MEFA - UNIT-III

Accounting Definition:
The American Institute of Certified Public Accountants (AICPA) has defined the term Accounting
as “the art of recording, classifying and summarizing in a significant manner in terms of money
transactions and events which in part, at least of a financial character and interpreting the
results thereof”.

Objectives of Accounting:

 To maintain accounting records

 To calculate the result of operations
 To ascertain the financial position
 To communicate the interpretation to users

Accounting Cycle:
The accounting cycle refers to the complete process of accounting procedure followed in
recording, classifying and summarizing the business transactions. The accounting cycle starts
right from the identification of business transactions and ends with the preparation of financial
statements and closing of books.

These include Journal, Ledger, Trial Balance and financial statements such as Trading Account,
Profit & Loss Account and Balance Sheet.

Journa
l
Trading
A/c, P& L Accounting Ledge
A/c, Cycle r
Balance
Sheet
Trial
Balance

Steps of Accounting Cycle

1) Identification of business transactions

The first step of the accounting cycle begins with the identification of financial transaction that
has occurred in the business. In this accounting cycle, the accountant or the bookkeeper
collects the data of all the transactions such as purchases, sales, payments, receipts etc. and
keeps the data ready to complete the next step of the accounting cycle.

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2) Recording of transactions in the books of accounts

The next step of the accounting cycle is the most crucial and important. In this accounting cycle,
the bookkeeper or accountant records the financial transaction in the book of accounts. This
step of the accounting cycle is also known as a journal entry and the book in which it is
recorded is a journal book.

Here, all the transactions are recorded in chronological order along with the ledger accounts
involved, amounts in Dr/Cr and narration (a brief note on the transactions)

3) Ledger posting

Ledger posting simply refers to posting the financial transactions recorded in journal books to
individual ledger statements. For example, in preparing a cash ledger account, you must post all
Debits (receipts) and Credit (payments) into a statement and the difference between these two
including the opening balance of cash will be the closing balance.

4) Prepare un-adjusted trial balance

In this step, you must list all ledger accounts with closing balance posted from individual ledger
accounts statement. The format of the trial balance consists of the Debit column and Credit
column in which the closing balance of each ledger account will be posted. After posting the
closing balances of all the ledger accounts, the debit balance should match with the credit
balance.

5) Post the adjustment entries

Here, adjustment entries such as accrued incomes, depreciation, etc. are posted considering
the unadjusted trial balance prepared earlier.

6) Prepare the adjusted trial balance

Adjusted trial balance is a statement listing all the closing balance of the ledger accounts after
all the adjustment entries related to the accounting period is posted into the books of accounts.

7) Prepare financial statements

This is the most important step of the accounting cycle. Once you have followed all the above
steps of the accounting cycle, it’s time for you to start preparing financial statements. Trading
Account, Profit & Loss account and Balance sheet are prepared in this final stage.

8) Closing the books of accounts

Closing books of accounts refer to freezing books from recording the business transaction. This
is done after the closure of the accounting period and posting all the adjustment entries. At this
stage of the accounting cycle, all the financial statements are prepared and new books for the
subsequent financial year will be started.

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3 Types of Accounts:
1) Personal Account: The Accounts which relate to individuals, group of persons, firms or
institutions are called as Personal Accounts.

Examples: Individual (natural persons) – [Link] A/c, [Link] A/c

Firms or institutions (artificial persons) – SBI Bank A/c, Kishore Traders A/c, Infosys Ltd A/c

2) Real Account: Accounts relating to properties and assets which are owned by the business
concern are known as Real Accounts.

Examples: Building A/c, Machinery A/c, Furniture A/c, Stock A/c

3) Nominal Account: These accounts relate to incomes and expenses, or gains and losses of a
business concern.

Examples: Salaries A/c, Rent A/c, Discount A/c, Commission A/c.

Double Entry Book Keeping System

Double Entry Book Keeping is a method of recording transactions where for every business
transaction, an entry is recorded in at least two Accounts as a debit or as a credit. The amounts
recorded as debit must be equal to the amount recorded as credit.

The fundamental rule under Double Entry Book-keeping system is that, “for every Debit, there
must be corresponding value of Credit”.

Rules of Accounting
1) Personal Accounts - a) Debit the receiver
b) Credit the giver

2) Real Accounts - a) Debit what comes in

b) Credit what goes out

3) Nominal Accounts - a) Debit all expenses & losses

b) Credit all incomes & gains

Journal
A journal is a record of financial transactions where transactions of a business are ordered by
date. Traditionally, a journal has been defined as the book of original entry.

A journal stores a complete record of every business transaction the company makes. This
usually includes the transaction date, transaction description, accounts that were affected, as
well as the debits and credits.
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 Journal Format
Journal Entries in the books of …………………….for the month of…………

Date Particulars LF Debit Amount (Rs.) Credit Amount (Rs.)

Name of the A/c………………………….Dr. xxx
To Name of the A/c xxx
(Being…………………………………..………..)
(narration of the transaction)

Question 1

Journalize the following transactions in the books of [Link] & Co.

Date Rs.
April 01 Started Business with cash 50,000
02 Purchased goods for cash 25,000
04 Sold goods on credit to Mr. Raghu 35,000
06 Purchased goods for credit from Mr. Kamal 8,000
08 sold goods for cash 20,000
10 Srivastav paid cash 5,000
15 Received Commission 1,000
29 Paid Rent 2,000

Solution
Journal entries in the books of [Link] & Co. for the month of April

LF Debit Credit
Date Particulars No Amount Amount
April Cash A/c Dr 50,000
01 To, Capital A/c 50,000
(Being, Started Business with Cash)
April Purchases A/c Dr 25,000
02 To, Cash A/c 25,000
(Being, Goods Purchased for Cash)
April Mr. Raghu A/c Dr 35,000
04 To, Sales A/c 35,000
(Being, Goods sold on credit to Mr. Raghu)
April Purchases A/c Dr 8,000
06 To, Mr. Kamal A/c 8,000
(Being, Goods Purchased from Mr. Kamal)
April Cash A/c Dr 20,000
08 To, Sales A/c 20,000
(Being, Goods sold for Cash)
April Cash A/c Dr 5,000
10 To, Srivastav A/c 5,000
(Being, Cash received from Srivastav)
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 April Cash A/c Dr 1,000
15 To, Commission A/c 1,000
(Being, Commission received)
April Rent A/c Dr 2,000
29 To, Cash A/c 2,000
(Being, Rent Paid)

Ledger
Accounting involves recording, classifying and summarizing financial transactions. Recording is
done in the journal and classification of the recorded transactions is done in the ledger. The
Journal doesn’t provide all the information regarding a particular account at one place and it
does not show the net effect of various transactions affecting a particular person, assets,
revenue and expense. Hence, to know the summary of individual accounts the ledger is
prepared.

Ledger is a book with various accounts (Real, Personal and Nominal Accounts) and each account
is shown on a separate page, that gives the details of the different transactions and its
summary. Ledger i’s a book of account containing a classified summary of every transaction
recorded in journal.

Ledger is a main book which contains all the accounts in which the transactions recorded in the
books of original entry are transferred. Ledger is also called the 'Book of Secondary Entry',
because the transactions are finally incorporated in the Ledger.

LEDGER FORMAT

Dr NAME OF ACCOUNT Cr
Date Particulars J.F Amount Date Particulars J.F Amount
Rs. Rs.

Year To, (Name of Credit XXX Year By, (Name of Debit Account XXX
Month Account in Journal) Month in Journal)
Date Date

Explanation
1. Each ledger account is divided into two parts. The left-hand side is known as the debit
side and the right-hand side is known as the credit side. The words “Dr” and “Cr” are
used to denote Debit and Credit.

2 The name of the account is mentioned in the top (middle) of the account.

3 The date of the transaction is recorded in the date column.

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 4 The word “To” is used before the accounts which appear on the debit side of an account
in the particulars column. Similarly, the word “By” is used before the accounts which
appear on the credit side of an account in the particulars column.

5 The name of the other account which is affected by the transaction is written either on
the debit side or credit side in the particulars column.

6 The page number of the Journal or Subsidiary Book from where that particular entry is
transferred is entered in the Journal Folio (J.F) column.

7 The amount pertaining to this account is entered in the amount column.

POSTING

The process of transferring the entries recorded in the journal or subsidiary books to the
respective accounts opened in the ledger is called Posting. In other words, posting means
process of grouping of all the transactions relating to a particular account at one place. It is
necessary to post all the journal entries into various accounts in the ledger because posting
helps us to know the net effect of various transactions during a given period on a particular
account.

Rules Regarding Posting

Following steps should be taken into account while making posting:

(A) Opening of separate accounts: Each transaction affects minimum two accounts for which
separate accounts are to be opened in the ledger. An account may be real, nominal or personal
account. All transactions relating to an account, debit as well as credit, are to be posted to
know the net position of the account.

B) Posting journal entry to concerned side: If an account is debited in the journal, posting will
be made on the debit side of the account in the ledger. Similarly, if an account is credited in
the journal, that account would be credited in the ledger.

To illustrate, if furniture is purchased for cash, furniture account is debited in the journal while
cash account is credited. So, we have to open 'Furniture' account in the ledger and debit the
account with the amount, appearing against the debit column in the journal. To the Cash
account, amount appearing on the credit side in the journal would be credited.

C) Use of word "To" and «By: While writing the debit side, commence with word "To" and
Write the name of the account, which is credited in the journal. Write the word "By" on the
Credit side before writing the name of the account that is debited in the journal.

D) Balance in account: The difference between debit and credit totals of an account is the net
position of the account, known as balance of the account.
BALANCING AN ACCOUNT

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Balancing is the process of finding the difference between the total debits and the total credits
of an account. When posting is done, many accounts may have entries on their debit side as
well as Credit side. The net result of such debits and credits in an account is the balance.

Balancing means the writing of the difference between the amount columns of the two Sides in
the ledger (smaller total) side, so that the totals of the two sides become equal.

Debit Balance: The excess of debit total over the credit total is called the debit balance.
Credit Balance: The excess of credit total over the debit total is called the credit balance.

PROCEDURE FOR BALANCING

While balancing an account, the following steps are involved:

I. Total the amount column of the debit side and the credit side separately and then ascertain
the difference of both the columns.

II. If the debit side total exceeds the credit side total, put such difference on the amount
column of the credit side, write the words "By Balance c/d" (c/d means carried down) in the
particulars column.
or
If the credit side total exceeds the debit side total, put such difference on the amount column
of the debit side, write the words "To Balance c/d" in the particulars column.

III. Total again both the amount columns put the total on both the sides and draw a line
above and a line below the totals.

IV. Enter the date of the beginning of the next period in the date column and bring down
the debit balance on the debit side along with the words "To Balance b/d" (b/d means
brought down) in the particulars column and the credit balance on the credit side along with
the words "By balance b/d" in the particulars column.

(For Question & Solution on Ledger, refer the Question No.1 on Journal [Link] & Co. along
with all Ledger Accounts, which was done in the class)

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 Cash Book
Cash Book records all cash receipts and cash payments and gives the balance of cash in the
Business unit at any time.

The Cash Book plays dual role as a Journal (“Book of First Entry") as well as Ledger (‘Book of
Final Entry'). It is a Subsidiary Book because all cash transactions are first recorded in cash book.
It is also a Ledger, because the recording of transactions in the cash book takes the shape of a
Ledger A/c. All the receipts of cash are entered on the debit side and the payments of cash are
entered on the credit side. So, there is no need of cash account in the ledger as cash book
serves the purpose of a ledger account also.

Simple Cash Book

It is a single column cash book, which records all cash transactions of the business in a
chronological order. This cash book contains only one amount column on each side Debit side
and credit side. Cash receipts are to be debited and cash payments are to be credited. After
entering all the transactions, the balance is ascertained like other accounts.

The Pro forma of Simple Cash Book (Single Column Cash Book)

Dr. Cash Book of ………………… for the month of ……………… Cr.

Date Particulars J.F Amount Date Particulars J.F Amount
Rs. Rs.

Debit Side (Left side)

1. Date Column: Date on which cash received is recorded.

2. Particulars Column: Name of the account from which cash is received is written.
3. L.F. (Ledger Folio) Column: Page Number of the account in the ledger is recorded.
4. Amount Column: Amount of transaction is recorded.
Credit Side (Right side)

1. Date Column: Date of cash payment is recorded.

2. Particulars Column: Name of the account to which payment is made is recorded.
3. L.F. (Ledger Folio) Column: Page Number on which the account appears in the
ledger is recorded.
4. Amount Column: Amount of the transaction is recorded.

Points to Remember for the preparation of Simple Cash Book

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 1. Only cash transactions are to be recorded
2. Enter Cash Receipts on the debit side.
3. Enter Cash Payments on the credit side.
4. After entering all transactions find out the Balance (Balance = Debit Total-
Credit Total).
5. Simple Cash Book Resembles an Ordinary Account.

Example: Record the following transactions of Shalimar Enterprises in a Simple Cash Book as
on 01.01.2014

2014
Jan 01 Brought cash into the business 8000
04 Cash Sales 2000
06 Received Commission 550
09 Deposited cash into Bank 800
11 Cash purchases 4800
16 Paid to varun 1000
18 Paid office expenses 450
20 Purchased goods from AK 600
24 Paid advertisement expenses 220
26 Received Interest 400
28 Paid Rent 500
31 Paid salaries 900

Ans: Both sides balance: 10,900/-

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 TRIAL BALANCE
All the businesses, after completion of postings from journal or subsidiary books to the ledger,
need to verify accuracy of such posting. For this purpose, a statement is prepared where in, the
balances of all the accounts in the ledger are incorporated. The statement so prepared is called
the Trial Balance, the equality of debit totals with credit is known as agreement of trial balance.
The reason for agreement of a trial balance is that under the double entry system, each
transaction is recorded two times, once on the debit side of an account and again on the credit
side of another account. If the totals of both the sides of a trial balance are equal, it is
presumed that the books are at least arithmetically correct. The other reason to prepare the
trial balance is its usefulness in the preparation of final accounts.

In specific terms,

“Trial balance is a statement, prepared with the debit and credit balances of ledger accounts to
test the arithmetical accuracy of the books”- [Link].

FEATURES

1. It is a list of balances of all ledger accounts and the cash book.

2. It is just a statement and not an account.
3. It is just a working paper
4. It is prepared at the end of accounting year before preparing the final accounts.
5. It is always prepared on a particular date and not for a particular period.
6. It is not an account; it is only a statement which is prepared to verify the
arithmetical accuracy of ledger accounts.

PROFORMA
TRIAL BALANCE OF AS ON

[Link] PARTICLUARS [Link] DEBIT BALANCE CREDIT BALANCE

(AMOUNT) (AMOUNT)

Note: While transferring the balances in to the trial balance, all assets and expenses accounts
are placed in the debit column and all liabilities and incomes are placed in the credit column.

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The following points are to be kept in the mind while preparing the Trail Balance

1. Draw the proforma of trial balance with the title.

2. Trial balance is a statement; hence we need not use the words ‘to' or 'by’
3. Show all the assets in debit column.
4. Show all types of expenses in debit column.
5. Show all types of liabilities in credit column.
6. Show all types of incomes in credit column.
7. Show reserves and surpluses/ reserve funds/ provisions in credit columns e.g.
provision for doubtful debts, general reserve, reserve fund etc.
8. Show intangible assets in debit column e.g. goodwill, patents, royalties.
9. Show Purchases and sales returns in debit column
10. Show Sales, purchase returns in credit column.

Example: Prepare a trial Balance from the following balances of Kushal as on

30.06.2013

Name of the accounts Amount Name of the accounts Amount

Opening Stock 20,000 Furniture 6,000
Purchases 85,000 Machinery 62,000
Purchase Returns 5,000 Debtors 36,000
Sales 1,60,000 Creditors 12,750
Sales Returns 6,200 Bills receivable 4,600
Rent 1,200 Bills payable 2,500
Salaries 5,700 Cash in Hand 5,220
Advertisements 880 Bank overdraft 10,000
Commission Received 1440 Interest Overdraft 1,800
Discount Cr 710 Capital 50,000
Cash in Hand 7,800

Ans: Balances: 2,42,400

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