Certified Professional in Cooperative Banking (CPCB) Level-I 2024-2025 Module 4: Accounting & Audit PDF

Certified Professional in Cooperative Banking (CPCB)-Level-I Certification Course 2024-25 Batch Module 4: Accounting and Audit 2024 Centre for Professional Excellence in Cooperatives (C-PEC), Bankers Institute of Rural Development (BIRD) An autonomous instit...

Certified Professional in Cooperative Banking (CPCB)-Level-I Certification Course 2024-25 Batch Module 4: Accounting and Audit 2024 Centre for Professional Excellence in Cooperatives (C-PEC), Bankers Institute of Rural Development (BIRD) An autonomous institute established by NABARD. Sector-H, LDA Colony, Kanpur Road, Lucknow – 226 012, INDIA Phone +91-522-2421799 Email [email protected] Homepage https://bird-cpec.nabard.org/ 2 Contents Unit-1: Accounting System.................................................................................... 11 Lesson No. 1.1: Concepts, conventions and principles........................................... 12 1.1.1 Objectives...................................................................................................... 13 1.1.2 The meaning and purpose of accountancy..................................................... 13 1.1.3 Basic terms in accounting............................................................................. 14 1.1.4. Accounting Principles.................................................................................. 16 1.1.5. Accounting Concepts.................................................................................... 16 1.1.6. Accounting Conventions.............................................................................. 18 1.1.7 Let’s sum up................................................................................................. 20 1.1.8 Key words..................................................................................................... 21 1.1.9 Multiple Choice Questions............................................................................ 21 1.1.10 Answer keys............................................................................................... 24 Lesson No. 1.2: System of accounting................................................................... 24 1.2.1 Objectives...................................................................................................... 25 1.2.2 Different accounting systems....................................................................... 26 1.2.3 Flow of an accounting transaction............................................................... 26 1.2.4 Source documents....................................................................................... 28 1.2.5 Types of vouchers........................................................................................ 28 1.2.6 Identifying two accounts in a transaction.................................................... 28 1.2.7 Three Golden Rules of Accounting............................................................... 30 1.2.8 Five Golden Rules of Accounting.................................................................. 31 1.2.9 Let’s sum up.................................................................................................. 35 1.2.10 Key words:.................................................................................................. 35 1.2.11 Multiple Choices Questions........................................................................ 36 1.2.12 Answer keys............................................................................................... 38 Lesson No. 1.3: Books of accounts to be maintained............................................ 39 1.3.1 Objectives...................................................................................................... 41 1.3.2 Background.................................................................................................. 41 1.3.3 Journal format............................................................................................. 41 1.3.4 Subsidiary books/ Special journals...............................................................45 1.3.5 Various types of subsidiary journals.............................................................45 1.3.6 Adjustment entry......................................................................................... 48 3 1.3.7 Ledger........................................................................................................... 51 1.3.8 Balancing of Ledger...................................................................................... 52 1.3.9 Difference between Journal & Ledger........................................................... 53 1.3.10 let’s sum up................................................................................................ 60 1.3.11Key words:................................................................................................... 61 1.3.12 Multiple Choices Questions......................................................................... 61 1.3.13 Answer Keys............................................................................................... 64 Lesson No 1.4: Bank reconciliation statement.......................................................65 1.4.1 Objectives..................................................................................................... 66 1.4.2 Introduction................................................................................................ 66 1.4.3 Need for bank reconciliation statement....................................................... 66 1.4.4 Possible reasons for the difference............................................................... 67 1.4.5 Steps for preparing bank reconciliation statement...................................... 69 1.4.6 Let’s sum up................................................................................................. 73 1.4.7 Key words..................................................................................................... 74 1.4.8 Multiple Choice Questions............................................................................ 74 1.4.9 Answer keys.................................................................................................. 76 Lesson No 1. 5: Trial balance, Profit & loss account and Balance sheet................. 77 1.5.1 Objectives...................................................................................................... 78 1.5.2 Preparation of trial balance.......................................................................... 78 1.5.3 Error not disclosed by Trial balance............................................................ 80 1.5.4 Preparation Of financial statements............................................................ 80 1.5.5 Income statement........................................................................................ 83 1.5.6 Balance Sheet.............................................................................................. 85 1.5.7 Horizontal presentation of the Profit and Loss Account and Balance Sheet. 86 1.5.8 Vertical presentation of the Profit and Loss Account and Balance Sheet...... 87 1.5.9 Adjustment entries...................................................................................... 90 1.5.10 let's sum up................................................................................................ 94 1.5.11 Key words....................................................................................................95 1.5.12 Multiple of choice questions........................................................................95 1.5.13 Answer Key................................................................................................ 98 Unit-2: Analysis and Interpretation of Financial Statement................................. 99 Lesson no. 2.1: Analysis and interpretation........................................................ 100 4 2.1.1 Objectives.................................................................................................... 101 2.1.2 Introduction............................................................................................... 101 2.1.3 Financial statement analysis....................................................................... 101 2.1.4 Interpretation of the key terms of the financial statements........................ 102 2.1.5 Tools & Techniques of Financial Statement Analysis.................................. 106 2.1.5.1 Comparative financial statements analysis........................................... 107 2.1.5.2 Common size financial statements analysis.......................................... 110 2.1.5.3 Trend analysis........................................................................................115 2.1. 5.4 Funds flow statement analysis.............................................................. 119 2.1.5.5 Cash flow statement analysis................................................................ 121 2.1.5.6 Ratio analysis........................................................................................ 128 2.1.6 Let's sum up................................................................................................ 142 2.1.7 Key words:.................................................................................................. 143 2.1.8 Multiple choice Questions.......................................................................... 143 2.1.9 Answer Keys............................................................................................... 149 Unit-3: Audit, Inspection and Control................................................................. 150 Lesson No. 3.1 Internal Control and Checks......................................................151 3.1.1 Objectives.................................................................................................... 152 3.1.2 Introduction............................................................................................... 152 3.1.3 Meaning and need of internal controls....................................................... 152 3.1.4 Essentials of Good Internal Controls.......................................................... 154 3.1.5 Nature of internal controls......................................................................... 154 3.1.6 Roles and responsibilities in internal control............................................. 156 3.1.7 Limitations of Internal Control................................................................... 157 3.1.8 Setting up of the internal control system.................................................... 157 3.1.9 Internal check............................................................................................. 158 3.1.10 Objectives of internal check...................................................................... 159 3.1.11 Points that are taken into consideration while framing a System of Internal Control............................................................................................................... 159 3.1.12 Let’s us sum up.......................................................................................... 160 3.1.13 Key words................................................................................................. 160 3.1.14 Multiple choice Questions......................................................................... 161 3.1.15 Answer keys.............................................................................................. 163 Lesson No 3.2 Preparatory works for audit and inspection.............................. 164 5 3.2.1 Objectives................................................................................................... 165 3.2.2 Introduction............................................................................................... 165 3.2.3 Audit process in brief................................................................................. 165 3.2.4 Audit preparation from the Auditee’s ( bank’s/company’s or firm’s) side.. 167 3.2.5 Let us sum up............................................................................................. 169 3.2.6 Key words.................................................................................................. 169 3.2.7 Multiple choice questions........................................................................... 170 3.2.8 Answer keys................................................................................................ 171 Lesson No. 3.3 Audit and inspection................................................................... 172 3.3.1 Objectives................................................................................................... 173 3.3.2 Introduction............................................................................................... 173 3.3.3 Definition of Audit...................................................................................... 173 3.3.4 Main features of audit................................................................................ 174 3.3.5 Objectives of an audit................................................................................ 174 3.3.6 Advantages of audit.................................................................................... 176 3.3.7 Audit types................................................................................................. 176 3.3.8 CAMELSC.................................................................................................. 178 3.3.9 Let’s us sum up.......................................................................................... 179 3.3.10 Key words................................................................................................ 179 3.3.11 Multiple choice questions......................................................................... 180 3.3.12 Answer keys.............................................................................................. 181 Lesson No. 3.4 Role of an Auditor& areas to be covered...................................... 182 3.4.1 Objectives................................................................................................... 183 3.4.2 Role of an Auditor...................................................................................... 183 3.4.3 Items to be checked on first day of audit.................................................... 185 3.4.4 Areas to be covered.................................................................................... 185 3.4.4.1 Credit Area........................................................................................... 185 3.4.4.2 Non credit Area.................................................................................... 187 3.4.4.3 Computer Area..................................................................................... 188 3.4.4.4 Branch Management............................................................................ 188 3.4.4.5 Compliance.......................................................................................... 188 6 3.4.5 Key words................................................................................................... 189 3.4.6 Let's sum up............................................................................................... 189 3.4.7 Multiple choice questions........................................................................... 189 3.4.8 Answer keys............................................................................................... 191 Lesson No. 3.5: Frauds- Classification, Reporting and Monitoring.................... 192 3.5.1 Introduction............................................................................................... 193 3.5.2 Classification of Frauds.............................................................................. 193 3.5.3 Reporting to NABARD................................................................................ 194 3.5.4 Reporting to Board..................................................................................... 194 3.5.5 Quarterly return......................................................................................... 195 3.5.6 Cases of attempted fraud............................................................................ 195 3.5.7 Closure of fraud cases................................................................................. 195 3.5.8 Cases to be referred to Local Police:........................................................... 196 3.5.9 Preventive measures to be taken in Cheque related Frauds........................ 197 3.5.10 Reporting Cases of Theft, Burglary, Dacoity and Bank Robberies............. 198 3.5.11 Legal Audit of Title Documents in respect of Large Value Loan Accounts.. 198 3.5.12 Key words................................................................................................. 198 3.5.13 Let's sum up.............................................................................................. 198 3.5.14 Multiple choice questions......................................................................... 199 3.5.15 Answer keys.............................................................................................. 201 Additional Reading............................................................................................ 202 7 Abbreviations ACB Audit Committee of Board ALM Asset liability management AOF Account opening form ATM Automated teller Machine B/D Brought down B/F Brought forward BDDR Bad & doubtful Reserve C/D Carried down C/F Carried forward CA Current asset CC Cash credit CIBIL Credit information bureau (India) limited CL Current liability COGS Cost of goods sold COO Chief operating officer CP Commercial paper CR Current ratio Cr Credit CR Confidential report CTS Cheque truncation system Dr Debit DSCR Debt Service Coverage ratio DTL Demand and Time Liabilities DTO Debtor turnover EBIT Earnings before interest & tax EBITDA: Earnings before Interest, Tax, Depreciation & Amortization ECS Electronic clearing system GAAR General anti-avoidance rule GP Gross profit 8 ICAI The Institute of Chartered Accountants of India ICR: Interest coverage ratio IMPS Immediate payment service IP Immoveable property JF Journal folio KYC Know your customer LF Ledger folio LFAR Long form audit report LLC Limited liability company LLP Limited liability Partnership LTL Long term liability LTU Long Term Use MPBF Maximum permissible bank finance NABARD National Bank for Agriculture and Rural Development NCA Noncurrent asset NCL Normal credit limits NCL Noncurrent liability NEFT National electronic fund transfer NGO Non-governmental organisation NOI Non operating income NP Net profit NPA Non-performing asset NPA Nonperforming asset NPAT Net profit after tax NPBT Net profit before tax NW Net worth NWC Net working capital OD Over draft OE Operating expenses OI Operating income OP Operating profit 9 RBI Reserve Bank of India ROCE Return on capital employed RTGS Real time gross settlement SFF Safe, Furniture & Fixture STL Short term liability/Loan STS Short Term Source STU Short Term Use TNW Tangible net worth UPI Unified payments interface USP Unique selling proposition UV Ultra Violet WC Working capital 10  Unit-1: Accounting System Lesson No. 1.1 Concepts, Conventions and Principles Lesson No. 1.2 System of Accounting Lesson No. 1.3 Books of accounts to be maintained Lesson No. 1.4 Bank Reconciliation Statement Lesson No. 1.5 Trial Balance, Profit & Loss and Balance Sheet 11 Lesson No. 1.1: Concepts, conventions and principles 1.1.1 Objectives 1.1.2Meaning and Purpose of Accountancy 1.1.3 Basic Terms in Accountancy 1.1.4 Accounting Principles 1.1.5 Accounting Concepts 1.1.6 Accounting Conventions 1.1.7 Let us sum up 1.1.8 Key words 1.1.9 Multiple choice questions 1.1.10 Answer keys 12 1.1.1 Objectives The objectives of this lesson are to understand:  The meaning and purpose of accountancy  Basic terms in accounting  Accounting principles  Accounting concepts  Accounting conventions and principles 1.1.2 The meaning and purpose of accountancy Business involves transactions for exchange of goods or services against cash or credit. These transactions take place throughout the year. As the business volumes increases, it is beyond the capacity of the owner to remember all the transactions. This necessitates recording of the business transactions in systematic and orderly manner. The recording of business transactions has to be systematic, so that it will provide useful information to the owner about the financial position of the business entity. Book keeping is the system of recording the business transactions in a set of books. The recording of transactions has to be based on some documents which evidence the nature and the amount of such transactions. From book keeping the owner might ascertain details such as total purchases, total sales, total expenses, cash, etc. The term ‘Book keeping’ and ‘Accounting’ are often used interchangeably. However accounting is a much wider concept and it starts where book keeping ends. In other words, book keeping is concerned with the recording of transactions in the books, the original entry, based on the documentary evidence, whereas, accounting is concerned with grouping of the transactions, interpreting them and presenting them in a specific manner to communicate the results of the entity. Together, these are called “Book of Accounts”. Book keeping is the art of identifying & recording all such business transactions which can be recorded and measured in money terms, in the book of accounts. Accounting is the process of classifying, summarizing and analyzing all monetary transactions and communicating the required information relating to the organization to the interested users of such information. 13 1.1.3 Basic terms in accounting Purchases: Purchases indicate the money value of goods which the owner purchases as raw material for the process of manufacture or for the purpose of trading in goods. It includes both cash and credit purchases. Creditors: When goods are purchased against the assurance to pay in future, such goods are said to be purchased on credit and the suppliers of those goods are called creditors and purchasers of goods are called debtor. Sales: Sales are revenues generated from sale of goods. It includes both cash sales and credit sales. Assets: Properties/resources owned by the enterprise are called assets. Assets can be classified into current assets, fixed assets and non-current assets. Current assets are those assets, which are held for a short period of time, say up to one year e.g. cash, stock, debtors etc. Fixed assets are of long term in nature and they are acquired for increasing the income/profit generating capacity of the enterprise e.g. land and building, plant and machinery etc. Non- current assets can include investments, long term loans given to parties, etc. Tangible assets are those assets which are physically visible and can be touched and felt; like Building, Machine etc. Intangible assets are those assets which cannot be seen and touched. They are non-visible, like Goodwill, patent, Trade Mark etc. Liabilities: These refer to the amounts owed by the business to others. These are the obligations that the enterprise must repay in future. Capital: This is the amount invested by the owner in the business. The amount introduced in the business by the owner is a liability for the business entity (entity means either a Company or a Proprietary Firm or a Partnership firm). 14  Capital= Assets- Liabilities Drawings: Drawings occur in the case of sole proprietor and partnerships. It is the amount withdrawn by the ownerr from the business. Any drawings from the business, reduces the net-worth of the enterprise. Net-worth: It is also the owners’ fund. It includes the capital plus reserves. Net-Worth = Total Assets - Total outside liabilities = Share Capital + Reserves + Profits + Retained Earnings Contingent liabilities: These are liabilities, which might arise in future depending on the happening or non- happening of any future event. Profit and loss account: It is statement of total revenues and total expenses (which would include purchases, cost of running business, etc.) of the enterprise over a period of time. A firm/company is said to be in profit, when the revenues are more than expenses and in loss, when expenses are more than revenues. Balance Sheet: It is a statement of total assets and total liabilities of the enterprise on a particular date say, at the end of a financial year. Capital expenditure: It refers to funds that are used by a company for the purchase, improvement, or maintenance of long-term assets, benefit of which is received over a longer period, to improve the efficiency or capacity of the company.For example, expenditure incurred, on purchase of plant and machinery, land and building etc. Revenue expenditure: It is the expenditure, the benefit of which is received within an accounting year and is incurred for running the business on a day to day basis. For example, expenses for rent payment, electricity expenses etc. 15 Deferred revenue expenditure: It is revenue in nature, the benefit of which is however extended beyond a period of one year. These expenses are written off over a period of time. Example: Preliminary Expenses, advertising expenses etc. 1.1.4. Accounting Principles Financial statements such as Profit and Loss Account and Balance Sheet are used by different stakeholders such as owners, bankers, investors etc for different purposes. In order to maintain the consistency and uniformity in recording and maintaining of the books of accounts, certain principles have evolved over a period of time, called accounting principles. The principles, which are followed in maintaining the books of accounts, are classified as  Accounting Concepts and  Accounting Conventions. 1.1.5. Accounting Concepts Accounting concepts are the necessary assumptions, conditions or postulates upon which the accounting is based. Separate Entity Concept This concept differentiates the identity of the owner or proprietor from the enterprise. According to this concept, capital brought in to the business by the proprietor is considered as a liability of the enterprise. Any drawings from business for personal use of proprietor, results in, bringing down the capital of the enterprise. For example, if Mr. ABC purchases plant and machinery of ₹. 100,000, for the enterprise, these would be assets of the enterprise and not of Mr. ABC and ₹. 1, 00,000 would be shown as capital introduced by Mr. ABC. Money Measurement Concept This concept implies that only those transactions, which can be measured in terms of money only, are recorded in the books of the enterprise. Therefore assets of the company 16 should not be measured in the terms of the physical units (10 machineries; 20office cabinets etc., but have to be recorded in terms of money. Further, events such as death of the partner, existence of very loyal committed employees, etc. cannot be recorded in the books of the company Accounting Cost Concept This concept assumes that the assets are recorded in the books of the firm at acquisition cost in the first year of accounting and thereafter at ‘book value’ (Acquisition cost- *Depreciation) and not of market value or realisable value. For example, if an asset is purchased by the firm at ₹. 1, 00,000, its value would be recorded in the books at ₹. 1, 00,000 in the first year of accounting and book value in subsequent accounting yea₹ even if the market price of the same is something else.  Depreciation is defined as the reduction of recorded cost of a fixed asset, as prescribed by income tax department, in a systematic manner until the value of the asset becomes zero or negligible Accrual Concept This concept assumes recording the revenues in the accounting year when they are earned and not when they are received in cash, and recording the expenses in the accounting year when they are incurred and not when they are paid. For example, if salaries of the employees for the month of March 21 are paid on the 7th of April 21, the expenses shall be booked for FY 20-21 not for FY 21-22. Dual Aspect Concept In accounting concept, every transaction has a dual effect i.e. both debit & credit. When one head is debited the proceeds are credited to another head. For example, if Mr. ABC pays salaries of ₹. 500000 to his employees "Salaries” head is debited for the amount & individual staff accounts are credited aggregating to the same amount. 17 Realization Concept This concept assumes recording the revenues in the accounting year when they are received and not when they are earned, and recording the expenses in the accounting year when they are paid and not when they are incurred. For example, if salaries of the employees for the month of March 21 are paid on the 7th of April 21, the expenses shall be booked for FY 21-22 not for FY 20-21. Going Concern Concept This concept implies that in accounting, a business is expected to continue for a fairly long time and carry out its commitments and obligations and also assumes that the business will not be forced to stop functioning in near future and liquidate its assets at “fire-sale” prices. Accounting Period Concept According to this concept, all the transactions are recorded in the books with the assumption that profit/loss is to be ascertained for specific period say a year, six months, three month etc, called accounting period Accounting period for the enterprise can be a calendar year or financial year. Matching Concept This concept states that income of a certain period has to match with the expenses of that period. This concept has its base in the ‘Accounting period’ concept. In other words, this concept states that the revenue earned and the expenses incurred to earn the revenues must belong to the same accounting period. This concept helps in determining the exact profit or loss for a particular period. 1.1.6. Accounting Conventions Accounting conventions refer to the common practices which are universally followed in recording and presenting accounting information of the business entity. Following are the most important conventions which have been practiced over a long period: 18 Consistency This convention means that same accounting principles should be used for preparing financial statements year after year and whenever it is necessary to change, the impact of such change must be given separately. For example a company may adopt a straight line method, written down value method or any other method for providing depreciation on fixed assets. However it is expected that a company follows a particular method of depreciation for long yea₹. Materiality According to this convention, all material details are to be reported and insignificant details can be ignored. An item can be considered as material, if there is a reason to believe that knowledge of it would influence the decision of the informed investor. Thus the materiality of the fact depends on the nature and the amount involved. For example, a businessman sets up the plant for manufacturing of plastic goods. He purchases plant and machinery, office furniture, raw materials etc. These items are significant items; thus they should be recorded in books of accounts in detail. At the same time, he also purchases pens, pencils, papers, registers, etc. to maintain day to day office work where he will use a small amount of his capital. Now here, maintaining the details of every pen, pencil, match box or other small items is not considered of much significance and these should not be recorded separately. An item may be material for one concern but immaterial for another concern or material for one year or immaterial for another year. The accountant has to judge relative importance of each item and its significance. Conservatism This states that an enterprise must take into account all possible losses but do not take into account expected future gains. As per this convention, revenues or gains should be recognised only when they are realised. However provision for all known liabilities, expenses and losses must be made. It is based on the premise that profit should not be overstated. 19 For example, valuing closing stock at cost or market price whichever is lower, creating provision for doubtful debts, discount on debtors, writing off intangible assets like goodwill, patent, etc. Full disclosure It requires that all relevant and material details of the financial statements are disclosed. This implies that accounts must be honestly prepared and all material information must be disclosed therein. There are many disclosures required by the Accounting Standard rules prescribed by the Companies Act, 2013. 1.1.7 Let’s sum up The term ‘Book keeping’ and ‘Accounting’ are often used interchangeably. However accounting is a much wider concept and it starts where book keeping ends. Further, basic accounting terms such as Sales, purchases, creditors, debtors, assets, liabilities, capital, net-worth, contingent liabilities, depreciation, profit and loss account, balance sheet, capital expenditure, revenue expenditure, deferred revenue expenditure are explained in this module. In order to maintain the consistency and uniformity in recording and maintaining of the books of accounts, certain principles have evolved over a period of time, called accounting principles. The principles, which are followed in maintaining the books of accounts, are classified as concepts and conventions GAAP Accounting Concepts Accounting Conventions 20 1.1.8 Key words Book keeping, Accounting, Accounting concepts, Depreciation 1.1.9 Multiple Choice Questions 1. According to accrual concept of accounting, financial or business transaction is recorded a. When cash is received or c. When profit is computed paid d. When balance sheet is b. When transaction occurs prepared 2. M/S ABC Company provides advertising services to an investment company in the month of March 20 but receives advertising fee in the month of April 20. M/S ABC recognizes this revenue in financial year 19-20. This action of M/S ABC is justified by a. Business entity concept 21  b. Revenue recognition c. Economic entity concept principle d. Going concern concept 3. A company is a going concern if a. Its balance sheet shows a c. There is no evidence that it strong financial position will or will have to cease b. Its income statement for operations within the current year shows foreseeable future. huge profit d. It is a public limited company 4. Which accounting concept or principle states that the transactions of a business must be recorded separately from those of its owners or other businesses? a. Materiality concept of c. Matching principle of accounting accounting b. Time period concept of d. Business or economic accounting entity concept of accounting 5. The business or economic entity concept is applicable to: a. Sole proprietorship form c. Corporate form of of business business b. Partnership form of d. All of the above business 6. The revenue is not recognized until it is earned and realized or at least realizable. To which accounting principle/concept this statement belongs? a. Separate entity concept c. Going concern concept d. Conservatism concept b. Revenue recognition principle 7. In certain situations, companies might recognize losses but not gains. This action belongs to: a. Revenue recognition c. Conservatism principle principle d. Matching principle b. Monetary unit assumption 22 8. Which accounting principle/concept allows accountants to ignore other accounting principle/concept if the amount in question is immaterial? a. Materiality concept c. Conservatism principle b. Monetary unit assumption d. Matching principle 9. The art of recording, classifying and summarizing is called: a. Journalizing c. Bookkeeping b. Accounting d. Record Keeping 10. The position of assets and liabilities during an accounting period is shown in a. Balance sheet c. Cash flow statement b. Profit and loss account d. None of the above. 11. The position of income and expenditure as on particular date can be depicted from a. Balance sheet c. Cash flow statement b. Profit and loss account d. None of the above. 12. The position of income and expenditure during an accounting period can be depicted from a. Balance sheet c. Cash flow statement b. Profit and loss account d. None of the above 13. The position of assets and liabilities on particular date is shown in a. Balance sheet c. Cash flow statement b. Profit and loss account d. None of the above. 14. What the company owns is called? a. Asset c. Capital b. Liability d. Capital expenditure 15. What the company owes is called? a. Asset c. Capital b. Liability d. Capital expenditure 16. Benefits if expenditure is received over a long period is called a. Asset b. Revenue expenditure 23  c. Capital d. Capital expenditure 17. The person to whom goods are sold on credit and owe money to the organisation a. Debtor c. Prepaid expenses b. Creditor d. Advance payment 18. The person to whom organisation owes money: a. Debtor c. Prepaid expenses b. Creditor d. Advance payment 19. Debtor is a. Current asset c. Contingent liability b. Current liability d. Fixed asset 20. Creditor is a. Current asset c. Contingent liability b. Current liability d. Fixed asset 21. Plant & Machinery is a. Current asset c. Contingent liability b. Intangible asset d. Fixed asset 1.1.10 Answer keys 1-b 2-b 3-c 4-d 5 6-b 7-c 8-a 9-b 10-d 11-d 12-b 13-a 14-a 15-b 16-d 17-a 18-b 19-a 20-b 21-d Lesson No. 1.2: System of accounting 1.2.1 Objectives 24 1.2.2 Different accounting systems 1.2.3 Flow of an accounting transaction 1.2.4 Source documents 1.2.5 Types of vouchers 1.2.6 Identifying two accounts in a transaction 1.2.7 Three golden rules of accounting 1.2.8 Five golden rules of accounting 1.2.9 Let’s sum up 1.2.10 Key words 1.2.11 Multiple choice questions 1.2.12 Answer keys 1.2.1 Objectives 25 The objectives of this lesson are to understand:  Different accounting systems  Double entry accounting system  Different types of accounts 1.2.2 Different accounting systems There are many systems followed for maintaining books of accounts. It depends on the nature of business, volume of business, and the regulatory requirement for the same. Following are the various systems of accounting Single Entry system: A single entry system of accounting is a form of bookkeeping in which each of a company’s financial transactions is recorded as a single entry in a log. This process does not require formal training and is usually used by new small businesses because of its simplicity and cost effectiveness. It records the date, description, the value of the transaction and whether it’s an income or expense, and then the balance. Double entry system Every business transaction has two fold effects with the same amount i.e. Debit and Credit. The number of accounts in both sides i.e. debit and credit side, may be more than one but the total amount of both sides shall remain equal. Example:  A borrows from bank.₹100000 ✓ Cash/bank account will increase by ₹ 100000. ✓Liability to pay will also increase by₹ 100000 Therefore, under double entry accounting system, the arithmetical accuracy of the records is automatically checked. 1.2.3 Flow of an accounting transaction 26  Business transaction Generation of source documents like bill,invoice,reciept etc. Identifying two accounts of the transaction.Generating a voucher Journal Entry Effect into Ledger Trial Balance Preparation of Profit and Loss Account and Balance Sheet Source documents and voucher are explained below. Other components are explained in subsequent paragraphs and chapter. 27 1.2.4 Source documents As shown above, accounting transactions starts from business transaction and a document which provides evidence of the transactions is called the ‘Source Document’. This source documents may be cash memo, sales invoice, expenses invoice etc. Based on such supporting source documents, accounting vouchers are prepared. Accounting voucher give details of the transaction and are prepared and authorised by authorised officials. While preparing the accounting voucher, short notes is being written on voucher, called "Narration". The basic purpose of narration is to provide short details through which an independent person can understand the flow of cash/fund. 1.2.5 Types of vouchers Cash voucher These vouchers are prepared only when the business transaction is in cash i.e. business has either paid cash or received cash. If business has received cash there will be cash receipt voucher and if paid by business there will be cash payment voucher. Transfer voucher All non-cash transactions are recorded through the transfer voucher. Examples of non- cash transactions are credit purchases, depreciation of goods, transfer from one account to other account etc. 1.2.6 Identifying two accounts in a transaction 28 As stated earlier, in each business transaction minimum two accounts are involved and hence it is very important to identify the affected accounts correctly. Classification of Accounts Personal A/c Impersonal A/c Natural Personal A/c Artificial Personal A/c Representative Personal A/c Real A/c Nominal A/c Tangible Real A/c Intangible Real A/c Personal Accounts:  These accounts which are related to individuals, firms, companies, etc o Natural personal account: Personal account & God’s account eg. Kumar’s A/C, Adam’s A/C, etc. 29  o Artificial personal account: Accounts which are created artificially by law. Example: Pvt. Ltd companies, LLCs, LLPs, clubs, schools, etc. o Representative personal account: Accounts which represent a certain person or a group directly or indirectly. Example: Wage prepaid account Real Account:  All assets of a firm, which are tangible or intangible, fall under the category “Real Accounts". o Tangible Real account: Those assets which is physical in nature. Example: Building, machinery, stock, land, etc o Intangible Real account: Those assets that is not physical in nature. Example: Good will, patents, trademarks, etc. Nominal Account:  Accounts which are related to expenses, losses, incomes or gains.  Nominal accounts do not really exist in physical form, but behind every nominal account money is involved. E.g. Purchase A/C, Salary A/C, Sales A/C, Commission received A/C, etc.  The final result of all nominal accounts is either profit or loss which is then transferred to the capital account. 1.2.7 Three Golden Rules of Accounting When any business transactions occur, any two or more accounts mentioned above will either be debited or credited & shall be governed by the Three Golden Rules of Accounting which is as under: Types of Account Example Rules Individual/ Artificial Personal Debit the Receiver, Credit the /representative giver Real All assets Debit what comes in, Credit what goes out Debit the expenses or loss of the business Nominal Expenses/ Gains Credit the income or gain of the business 30 1.2.8 Five Golden Rules of Accounting For simplification there is another school of thoughts under which all the affected accounts are classified in five categories as Asset, Liability, Owner’s equity, Revenue and Expense and rules of accounting on this basis is called “5 Golden Rules of Accounting”. When any business transactions occur, any two or more accounts mentioned above will either increase or decrease and their rules of debit & credit shall be governed by the following rules. Account Increase/Decrease Debit/Credit Asset Increase Debit Asset Decrease Credit Liability & Owner's Increase Credit Equity Liability & Owner's Decrease Debit Equity Revenue/Income Increase Credit Revenue/Income Decrease Debit Expenses/Loss Increase Debit Example Expanses/Loss Decrease Credit Nature of Transactions Accounts involved Debit/Credit account Rent a/c Nominal a/c Debit Rent paid Bank a/c Real a/c Credit Salary a/c Nominal a/c Debit Salaries paid Bank a/c Real a/c Credit Bank a/c Real a/c Debit Interest received Interest a/c Nominal a/c Credit Bank a/c Real a/c Debit Dividends received Dividend a/c Nominal a/c Credit Furniture Furniture a/c Real a/c Debit purchased Bank a/c Real a/c Credit 31  Nature of Transactions Accounts involved Debit/Credit account A’s a/c Personal a/c Debit Paid to Mr. A Bank a/c Real a/c Credit Received from A Bank a/c Real a/c Debit (Prop.) Capital a/c Personal a/c Credit Bank a/c Real a/c Debit Machinery sold Machinery a/c Real a/c Credit Telephone charges Telephone charge a/c Nominal A/c Debit paid Bank a/c Real a/c Credit Received from Mr. Bank a/c Real a/c Debit A (Prop.) Capital A/c Personal a/c Credit Lighting a/c Nominal A/c Debit Lighting expenses Bank a/c Real a/c Credit Illustration no. 1 March 2021 1. Mr. A started business with cash ₹. 250,000. 2. Purchase goods for cash ₹. 15,000. 3. Sold good to Mr. B ₹. 5,000. 4. Purchase furniture for cash ₹. 30,000. 5. Bought goods from Mr. C ₹. 45,000. 6. Received from Mr. D ₹. 3,000. 7. Goods bought from Mr. E ₹. 10,000. 8. Sold goods to Mr. F ₹. 8,000. 9. Paid to Mr. G ₹. 25,000. 10. Sold goods for cash ₹. 12,000. 11. Paid rent of shop ₹. 17,000. Please identify the affected accounts & its type of each transaction with reasons based on golden rules. 32 Solution Sr Name of Type of Debit/ no. Rea sons Account Account Credit 1 Cash Real Dr. Cash comes in Mr. A(Capital) Personal Cr. Proprietor is a giver Purchase is an Purchase Nominal Dr. expense 2 Cash Real Cr. Cash going out Cash Real Dr. Cash comes in 3 Sales Nominal Cr. Income of the business Furniture Real Dr. Furniture comes in 4 Cash Real Cr. Cash goes out Purchase Nominal Dr. Purchase is an expense 5 Cash Real Cr. Cash going out Cash Real Dr. Cash comes in 6 Mr. D Personal Cr. Mr. D is a giver Purchase Nominal Dr. Purchase is an expense 7 Cash Personal Cr. Cash goes out Cash Real Dr. Cash comes in 8 Sales Nominal Cr. Income of a business Mr. G Personal Dr. Mr. G is a receiver 9 Cash Real Cr. Cash goes out Cash Real Dr. Cash comes in 10 Sales Nominal Cr. Income of the business Rent Nominal Dr. Rent is an expense 11 Cash Real Cr. Cash goes out 33 Illustration no. 2 An entity named Stranger Ltd. has the following transactions. 1. It deposits ₹.100000 into Bank 2. It buys goods worth ₹.150 000 from RIL 3. It sells goods worth ₹.85, 000 to L & T 4. It pays ₹.15,000 as rent for its premises 5. It earns ₹.13, 000 as interest on a bank account. Please identify the accounts involved in these transactions and classify them into the different types of accounts Solution Transactions Accounts involved Type of account Bank a/c Real a/c Deposited in bank Cash a/c Real a/c Purchase a/c Nominal a/c Bought goods from RIL RIL a/c Personal a/c L & T a/c Personal a/c Sold goods to L & T Sales a/c Nominal a/c Rent a/c Nominal a/c Paid rent Bank a/c Real a/c Bank a/c Real a/c Earned interest Interest a/c Nominal a/c 34 1.2.9 Let’s sum up There are various methods of maintaining accounts such as Indian system, cash system, and English system. The English system can be further classified into single entry system and double entry system. The double entry system of book keeping is based on the premise that every transaction has two aspects and the effect of both these aspects is to be recorded in the books of account. The basic rule of accounting is “every debit must have a corresponding credit and every credit must have a corresponding debit”. Business transactions are recorded in the books based on the source documents such as cash memo, sales invoice, purchase invoice etc. Based on the source documents accounting voucher are prepared. There are two types of vouchers such as cash voucher and transfer voucher. Cash voucher are used for recording cash transactions. Transfer vouchers are used for recording non-cash transactions. There are basically three types of accounts- Personalaccount, real account and nominal account. Personalaccount represents natural person, legal person and even representative grouped accounts (subsidiary ledger). Real account represents assets. Nominal account represents accounts related to expenses, losses, income and gains. Rule for Personalaccount is ‘Debit the Receiver and Credit the Giver.’ Rule for real account is ‘Debit what comes in and Credit what goes out. Rule for nominal account is ‘Debit Expenses and Losses and Credit Incomes and Gains. On the basis another school of thoughts there are five types of account- Asset, Liability, Owner’s equity, Revenue and Expense and rules on the basis of these accounts are called "5 Golden Rules of Accounting” 1.2.10 Key words: Double entry system, Personal accounts, Real accounts, Nominal accounts, Narration 35 1.2.11 Multiple Choices Questions 1. Identify the affected accounts When goods are purchased on cash, a. Stock account & Cash c. Bank account & stock account account b. Cash account & bank d. Supplier account & stock account account 2. W hen goods are purchased on cash, w hich account shall be credited a. S tock account c. B ank account b. Cash account d. S upplier account 3. W hen goods are purchased on cash, w hich account shall be debited a. Stock account c. B ank account b. C ash account d. S upplier account 4. W hen goods are sold on cash, w hich account shall be credited a. Stock account c. B ank account b. C ash account d. S upplier account 5. W hen goods are sold on cash, w hich account shall be debited a. S tock account c. B ank account b. Cash account d. S upplier account 6. Identify real account/s a. Insurance premium c. Commission received b. Properties d. Drawing 7. Identify nominal account/s a. Income tax account c. Commission received b. Properties d. Drawing 8. Identify personal account/s 36  a. Income tax account c. Outstanding salaries b. Drawing d. All of the above 9. Identify nominal account/s a. Provision of depreciation c. Loans and advances b. Investments d. All of the above 10. "Drawing" is a. Real account c. Nominal account b. Personal account d. Tangible account 11. Identify the affected accounts when Purchased goods from Mr X a. Purchase account & Mr. X c. Purchase account & cash account account b. Sales account & Mr. X d. None of the above account 12. Identify the affected accounts when paid shop rent a. Rent account and bank c. Rent account and Mr. X account account b. Rent account & cash d. Cash account and bank account account 13. Identify the affected accounts when goods bought from Mr. X a. Sale account & Mr. X c. Bank account and Mr. X account account b. Cash account & Mr. X d. Purchase account and Mr. account X account 14. Which accounts shall be debited when goods sold to Mr. X a. Sales account c. Cash account b. Mr. X account d. None of the above 15. Identify the affected accounts when ₹. 10000/ deposited in bank a. Capital account & bank c. Capital account & cash account account b. Bank account & cash d. None of the above account 37  16. Identify the types of affected accounts when interest earned on bank account a. Nominal & Real account c. Real & personal account b. Nominal & Personal d. All of the above account 17. Which account shall be debited when interest earned on bank account a. Interest received account c. Personal account b. Bank account d. Intangible account 18. Which account shall be credited when interest earned on bank account a. Interest received account c. Personal account b. Bank account d. Intangible account 19. Identify the affected accounts when purchased furniture for cash from Mr. X a. Purchase account & bank c. Furniture & cash account account d. Any one of the above b. Purchase account & MR X account 20. Identify the types of affected accounts when purchased furniture for cash from Mr. X a. Real & Real account b. Nominal & Personal account c. Real & personal account d. All of the above 1.2.12 Answer keys 1-a 2-b 3-a 4-a 5-b 6-b 7-c 8-d 9-a 10-b 11-a 12-b 13-d 14-b 15-b 16-a 17-b 18-a 19-c 20-a 38 Lesson No. 1.3: Books of accounts to be maintained 1.3.1 Objectives 1.3.2 Background 1.3.3 Journal format 1.3.4 Subsidiary books/special journals 1.3.5 Various types of subsidiary journals 1.3.6 Adjusting entry 1.3.7 Ledger 1.3.8 Balancing of ledger 1.3.9 Difference between journal & ledger 1.3.10 Let’s sum up 1.3.11 Key words 1.3.12 Multiple Choice questions 1.3.13 Answer keys 39 40 1.3.1 Objectives The objectives of this lesson are to understand:  Introduction  Journal – meaning and Format  Subsidiary Books/ Cash Book  Posting into Ledger  Balancing of Books 1.3.2 Background We have seen in earlier lesson that Business transactions are classified into five categories of accounts such as assets, liabilities, expenses, revenue and capital/owner equity and once a decision is taken on types of accounts and its debit or credit, its recording in a book is required,, called Journal and the process of recording of transactions is known as recording "Journal Entries "A journal is a book of “original entry” or “primary entry” as it is a book of accounts in which all day to day business transactions are recorded in a chronological order (i.e. in the order of their occurrence).Since this is first step in accounting, hence, this is also called Original or Prime entry. Depending upon the volume and complexities of the transactions, business houses may maintain only one Journal Book or many “Subsidiary books”. When transactions are large in number and cumbersome, it is necessary to divide the whole Journal into several subsidiary journals. 1.3.3 Journal format It has 5/6 columns and for the sake of simplicity we have taken 6 columns. Date Particular Nature of LF Amount account (1) (2) (4) Debit Credit (3) (5) (6) Steps for recording 41  1. Determine the a/c and its nature before recording 2. Determine applicable rules to ascertain which a/c is to be debited &which is to be credited. 3. Record the date of transaction in chronological order in column no.1 4. Particular (Column no. 2) a. Extreme left---Write Name of a/c to be debited & in the same line Extreme right….write "Dr" b. 2nd line in the same row and same column, write Name of a/c to be credited and prefixed by "To" c. Below the 2nd line under bracket in the same row and same column, short explanation of transaction, called Narration, is written. 5. Nature of account (Column no.3) a. Name of the affected account is written. b. Practically this columndoes not exist. 6. Ledger folio (Column no.4) a. Respective number of Ledger folio where these entries are to be transferred at later stage i.e. at the time of posting and hence at the time recording it is kept blank. 7. Debited & Credited amount is recorded in respective column (Column no. 5 & 6) Illustrations no. 1 Journalize the following transactions in the books of Mr. A i. Jan. 1, 2021 Mr. A started a business with cash of ₹ 40000 ii. Jan. 3, 2021 He paid into bank ₹ 20000 iii. Jan. 5, 2021 Purchased goods for cash ₹ 15000 iv. Jan. 10, 2021 Sold goods for cash ₹ 6000 v. Jan. 11, 2021 Sold goods Mr. B ₹ 3000 vi. Jan. 31, 2021 Paid for stationery for ₹ 600, rent for ₹1000 & telephone bill for ₹500. 42  Solution Sr.no Date Particular Nature LF Dr. Cr. of a/c 1 Jan 1 Cash a/c Dr Real 40000 2021 To capital a/c Personal 40000 (Being commencement of business) 2 Jan 3 Bank a/c Dr Personal 20000 2021 To cash a/c Real 20000 (being cash deposited in the bank) 3 Jan 5 Purchase a/c Dr Nominal 15000 2021 Cash a/c Real 15000 4 Jan 10 Cash a/c Dr Real 6000 2021 To sales a/c Nominal 6000 (Being goods sold for cash) 5 Jan 11 B a/c Dr Personal 3000 2021 To sales a/c Nominal 3000 (Being goods sold to B) a/c 6 Jan 31 Stationery a/c Dr Real 600 2021 Rent a/c Dr Nominal 1000 Telephone bill Dr Nominal 500 To Cash a/c Real 2100 (Being cash paid for stationery, rent& Telephone expenses) Total 86100 86100 Illustrations no. 2 Journalize the following transactions in the books of Mr. B 1. May 1 2021 Mr. B started business with cash of ₹ 350000 2. May 2 2021 Purchased machinery for ₹ 200000 from M/S XYZ Pvt. Ltd Purchased furniture for ₹ 20000 from Mr. C 3. May 8 2021 Purchased goods for ₹ 80000 4. May 12 2021 Sold goods for ₹ 10000 5. May 16 2021 Purchased goods from Mr. D for ₹5000 6. May 18 2021 Sold goods to Mr. E for ₹30000 43  7. May 31 2021 Paid for stationery for ₹.600, rent for ₹10000 & telephone bill for ₹1500. Solution Journal Entries (In the books of Mr. B) Sr.n Date Particular Nature of L Dr. Cr. o a/c F 1 May 1 Cash a/c Dr Real 350000 2021 To capital a/c Personal 350000 (Being commencement of business) 2 May 2 Machinery a/c Dr Real 200000 2021 To M/S XYZ pvt ltd a/c Personal 200000 (Being machinery bought from M/S XYZ pvt ltd) 2 May 2 Furniture a/c Dr Real 20000 2021 To Mr C a/c Personal 20000 (Being furniture bought from Mr C) 3 May 8 Purchase a/c Dr Nominal 8000 2021 To Cash a/c Real 8000 (Being goods purchased for cash) 4 May 12 Cash a/c Dr Real 10000 2021 To sales a/c Nominal 10000 (Being goods sold for cash) 5 May 16 Purchase a/c Dr Nominal 5000 2021 To Mr D a/c Personal 5000 (Being goods purchased from Mr D) May 18 Mr E a/c Dr Personal 30000 2021 To Sales a/c Nominal 30000 (Being goods sold to Mr E) 6 May 31 Stationery a/c Dr Real 600 2021 Rent a/c Dr Nominal 10000 Telephone bill Dr Nominal 1500 To Cash a/c Real 12100 (Being cash paid for stationery, rent & Telephone expenses) Total 63510 635100 0 44 1.3.4 Subsidiary books/ Special journals In case of small businesses, it is convenient to maintain one Journal. However for large number of business transactions, the Journal would be very huge and it would be very difficult to make a ready reference to such a Journal. Further it would be very difficult for many accountants to handle the same journal. A logical solution to this problem would be to group similar types of transactions and record them at one separate Journal. Thus special journals are those journals, which are meant for recording repetitive type of transactions. For example, Cash book would be maintained for cash transactions, purchase book would be maintained to record all credit purchases of the organization. Thus as similar transactions are grouped together under subsidiary journal; there is no need to record the entries in the form of ‘Journal Entry’ as described above. In other words, instead of writing several repetitive separate entries for each credit sales as Various Customers A/c…….. Dr. To Sales a/c; A Sales Journal is maintained where details of the all the customer would be mentioned along with date and amount and thus separate ‘Journal Entry’ as shown above need not be passed for every transaction. In the Sales Journal, the account that would be credited would be the same for all entries i.e. Sales A/c and same procedure apply for other subsidiary maintaining one journal or many subsidiary journals does not make any difference in the subsequent accounting process i.e. at the time of posting, preparation of Trial balance and financial statements 1.3.5 Various types of subsidiary journals Subsidiary Category of business transactions recorded Journals Sales Book All sales on credit basis Purchase Book All purchases on credit basis All transactions of return of goods by our customer i.e. Sales return book Return Inwards 45  Subsidiary Category of business transactions recorded Journals All transactions of return of goods purchased from the Purchase return book supplier i.e. Return Outward Cash Book All cash/ Bank receipts and payments All remaining transactions, which cannot be entered in the above mentioned journals, are entered in this book. Journal proper (Transactions are entered in the Journal Entry form, which is described earlier) Cash book with cash and bank column Nowadays with the increase in the number of bank transactions, it is required to have a separate bank book on similar lines of the cash book. Sometimes instead of having separate book to record bank transactions, a column is added on to each side of the simple cash book. This is called Bank Column Cash Book. As recorded in the cash book, all receipts into the bank account are recorded on the debit side of the bank book and all withdrawals/payments from the bank account are recorded on the credit side of the bank book. Petty cash book In addition to above mentioned Subsidiary Journals, petty cash book is maintained for recording small expenses such as conveyance, postage, stationery etc. Generally imprest system is followed in the petty cash system. Under this system a specific sum is handed over to the officials concerned at the beginning of the period and he/she meets all the small payments through this amount. At the end of the period he/she submits all the vouchers to the cashier and gets the amount reimbursed. Thus at any given point of time, the cash and vouchers with the petty cashier tally with the amount specified at the beginning of the period. 46 Illustration no.2 Prepare Bank Column Cash Book for March 2021 Date Details Amount (₹.) 2018 Mar 2 Cash in hand 15000 Mar 4 Bank Overdraft 9000 Mar 5 Paid Wages 1000 Mar 7 Cash Sales 20,000 Mar 12 Cash deposited into Bank 15,000 Mar 16 Purchased Goods and paid by cheque 8,000 Mar 22 Cash deposited into Bank 5,000 Mar 23 Paid Trade Expenses by cheque 2000 Mar 23 Rent paid 5000 Mar 25 Received Cash from ABC 9000 Mar 27 Commission paid 4,000 Mar 29 Salary paid 10,000 Mar 31 Bought Goods by cheque 7,000 Solution: Bank Column Cash Book Date Particular LF Cash Bank Date Particular L Cash Bank F Mar Mar 2 To Bal 15,000 4 By Bal b/d 9,000 b/d 7 To Sales 20,000 5 By wages 1,000 A/c A/c 12 To Cash 15000 12 By Bank 15,000 A/c A/c 22 To Cash 5000 16 By Goods 8,000 A/c A/c 47 25 To ABC 9,000 22 By Bank 5,000 A/c A/c 31 To Bal 6000 23 By Trade 2,000 c/d Exps A/c 23 By Rent A/c 5,000 25 By 4,000 Commissio n A/c 29 By Salary 10,000 A/c 31 By Goods 7000 A/c 31 By Bal c/d 4,000 44,000 26,000 44,000 26,000 1.3.6 Adjustment entry To justify the principle of matching cost and revenue, amount of every expenses and revenue should pertain to the period for which accounts are being prepared. There can be a situation where amount received or paid is for more than one accounting year or the amount due to be paid or received for the current year is not paid/received. Further there are adjustment entries for charging depreciation, recording of the closing stock entry etc. Examples 1. Amount received is for more than one accounting year (income received in advance) Since some income has been received in advance for next accounting period also hence in view of principle of matching cost and revenue, income head is to be debited and advance income received account, which is liability for next accounting year, should be credited. Income A/c ……………………. Dr To advance income received account (Liability) A/c 48 2. In the same manner it is possible that we paid some expenses in advance. For example if we got insured our stocks in the month of January 21 for 12 months and paid ₹ 12000/ as premium. The adjustment entry shall be as under Prepaid expenses a/c Insurance Dr To Expenditure a/c Insurance There may be many entries/transaction of such nature. Here we are giving some common entries and their journal entries. 3. Outstanding Expenses: Those expenses which should be paid in last accounting year but paid in subsequent accounting period. Salaries (Expense) A/c ………………. Dr To Salaries outstanding (Liability) A/c (Salaries not paid for the month of March’21 provided for) 4. Accrued income Income earned but not yet received is the accrued income. Accrued income is an asset as income is already earned but not received. Accrued income Fee A/c ………………. Dr To Fee (Income) A/c (Being service fee due but not yet received) 49 5. Closing Stock At the end of the accounting period unsold stock is called closing stock. Keeping the principles of matching cost and revenue in mind, the value of closing stock (Unsold stock) must be account for. Closing stock A/c (asset side of the balance sheet)………….. Dr To closing stock (Right side of Profit and Loss account) 6. Provision for bad and doubtful debt As per regulatory norms, certain %age of debts is provided for provision for bad and doubtful debt in the banking industry and in the same manner in business also, loss on credit sales are estimated and provided accordingly. Their journal entry shall be passed as under. Expenditure a/c Provision for bad & doubtful reserve (P & L account) Dr To bad and doubtful reserve (Balance sheet) 7. Bad debts: Once it is confirmed that amount would not be realized from certain debtors, it is termed as bad debts. The amount of bad debts has to be deducted from the debtors and the amount has to be booked as loss in the profit and loss account. The journal entry for accounting shall be passed as under Bad debts A/c (P & L a/c) Dr To Debtor A/c ((Balance sheet) (Being bad debts written off) Bad and doubtful reserve (BDDR) (Balance sheet) Dr To bad debts (P & L a/c) 50 In certain business and industries, certain %age of debts has to be maintained as reserve for bad and doubtful debts which should be maintained by debiting Expenditure a/c provision for bad & doubtful reserve (P & L account) and crediting to Bad and doubtful reserve by deficit amount. For example, i. If the opening balance of BDDR as on 01.04.2021 is ₹. 5,000. The bad debts for the year 2021-22 are ₹. 1000 and the reserve required for the current year is ₹. 5,500. The additional provision required is ₹. 1,500 (debit to Profit and Loss account) {5,500 – (5,000-1000)} ii. If the opening balance of BDDR as on 01.04.2021 is ₹. 5000. The bad debts for the year 2021-22 are ₹. 1000 and the reserve required for the current year is ₹. 3500. The provision that would be reversed to the Profit and Loss account is ₹. 500 (credit to Profit and Loss account) {3,500 – (5,000-1000)} 1.3.7 Ledger Ledger is an accounting book which contains permanent record of all transactions in classified & summarized manner. At the time of the recording in the Journal Entry, the accounts are identified and are debited and credited based on rules as we discussed in earlier lesson. Then all the accounts identified at the Journal Entry stage are opened in the book separately, called as Ledger. Therefore a ledger is a book of account; where all accounts related to assets, liabilities, capital, revenue, expenses are maintained separately. The process of transferring the entries from Journal/ Subsidiary Journal to the individual account is called Posting. In other words, the process of transferring “Debit” & “Credit "entries from Journal (Book of prime entry)to respective a/cs in ledger(Principal book of account) is called Ledger posting 51 Format of the Ledger Name of Account Dr Cr Date Particular JF Amount Date Particular JF Amount Ledger is a book containing many pages, each page is called "Ledger Folio" and they are consecutively numbered, called "Ledger Folio no." All identified accounts (Assets, Liabilities, Capital, revenue, Expenses) are opened in the folio separately. Steps for posting  Identify first affected a/c in first journal entry.  Open folio of respective account  Write date and amount of transaction in respective side i.e. Dr/Cr of ledger folio.  Particular Column o Debit side write name of a/c credited prefixed by "To" o Credit side write name of a/c debited prefixed by "By"  Write respective folio no. of journal under column "JF" of ledger and write respective folio no. of ledger under column "LF" of journal which was kept blank at the time recording in journal.  Similar procedure is followed for posting all entries of journal  Periodicity of posting may vary from one day to one month depending upon number of business transaction per day. 1.3.8 Balancing of Ledger After all entries are posted in the ledger, next step is the balancing of the ledger accounts. Balance of any account is the difference between the total of the debits and total of credits of an account. If the debit side is more than the credit side, the balance calculated is the debit balance. Similarly when the credit side is more than the debit side, the balance calculated is the credit balance. At the end of the financial year of the organization, all ledger accounts are closed by taking out the balance of each account. Then the balances are carried over to next accounting period. (Examples are given above) 52 Steps of balancing  Total both sides (Debit/Credit side) of the ledger and find the larger total.  Put the larger total in the total box on the debit / credit side.  Insert a balancing figure to the side of the account which does not currently add up to the amount in the total box.  Call this balancing figure either ‘To/ By balance c/f’" (carried forward) or ‘To/By balance c/d" (carried down).  Carry the balance down diagonally and call it ‘balance b/f’' (brought forward) or ‘balance b/d’ (brought down) prefixed by "To or By" appropriately. 1.3.9 Difference between Journal & Ledger  Journal is called the original book of entry because the transaction is recorded first in the journal. Ledger, on the other hand, is called the second book of entry because the transaction in the ledger is transferred from journal to ledger.  In a journal, the entry is recorded sequentially, i.e., as per the happening of the transaction. In the ledger, the entry is recorded account wise.  The act of recording into the journal is called journaling. The act of recording into the ledger is called posting.  In a journal, the narration is a must because otherwise, the entry would lose its value. In the ledger, the description is optional.  In a journal, there is no need for balancing. In the ledger, balancing is a must at the end of the period. Illustration no. 3 From following journal entries prepare ledger account. 53  Particular L.F. Debit Credit Date Amount Amount ₹. ₹. 2020 Cash A/c …………… Dr 100,000 Apr 1 To Capital A/c 100,000 (Being capital brought in the business) Apr 1 Bank A/c …………… Dr 90,000 To Cash A/c 90,000 (Being cash deposited in the bank) Apr 4 Plant and Machinery A/c …….. 75,000 Dr 75,000 To Bank A/c (Being Plant and machinery purchased) Apr 4 Office Furniture A/c …………… Dr 5,000 To Bank A/c 5,000 (Being office furniture purchased) Apr 5 Bank A/c …………… Dr 100,000 To Loan A/c 100,000 (Being bank loan availed) Apr 6 Stationery A/c …………… Dr 5,000 To Cash A/c 5,000 (Being stationery purchased for the office) Apr 12 Cash A/c …………… Dr 9,000 To Sales A/c (Being goods sold on cash ) 9000 Apr 14 ABC A/c …………… Dr 30,000 To Sales A/c 30,000 (Being goods sold on credit to ABC) Apr 20 Insurance A/c …………… Dr 2,000 To Bank A/c 2,000 (Being insurance premium paid.) 54  Apr 20 Sales Return A/c ………… Dr 3000 To ABC A/c 3,000 (Being goods returned by ABC) Apr 25 Bank A/c …………… Dr 26,500 Bad debts A/c ………. Dr 500 To ABC A/c 27,000 (Being amount received from ABC in full and final settlement) 2021 Mar 31 Depreciation on Plant and 22,500 Machinery A/c …………… Dr 22,500 To Plant and Machinery A/c (Being provision for depreciation made for the year ended March’12) Mar 31 Salaries A/c …………… Dr 10,000 To Outstanding salaries A/c 10,000 (Being salary outstanding for the month of March provided for.) Solution i.e. Ledger Posting Dr Cash A/c Cr Date Particular J.F Amount Date Particular J.F. Amount 2020 2020 Apr 1 To Capital A/c 100,000 Apr 1 By Bank A/c 90,000 Apr To Sales A/c 10,000 Apr 6 By Stationery 5,000 12 A/c 2021 March 15000 31 55  By balance c/d 110000 110000 2021 Apr 1 To balance 15000 b/d Dr Bank A/c Cr Date Particular J.F Amount Date Particular J.F. Amount 2020 2020 Apr 1 To Cash A/c 90,000 Apr 4 By Plant and 75,000 Machinery A/c Apr 5 To Loan A/c 100,000 By Office Fur. A/c Apr To ABC A/c 26,500 Apr 4 5,000 25 Apr By Insurance A/c 2,000 20 2021 March By balance c/d 134500 31 2165000 216500 2021 Apr 1 To balance 134500 b/d Dr Capital A/c Cr Date Particular J.F Amount Date Particular J.F. Amount 2021 2020 March To balance c/d 100000 Apr 1 By Cash A/c 100,000 31 100000 100000 2021 By balance b/d 100000 56  Apr 1 Dr Plant and Machinery A/c Cr Date Particular J.F Amount Date Particular J.F. Amount 2020 2021 Apr To Bank A/c 75,000 Mar By Depreciation 22,500 4 31 A/c By balance c/d 2021 52500 Mar 31 75000 75000 2021 To balance 52500 Apr 1 b/d Dr Office Furniture A/c Cr Date Particular J.F Amount Date Particular J.F. Amount 2020 2021 Apr 4 To Bank A/c 5,000 Mar 31 By balance c/d 5000 5000 5000 2021 To balance 5000 b/d Apr 1 Dr Loan A/c Cr Date Particular J.F Amount Date Particular J.F. Amount 2021 2020 Mar 31 To balance c/d 100000 Apr 5 By Bank A/c 100,000 100000 100000 2021 By balance b/d 100000 57  Apr 1 Dr Stationery A/c Cr Date Particular J.F Amount Date Particular J.F. Amount 2020 To Cash A/c 5,000 2021 By balance c/d 5000 Apr 6 Mar 31 5000 5000 2021 To balance b/d 5000 Apr 1 Dr Sales A/c Cr Date Particular J.F Amount Date Particular J.F. Amount 2021 2020 By Cash A/c 10,000 Mar 31 Apr 12 By balance c/d 40000 Apr 14 By ABC A/c 30,000 40000 40000 2021 By balance b/d 40000 Apr 1 Dr ABC A/c Cr Date Particular J.F Amount Date Particular J.F Amount 2020 2020 Apr To Sales A/c 30,000 Apr By Sales Return 3,000 14 20 A/c 26,500 Apr By Bank A/c 500 25 By Bad debts A/c Apr 25 30000 30000 Dr Insurance A/c Cr 58 Date Particular J.F Amount Date Particular J.F. Amount 2020 2021 Apr To Bank A/c 2,000 Mar By balance 2000 20 31 c/d 2000