TO ENABLE THE STUDENTS TO UNDERSTAND

The concept & significance of accounting, branches of

accounting, key terms used in accounting, accounting
concepts, double-entry system of book keeping, types of
accounts and rules governing the same, preparation of
journal/subsidiary books and ledger accounts

SRIHARSHA
SREYAS INSTITUTE OF ENGINEERING & TECHNOLOGY

FINANCIAL
ACCOUNTING
INTRODUCTION
 FINANCIAL ACCOUNTING

INTRODUCTION

A business concern has to keep a systematic record of its business transactions. Book-keeping is the art of
recording business transactions in regular and systematic manner. According to Carter “Book-keeping” is
the science and art of correctly recording in books of account all those business transactions that result in
the transfer of money or money’s worth.

The term ‘Accountancy’ is used for accounting work of a higher order. According to Smith and Ashburne
“Accounting is the science of recording and classifying business transactions and events, primarily of
financial character, and the art of making significant summaries, analysis and interpretations of those
transactions and events, and communicating the results to persons who must make decisions or form
judgements”.

Accounting involves the following characteristics.

1. It is an art of recording financial transactions.

2. It involves making summaries and analysis of financial transactions.
3. It is an art of interpreting the results of the financial transactions and communicating the results to
the persons who are interested in such results. Accounting is regarded as “Language of business”. It
means that it communicates with parties concerned through accounting statements.

Objects of Accountancy:

1. To keep a permanent, accurate and complete record of business transactions.

2. To maintain records of incomes, expenses and losses in such a way that the net profit or loss for
any specified period may be ascertained.
3. To keep records of assets and liabilities in such a way that the financial position of the business at
any point can be easily ascertained.
4. To enable the businessman to review and revise his policies in the light of past experience brought
to light by analysing and interpreting records and reports.
5. To provide information for legal and tax purposes.

Distinction between Book-keeping and Accounting:

Book-keeping means recording of daily business transactions in a systematic manner. Accounting is a wider
term and includes besides book-keeping, preparation of financial statements and their analysis and
interpretation. Accounting is a broad subject. It involves greater understanding of records and capacity to
analyse and interpret the information provided by book-keeping records. The process of accounting begins
where book-keeping process ends.

Advantages of Accounting:

1. Innumerable monetary transactions occur in a business organisation. Accounting keeps a

systematic record of such transactions.
 2. When a business maintains a complete record of its transactions, it has complete information about
expenses, losses, incomes and gains, hence, it can easily ascertain the net profit or net loss for any
period.
3. Accounting records will help a concern to know not only its net profit or net loss but also the exact
reasons that has contributed to the profit or loss.
4. When accounting records are available over a period of time, it can compare the results of its
business from year to year and study the progress of business over a period of time.
5. When a business house keeps accounting records, it has a complete record of what it owns (i.e., its
assets), what it owes (i.e., its liabilities) and what it has invested (i.e., its capital). So, it can know the
true and correct financial position of its business at any time.
6. Accounting records enable a business concern to detect the frauds that have taken place in the
business. It can take effective steps to stop its reoccurrence.
7. Accounting records enable a business concern to keep effective control over its activities. For this
reason, accounting records are called “the eyes and ears of a business”.
8. Accounting records and reports help the management in planning, controlling and decision making
functions.
9. Claims against a business by its creditors, and claims by the business against its debtors can be
established and proved in courts of law by producing accounting records as evidence.
10. Accounting records will enable the business concern to know its tax liability and settlement of claim
from different departments of government.

Users of Accounting Information:

Accounting is the language used to communicate financial information of a concern to various parties who
are interested in such information. The parties that may be interested in accounting information are as
follows.

1. Owners: The owners provide funds for the operations of a business. They are interested in
knowing whether their funds are being properly utilised or not, and the return they would get on
their capital. This information will be provided by the financial statement prepared by the business
concerns.
2. Creditors: Creditors i.e., suppliers of goods and services on credit and bankers are interested in
knowing the financial position of a business concern before giving loan or granting credit. The
financial statements (Trading Account, P&L Account and Balance Sheet) help them in judging such
position.
3. Prospective Investors: investors use accounting information while determining the relative merits
of various investment opportunities. They will be interested in knowing the profitability and safety
of their investment which they can know by studying the financial statements carefully.
4. Management: The management requires financial information for planning, control and decision
making.
5. Government: Government is interested in financial statements for the purpose of taxation.
Limitations of Financial Accounting:

1. Financial Accounting is historical in nature: It supplies information in the form of P&L account and
Balance sheet normally for one year which is past. The information is of historical interest and is in
the nature of “post-mortem” of financial activities of the previous year. The management need
timely information at frequent intervals to take corrective steps at the appropriate time.
2. Financial accounting does not provide detailed analysis: Financial accounts are concerned with the
ascertainment of Profit or loss of the business as a whole. They reveal the overall Trading results for
a period. They merely show the result of the collective activities of the business. No detailed
information is provided of the exact manner in which the net profit or loss has been made. In a
business, the total turnover may comprise many activities, processes, jobs, contracts etc., some of
which may be profitable, while others may be at a loss. Separate information for each activity is not
revealed hence profit or loss of each activity cannot be known.
3. It ignores non-monetary information: Accounting deals only with those transactions which can be
measured in terms of money. Extent of competition faced by the business, efficiency and loyalty of
employees, effect of technical inventions etc., are the important matters in which the managers of
the business will be highly interested, but, accounting information cannot provide such
information.
4. Financial accounting does not reveal the efficiency of a business concern: Profit is not the only
measure of efficiency of a business concern. Inefficient concerns can make profits or efficient firms
lose money during different economic conditions. Financial accounting fails to inform whether
profits are due to efficiently in operation or due to external factors such as inflation, trade
depression, etc. Material losses due to pilferage wastage etc., labour and machine hour lost due to
idle time cannot be found out with the help of financial accounting.

Accounting Terms:

1. Business: It is an activity which involves exchange of goods/services with the intention of earning
income and profit.
2. Business transactions: It refers to any transaction, dealing or event which involves transfer of
money or money’s worth between two parties. Events like purchase and sale of goods, receipts and
payments of cash etc., are examples of business transactions.
3. Cash transaction: When payment for business activity is made immediately, it is called cash
transaction.
4. Credit transaction: When the payment is postponed to a future date, it is called credit transaction.
5. Non-cash transaction: A non-cash transaction is a business transaction where there is no payment
or receipt of cash either immediately or at a future date. Example: Depreciation, Bad debts etc.
6. Proprietor: The owner of business is called proprietor. He invests capital in the business with the
intention of earning profit.
7. Capital: It is the amount invested by the proprietor in the business. It is always equal to assets
minus liabilities. It is also called “Owner’s Equity” i.e., owner’s claim against the assets.
8. Drawings: It is the value of cash or goods withdrawn from the business by the owner for his
personal use.
9. Goods: It refers to commodities, articles or things in which a trader deals. Goods refer to
commodities or things intended for resale. Unsold goods lying in a business concern on any given
date are called stock.
10. Debtor: A debtor is a person who owes money to the business.
11. Creditor: A creditor is a person to whom the business owes money.
12. Assets: Assets refer to any properties or things owned by a business concern including the amounts
due to it from others. Examples: Building, Machinery, Stock, Cash and Bank balances, Investments
etc.
13. Liabilities: the term “Liabilities” refer to debts or amounts due from a business to others either for
money borrowed or for goods or assets purchased on credit or services received without making
immediate payment. This include bank loan, over draft, trade creditors, outstanding expenses, etc.
14. Equity: All claims against the assets of business are called “equity”. The claim of outsiders is called
“Creditor’s equity” or “Liability”. The claim of proprietor is called “Owners Equity” or “Capital”.
15. Book Debt or Debt: The amount due from a debtor is called Debt. “Book debt” is nothing but debt.
It is called “Book debt” because it is the amount due from debtor as per the books of accounts.
16. Good debt: it is a debt which is fully recoverable.
17. Bad debt: a debt which is irrecoverable is called “Bad debt”.
18. Revenue: Revenue refers to the earnings of a business. It includes the sale proceeds of goods,
receipts of goods, receipts of services rendered and earnings from interest, commission etc.
19. Expense: It is the amount spent in conducting business activities. It is the expenditure, in return for
some benefit. Example: Salary paid to staff, rent paid to landlord etc.
20. Loss: Loss refers to money or money’s worth given up without any benefit in return. It is an
expenditure in return for which no benefit is received. Loss of goods by fire, damages paid to others
are examples of losses. Loss is different from expense. Rent paid is an expense but goods destroyed
by fire is a loss.
21. Debit and Credit: To debit an account means to enter the transaction on the debit side of that
account. To credit an account means to enter the transaction on the credit side of that account.
‘Debit side’ means left hand side of an account. ‘Credit side’ means right hand side of an account.
22. Entry: The record of a transaction in a journal is called ‘entry’. In practice, the term is used for
record made in any book of account.
23. Posting: Posting is the process of entering in the ledger the information already recorded in journal
or subsidiary books.
24. Books of accounts: Books of accounts refer to suitably ruled account books in which business
transactions are recorded. There are mainly two sets of books of accounts maintained by a concern.
They are (a) Journal or subsidiary books and (b) Ledger.
25. Journal: It is an account book where business transactions are first recorded. It is a book of original
entry.
26. Ledger: it is a book in which various accounts are opened.
27. Brought Down (b/d): this term is written in the ledger to show the opening balance in any account.
It suggests that the account has been brought down from the previous period.
28. Carried Down (c/d): This is written in the ledger account at the time of closing the account.
ACCOUNTING PRINCIPLES:

If accounting has to serve the purpose of communicating the results of a business to the outside world, it
should be based on certain uniform and scientifically laid down principles. Accounting principles or
standards are general rules adopted in accounting. These principles enable standardisation in recording
and reporting of financial information. They are developed for common usage to ensure uniformity and
understand ability. Accounting principles may be defined as those rules of conduct of procedure which are
adopted by the accountants universally while recording the accounting transactions. Accounting principles
are not rigid. They are in the process of evolution, i.e., they are fast developing. Accounting principles can
be classified into two categories.

1. Accounting concepts and

2. Accounting conventions.

ACCOUNTING CONCEPTS:

Accounting concepts mean the assumptions or conditions upon which accounting is based. There are a
number of accounting concepts agreed upon and adopted by accountants. Some of the important
accounting concepts are:

1. Business Entity concept: In accounting, business is treated as an entity different from the
proprietor. The business and the proprietors, i.e., owners are regarded as two separate entities
(i.e., parties). All the transactions of the business are recorded in the books of the business from
the view point of business as an entity. In case this concept is not followed, affairs of the business
will be mixed with the personal transactions of the proprietor and the true picture of the business
will not be known. Even the proprietor is regarded as a creditor to the extent of the capital
contributed by him to the business. Capital is regarded as a liability of the business to the
proprietor.
2. Dual aspects Concept or Accounting Equation Concept or Balance sheet concept: According to this
concept, every business transaction has a dual aspect. Every business transaction always results in
receiving of some benefit of some value and giving of some other benefit of equal value. For
instance, when a business purchases goods for cash, it receives goods of some value and gives cash
of equal value. Every business transaction involves dual or double aspects of equal value so in
accounting, a record is made of the dual or wo aspects of each transaction. The dual aspect is also
expressed in another form of equation as under:
Capital + Liabilities = Assets or Capital = Assets – Liabilities
Suppose, Satyanarayana commences business with Rs. 50,000 cash. This fact is recorded at two
places.
(a) Business has received Rs. 50,000 in cash (Asset) and
(b) Satyanarayana has a claim for Rs. 50,000 (liability).

The equation is: Capital = Assets or Liability = Asset.

Suppose, cash is used for the purpose of purchasing machinery worth Rs. 30,000 and goods worth
Rs. 15,000, then, equation would be,
 Capital = Assets

Rs. 50,000 capital = Machinery Rs. 30,000 + Stock of goods Rs. 15,000 + Cash of Rs. 5,000

Suppose, he borrows Rs. 25,000, then,

Capital + liabilities = Assets

Capital Rs. 50,000 + loan Rs. 25,000 = Machinery Rs. 30,000 + Stock Rs. 15,000 + Cash Rs. 30,000.

3. Going Concern Concept: Accounting is done on the assumption that the business shall have a long
life and it will continue to exist until it is dissolved. It is for this reason that fixed assets are recorded
at original cost and are depreciated on the basis of their expected life rather than on the basis of
market value. It is not proper to show fixed assets in the balance sheet at the market value, as they
are not intended to be sold immediately.
4. Cost Concept: According to this concept, an asset is recorded in the books at the price paid to
acquire it and this cost is the basis for all subsequent accounting for the asset. Assets are not
recorded at market values because these values keep on changing with changes in price level from
time to time.
5. Money Measurement Concept: the money measurement concept signifies that in accounting a
record is made only of those transactions or events which can be expressed in terms of money. Any
happening or fact which cannot be expressed in terms of money cannot be recorded in accounting
books. Non-monetary events such as retirement of manager, sales policy of management, working
conditions of workers, etc., cannot be recorded in accounting books. The money measurement
concept has one great advantage. It helps a concern to express heterogeneous items such as bank
balance, stock-in-trade, furniture, machinery, buildings etc., in terms of a common denominator
viz., money.
6. Accounting Period Concept: Even though it is assumed that business will continue to exist for a
long period, it is necessary to keep accounts in such a way that the results are known at frequent
intervals. Accountants generally adopt a twelve-month period for measuring the income of a
concern. This time interval is called “Accounting Period”.

ACCOUNTING CONVENTIONS:

Accounting conventions refer to customs, traditions, usages or practices followed by accountants as a

guide in preparation of financial statements. They are followed to make the financial statements clear
and meaningful.

1. Convention of Consistency: The convention of consistency signifies that the accounting practices
and methods should remain consistent (unchanged) from one accounting year to another. In other
words, accounting practices should remain the same from one period to another. Comparison of
results from one period to another is possible only when same accounting rules are followed. For
example, if a concern adopts reducing instalment method of depreciation in one year and straight
line method of depreciation in another year, then it will be difficult to make comparison between
the results of the two periods. Sometimes, wring conclusions may be drawn. If change becomes
necessary the change and its effect should be stated clearly.
2. Convention of Disclosure: The convention of disclosure means that all the material facts must be
disclosed in the financial statements. For example, in case of sundry debtors not only the total
amount sundry debtors should be disclosed, but also the amount of good and secured debtors, the
amount of good, but unsecured debtors and amount of doubtful debts should be stated. Full
disclosure does not mean disclosure of each and every item of information. It only means
disclosure of such information which is of significance to owners, investors and creditors.
3. Convention of Materiality: According to this convention, a detailed record is made only of those
business transactions which are material (i.e., significant). Accounts must not be over burdened
with unnecessary minute details. Only material facts should be disclosed “an item should be
regarded as material if there is reason to believe that knowledge of it would influence the decision
of informed investors”. Hence, unimportant matters should be either left out or merged with other
items.
4. Convention of Conservatism: This convention is based on the policy of ‘playing safe’. According to
this convention all possible or expected losses should be provided for but unearned or unrealised
profit should be lift out. Examples of application of this convention are valuation of stock at cos
price or market price, whichever is less, making provision for doubtful debts etc. The idea behind
convention of conservatism is that the financial position a firm should not be shown better than
what it is.

BRANCHES OF ACCOUNTING:

The various branches of Accounting are as follows:

1. Financial accounting: Known as historical accounting deals with recording, classifying and
summarising business events. The day-to-day transactions are journalised and posted in the ledger
and at the end of the year profit and loss account and balance sheet are prepared. The object of
financial accounting is to show the profit or loss made by a business concern and its financial
position as on a particular date.
2. Cost accounting: The object of cost accounting is to find out the cost of the goods produced and
services rendered by a business concern. It also helps the business in controlling the costs by
indicating avoidable losses and wasters. It helps at estimating costs in future. The emphasis is on
ascertainment of cost and future decision making.
3. Management Accounting: The Management accounting is concerned with internal reporting of
information to management for (a) planning and controlling operations (b) decision making and (c)
formulating long-term plans.

BASIS OF ACCOUNTING:

The matching of revenues and expenses of a period can be done o the three-following basis.

1. Cash Basis: In the cash system of accounting, entries are made only when cash is received or paid.
No entry is made when a payment or receipt is merely due. In other words, the revenues are not
recognised and recorded unless they are received in cash. Professional persons like doctors,
lawyers and non-trading concerns generally adopt this system of recording business transactions.
This system does not make a complete record of financial transactions in an accounting period.
 Hence, it does not disclose the correct profit or loss for a particular period and will not disclose true
and fair position of the business on the specified date.
2. Mercantile or Accrual Basis: Under this system, income as well as expenses are considered on the
basis of their occurrences in an accounting period and not on the basis of their actual receipts and
payments. Hence, incomes and expenses are recognised if they belong the particular period,
irrespective of the fact whether they are received or paid in that period. It takes into consideration
all transactions relating to a particular period. Outstanding expenses and incomes are takn into
consideration. Hence, it discloses correct profit or loss for a particular period and shows true and
fair financial position of a business on a particular day. The Companies Act requires all companies to
maintain accounts on accrual basis of accounting.
3. Mixed basis: It is a combination of both the basis of maintaining accounts. Income are recorded on
cash basis, but expenses are recorded on mercantile basis. This is a conservative principle where in
all expenses relating to a period whether actually paid or not is considered whereas only that
income which is received in cash is taken into consideration.

ACCOUNTING SYSTEM:

• Accounting system consists of collecting, summarising, analysing and reporting in monetary terms
information about a firm.
• It is obvious that a number of transactions will take place daily in any business. It is possible to
remember all these transactions and hence they are to be regularly and systematically recorded.
This is done by book-keeping.
• Book-keeping is the art of keeping accounts in a regular and systematic manner which records all
the dealings related to money, goods and services. This is done to supply any information
pertaining to the business to the management or owners of the firm.

SYSTEMS OF BOOK-KEEPING:

There are two systems of book-keeping, namely,

• Single entry system

• Double entry system

Single Entry System:

When accounts are not entered in a systematic and scientific way, or in an incomplete manner, it is
called as “Single entry system”. This system records only one side of the transaction and hence is not
generally used.

Double Entry System:

This system is a scientific method of recording business events/transactions. As per Newton’s law of
motion, for every action there is an equal and opposite reaction. The double entry book keeping
system has been developed based on this law of motion. In every transaction, there are two steps. One
aspect is opposite to the other. Both these aspects are recorded. The two entries are called double
entry and this method of book keeping is called as “Double entry book-keeping”.

Advantages of Double Entry System of Book keeping:

i. A firm can have a clear idea of its status of profit and loss during a particular period.
ii. Factors that affect profit or loss of a firm can be identified to take suitable action.
iii. It helps to prepare a balance sheet to assess whether the unit has enough assets to meet its
liabilities.
iv. The total amount to be recovered from customers can be noted and suitable steps can be taken
to recover the amount in order to avoid bad debts.
v. The total amount to be paid to outsiders can be noted to make timely payments.
vi. It is used to discover errors and frauds.
vii. It is used by the management for decision making.

THE JOURNAL:

Each and every business transaction is recorded as and when it takes place on the same day in a
book called as “The Journal”. Hence, a journal is a book containing a chronological listing of
transactions. A journal records many accounts related to many persons or firms.

TYPES OF ACCOUNTS & RULES GOVERNING EACH ACCOUNT:

There are three types of accounts. They are Personal account, Real account and Nominal account.

1. Personal Account

Business dealing can be made only with persons. Persons include individuals, firms, companies,
banks, etc. Goods can be purchased only from persons, firms, companies etc. In the same manner,
services can be rendered by a person and only to a person. Hence, recording of all such dealings
with these persons, firms, companies, etc., and maintaining accounts is called Personal accounts.

The rule governing the Personal account is “Debit the receiver and Credit the giver”.

2. Real Account

Only goods (things that have no life, but which can be seen and touched) can be bought and sold.
All accounts related to these goods are called real or assets accounts. Things like cash, land,
buildings, plant, machinery, furniture, vehicles including small things like pens, files, books etc., are
put under real accounts.

The rule governing the Real account is “Debit what comes in and Credit what goes out”.

3. Nominal Account

There are certain items in business that cannot be seen but can only be experienced (felt).

For example,

• Cash paid to the house owner = Rent

• Cash paid to the employee by employer = Salary
• Cash paid to a broker for his services = Commission
• Cash concession given for the promptness by the payer = Discount

Hence in real life, there are many such items such as interest, advertisement expenses, travelling
expenses etc., with a nature of loss or income. All of these items cannot be seen but can be
experienced. Recording and maintaining of the accounts of these items is called Nominal accounts.

The rule governing the Nominal account is “Debit all expenses and losses and Credit all incomes
and gains”.

Depending upon the transaction, the item can be an expense or an income. For example, for a
person who pays rent or salary or interest etc., it is an expense. But for the person who receives
rent or salary or interest etc., it is an income.

All transactions are first written in a book called JOURNAL. Transactions entered into the JOURNAL
are called Journal Entries.

THE LEDGER:

After all the transactions are journalised, the entries in the journal are transferred to the
appropriate accounts in the ledger to know the exact position of each account on any particular
date. In journal, the transactions pertaining to a particular person, asset, expense, or income are
recorded at different dates. Hence journal fails to bring together similar transactions. From the
journal, it is not possible to know the total purchases, sales, rent and salaries paid the amount due
from each customer and amount payable to each supplier etc. This limitation is overcome by
ledger. Ledger is a book where the various accounts pertaining to a particular person, thing or
service are grouped together in one place in the form of an account. It contains accounts for all the
persons with whom the business deals, for all the assets or things held by the business and for all
the expenses incurred and incomes earned by the business. Ledger may be defined as a book which
contains records of all transactions permanently in a summarised and classified form.

It is a book of final entry. All business transactions are first recorded in the journal and finally
recorded in the ledger. The process of transferring the transactions from journal to the ledger is
called “posting”. Ledger is the main or principal or most important book of the business and hence
called King of books of accounts.

SUBSIDIARY BOOKS:

When business transactions are very few, there is only one Journal, wherein all transactions are
recorded. In big business concerns, recording of all transactions in one journal and then posting
them into ledger will be very inconvenient and will involve a lot of clerical work. Moreover,
transactions are usually of repetitive in nature. To overcome this difficulty big business concerns
have introduced the system of subsidiary books. Under the system of subsidiary books, instead of
maintaining only one book of original entry called Journal for all types of transactions, several
books of original entry called Subsidiary books are maintained.
 Subsidiary books are books of original entry as all transactions are first recorded in these books
before they are recorded in respective accounts in ledger. These special journals are called
subsidiary books because they are subsidiary to the principal or main book namely Ledger.
Subsidiary books do not provide final accounting information relating to the business but merely
help in the preparation of ledger accounts.

Advantages:

1) Sub-division of the Journal into subsidiary books will make the recording work easy and quick.
2) It helps in the division of labour as accounting work may be divided among a number of clerks.
3) Easy reference becomes possible since each subsidiary book provides information relating to a
particular aspect of the business only.
4) There is a substantial reduction of clerical work. Normally the following subsidiary books are
used in business.
a. Cash book = to record receipts and payments of cash including deposits and payments of
bank.
b. Purchases book = to record credit purchases of goods.
c. Purchases returns book = to record all purchases returns i.e., all gods returned by the trader
to his suppliers.
d. Sales book = to record all credit sales of goods.
e. Sales returns book = to record all sales returns i.e., goods returned by the customers to the
trader.
f. Bills Receivable Book.
g. Bills Payable Book.
h. Journal Proper = to record all those transactions that cannot be recorded in any of the
above books. For example, opening entries, closing entries, adjustment entries etc.

CASH BOOK:

In every business, there will be a larger number of cash transactions that take place i.e., receipts
and payments of cash. So, it is necessary to maintain a separate subsidiary book for recording the cash
transactions. The separate subsidiary book maintained for recording cash transactions is called the Cash
book.

Cash book is a book of prime, or first entry, because all cash transactions are first recorded in the
cash book. It is also a book of final entry (i.e., Ledger) as cash book itself serves as cash account and bank
account. Separate cash account and bank account are not opened.

Cash book serves the following purposes.

a. To find out the total cash receipts and cash payments during a particular period.
b. To know the Cash and Bank balance at any time without the physical (i.e., actual) counting of cash
and verification of Pass book.
c. To verify the correctness of cash in hand and cash at bank.
Types of Cash Book:

1. Simple Cash Book or Cash Book with only cash column (Single Column Cash Book).
2. Two-column Cash Book with cash and discount columns.
3. Three-column or Cash Book with Cash, Discount and Bank columns.

A. Simple Cash Book:

A simple cash book makes a record of only cash transactions. It is like an ordinary cash account. It is
maintained by small business concerns. It has two sides.

1. Debit side or left hand side and

2. Credit side or right hand side.

The debit side is used for recording cash receipts and the credit side is used for recording cash payments. A
single column cash book is ruled as follows:

Cash Book

Date Particulars Ledger Amount Date Particulars Ledger Amount

Folio Rs. Folio Rs.

The cash book has to be balanced at the end of the given period. The total of the debit side should always
be more than the total of the credit side, as the cash payments cannot be more than cash receipts. The
balance indicates the cash in hand at the end of the period.

When cash transactions are recorded in the cash book, only one aspect of cash transactions is recorded. To
complete the double entry of cash transactions, all items appearing in the cash book should be posted to
the respective ledger accounts.

All the items (except the opening cash balance) appearing on the debit side of the cash book have to be
posted to the credit side of the respective ledger accounts as “By Cash Account”. All the items (except the
closing cash balance) appearing on the credit side of the cash book have to be posted to the debit side of
the respective ledger accounts as “To Cash Account”.

B. Two Column Cash Book or Cash Book with Cash and Discount Columns:

This Cash book is an extension of simple cash book. Under this method an additional column is provided
both on debit side and credit side for recording discount allowed and discount received.

Cash Discount:

It is a rebate or an allowance made by the receiver of cash to the payer. Cash discount arises when
payment is made before a specified date. For instance, the supplier may say that if payment is made within
one month, a discount of 2% will be allowed. It means that a debt of Rs. 100 can be discharged by paying
only Rs. 98 before the end of the month.

Thus, cash discount allowed by the trader to his debtor is a loss to him and is called discount allowed and
is recorded on the debit side of cash book. Whereas, cash discount received by him from his creditor is gain
and is known as discount received and is recorded on credit side of the Cash book.

However, cash discount should not be confused with trade discount. Trade discount is an allowance made
by the manufacturer or wholesaler to the retailer, off the catalogue price of goods sold. It is granted to old
and regular customers, in case of bulk sales or as a custom of trade. The main idea behind providing the
trade discount is to enable the retail trader to sell of goods at catalogue price by keeping some margin to
meet his business expenses and profit. Trade discount is deducted from catalogue price and the balance is
recorded in the books of accounts. There is not entry made for trade discount in the books of the trader, it
never appears in the books of account.

Differences between Cash Discount and Trade Discount:

Cash Discount Trade discount

Cash discount is an allowance made by the Trade discount is an allowance given by the
receiver of cash to the person paying it. wholesaler to the retailer.
it is deducted from the amount of debt or net It is deducted from the catalogue price in the
invoice price. invoice.
It occurs at the time of settlement i.e., when cash It occurs at the time of sale or purchase.
is received or paid.
The object is to induce the debtors to pay Its object is to enable the retail to sell goods at the
promptly within the period of credit. catalogue price and to keep margin of profit.
It is recorded in the books of debtor and creditor It is not recorded in the books of either seller or
buyer.

In the cash column on the debit side actual cash received will be entered; the amount of the discount
allowed, if any, to the customer concerned will be entered in the discount column. Similarly, actual cash
paid will be entered in the cash column on the payments side and discount received in the discount
column. The Pro-forma of Double Column Cash Book is as follows:

Two Column Cash Book

Date Particulars Ledger Discount Cash Date Particulars Ledger Discount Cash
Folio Rs. Rs. Folio Rs. Rs.

Balancing:

It should be noted that discount columns are not balanced. They are merely totalled. The total of the
discount column on the debit side shows the total discount allowed to customers and is debited to the
discount account. The total of discount column on the credit side shows total discount received and is
credited to the Discount account. The cash columns are balanced like in Single Column Cash book.

C. Three Column Cash Book or Cash book with Discount, Cash and Bank columns:

The Cash book which contains bank column in addition to discount and cash columns is called Three
Column Cash Book or Cash book with Discount, Cash ad Bank columns.

The following points must be noted while preparing Cash book of this type.

• Opening balance: the opening balance of cash in hand and cash at bank is written on the debit side
as “To Balance b/d”. The amount of cash in hand is written in cash column and of cash at bank in
bank column. In case of bank overdraft, it is written on the credit side as “By Balance b/d”.
• All the receipts will be written on the debit side. Cash receipts will be entered in cash column and
cheques in bank column. If a cheque is received and deposited in the bank on the same day, then it
should be entered in bank column on the debit side. A cheque received but not deposited in bank
on the same day must be first debited in cash column and when it is deposited in bank on some
other day it should be treated as deposit of cash in the bank. However, in the absence of any
information cheque received may be entered in the bank column on the assumption that it is
deposited in bank for collection on the same day. If any discount is allowed while receiving cash or
cheque then it should be entered in Discount column on the debit side.
• Any payments are entered on the credit side cash payments in cash column and payments through
cheque in bank column. If any discount is received while making cash or bank payment, then it
should be entered in discount column on the credit side.
• Contra Entries: if cash is deposited in the bank, it should be entered in the bank column on the
debit side as “To Cash” and again on the credit side as “By Bank”. If cash is withdrawn from bank for
office use, it should be entered in cash column on the debit side as “To Bank” and again on the
credit side in the bank column as “By Cash”. These transactions are not posted in the ledger as both
the accounts (Cash and Bank) are in the Cash Book itself. For such entries, letter “C” is written in
Ledger Folio column on each side to indicate that contra effect of this transaction is recorded on
the opposite side. Such entries are called “Contra entries”.
• If a cheque is drawn for personal use, it has to be entered in the Bank column on the credit side as
“By Drawing Account”. In such a case, no contra entry is involved.
• If there are bank charges that are debited by the Bank to the business concern, then, it has to be
entered in the Bank column of the Cash book on the credit side as “Bank charges”.
• If interest or dividend on securities is collected by the Bank as per our standing instructions, then, it
has to be entered in the Bank column on the debit side s “To Interest/dividend on Securities”.
• If a cheque received from a customer and deposited in the bank is dishonoured, then the entry
passed for receipt of cheque has to be cancelled by reversing it, i.e., it should be entered on the
credit side of Cash book in the bank column as “By concerned Party Account”. (Name of the
Customer). Similarly, if a cheque issued to a creditor is dishonoured then the entry passed for the
issue of cheque has to be cancelled by reversing it, i.e., it should be written on the debit side of
bank column as “To concerned Party Account” (Name of Creditor).
 • Balancing: The discount columns are totalled but not balanced. The cash columns are balanced
exactly in the same manner as indicated for simple cash book. The process is similar for balancing
the bank columns also. It is possible that the bank may allow the firm to withdraw more than the
amount deposited i.e., to have an overdraft.
In such a case, the total of the bank column on the credit side will be bigger than the one on the
debit side. The difference is written on the debit side as “To Balance c/d”. then the totals are
written on the two sides opposite one another. For the next period, the balance is entered on the
credit side as “By Balance b/d”.
Postings from the Three column cash book:
The double entry of the transactions entered in the cash book is completed by making postings into
the ledger. As already explained from debit side the postings are made to the credit of the accounts
affected as “By Cash” or “By Bank” as the case may be. From the credit side the entries are posted
to the debit of the accounts concerned as “To Cash” or “To Bank” as the case may be. Posting of
discount allowed and discount received is same as in two column cash book.
The ruling of Three Column Cash Book will be as follows:

Three Column Cash Book

Date Particulars Ledger Discount Cash Bank Date Particulars Ledger Discount Cash Bank
Folio Rs. Rs. Rs. Folio Rs. Rs. Rs.