whichever is lower
Provide for anticipated losses
Ignore anticipated profit
Net Realisable value

Trading A/c

Case I When cost is less than market value

By Sales A/c 10,00,000
Cost 50,000 To Purchase A/c 5,00,000

or

Net Realisable value 60,000 To Direct Expenses:- 2,50,000 By Closing Stock A/c 50,000
60,000

To Gross Profit 3,00,000

3,10,000
 Closing Stock Valuation
Case I When cost is more than market value

Cost 50,000

or

Net Realisable value 10,000

Trading A/c

By Sales A/c 10,00,000

To Purchase A/c 5,00,000

To Direct Expenses:- 2,50,000 By Closing Stock A/c 10,000

50,000

To Gross Profit 2,60,000

3,00,000
 Liabilities Balance Sheet Assets

Capital
Office Building
Add: Profit
Less: Loss
Factory Building
Drawings

Machine

Furniture
Liabilities
Bank Loan
Investment
Creditors

Outstanding Expenses
Goods

Cash & Bank Balance

 Trading Account

To Purchase A/c (100 piece.) 15,00,000 By Sales A/c (90 piece.) 27,00,000

{100 15,000} {90 30,000}

To Direct Expenses:-

 Freight/ Carriage Inward

 Power, Water, Fuel & Gases By Closing Stock A/c 1,50,000
 Wages (Godown Staff)
 Packaging material and 5,50,000 {10 15,000}
Packing charges
 factory lighting, coal

To Gross Profit 8,00,000 By Gross Loss

 Profit & Loss Account

Office and Administration Expenses Other Income

 Rent, rates and taxes  Discount Received
 Postage, printing and stationery  Commission Received
 Insurance
 Legal charges, audit fees Non Trading Income
 Electricity, telephone & internet  Bank Interest
 Office staff salaries  Rent Received
 Dividend from shares
Selling and Distribution Expenses  Interest on Debentures
 Salary (Sales Staff ) Abnormal Gains
To Indirect Expenses

 Rent of Showroom
 Profit on sale of machinery
 Bad Debts  Profit on sale of investments
 Cash Discount
 Carriage Outward
 Advertisement
 Travelling Expenses
 Depreciation of Delivery Van
 Salesman Commission
Financial Expenses
 Interest on loan
 Interest on Capital
 Discount on bills
 Bank Charges
Repairs & Maintenance
 Depreciation
 Maintenance
 Amortisation Abnormal Loss

To Net Profit By Net Loss

 3. Account
Profit and Loss Account is prepared to calculate the net profit or loss of
the business for a given accounting period. The balance of Trading
Account i.e. gross profit/gross loss is transferred to the Profit and Loss
Account which is the starting point of the preparation of this account.
Thereafter, all those expenses and losses which have not been debited Notes
already to the Trading Account are debited to the Profit and Loss
Net profit = Total Revenues —
Total Expenses
Net Loss = Total Expenses —
Total Revenues
Account. Other incomes and gains, if any, are credited to this account, e.g. interest earned or commission
received etc. The net profit, thus arrived at is transferred to Capital Account of the proprietor/partners.
Specimen of Profit & Loss Account is given on next page. Net profit increases the capital whereas net loss
decreases the capital.
MAIN PRINCIPLES FOR PREPARATION OF TRADING AND PROFIT & LOSS ACCOUNT
The following principles must be kept in mind while preparing Trading and Profit & Loss Account:
Only revenue receipts i.e. sale proceeds and other incomes should be entered.
— Only revenue expenses together with losses should be taken into account.
— Profit or loss is determined by matching revenues and expenses according to the matching principle.
Application of Concept of Matching Principle
A fundamental principle which must be observed while preparing final accounts is that of 'matching cost
and revenue'. It means that in final accounts, expenses and incomes for the full trading period whether
they have been paid or received or not, must be included and no expenditure or income which does not
pertain to the period for which final accounts are being prepared be included. The distinction between
capital and revenue items is also made on the basis of this principle.
DIFFERENCE BETWEEN TRADING AND ACCOUNT PROFIT & LOSS ACCOUNT
Trading Account
(i) Trading account is prepared to calculate the
gross profit (loss) for a particular period.
(ii) In trading account, cost of goods sold,
and direct expenses are accounted.
(iii) The result of trading account i.e. gross
(loss) is transferred to profit and
sales
profit
loss
Profit and Loss Account
(i) Profit and loss account is prepared to arrive
at the net profit (loss)
f operating revenue over operating expenses. While calculating operating profit, the incomes and expenses of a purely financial nature are not taken into account. Thus, operating profit is profit before interest

Cost of Goods Sold = Opening Stock+Purchases Direct E