Accounting for Managers

Contents
Unit 1 Introduction to Accounting 1

Unit 2 Accounting Concepts & Conventions 11

Unit 3 Introduction to Accounts 16

Unit 4 Journal Entry 27

Unit 5 Ledger & Subsidiary Book 40

Unit 6 Trial Balance 60

Unit 7 Trading, Profit & Loss Account and Balance Sheet 66

Unit 8 Cash Flow Statements 82

Unit 9 Depriciation 86

Unit 10 Company Accounts 90

Unit 11 Introduction to Accounting Standards 99

Unit 12 Cost Accounting 106

Unit 13 Marginal Costing 139

Unit 14 Break Even Point (BEP) Analysis 150

Unit 15 Overview of Fintech 156

Unit 16 Digitalisation in Accounting System 163

152 Meaning and Definitions of Consumer Buying Behavior

 Unit 1

Introduction to Accounting

Learning Objectives Introduction

By the end of this unit, you will be

Throughout the ages, accounting has only been used for
able to understand:
the accountant’s financial record-keeping duties. However,
● What is accounting
accountants have been pushed to re-evaluate their duties
● Accounting information and responsibilities both inside the organization and

● Branches of accounting the society due to the quickly evolving business climate
today.
● Objectives of accounting

What is Accounting?

Accounting is a mechanism for tracking corporate

activities, compiling data into reports, and providing
decision-makers with information. Financial statements
are the documents that convey these conclusions about
an organization’s financial performance.

The term “business jargon” is frequently used to describe

accounting. The main goal of every language is to improve
communication. In this case, accounting’s objective is to
communicate or report the results of business activities
in all of their diverse manifestations.

Accounting has a wide range of definitions. According to

one widely accepted definition, accounting is the art of
meaningfully documenting, classifying, and summarising

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Introduction to Accounting
events, transactions, and occurrences that have ● Give information that is both true and illustrative
some degree of financial significance, as well as by revealing underlying
analyzing the results of those events.
● Assumptions pertaining to subjects up for
interpretation, assessment, and prediction or
A less narrow definition of accounting reads as “The
estimation; and
act of identifying, measuring, and disseminating
● Offer details about events that have an impact
economic information to permit users of the
on society.
information to make educated judgments and
decisions.”

Accounting Information

The balance sheet, trading account, profit and

loss account, and other financial statements
generated by the bookkeeping and accounting
process are examples of accounting information.
An accounting information system that processes
data using computers receives accounting Branches of Accounting
information. Utilizing information technology
tools and resources, it logs and monitors all of the As diverse forms of accounting information
company’s accounting operations. Both internally were required by various classes of individuals,
within the organization and externally for other distinct fields of accounting emerged. Owners,
stakeholders and consumers, the reports produced shareholders, managers, suppliers, creditors, taxing
by the system are useful. authorities, governmental organizations, etc. could
all be included.
Information sharing is a crucial part of accounting.
The accounting data must guarantee the following Other accounting specialties have emerged as a
in order to be useful: result of global business reporting requirements
and commercial development. The branches of
● supplying data for economic decision-making; accounting are described below.
● Assist people who utilize financial statements as
their main source of information or knowledge; 1. Financial Accounting

● Include details that are helpful for estimating and

Creating financial statements is a key component
analyzing the amount,
of financial accounting, and its main objective is
● Timeliness and apprehension about potential to inform a variety of interested parties, including
financial flows; shareholders, creditors, banks, investors, financial
● Offer data to assess management’s capacity to institutions, the government, and consumers,
use resources among others. Financial statements, such as
income statements and balance sheets, provide
● effectively achieving objectives;
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Introduction to Accounting
information on the activities of the company over a In order to implement effective cost control, cost
specific time period. accounting’s primary goal is to offer a complete
breakdown of the costs associated with various
The primary responsibility of financial accounting departments, processes, tasks, goods, sales
is external reporting. Users of financial accounting regions, etc.
information, including banks, financial institutions,
regulatory bodies, the government, investors, and Therefore, the following is a list of the goals of cost
others, require the accounting data to be consistent accounting:
to allow for comparison. The tenets of financial
accounting are as follows: ● The structure of three crucial claims, namely, to
calculate costs,
● Separate legal entity,
● To help with corporate activity planning and
● Going concern, cost measurement, control, and

● Dual aspect, ● To provide data for both immediate and long-

term decision-making.
● Accounting period,

● Matching, realization,
Several potential courses of action can be properly
● Conventions of conservatism, analyzed using the data generated by cost
accounting. A cost accounting system ensures the
● Disclosure,
optimal use of both physical and human resources,
● Consistency, etc.
and that is not an exaggeration. It guards against
fraud and deception and directs both the labor
However, the constraints of financial accounting
and the employer toward accomplishing the
should not cause one to believe that it is of no
organizational goal.
use. It serves as the fundamental support for the
foundation for additional accounting analytical
3. Management Accounting
branches and tools. That is a source of knowledge
that can be examined and evaluated further
The practice of delivering financial resources and
appropriate to the decision-makers specific criteria.
information to managers for decision-making is
known as management accounting, also known as
2. Cost Accounting
managerial accounting. The only way management
accounting differs from financial accounting is that
Cost analysis is a significant management
it is solely used by the internal staff of the firm. In
accounting type. Cost accounting creates detailed
this procedure, the company’s management team
cost records for a variety of goods, operations, and
receives financial reports and information from
tasks. It is the process of figuring out and adding up
the finance administration, including invoices and
the cost of a specific good or activity. Cost centers
financial balance sheets. The goal of management
are any goods, services, tasks, or operations for
accounting is to use this statistical data to make
which costs are calculated and accrued.
more informed decisions that will help you manage

3
Introduction to Accounting
your company’s growth and day-to-day operations. ● Making a balance sheet

● Maintaining a log of cash transactions

Additionally, it produces additional information that
● Assessing and managing assets and liabilities
is both financial and non-financial, quantitative and
qualitative referring to the future and is important ● Avoiding Debt Defrauding and Price
for organizational decision-making. These details
● Error detection and prevention
include sales projections, financial flows, and
● Fraudulence Detection and Prevention
procurement requirements.
● Cost and Property Management of audits,
A need for more workers, information on income taxes, and social audits
environmental consequences on the land, water,
natural resources, flora, fauna, the health of people, Identification and Transaction Recording
social obligations, etc.
Recognizing financial transactions and accurately
Due to the fact that management accounting takes recording them in the books of accounts
a specific choice, it is not based on any established is accounting’s main objective. Thus, each
and clearly defined principles. A management transaction’s precise nature may be grasped
accountant can produce reports for any time without any mental effort
period, depending on the objective, either short or
long. Additionally, the reports may be prepared for With this goal in mind, the transactions are initially
both the organization’s segments and the total. noted in a general notebook as well as a specific
journal. Later, numerous accounts are retained
permanently in the ledger.

2. The creation of a Profit and Loss Statement

Every business is curious about how things are

going at the conclusion of a certain time frame.

It can be created to calculate a business concern’s

profit or loss for a given period of time using ledger
Objectives of Accounting account balances of a particular revenue kind.

Determining the results of financial transactions A non-trading company can also determine its
and statements is one of the top 10 objectives of revenue surplus or deficit for a certain time period
accounting. These results will help decision-makers by creating an income and expenditure account or
reach a company’s objectives. statement.

● Identification and Transaction Recording

● The creation of a profit and loss statement

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Introduction to Accounting
3. Making a Balance Sheet 6. Avoiding Debt Defrauding and Price

Another significant goal of accounting is to One of the fundamental goals of accounting is

determine the debts, liabilities, property, and to prevent cash defalcation, which is the theft of
assets, or the complete financial situation of an funds by a person who is trusted, through fraud,
organization, at a given time. forgeries, and cost control. If financial reports, data,
and accounts have been maintained consistently
By creating a balance sheet, it is possible to and precisely, preventing cash defalcation and cost
determine the financial circumstances of interest control becomes easy.
at a specific time.
7. Error Detection and Prevention
4. Maintaining a Log of Cash Transactions When systematic financial records are kept, proper
trial and error are carried out, preventing errors
The cash book is a recognized reserved book that from being made and allowing for the correction of
is connected to accounting books. This cash book any upcoming errors in the books of accounts.
is used to keep track of both cash received and
cash payments. Accounting goals include keeping 8. Fraudulence Detection and Prevention
track of daily cash transactions, cash payments, in-
hand, and bank cash balances, and keeping them It is difficult for nearly any employee involved with
accessible from cash books at all times. Simply by the firm to undertake any such financial work that
maintaining a cash book precisely and consistently, can both fill their pockets and empty the business
fraud, cash theft, and forgeries are reduced. due to the necessity of maintaining and recording
adequate accounts. Because of keeping accurate
5. Assessing and Managing Liabilities and Assets books of accounts, the company’s fraud ratio may
of a Company even go to zero.

To successfully run a business, it is important to 9. Cost and Property Management of Audits,

purchase a number of fixed assets. Income Taxes, and Social Audits

One must also handle a variety of liabilities and A proper property and cost audit is carried out in
debts. order to meet accounting goals since accurate
estimating helps the company make significant
Through the accurate keeping of accounts, it is profits. In addition to cost and property audit.
possible to determine the actual situation of these Conducting management audits, income tax audits,
debts, liabilities, properties, and assets. and social audits as part of accounting audits is one
of accounting’s additional goals. Any corporation
A businessman can manage how much his
will typically find it challenging to conduct business
assets decline and his liabilities rise by taking the
operations without the assistance of the company’s
appropriate actions.
records and accountant.

5
Introduction to Accounting
Uses & Limitations of Accounting accounting aids in the fulfillment of all statutory
requirements.
Firstly, we will understand the uses of accounting.
3. Calculating the Business’s Profit and Loss
Uses of Accounting
Any company is founded with the intention of
Accounting is crucial to the efficient and successful making a profit. Net profit or loss is purely a
operation of any firm. In actuality, only by accurately business-related outcome. It is vital to apply
recording and analyzing all business transactions is accounting rules for accurate recording in order to
the growth of any business feasible. The following calculate business profit.
are accounting’s primary applications:
4. Determining the Company’s Financial Situation
● Avoiding the memory-capacity restrictions

● Observance of statutory requirements From the financial statement, the corporation

learns of its assets and liabilities at a certain
● Determining the company’s profit and loss
time. Liabilities refer to all outstanding corporate
● Assessing the financial status of the business obligations, whereas assets refer to all sources of
● Assessment of Tax Knowledge of Debtors and revenue. If a businessman accurately documents all
Creditors assets and obligations in accounting, the company
can determine its true financial condition.
● Calculating the cost to sell a business

● Evidence in a legal proceeding 5. Assessment of Debtors’ and Creditors’ Tax

● Help with decision-making at the managerial Knowledge
level
A merchant must pay numerous taxes today. For
● Advancement of the country
instance, excise taxes, sales taxes, property taxes,
import duties, and customs duties, among others.
1. Avoiding the Memory-Capacity Restrictions
Only if the businessman employs accounting to
meticulously record all of his sales, production,
Due to the limitations of human memory,
and income will he be able to create an accurate
businessmen cannot remember every business
estimation. If a businessman fails to maintain
transaction. Accounting is useful for documenting
proper records, the Assessing Officer will estimate
every business transaction so that when a
the tax amount.
businessman reviews the record, he can quickly
recall it and apply it to his own commercial
A businessman can quickly determine how much is
endeavors.
owed to creditors and how much is owed to debtors
using accounting.
2. Observance of Statutory Requirements

The documenting of company transactions is

necessary from an accounting perspective. Thus,

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Introduction to Accounting
6. Calculating the Cost to Sell a Business Limitations of Accounting

Accounting makes it simple for business owners to About accounting, there are several myths. For
determine what they owe their creditors and what example, a balance sheet accurately reflects the
they owe their debtors if he keeps their accounting financial standing of an organization, and a profit
records in good condition. and loss statement accurately reflects the profit or
loss that was really achieved throughout the year.
7. Evidence in a Legal Proceeding
Accounting is not yet a perfect science, art, or
Accounting makes it simple for business owners to language, despite popular belief. For so many
determine what they owe their creditors and what years, it has been evolving, and it still is. To better
they owe their debtors. assuming they keeps up-to- comprehend accounting, one must research its
date accounting records. limitations.

8. Help with decision-making at the managerial These limitations are as follows:

level
● Expresses accounting data in monetary terms.
It is helpful for many decisions related to
● Accounting data is based on projections.
management, such as figuring out the cost of
● Accounting data could be skewed.
goods and services, calculating the product mix
and sale mix, making purchases, figuring out how ● Fixed assets are recorded at their original cost.
productive different production sources are, and
● Changing the Accounts
deciding whether to keep the business open or shut
● The value of money as a unit of measurement
it down, replacing machinery, accepting particular
fluctuates.
orders, making tender decisions, etc.

1. Expresses Accounting Data in Monetary Terms

9. Advancement of the Country

One of accounting’s primary flaws is that it

If all business persons keep accurate records,
cannot evaluate things or events that do not have
accounting can also aid in the development of
a monetary value. No matter how important a
a nation. With this, it is impossible to save black
component may be, if it cannot be expressed in
money, and the government can use the money
monetary terms, accounting cannot take it into
collected in taxes to fund national development
consideration. Several very important traits, such
initiatives. Following this, national development is
as management, loyalty, reputation, etc., are not
conceivable.
well reflected in the balance sheet or the income
statement.

2. Accounting Data is Based on Projections

The firm’s financial situation as of the date of

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Introduction to Accounting
preparation is depicted in the financial statements. cost and the current replacement cost. The financial
The long, as well as short-term prospects of the status as of a certain date may not be accurately
company, are of more relevance to the statement’s represented by a balance sheet.
users. Accounting, however, does not make any
such assumptions. 5. Changing the Accounts

Accounting data should not be the exclusive

In addition, since the business climate is dynamic, yardstick for measuring managerial effectiveness
a lot might change between such dates. To address because earnings can be fudged or misrepresented.
these accounting limits, auditors occasionally do
reveal significant events that occurred after the 6. Money Changes in Value as a Unit of

balance sheet date. Measurement.

3. Accounting Data Could be Skewed It is among the largest accounting flaws. Non-
monetary terms, things, or events cannot be valued
Human error is always a possibility because in accounting. In other words, no matter how
accounting is done by humans. Additionally, there is crucial they are to the business, certain elements
concern regarding potential account manipulation cannot be included in accounting if they cannot be
to hide fraud. Fraud is difficult to detect since it stated in monetary terms. Management, loyalty,
is intentional. One of the most hated accounting reputation, hard effort, employee and customer
limits is this one. satisfaction, the company’s ability to develop new
products, a positive management-labor connection,
4. The Cost of Fixed Assets is Noted at That Time. and other significant but non-financial traits are
not mentioned in the balance sheet or income
Due to changes in fixed asset values over time, statement of the company. As a result, accounting
there may be a large difference between the initial simply emphasizes quantities and not attributes.

Bookkeeping Accounting

Definition The primary goals of bookkeeping are to The act of accounting involves compiling,
recognize, quantify, and record financial analyzing, and disseminating financial
transactions. transactions that were recorded in ledger
accounts.

Objective The goal of bookkeeping is to maintain The objectives of accounting include

accurate and organized records of all assessing the financial situation and
financial activities. conveying information to the proper
authorities.

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Introduction to Accounting
Preparations of Financial Financial statement creation is The process of accounting also involves
Statements excluded from this process. creating financial statements.

Skills Required No specialized skill sets are needed for Accounting is an analytical and
bookkeeping. sophisticated field that calls for
specialized knowledge.

Analysis There is no need for analysis throughout Accounting analyses and interprets
the bookkeeping procedure. data using bookkeeping information
before compiling it into reports.

Types The two major methods of bookkeeping The accounting division creates a
are single entry as well as a double company's budgets and plans loan
entry. applications.

Bookkeepers and Bookkeepers are expected to complete Accountants can become Certified
Accountants their tasks accurately and to be Public Accountants provided they have
educated about financial matters. An the necessary training and education
accountant typically monitors the work (CPA)
of a bookkeeper.

Summary

● The process of reporting, recording, evaluating, and summarising economic data is referred to as accounting.
By giving information about the company’s financial situation, accounting enables a company’s decision-
makers to take wise decisions.

● Accounting is the “art of recording, classifying, and summarising in a meaningful way and in terms of
money, transactions and events which are, at least in part, of financial character, and interpreting the results
thereof,” according to the American Institute of Certified Public Accountants (AICPA).

● Everyone uses accounting today; therefore having a solid understanding of it is advantageous to everyone.
Accounting serves as a financial language. It is critical to comprehend the components of accounting in
order to understand it effectively.

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Introduction to Accounting
 Unit 2

Accounting Concepts &

Conventions
Learning Objectives Introduction

By the end of this unit, you will be

It is preferable to refer to all regulations and practices
able to understand:
that govern accounting to be “Basic Accounting
● Introduction to GAAP
concepts.” These are the core concepts or fundamental
● Accounting concepts presumptions that underlie the theory and practice of

● Modifying principles of financial accounting, and they serve as the overarching

accounting guidelines for all accounting-related tasks that have been

created and approved by the accounting profession.

Introduction to GAAP

Generally Accepted Accounting Principles is what this

term refers to. These are some accounting procedures
that are often used and have gained some degree of
popularity throughout the world. These accounting
principles outline specific definitions, the accounting
handling of ambiguous entries, and even some regulations
and practices particular to a given industry.

The goal of GAAP is to guarantee a fundamental amount

of constancy in the financial reports of all diverse firms.
It makes it simple for external consumers of financial
statements to interpret and comprehend a company’s
finances. In order to aid these users in making investment
decisions, GAAP will also permit intra- and inter-firm

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Accounting Concepts & Conventions
comparisons. buying and selling of things, paying rent, paying
bills, earning money, etc., would be noted in the
Accounting Concepts (Part 1) company’s books of accounts. However, the
company’s books of finances won’t record things
The fundamental concepts or presumptions that like the innovation of the research department or
form the foundation of accounting theory set out the breakdown of equipment.
specific operational guidelines for an organization’s
accounting activities. Companies must adhere to 3. Going Concern Concept
13 fundamental accounting principles in order to
create truthful and fair financial accounts. According to this idea, a corporate organization
will continue to operate for an endless amount of
time. It simply means that every corporate entity
has a continuing existence. As a result, it will not
dissolve anytime soon. This is a crucial accounting
presumption.

4. Cost Concept

This cost concept states that the amount paid

1. Business Entity Concept to acquire an asset is what is mentioned in the
accounting books as its cost. In addition the asset’s
According to the notion, this concept is the subsequent accounting is based on this cost. The
commercial enterprise is independent of its owner. market value of assets is not taken into account for
Simply put, the company and its owners are handled accounting purposes when valuing or deducting
differently for accounting purposes. Any financial depreciation from such assets. The benefit of using
investment made by an owner will be considered the Cost Concept is that financial statements are
a liability for the company. However, if the owner ready and delivered objectively. Without a cost
withdraws funds from the company for private notion, the numbers mentioned in accounting
utilization, those withdrawals will be regarded records would be arbitrary and dubious. However,
as drawings. As a result, a business’s assets and because of inflationary tendencies, it is no longer
liabilities are those of the business, not the owner. appropriate to judge the true financial status of the
As a result, the accounting records from the organization to prepare financial statements using
perspective of the company rather than the owner the cost concept.
are included in the books of accounts.
5. Accounting Period Concept
2. Money Measurement Concept
This idea establishes the duration at the conclusion
The rule of money measurement states that a of which an organization must ready its financial
company should only record transactions with a accounts in order to ascertain whether it has made
monetary value. It indicates that events like the profits or suffered losses over the course of a

11
Accounting Concepts & Conventions
given period of time. It also specifies the precise The company won’t realize the revenue until after all
situation of the company’s assets and liabilities at of its work on the product is done. The merchandise
the conclusion of the time period. Different internal will be transferred to the revenue account once it
and external users of the organization regularly use has been dispatched to the customer.
this information for a variety of purposes. Because
it aids in decision-making, the financial statements 8. Matching Concept
are made regularly, and no company can afford to
wait too long to learn the findings. The average time According to the matching idea, if an expense is
between financial statement preparations is one connected to revenue from the same financial year,
year. The accounting year is the period of time in it should be recorded during the same financial year.
question. In other words, if a company makes money during
a given accounting period, even when it pays the
6. Duality Concept expenses associated with that money during the
following fiscal year, the expense will be recognized
The underlying idea or fundamental accounting during the fiscal year in which the company has
theory is dual aspect. This idea makes the made money.
assumption that every entry has a double effect,
meaning that it has an impact on two accounts 9. Full Disclosure Concept
on the opposing sides of the ledger. As a result,
the transaction needs to be recorded twice. This The full disclosure concept, as its name suggests,
means that the transaction’s two components contends that a company must be completely
must be documented in the books of accounts. transparent about all aspects of its financial
For instance, giving money to acquire products performance. The idea is that an organization’s
involves two components: I giving the cash; and (ii) financial statements must contain all pertinent
receiving the items. These two elements must be and important facts and numbers. An organization
noted. must create its balance sheet and profit and loss
account using the format specified by the Indian
The Accounting Equation can be used to convey Companies Act 1956 in order to properly ensure
this idea: this idea. Additionally, various regulatory agencies,
like SEBI, mandate that businesses fully provide a
Liabilities + Capital = Assets genuine and fair image of their financial health and
state.
7. Revenue Recognition Concept
10. Consistency Concept
According to the revenue recognition idea,
sometimes referred to as the realization principle, According to the concept of consistency, an
a company should only record its commercial organization’s accounting methods and regulations
revenue when it is realized, not when it has received should be uniform or consistent. Because only
the money. when it enables its users to compare the financial
statements of several years or with those of other

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Accounting Concepts & Conventions
companies, the accounting information offered costs instead of being part of the closing stock of
by a company through its financial statements the statements.
will be useful. It does not imply, however, that the
company cannot alter its accounting procedures as 13. Objectivity Concept
necessary. By accurately showing the likely impact
of the modifications on its financial results, the According to the accounting principle of objectivity,
company may make the necessary changes to its transactions should be objectively recorded by
policies. a company. It indicates that there shouldn’t be
any prejudice on the recording from accountants
11. Conservatism Concept or other parties. The firm’s transactions can be
recorded objectively if they are backed up by valid
The conservatism or prudence concept is based vouchers or other supporting documentation. An
on the idea that it is best to play it safe while organization may find the idea useful in developing
keeping track of all transactions. This idea holds its goodwill. Additionally, it cautions businesses
that a company should take a deliberate approach about the consequences of any misreading of
and hold off on recording earnings until they are financial accounts.
actually realized. But it also stipulates that the
organization should recognize any loss, even if it
hasn’t happened yet or if there’s a remote chance it
might in the future. Regardless of how pessimistic
this idea may seem, it is necessary for a company
to manage in crucial circumstances since it enables
them to safeguard creditors’ interests against any
unauthorized distribution of their assets.

12. Materiality Concept

According to the materiality notion, an organization

should only concentrate on tangible facts. Simply
put, an organization shouldn’t waste time on Modifying Principles of Accounting
unimportant details that don’t contribute to
The essential presumptions and concepts that were
calculating its profits for the period. One should
previously discussed have been modified in order to
take into account the fact’s nature and the quantity
create accounting information that is beneficial to
at stake in order to determine if it is material or
various interested parties. The principle should be
inconsequential. A fact will therefore be deemed
changed if the expense exceeds the gain realized.
material if the accountant thinks it may have
The adoption of a concept should be flexible,
an impact on how someone uses the financial
and the benefits of following the principle should
statements. For instance, the users of financial
outweigh the costs.
statements don’t give much thought to the initial
cost of stationery. They are therefore listed under

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Accounting Concepts & Conventions
The key modifying factors are: years be valid and useful.

● Cost-Benefit;
4. Prudence or Conservatism Principle
● Materiality;
According to the conservatism concept, when
● Consistency;
alternative valuations are available, one should
● Prudence or conservatism;
choose the option that most accurately captures
● Timeliness; the economic substance of the transaction;
however, if such a choice is not obvious, one should
● Substance over legal form; and
choose the option which is less exaggerated net
● Variation in accounting standards.
assets and net income. It does not record revenues
or gains based on anticipation but does provide for
1. Cost-Benefit Principle
all known expenses and losses by best estimates if
the amount is not known with certainty.
The cost of doing anything must not exceed the
potential value that may be obtained, according to
5. Timeliness
the widely acknowledged Cost-Benefit Principle.
This holds true for the field of accounting as well.
The term “timeliness” suggests that the financial
Accounting work should unquestionably yield
statements must be produced and released on
returns that outweigh the costs involved.
schedule. The timely release of financial statements
is essential for the financial information’s relevance,
2. Materiality Principle
dependability, and utility. Timely information is
required by the users of the financial statements.
Materiality is defined as relevance, importance, or
significance in the materiality principle. According
6. Substance Over Legal Form Principle
to this rule, all the required data shall be included in
the financial statements, but useless data should
According to this idea, activity and occurrences
not be detailed. For instance, while the acquisition
related to finance are recorded and presented in
of products like pens, pencils, scissors, and other
line with their actual economic effects rather than
such items should be recorded as assets, in
only their legal form.
practice, these items are classified as stationery-
related expenses.
7. Variations in Accounting Practices Principles

3. Consistency Principle
Businesses adhere to a precise set of rules
and procedures known (GAAP) while preparing
Consistency denotes steadiness or a constant
financial statements. A few industries occasionally
state of being. Adopted accounting principles and
depart from GAAP due to the unique nature of their
practices must remain constant for a comparatively
operations and procedures.
long length of time. Only if accounting practices
and processes stay constant from year to year will
a comparison of financial statements between two
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Accounting Concepts & Conventions
Summary

● The term “accounting concept” refers to the fundamental presumptions used to support the recording of
actual business transactions.

● Business entity, money measurement, going concerned, accounting period, cost concept, dual aspect
concept, realization concept, accrual concept, and matching concept are among the key accounting
concepts.

● The idea of a business entity posits that the business enterprise and its owner(s) are two different entities
for accounting purposes.

● All company transactions must be recorded in the books of accounts in terms of money, according to the
money measurement concept.

● According to the “going concern” notion, a company firm will continue to operate for an extended amount
of time.

● According to the accounting period idea, all business transactions are entered into the books of accounts
under the presumption that profits would be calculated over a given period of time.

● All assets are listed in the books of accounts at their cost price, according to the accounting cost principle.

● According to the “realization idea,” revenue from any commercial transaction should only be recorded once
it has been realized.

● According to the matching idea, revenue and expenses incurred to generate it must occur during the same
accounting period.

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Accounting Concepts & Conventions
 Unit 3

Introduction to Accounts

Learning Objectives Introduction

By the end of this unit, you will be

The word “account” typically alludes to a ledger or record-
able to understand:
keeping activity. In the financial sector, it can be used in a
● Introduction to account
wide variety of ways. An account in banking is a contract
● Types of account whereby a company, generally a bank or credit union,

● Difference between accounts takes a customer’s financial assets and retains them on
the customer’s behalf at the customer’s choice.
● Introduction to accounting
equation
A statement that summarises transactions in the form of
● Double entry system credits, debits, accruals and adjustments that have taken

● Double entry system v/s single place and have an impact on an asset, equity, obligation,

entry system or past, present, or future revenue is referred to as an

“account.”

Introduction to Account

In an accounting system, a track of financial activities

involving a specific asset, liability, equity, revenue, or
expense is known as an account. As business events take
place throughout the course of the accounting period,
these records grow and shrink. The general ledger stores
each individual account and is used to create financial
statements at the end of an accounting period.

The account is nothing more than a summary of the

16
Introduction to Accounts
business’s dealings with individuals, their agents, statements. For example, your business may have
and objects. office materials like computers that are tangible
assets and design patents that are intangible.
As an illustration, when a business transacts with You might also include the following items in your
suppliers or customers, both parties represent assets account:
different accounts.
● Vehicles: Since they are real tools that your

Similar to this, businesses that buy tangibles like business utilizes, company automobiles and

buildings, land, machinery, and other items handle other vehicles are tangible assets.

each tangible as a separate account. These stories ● Machinery or Equipment: Company-owned

have a connection to reality. machinery and equipment are also considered
tangible assets because they are tangible
In order to properly record transactions, a physical items.
corporation must first identify the accounts that will
● Property and Buildings: As physical places or
be affected by them before applying the necessary
structures, company property and buildings are
accounting standards and golden accounting
also tangible assets.
principles.
● Copyrights: Because they are intellectual
Types of Accounts property, copyrights are intangible.

● Logo: A company’s logo is another intangible

As soon as you make a purchase or a sale of products asset because it contributes to the brand image
or services, you must update your company’s of the business and may affect how customers
accounting records by entering the information in see its goods and services.
the appropriate account. The total amount of money
● Trademarks: Trademarks are non-physical
entering and leaving your company is displayed
protections that stop others from utilizing a
here. The amount of money in each account is
company’s logo or other brand elements, so you
also visible. For the purpose of producing financial
can include them with your intangible assets.
statements and making company decisions, sort
and keep track of transactions using accounts.
2. Expenses

Business organizations typically list their accounts

The goods or services your business purchases to
by developing a chart of accounts (COA). Your
assist create additional revenue can be included
account types can be arranged, each account can
in your expenditure account. This could involve
be given a number, and transaction data can be
investing in goods or services to increase the output
quickly located using a chart of accounts.
of your distribution or production processes. Other
costs could include:
1. Assets

● Employee salaries
The items your company possesses, both tangible
and intangible, are typically included in asset ● Marketing expenses

17
Introduction to Accounts
● Facility expenses ● Late utility payments

● Unacceptable prices for facility upkeep

You can record both in your expense account if your
● Overdrawn accounts
business makes donations or trip arrangements. To
keep proper financial records for your business, it’s
Other liabilities charges that pertain to your
crucial to keep personal costs out of your company
business may be documented. To make sure your
expense account.
business is always aware of its existing liabilities,
it’s crucial to take into account accounting for any
3. Revenue
possible interest costs while recording these costs.

Accounts for income or revenue track the money 5. Equity

your business makes by selling the products or
services. Include any earnings that your business Equity accounts display the value of your remaining
receives from investments as well. However, you assets after subtracting all of your liabilities to
must record the investments themselves in your illustrate the current value of your business. Create
asset account. In essence, your income account a balance sheet with an exhaustive inventory of
is where you keep track of the financial success of everything your business owns and owes in order
your business. to determine the worth of your equity account.
The entire liabilities of your company can then be
Revenue is the money that your business brings in. subtracted from its total assets using the balance
Additionally, revenue accounts are used to track sheet as a guide. This enables you to comprehend
everything that generates revenue for whatever the equity level and existing value of your business,
reason. which can help you decide how to raise its value.

Following are a few typical revenue sub-accounts: Examples of equity accounts include the following:

● Common Stock
Every business needs Earned Interest, Product
Sales, and Income Revenue accounts, and making ● Retained Earnings
sure you are precisely monitoring your transactions ● Owner’s Equity
can offer you real-time information on how your
firm is doing. Once more, equity accounts rise with credits and fall
with debits. Your equity increases as your assets
4. Liabilities do. Your equity declines as your liabilities rise.

The liabilities account of your business may Difference Between Accounts

include things like unpaid debts, creditor payment
commitments, and other upcoming payments. Your A financial year’s end statement is made up of
liabilities may specifically include the following: various transactions from various accounts that
were documented during that time. Accounts used
● Commercial loans by businesses to record transactions include those

18
Introduction to Accounts
for assets, equity, liabilities, gains, earnings, losses, ensured by these golden principles. The golden
and expenses. rules reduce the intricate bookkeeping regulations
to a collection of straightforward concepts that
The balances in the incomes, losses, and gains may be learned and used.
accounts—also known as the nominal accounts— 1. Debit the Receiver, Credit the Giver
are then closed out at the annual closing. Asset,
equity, and debt account balances are carried over Personal accounts fall under the purview of this
to the following accounting year. These accounts principle. A person must be given credit in the
fall under the category of actual accounts. books of accounts when they donate something to
the company since it counts as an input. This also
Unrelated to persons accounts, a real account is applies to the contrary, thus the receiver must be
a general ledger account for assets and liabilities. debited.
These are open accounts that are carried over from
year to year. A bank account is an illustration of a 2. Debit What Comes In, Credit What Goes Out
real account.
Applying this theory to real-world accounts Real
A personal account is linked to every person, accounts involve things like buildings, land, and
including individuals, businesses, and associations. machinery. By default, they have a debit balance.
A creditor account is an illustration of a personal Therefore, when you debit what is received, you
account. are increasing the balance of the account. This is
the precise action that must be taken. Similar to
All revenue, costs, losses, and gains are recorded crediting what comes in, when a tangible asset
in a nominal account, which is a general ledger leaves the company, the account balance is
account. An interest account is a type of nominal decreased.
account.
3. Debit all Expenses and Losses, Credit all
The Golden Rules of Accounting Incomes and Gains

More than just bookkeeping is involved in financial When the account in question is a notional account,
accounting. Every transaction in accounting has a this rule is applied. The company’s capital is a
debit and a credit entry. It is necessary to distinguish liability. As a result, there is a default credit balance.
which account has to be credited and which one Capital is increased when all gains and losses are
debited. This is the dual entry accounting method. credited and decreased when losses and expenses
The three principles that make up the “golden rules are debited. To keep the system in balance, this is
of accounting” govern financial accounting. The exactly what must be done.
methodical recording of financial transactions is

19
Introduction to Accounts
 Type of Account Golden Rules

Real Account *Debit what comes

into the business
*Credit what goes out
from the business
Personal Account *Debit the receiver
*Credit the giver
Nominal Account *Debit the expenses
or loss of the busi-
ness
*Credit the income or
gain of the business

Introduction to Accounting Equation In accounting equations, liabilities usually precede

owner equity because the rights of creditors are
The accounting equation demonstrates that the always given precedence over owners’ rights. This
total assets of a corporation equal the sum of preference causes the liabilities to occasionally
its obligations and shareholders’ equity (assets be translated to the left side, giving rise to the
= liabilities + equity). The basis of double-entry accounting equation shown below:
accounting is the distinct relationship between a
company’s liabilities, assets, and equity. The source The Accounting Equation’s Restrictions
of a company’s accounting equation numbers is its
balance sheet. Owner’s equity, shareholder equity, Despite the fact that the balance sheet always
or stockholder equity are all examples of equity. balances, the accounting equation cannot inform
investors about the performance of a company.
The present double-entry system of accounting, Investors must analyze the data and make their own
utilized by small businesses to giant multinational judgments about the company’s financial health,
enterprises, is built on this equation. This equation including whether it has enough or too few assets,
also goes by the names fundamental or basic too many or too few liabilities, and whether its
accounting equation and balance sheet equation. funding is adequate to support long-term growth.

Every company, as we all know, possesses some Accounting Equation- Numerical 1

assets. The claims of creditors and the claims of
the business owner make up the majority of the Calculate the missing numbers from the following
claims made against the assets possessed by a using the accounting equation concept:
company. In accounting, the owner’s assertions
are known as its equity, whereas the claims of the 1.Assets = Rs. 100,000, Liabilities = Rs. 40,000, and

creditors are known as liabilities. Owner equity worth = ?

Assets= Liabilities + Owner’s Equity 2.Assets =?Liabilities = Rs. 70,000, While owner

20
Introduction to Accounts
equity =Rs. 40,000 Accounting Equation- Numerical 2

3.Liabilities =? and Assets = Rs. 110,000. Owner’s The following transactions are recorded by Mr.
equity = Rs. 60,000 Patel, a wholesale dealer, in Accounting Equation.

Solution: 1.Started company with Rs. 200,000 in cash and

Rs. 50,000 in the land.
1.Owner’s Equity= Assets - Liabilities
2.Purchased merchandise for Rs. 80,000 in cash.
= Rs. 1,00,000- Rs. 40,000
3.Sales are Rs. 25,000 in cash.
= Rs. 60,000
4.Bought things worth Rs. 50,000 on credit from
2.Assets= Liabilities + Owner’s Equity Salman.

= Rs. 70,000 + Rs. 40,000 5.Mr. Shah’s account sales of Rs. 12,000

= Rs. 1,10,000 6.Purchase Rs. 5,000 worth of furniture using cash.

3.Liabilities= Assets - Owner’s Equity 7.Rs. 10,000 in cash was received from Mr. Shah.

= Rs. 1,10,000- Rs. 60,000 8.Return damaged furniture for a total of Rs. 1500.

= Rs. 50,000

21
Introduction to Accounts
9.Paid salaries of Rs. 1,000, Rent of Rs. 2,000, and in at least two accounts under the double entry
Electricity bill of Rs. 1,500. method. In addition, it mandates that the sum of
all debits and credits entered in a transaction must
So, the Total Balance of Assets will be calculated match; otherwise, a journal entry is deemed to be
as: out of balance. These regulations are necessary
to make sure that a company always maintains a
(a)+(b)+(c)+(d) = Rs. 2,04,000 properly balanced accounting equation.

Similarly, the Total balance of Equities will be In a double-entry bookkeeping system, each
calculated as: transaction—both credits and debits—has a
matching record. Every transaction comprises
(e)+(f) = Rs. 2,04,000 two elements and impacts two ledger accounts,
which forms the foundation of the double-entry
Double Entry System - Part 1 accounting system. Every company transaction in
the double-entry system of bookkeeping involves
Every business transaction must be documented two or more accounts.

22
Introduction to Accounts
For instance, if a business borrows money from a detailed financial records, which ultimately aids
bank, there will be two entries—one for an asset in regulating
and one for a liability. This is so that it will both
● The details that were captured can also be used
raise the assets for the cash balance account and
to make comparisons. Details from the first
the liability for the account for loans that are still
and second years can be compared, and any
owing.
deviations that emerge during the comparison
can be addressed.
Therefore, there is an equal and opposite entry
for each event related to finance, in at least two
Adopt a Double-Entry System
independent accounts. It is common practice to
Remember this straightforward guideline when
utilize the double-entry system of bookkeeping,
utilizing the double-entry bookkeeping method.
which contains thorough descriptions of the
services and goods, expenses, income, bad debt,
Credits and debits should be completely equal.
loans, etc.

Using the double-entry method, transactions are

Among the basic accounting, equations is Assets =
recorded in the general ledger throughout this
Liability + Equity. Both sides of the equation should
period.
add up to the same total. There is an error in the
books of accounts if the total assets do not equal ● On the left are recorded debit entries.
the total liabilities plus capital. Every transaction,
● On the right, credit entries are kept track of.
therefore, requires two entries, and for the books to
● Liabilities are the section where debits belong.
be in balance, the assets must also increase if the
liabilities do. ● Credits belong in the assets section.

● In the end, the assets and liabilities should add

Principles of the Double-Entry Bookkeeping System
up.

The following guidelines should be observed when

Double Entry System - Part 2
using the double-entry bookkeeping system:

Delivery vehicles are purchased on credit by a fleet

● Credit appears on the right, with the debit to the
owner. The total amount of the credit purchase
left.
is Rs. 50,000,000. For the next ten years, no new
● There must be a credit for every debit.
trucks will be sold; instead, they will all be employed
● Credit provides the benefit, and debit receives it. in regular commercial operations. Trucks are
expected to last 10 years. Give an explanation of
Double Entry System Benefits the double entry system.

● Through the use of the trial balance device, this Answer:

system improves the accuracy of the accounting.

● This system allows the business to maintain Trucks are being bought on credit. Two actions
are involved in the transaction: one is the credit
23
Introduction to Accounts
purchase of the trucks, and the other is the addition payable liability balance by the same amount that a
of additional inventory. Entries can be found in the debit entry increases the inventory asset balance.
relevant accounting ledgers.
As the company’s assets grow, a debit entry for Example 2
Rs. 50,000 will be created in the inventory, which
is equal to the cost of the trucks. Due to the fact Let’s use the purchase of office furniture as a

that these are credit purchases, an equivalent straightforward example.

transaction must be recorded to the credit side of

The acquisition of office furniture must be
accounts payable.
documented using the following double-entry

We can see that a credit entry raises the accounts method.

As you can see, a single transaction had an To make things clearer, let’s use another example.
impact on two distinct accounts and resulted in
corresponding debit and credit entries. Take the example of wage this time around.

In this case, you debit your salary costs to increase Double Entry System v/s Single Entry
them and credit the cash account to balance it out. System

Two statements can be used to generalize and Earlier we studied the Double Entry System. In this
condense this. section, we will learn about the Single Entry System.
It is important to understand the concept of a Single
Whenever there is a debit, the assets or expenses Entry System in order to have a comparison with a
go up and the liabilities or revenue go down. Double Entry System.

Credits usually raise liabilities or income while Introduction to Single Entry System
reducing assets or expenses.
It is considered to be the most traditional system
for preserving financial records. Since transactions

24
Introduction to Accounts
are only recorded once in this system, the The one-sided entry makes it impossible to
corresponding opposing entry is not made. Due to reconcile finances, which increases the likelihood
a single entry for each transaction, complete record of fraud and mistakes. It does not follow generally
keeping of transactions is not done. It primarily accepted accounting principles because of this
records transactions involving cash receipts and (GAAP). Additionally, the accounting documents
payments. kept under this approach are insufficient for tax
purposes.
The majority of sole proprietorship and partnership
businesses adopt this type of record-keeping. For Single Entry System vs. Double Entry System
entering transactions, this system does not require Differences
a high level of competence or understanding.
Ledgers, journals, and trial balances are not The comparison chart below indicates which entry
equipped for it. The income statement, however, is system to be opted for..
created to reveal the company’s profit or loss.

25
Introduction to Accounts
Important Distinctions Between the Single-Entry transactions completely.
and Double-Entry Systems
● Comparison between two accounting periods is
especially challenging in single entry systems. In
The primary differences between the single entry
contrast, with the double entry approach, we may
system and the double entry system of bookkeeping
quickly compare two accounting periods.
are as follows:
● Small businesses should use the Single Entry
● Single entry transactions are quick and method, whereas large organizations should use
uncomplicated, however double entry systems the Double Entry System.
are complicated and demand accounting skills
● Frauds and embezzlement are easier to spot in
to keep records.
double entry systems which cannot be located in
● Single entry systems keep only partial records, single entry systems.
whereas double entry systems record all

Summary

● The double-entry accounting system is thought to be built upon the accounting equation.

● According to the accounting formula, a company’s total assets are equal to the sum of its liabilities and
shareholders’ equity on its balance sheet.

● The company’s significant resources are represented by its assets. Their responsibilities are represented
by their liabilities.

● Liabilities and shareholders’ equity both show how a corporation finances its assets.

● Debt funding is displayed as a liability, whereas equity financing is displayed as shareholders’ equity.

● A mathematical formula used in financial accounting is known as the accounting equation. It demonstrates
from a company’s balance sheet that Total Assets = Total Liabilities + Total Equity.

● Depending on the legal status of a corporation, Total Equity has different names.

● Accounting equation is also called the balance sheet equation and the fundamental accounting equation.

● The double-entry bookkeeping and accounting system is the foundation of the accounting equation
formula. When recording business transactions and creating financial statements, debits and credits are
equal.

● The basic accounting equation is less detailed than the expanded accounting equation. More shareholders’
equity components are included in the calculation in the expanded accounting equation. Results are
comparable.

● The accounting calculation does not take into consideration cash flow. The cash flow statement of the
business is not necessary to calculate the accounting equation.

26
Introduction to Accounts
 Unit 4

Journal Entry

Learning Objectives Introduction

By the end of this unit, you will be

The accounting cycle begins with a journal entry. A journal
able to understand:
records all of a business’s financial transactions that
● Type of books
identifies the accounts that are impacted. Every financial
● Golden rules of journal entry transaction affects at least two accounts since most

● Procedures - recording journal organizations employ a double-entry accounting system.

entry
Why Keep a Journal and for What Reason?
● Journal entry - characteristics

While many people are frequently interested in learning

how to journal, they aren't sure how doing so will assist
them to achieve their objectives. The main books of
accounting are journals. A journal keeps track of all
transactions in exact time sequence, or chronologically.
The journal is the most crucial book of entries since it
determines whether all other accounting procedures
are accurate. It not only lowers the likelihood of leaving
out a transaction, but it also makes it simpler to fix data
in the event of an error. It is now simpler to completely
comprehend the financial event because every journal
entry includes an explanation.

Type of Books

The recorded records of a company’s or an individual’s

27
Journal Entry
financial transactions and business operations are book to enter the financial transactions, provides
known as books of account. a reconciled balance by summarising the journal
entries of each account.
After registering your firm with the Bureau of Internal
Revenue, taxpayers and business owners should Assets, liabilities, receipts, outlays, and net profits
always maintain track of all financial transactions are all consistently tracked in this book of accounts.
to prevent penalties (BIR). Every transaction is
documented using books of accounts. 3. Journal of Cash Receipts

The taxpayers submit applications for both Books All financial settlements of expenses are
of Accounts and certificates such as a Certificate maintained in the unique sort of journal, together
of Registration (COR) with the Bureau of Internal with receivables collection.
Revenue (BIR).
Financial transactions can be recorded as the sale
Broadly, there are two types of books: of an asset, cash sales, client collections, interest
payments, rent payments, etc.
● Journal

● Ledger The cash receipts are utilized to record all cash

sales and receivables.

4. Journal of Cash Disbursements

The internal diary kept by accountants to track the

outflow of cash from businesses is called cash
disbursement.

This book of account records cash payments for

1. General Journal payables and expenses to greatly aid in the updating
of the general ledger and aid professionals in
The general journal, commonly known as the understanding the payment status of businesses.
initial entry book, that keeps track of all financial
transactions according to the date of the 5. Sales Journal
transaction. It is employed for real-time transaction
recording. A specific kind of diary called a sales journal is
used to track all of a company’s sales, including the
It adheres to the general debit and credit premise. selling of products.

2. General Ledger As a result, it is one of the best types of accounting

books for tracking credit sales.
General Ledger, additionally known as the final

28
Journal Entry
6. Journal of Purchase ● Debit/Credit Approach: Universal, Traditional, or
British
One of the books of accounts that the corporation
● American or contemporary methods
uses to track its credit-based transactions and
payments is this one.
In the traditional approach, the main idea is to divide
different accounts into two major groups, namely
These records are used to track credit purchases.
personal and impersonal accounts, which we
shall go into more depth about below. The modern
While the other four sorts of journals are likewise
Approach, on the other hand, classifies various
believed to be special journals, the general
transactions using the Accounting Equation.
journal previously described is understood to be a
traditional journal.
Real, personal, and nominal accounts are governed
by the “Three Golden Rules of Accounting.”
Golden Rules of Journal Entry
Golden Rules of Accounting is a set of guidelines
Every procedure is governed by a set of generally
that make up the traditional approach. All sorts
applicable guidelines that are adhered to by
of transactions are subject to these rules. Making
everyone. In order to add uniformity to the
debit and credit entries in the accounting ledger
presentation and overall structure of the notion,
by classifying each transaction or entry into one
these guidelines describe the process of basic
of these three categories is one of the three most
functions.
often discussed and fundamental Golden Rules of
Accounting.
Today’s accounting goes much beyond bookkeeping.
Debit and credit are two crucial components of
● Real
accounting. Before fully understanding which
account should be debited or credited, we cannot ● Specific or

enter a transaction. ● Normative Accounts

In the dual entry system of accounting, we have Let’s examine each accounting principle in further
two columns to enter our transactions because depth now.
every financial transaction affects two accounts.
We need to grasp the different account types and Real Account
their accompanying debit credit rules before we
can understand an accounting entry. Real Accounts are a group of material components
of a business, such as cash, furniture, etc.
One must make the difficult decision of choosing
the rule as a newcomer in the field of accounting. ● When completing accounting entries, the item
Basically, accounting can be carried out by using that belongs to the real account should be written
the on the Debit side if it is entering the business.

29
Journal Entry
● When creating accounting entries, the real If there’s a cost or loss to the company, debit it.
account item should be written on the Credit side
if it is leaving the company If the business receives income or a profit, credit it

Procedures - Recording Journal Entry

The accounting cycle’s first two phases are

transaction analysis and journal entries.
Transferring journal entries to a general ledger
often has a different way for each account, which
is known as posting. While ledgers list transactions
by account, journals keep track of transactions in
Real account’s accounting rule is as follows: chronological order. A posting in accounting only
requires a few easy actions.
“ Debit What Comes In, Credit What Goes Out”
Enter Your Account Name and Number
Personal Accounts
Sales, cost of goods sold, marketing and advertising
● If a person, group of people or legal entity receives expenses, depreciation expenses, interest, and
something from the company, debit the recipient. taxes are all recorded in the income statement
● Credit the payer or giver if an individual, group of accounts. Accounts on the balance sheet include:
individuals or legal entity pays a business.
● Cash
The personal account’s accounting principle is as ● Customer receivables
follows:
● Payables accounts

“ Debit The Receiver, Credit The Giver” ● Bonds owing

● Depreciation over time

Nominal Accounts
● Withheld profits

Every cost, loss, income, and gain incurred in the ● Public stock
course of conducting business is represented by
nominal accounts. The gradual distribution of a fixed asset’s cost over
its useful life is known as depreciation.
● Electricity costs
Post the Entry Information
● Calling-related costs,

● Received Interest, The second stage is to post each journal entry for
● Profit from Machine Sales, etc. each account during an accounting period with the
date, brief description, and reference number. The

30
Journal Entry
reference number could be written as “J#,” where Rectify any Mistakes
“J” stands for the company journal and “#” stands
for the page number. J1 denotes that the entry is Errors in maths and data transfer are checked as
from page 1 of the journal, for instance. Similar the last step before posting. Accounting software
to what is written in the notebook, the description solutions may automate these errors, but double-
reads, “Cash receipt, invoice number 11-1097.” checking the figures is a smart precaution that
stops errors from affecting financial accounts.
Entry of Debits and Credits
Journal Entry - Characteristics
The subsequent step in the posting process is the
recording of debits or credits. There must be at To pass the journal entries, one needs to understand
least one debit and one credit in every transaction. what journalizing is and why it is necessary.

Debits raise expense categories on the income We must comprehend the following aspects of
statement, like marketing and wage costs, as well this first stage of accounting in order to fully
as asset accounts on the balance sheet, like cash comprehend it:
and inventory. Credits increase shareholders’ equity
accounts like retained earnings while debits reduce ● Chronological: The diary entries must be made
balance sheet liability accounts like notes payable. in chronological order, or date-wise, in which the
On the revenue statement, debits also reduce the transactions occur.
sales accounts. ● Double entry system: Dual entry system in which
each transaction is evenly entered on the debit
Accounts for shareholders’ equity, liabilities on and credit sides. Alternatively put, a debit is
the balance sheet, and sales are all increased by made from one account, and a credit is made
credits. Asset accounts and cost accounts on the from another for the same amount.
balance sheet are reduced by credits.
● Daybook: Journal is used as a daybook to keep
track of daily activities.
Search for the Running Balances
● Compound entry possible: It is possible to make
Searching for running balances is considered to be a compound entry in a journal when there are
the fourth step. For instance, if the cash account multiple linked transactions that happen on the
records three separate debit entries on different same day or when there are multiple accounts
dates totaling Rs.10,000, Rs. 5,000, and Rs, 25,000, involved.
respectively, the total debits are Rs.10,000 plus Rs.
● Assistant to ledger: Because the ledger is created
25,000, or Rs. 35,000, and the total credit is Rs.5,000.
using the information given in the journals,
Therefore, $35,000 less $5,000, or $30,000, is the
journal entries act as the foundation for all other
debit balance as of the most recent date.
books of accounts, including it.

● Transaction identity: It keeps track of each

transaction’s supporting documentation and

31
Journal Entry
 makes it simple to recognize each business typically expressed in brackets (Being_) to better
activity by its date and other details. explain it.

● Original entry: Because a transaction is first

Journal Entry - Numerical (1)
entered in the journal rather than other books of
accounts, its originality and authenticity can be
Mr. Murthy owns a single-person supply business.
preserved.
The following lists the transactions made in January
● Includes small explanation: Each transaction 2017. Journalize them.
is accompanied by a brief narrative, which is

Solution:

32
Journal Entry
Journal Entry - Numerical (2)

Mr. Patel commenced his business on March 1st, 1993, with a capital investment of Rs.50,000. His transactions
for the month were as follows:

33
Journal Entry
Solution:
Journal of Mr. Patel for the year 1993

Journal Entry - Numerical (3)

Mr. Das began his business on April 1st, 1995, with a capital investment of Rs. 50,000. His monthly transactions
were as follows:

34
Journal Entry
Solution:
Journal Entry of Mr. Das for the year 1995

35
Journal Entry
36
Journal Entry
Journal Entry- Numerical (4)

Electronics merchant Bharat commenced his business in 2016. Pass journal entries for the following
transactions that happened in the month of March 2019.

37
Journal Entry
38
Journal Entry
Summary

● With accurate records of all financial activities, books of accounts define sound business practices for all
organizations.

● The accounting cycle is a procedure created to make it simpler for business owners to account for the
financial aspects of their operations.

● An accounting cycle normally has eight steps to be completed.

● Business owners receive thorough financial performance reports at the end of the accounting cycle, which
are used to evaluate the company.

● Despite the fact that practically all accounting is done electronically, it must still be carefully reviewed.

● Bypassing journal entries has various advantages for the company enterprise.

● First of all, it may gather all the results of transactions in one location.

● Second, it offers transaction records in chronological order, making it easier to find any transaction based
on its date.

● Thirdly, it reduces errors since it is simple to compare individual and total transaction debits and credits.

● Additionally, any entry that is made but does not appear in any of the company’s books is noted in the
journal.

● Journal entries describe how transactions influence accounts and balances and serve as a simple record
of all transactions that a business makes.

● The information in journal entries, which come in a variety of formats to suit corporate requirements,
serves as the foundation for all financial reporting.

● For instance, adjusting journal entries are used to accumulate or delay revenue and expenses, alter or
rectify earlier entries, or forecast non-cash events like allowances for written-off debt.

39
Journal Entry
 Unit 5

Ledger & Subsidiary Book

Learning Objectives Introduction

By the end of this unit, you will be

It is impossible to retain and maintain a record of
able to understand:
every business transaction that takes place in large
● Introduction to ledger
organizations since there are so many of them. While not
● Rules of ledger posting documenting even the smallest transaction might cause

● Difference between journal & devastation, the company will never do this.

ledger
This is where the ancillary books enter the picture and
step in to save the day. Subsidiary books are nothing
more than a system for keeping track of transactions of
a similar sort. Subdivisions of journals are books called
subsidiary books. We will get in-depth information about
these publications and many types of subsidiary books in
this article.

How do subsidiary books work? Original Entry books

are called subsidiary books. They are also called special
journals or day books. In subsidiary books, we record
transactions of a similar sort. They assist in getting
around the drawbacks of journal books or journal entries.
We shall examine various Subsidiary Book kinds in this
essay.

A tiny company might be able to keep track of every

transaction in a single book, called a journal. However, as

40
Ledger & Subsidiary Book
the company grows and there are more transactions, accounts as the business expands and there are
it gets more complicated to record them all in one more transactions.
book and more challenging to record them to the
appropriate financial records. Due to the repetitive nature of the bulk of
transactions, it is easier to record them in multiple
Since the majority of transactions are repeated in books that are each intended to record transactions
nature, it is simpler to record them in several books with a similar character. All credit sales, for
that are each designed to record transactions with instance, can be noted in the sales book, and all
a similar character. credit purchases, too.

Ledger Account Characteristics

● An account book called a ledger is where

different business transactions are recorded
under distinct accounts.

● It uses the double-entry method. As the book that

records transactions’ final entry following the
journal or all-purpose books,
Introduction to Ledger
● It is sometimes known to be a principal record of
accounts.
A ledger is an accounting-related book. Only the
accounts can provide any financial statement ● It maintains all forms of Accounts related to
pertaining to the company’s financial status. As a assets, liabilities, capital, and revenue.
result, this ledger is referred to as the main book. ● It is the only documentation of the commercial
Due to everything said above, it is essential to relate transaction categorized into pertinent Accounts.
every piece of data for each account.
● Future financial statement preparation is made
easier by it.
Due to the repetitive nature of the bulk of
transactions, it is easier to record them in multiple
Benefits of the Ledger
books that are each intended to record transactions
with a similar character. All credit sales, for
● Because it documents both sides of each
instance, can be noted in the sales book, and all
transaction, the double entry method is
credit purchases, too.
successfully applied through the ledger.

Concept of Ledger ● Specific people or things’ ledger information

is kept separate from other information in the
A tiny company might be able to keep track of all account. This gives the company the ability to
transactions in a single journal. This is increasingly review the totals for each account.
hard to maintain all of the events in a book and ● Analysis of a company’s overall revenues and
more difficult to do posting to the correct ledger outlays for a specific time period is feasible

41
Ledger & Subsidiary Book
 thanks to ledgers. business accounting. All Accounts will have all the
information about all the transactions pertaining to
● The journal is where transactions are first entered.
them by the conclusion of the Accounting period.
The ledger is the next place where transactions
are posted, reducing the possibility of mistakes
1. Basic facts regarding business: Ledger offers
and omissions.
a thorough record of all transactions, assisting the
● Managers benefit from the ledger’s assistance in
company in examining expenses and revenues.
supplying crucial data required to make sure the
The appropriate steps are performed if differences
operation of the company runs well.
between the two are discovered.

Different Ledger Types

2. Understanding asset book value: All of the
business’s asset-related records are centrally
There are three different types of ledgers:
located in the ledger. Each asset and its associated
transactions are kept in a separate Account. Any
● Sales Ledger
asset’s book value can be calculated by using the
● Purchase Ledger Ledger at any point in time.
● General Ledger
3. Beneficial for managing: Financial statements
1 Sales ledger: It is a record that a business uses go on to use the information provided by the ledger
to record financial events that involve the selling accounts to determine the company’s growth or
of products, services, or costs to customers. This the causes of any losses. Based on it, management
ledger provides a notion of sales revenue and an may make wise decisions.
income statement.
4. The cause of the gap in costs or earnings: The
2. Purchase ledger: It is a book where a business Ledger keeps track of both the business’s income
records the acquisition of goods, services, or both and expenses. Therefore, if there is any variation in
from other companies. their balance, they must reassess and address the
issue.
3. General ledger: Nominal Ledger and Private
Ledger are the two forms of general ledgers, Rules of Ledger Posting
respectively. Information on spending, income,
depreciation, insurance, etc. is provided by the Journal entries that have been passed in the journal

nominal ledger. Additionally, Private Ledger provides are made into ledger postings. This signifies that

private data such as salaries, wages, capital, etc. each journal activity must be recorded into all

Everyone cannot access the private ledger. accounts that the entry has debited or credited.

Importance of the Ledger Balance The ledger, which is the main book, is where the
transactions are posted once they have been noted
The ledger, which contains all of the transaction data in the journal. It is a way of moving the activities
in individual Accounts, serves as the foundation of from the journal to the appropriate ledger accounts.

42
Ledger & Subsidiary Book
At the end of the year, ledgers are balanced to column if the total of the credit side is greater
identify discrepancies. than the total of the debit side, and vice versa
if the total of the credit side is greater than the
As a result of this ongoing process, the ledger total of the debit side. If the sums on the credit
accounts are closed, tallied, and balanced at the and debit sides are equal, the balance should be
conclusion of the fiscal year. The balancing of the displayed in the balance column as “nil.”
ledger accounts is the term for this procedure.
Ledger balancing
Rules to be Followed While Posting in Ledger
The books of accounts are shut, tallied, and
It’s crucial work to post the entries from day books maintained at the conclusion of each financial year.
to the ledger. While publishing the entries, an
accountant must keep the following guidelines in Balancing Ledger Account: Steps
mind:
● To start, to prevent errors, total the credit and
● Only entries from the daybooks or journals may debit columns separately on a preliminary
be posted. page. Subtract the lower from the higher to get
the difference between the heavier and lighter
● The transactions must be recorded in date order.
totals. We refer to the discrepancy as a “Balance
● The day of recording in the ledger must match
amount.”
the date of entry in the day books.
● It is known to be a “Debit Balance” and is
● Each and every sum entered in the journal’s debit
mentioned on the credit side of the relevant
side must be posted to that account’s debit side.
account as “By Balance c/d” or “By Balance c/
● A specific account’s credit side must receive all FD”. The terms carried down (c/d) and carried
entries made on the journal’s credit side. The forward (c/FD) are used here.
other account’s name, as it appears in the journal
● Similar to this, the balance is known as “Credit
and relates to the same entry, must be written
Balance” if the total of the credit side is higher
in the ledger’s “particulars” column, and the
than the total of the debit side. On the debit side
account head must begin with “By.”
of the account, the difference is shown as “To
● Following the entry, the page number of the balance c/d” or “To balance c/fd.”
journal from which the entry is uploaded, as well
● The heavier total should be entered in both
as the page number of the ledger account, must
columns once we have it. The account is closed
be recorded in the L/F column of the journal or
and balanced if there are two double lines
day book.
crossing the sum below the amounts.
● After that, the ledger should be balanced.
● The opening balance for the current year is
The process of balancing might be executed
the ending balance from the previous year.
simultaneously or after the debit and credit side
Therefore, if there is a debit, it should be shown
totals have been computed. The balance should
as “To Balance b/d” or “To Balance b/fd” on the
be displayed as a debit balance in the balance
debit side of the relevant account. In this context,
43
Ledger & Subsidiary Book
 the terms dragged down and brought forward are Each transaction has an impact on two accounts.
both used. Each financial transaction in this system is
properly recorded using a process known as the
Difference between Journal & Ledger accounting process, which begins with the journal

and forwarded to ledger, trial balance, and final Ledger Posting - Numerical (1)
accounts. Two pillars of the base for preparing final
accounts are the journal and the ledger. Mr. Raheja’s company, Creative Advertising, offers
The comparison chart below depicts the difference advertising consultancy services. The following
between Journal and Ledger in a simplified way. things happened in January 2015:

44
Ledger & Subsidiary Book
The owner started her firm on January 2 with a Jan. 12. The utility bills were settled for Rs. 2,750 by
contribution of 50,000 rupees and a new computer Creative Advertising.
that cost 20,500 rupees.
Jan. 15. The Rs. 3,000 in Accounts Payable from
Jan. 4. Office supplies worth Rs. 4,000 were bought the Jan. 4 office supply transaction was paid.
on account on
Jan. 24. Client Annies’ Flowers received a bill for
Jan. 10. Creative Advertising secured a 12%, 5-year Rs. 18,300 for advertising services rendered in
loan from the bank for 10,000 rupees. January.

Account 1

Cash Account

45
Ledger & Subsidiary Book
46
Ledger & Subsidiary Book
47
Ledger & Subsidiary Book
Jan. 27. A client, Annies’ Flowers, gave Creative The purchase included an Rs. 150 freight fee.
Advertising Rs. 5,500 as payment on account
9 October, Sold garden products for Rs. 4,000 with
Jan. 30. Mr. Raheja withdrew Rs. 5,000 for his credit conditions of 3/20 net 30 FOB shipping point.
personal use The selling price of the supplies was Rs. 2,500.

Ledger Posting - Numerical (2) 10 October, the balance due for the inventory
purchase from October 2 was paid.
Retail garden supply Patel Garden Centre. For
October 2015 of the current year, record the below on 15 October, Mr. Patel received goods that had
events and post them to the appropriate ledger been returned because they were flawed. They had
accounts: been purchased for Rs. 500 on Oct. 9. The materials
were originally purchased for Rs. 275.
2 October: Inventory was purchased with a 1/10 net
30 credit term. For Rs. 3,000, FOB shipping point 25 October, Payment was received on account for

48
Ledger & Subsidiary Book
49
Ledger & Subsidiary Book
50
Ledger & Subsidiary Book
51
Ledger & Subsidiary Book
the transaction from Oct. 9 less the proper sales discount.

28 october inventory destroyed in the fire cost 350 rupees.

Ledger Posting - Numerical (3)

52
Ledger & Subsidiary Book
53
Ledger & Subsidiary Book
Mr. Das commenced his business with a capital first started her business and Rs. 100,000 in cash
of Rs. 50,000 on 1st April 2013. Below are the in a company’s bank account.
following transactions carried on by him:
● Purchase a pre-owned motor vehicle for Rs.
50,000 with a check.
Ledger Posting - Numerical (4)
● Painted a two-story house to completion and
Make Ledger Accounts for Singh Ltd as of charged the customer Rs. 24,800 (Account
March 30th, 2010 by posting transactions to the ● Receivable Dr). 4. Singh Ltd. was paid Rs. 5,000
appropriate T-account: to paint two rooms. It was kept in a till for cash.

● 5. Hired a coworker at a salary of Rs. 100 each

The following transactions were carried out by
day.
interior designer Anita Sharma in the month of
March 2010. ● Check was used to pay for the Rs.14,600 worth
of materials.
● She invested Rs. 80,000 in equipment when she
● Paid a helper Rs. 600 in cash for six days of work.

54
Ledger & Subsidiary Book
55
Ledger & Subsidiary Book
56
Ledger & Subsidiary Book
Cash Book - Numerical (1)

For December 2019, enter the following transaction in a cash book:

57
Ledger & Subsidiary Book
Cash Book - Numerical (2)

In a cash book, record the following transaction for April 2019:

58
Ledger & Subsidiary Book
Summary

● The process of posting involves adding the data from the journals to the ledger. The following are the
guidelines for posting transactions:

» The debit portion of the journal entry is recorded to the ledger account’s debit side, while the credit
portion is posted to the ledger account’s credit side.

» The journal is made up of unprocessed accounting entries, organised chronologically by date, that
document company activities.

» The five main accounting elements that the general ledger tracks are assets, liabilities, owner’s capital,
income, and expenses.

» The accounting process has been streamlined thanks to advancements in software technology, making
it simple and effective to integrate the two bookkeeping chores.

» The double-entry accounting system of a business is built on the general ledger.

» All transaction information required to generate the income statement, balance sheet, and other financial
reports is contained in general ledger accounts.

» Transactions recorded as journal entries to sub-ledger accounts are compiled into general ledger
transactions.

» Every general ledger account and its balance are listed in the trial balance report, which makes it simpler
to check adjustments and track out problems.

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Ledger & Subsidiary Book
 Unit 6

Trial Balance

Learning Objectives Introduction

By the end of this unit, you will be

The fact that there is a debit and credit of equal amounts
able to understand:
for each transaction in two or more accounts is a crucial
● Introduction to trial balance
component of the double-entry bookkeeping method. As
● Steps in preparing trial balance a result, the sum of both sides must match.

● Methods of preparing trial

In order to confirm that the debits and credits posted to the
balance
ledger accounts are equal, a trial balance is a statement
● Errors in trial balance
that lists the balances, or sum of debits and credits, of
all the accounts in the ledger. On a specific day, the trial
balance is created. It is assumed that the posting to the
ledger in terms of debit and credit amounts is accurate if
the debit and credit columns of a trial balance are equal.

Introduction to Trial Balance

A trial balance is a financial report that displays the

general ledger’s closing balances for all accounts at a
certain point in time. The first stage in closing the books
at the conclusion of an accounting month is to create a
trial balance.

Requisites

Initially, organizations would enter their financial

60
Trial Balance
transactions in the main ledger’s bookkeeping with the ledger accounts’ final closing amounts.
accounts. Accounts in the ledgers may have Find the closing balances of all the accounts you
recorded debits and credits during a certain have on your ledger before creating it in order to
accounting timeframe before being used on a reduce the no. of errors. An account’s balance is
trial balance worksheet depending on the types of the sum of all its credits minus all its debts.
business activities that have occurred.
2. Trial Balance Entries for Debit or Credit Balances
Additionally, a small number of accounts may
have been used to record a number of financial The leftover debit or credit balances in the different
transactions. As a result, the ultimate balance of ledger accounts that were previously determined
each ledger account, as shown in the trial balance are then recorded in the trial balance. According to
worksheet, would consist of the total of all credits the situation, the balances of each ledger account
and debits recorded on the basis of all pertinent are listed in the debit or credit columns.
financial transactions.
3. Calculate Debit Column’s Total

Calculate the debit column’s total. After entering

all aforesaid balances from the various ledger
accounts into the debit column of the trial balance,
this is done.

4. Calculate the Credit Column’s Total

Calculate the credit column’s total. After entering

all of the credit balances from the various ledger
Steps to Prepare Trial Balance accounts into the credit column of the trial balance,
this is done.
Trial balances can be created manually or with the
use of a computerized accounting system. Follow 5. Trial Balance Should be Closed
these procedures when creating a trial balance for
any type of business. If the credit and debit columns in your trial balance
worksheet are equal, you can close it. You must
1. The Ledger Accounts Should be Equal locate the error in your ledger if they are not equal
to one another. It can be simpler to find and fix the
Prior to making the corresponding entries in the typical mistakes that can result in insufficient credit
relevant ledger accounts, businesses first record and debit columns if you are aware of them. Only
their transactions as journal entries. Following that, after fixing all mistakes is the account able to be
they determine the closing balances for each ledger closed.
account for the accounting period. Inventory, utility,
loan, rent, and wage are typical types. It is filled out Methods of Preparing Trial Balance

61
Trial Balance
The following three methods are available for trial instead of the individual accounts of the debtors
balance preparation: and creditors.

1. Total Method or Gross Trial Method Advantage

● It facilitates the quick creation of final accounts.

Gross trial balance, also known as the total
approach, involves adding the two sides of the ● This strategy can help you build a trial balance
accounts together. “Debit total” and “credit total” more quickly and with less labor.
are the terms used to describe the sums on the
Disadvantage
debit and credit sides, respectively. Its debit side is
used for all debit totals, while its credit side is used ● Regardless of Trial Balance’s approval, errors
for all credit totals. may not be disclosed.

Any account with a total on one side will have that 3. Compound Method
total placed in the appropriate column, either the
The totals of both dr. and cr. are listed in distinct
credit or debit one, depending on the situation.
columns using this manner. The balances are
also listed beside this in their own independent
Advantage
columns. In this book, credit balances are written
● It supports the accounts’ mathematical precision. on the credit side and debit balances are put on the
debit side.
● In order to prepare the trial balance, ledger
balance extraction is not necessary. Advantage

Disadvantage ● It has the benefit of both approaches.

● A final account’s preparation is not possible Disadvantage

2. Net Trial Balance or Balance Method ● Lengthy procedure and longer time spent on trial
balance preparation.
With this approach, we add up and balance the
accounts’ credit and debit sides. Then, we enter Errors in Trial Balance
these ledger account debit or credit balances in
the corresponding dr. and cr. columns of this book. The creation of final accounts involves the use
When the totals in the debit and credit columns of trial balance accounting. It entails compiling a
match, the trial balance is considered to be summary of each ledger account. It is being said
accurate. that total has been tallied when the debit amounts
This method, which displays the net effect and and credit amounts in the trial balance are equal.
aids in the creation of financial statements, is the Although it is not foolproof proof, the trial balance in
most used one. Typically, we show Sundry Debtors trial balance accounting serves as a demonstration
and Sundry Creditors accounts in the trial balance of the ledger accounts’ mathematical accuracy.

62
Trial Balance
However, some inaccuracies that equally influence or added instead, you have committed a
the credit and debit amounts are not disclosed. commission error. This results from a lack of
mathematical correctness.
● Original Entry Error: This issue occurs when you
● Reversal Error: This error occurs when a debit
double-enter a transaction and enter the incorrect
transaction is entered as a credit transaction or
amount on both sides. It’s a matter of oversight.
vice versa.
● Error of Principle: This error can occur if you
● Error of Compensation: A compensating
enter a transaction in a way that violates
error happens when two faults are made
fundamental accounting rules due to ignorance
simultaneously and one of them cancels out the
or carelessness. A typical instance is when a
other. Although both amounts are incorrect as
payment transaction is recorded as a receivable
a result of this inaccuracy, the debit and credit
transaction, and vice versa.
accounts are still equal.
● Omission Error: An omission mistake happens
when you completely forget to enter a transaction Trial Balance - Numerical (1)
into the system. As it is an error in the journal
entry, this clerical error cannot be seen on the Create the correct trial balance using the following
trial sheet. trial balance, which has certain errors:

● Error of Commission: When you enter the correct

Trial Balance - Numerical (2)
amount into the correct account but the incorrect
ledger, the amount that should be subtracted
Make a trial balance using the following data:

63
Trial Balance
64
Trial Balance
Summary

● The company’s ledgers are all summarised in the trial balance. It saves time since you can check the net
balance shown on the trial balance rather than having to read a specific ledger again.

● Trial Balance verifies that the accounting system entries are accurate. The balance of the debit and credit
columns signifies the accuracy of the ledger entries for the business.

● A trial balance is an accounting document that shows the ledger balances for a business. It shows the
assets, liabilities, equity, receipts, payments, losses, profits, and other significant accounting elements
required to prepare an organization’s or person’s financial statements.

● If you become familiar with trial balance, you may determine the debit and credit transactions made by
a business during an accounting period and confirm the precision of its bookkeeping system in terms of
maths.

● Trial balance errors: If the trial balance does not add up, it reveals that the accountant made some errors
when documenting the transactions. These result from inattention.

● Errors that a trial balance does not reveal: The agreement of a trial balance does not always imply an
accuracy check. The trial balance may not reveal all problems because the values on the debit and credit
sides are equal.

65
Trial Balance
 Unit 7

Trading, Profit & Loss A/c, &

Balance Sheet
Learning Objectives Introduction

By the end of this unit, you will be

Before creating a balance sheet, a business must first
able to understand:
create a trade and profit and loss account. To determine
● Introduction to final account
a business’s gross as well as net earnings, trading and
● Introduction to trading account profit-and-loss statements are helpful.

● Introduction to profit & loss

To ascertain the revenue made or losses suffered
account
during the accounting period, trading and profit and loss
● Introduction to balance sheet
accounts are prepared.
● Importance to final
accounts Within the general ledger, two distinct accounts—the
trading account and the profit and loss account—are
created. The account is divided into two parts:

● Trading Account

● The Profit and Loss Statement

Introduction to Final Account

The accounting procedure ends with the final account. A

final account is created to display the company’s overall
performance for a given time period. Financial statement
is another name for a final account. The final account
includes the balance sheet and the profit and loss
statement. The balance sheet’s composition of various

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Trading, Profit & Loss A/c, & Balance Sheet
assets, liabilities, and shareholders’ equity during period.
the accounting period is reflected in the profit
● Company’s accurate financial situation as of the
and loss account, which displays the profitability
date is recorded in the balance sheet.
realized during the period. Final accounts are
● These accounts divide direct spending in half to
therefore the result of combining the balance sheet,
calculate gross profit and loss and divide indirect
profit and loss account, and trading account.
expenses in half to calculate net profit and loss
for the company.

● These accounts divide the assets and liabilities

on the balance sheet according to their holding
and usage periods.

Advantages

● The final accounts’ correctness and efficiency

Features of Final Accounts are improved by their preparation.

● Any unintentional errors or fraud can be found

● Legally, it is mandatory for the companies to
and swiftly fixed throughout the preparation.
provide the final account. Entities must keep
accurate financial records, prepare financial
Disadvantages
statements, and have those accounts audited.

● To display and convey the entity’s financial ● The preparation of final accounts mostly relies
viability and stand to stakeholders and other on past financial and accounting operations.
people involved these accounts have been Users and the general public are only given
created. the presentation and status of the financial

● The statements of accounts are more useful transaction; no information regarding the entity’s

when comparing data from the prior period is workplace or customer satisfaction with the

shown for the current period. company’s services and items is provided.

● It provides accurate & complete information ● The audit of the financials has intrinsic

about the business with appropriate comments constraints that prevent a 100% guarantee that

and disclosures of the real facts, presenting an the financials are error-free.

accurate & fair perspective of the organization’s ● It is a good likelihood that the accountant’s or
financial performance. management staff’s individual judgment will
have an impact on the financials.
Goals of the Final Accounts
Introduction to Trading Account
● By providing the Statement of Profit & Loss, they
are prepared to compute Gross profit and net The majority of trading operations pertain to the
profit made by the organization for the pertinent buying and selling that takes place in a business.

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Trading, Profit & Loss A/c, & Balance Sheet
Businesses engaged in trade can benefit from it offers information for comparing, analyzing, and
having a trading account. They can quickly ascertain planning for the future.
the business’s overall gross profit or loss thanks to 2. Offers a Chance to Protect Against Potential
this account. The sum thus calculated serves as a Losses
gauge for how effectively the company buys and
sells. Effective steps can be done to prevent future losses
if the gross profit ratio has reduced compared to the
years prior. For instance, actions could be done to
analyze and manage direct expenses or to improve
When establishing the Trading account, direct sales the sale price of commodities.
and direct costs associated with the manufacturing
or acquisition of a product, such as labor and 3. Gives Details on Direct Costs and Direct Incomes
octroi, are considered. To calculate the gross profit
or loss, the goods’ closing stock and opening stock All costs associated with the acquisition of
are also taken into consideration. Only the Trading commodities are direct costs. The trading account
Account can be used to calculate the gross profit keeps track of them. Sales revenue, a direct source
or loss. of income, is also displayed in this. The ratio of these
costs to sales revenue can be determined using
Cost of Goods sold = Opening Stock + Net the trading account and compared to similar ratios
Purchases + Direct Expenses - Closing Stock from prior years. As a result, it gives management
control over direct costs.
When determining gross profit, the trading account
solely takes direct costs and direct revenues into Introduction to Profit & Loss Account
consideration. The major goal is to explain the gains
that the company has made from the acquisition of A financial statement known as a profit and loss
items. (P&L) statement provides an overview of the
revenues, expenditures, and expenses incurred for
Direct expenses, purchases, opening stock, and a given time period, typically a quarter or fiscal year.
other items can be found on the debit side, whilst These documents reveal if a business can produce
closing stock and sales can be found on the credit the profit by raising sales, cutting expenses, or doing
side. both. P&L statements are frequently displayed
using the cash or accrual method. P&L statements
The Requirement for Setting Up a Trading Account are used by investors and corporate managers to
assess a business’s viability in finance.
1. Describe Gross Profit or Loss in Detail
Profit and Loss Statement Structure
Representing the gross profit as a proportion of
sales, this aids businesspeople in determining A month, quarter, or fiscal year is commonly used
the gross profit ratio. Analyzing and comparing to represent the span of time in a business’s
with ratios from prior years is helpful. As a result, statement of profit and loss.

68
Trading, Profit & Loss A/c, & Balance Sheet
 profit or a loss within a specific time period is the
fundamental aim of the profit and loss statement.
P&L’s principal categories are as follows: To put it another way, the P&L shows costs incurred
in an organization’s attempt to create a gain.
● Revenue (or Sales)

● Expense for Goods Sold (or Cost of Sales) Statement of P&L

● General and Administrative Selling (SG&A) Costs

An overview of a company’s sales, expenditures,
● Interest costs
and expenses for a certain period-typically a fiscal
● Taxes quarter or year-is provided in the P&L statement,

● Net Profit one of the most important financial statements.

Profit and Loss Account’s Purpose This part calculates the net profit or loss by taking
into account all indirect costs and revenues,
Finding out whether a company is earning a including the gross profit or loss.

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Trading, Profit & Loss A/c, & Balance Sheet
Intoduction to Balance Sheet 2. Leverage: Analysing a company’s financial
structure can reveal how much leverage it has,
The foundation for calculating investor return rates which in turn reveals the level of financial risk
and assessing the capital structure of a company is it is incurring. Leverage on the balance sheet is
provided by balance sheets. frequently evaluated by comparing debt to equity
and debt to total capital.
It’s a financial statement that provides a quick
overview of the assets and liabilities of the firm 3. Efficiency: It is used to determine how effectively
as well as the amount of shareholder investment. a company uses its assets. To demonstrate how
When doing basic analysis or calculating financial well a corporation converts assets into revenue, the
ratios, balance sheets can be utilized in conjunction Asset Turnover Ratio is created by dividing revenue
with other crucial financial data. by the average total assets. The working capital
cycle also demonstrates how effectively a business
Balance Sheet: Its Relevance controls its short-term cash flow.

There are numerous reasons why the balance sheet 4. Return rates: You can assess a company’s ability
is a crucial financial statement. It can be examined to create returns by looking at its balance sheet.
separately or in conjunction with other statements.
Final Account - Numerical (1)
1. Liquidity: Liquidity can be determined by
comparing a company’s current assets against Ms. Divya purchased items worth 1,250 yen for
its current obligations. The company’s current personal use, but she did not write this in the book.
assets should be greater than its current liabilities. Charge 10% depreciation on furniture and 20% per
Financial liquidity measurements include the year on machines. Debtors, creditors, and stock
current ratio and quick ratio. in trade were each valued at 35,000, 17,500, and
12,500 euros, respectively, as of March 31, 2015.

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Trading, Profit & Loss A/c, & Balance Sheet
71
Trading, Profit & Loss A/c, & Balance Sheet
Final Account - Numerical (2)

Prepare the Trading and Profit & Loss account and Balance sheet for the fiscal year that concluded on June
30th, 2017, using the following trial balance of Gupta & Brothers and any extra information.

Additional Information: the month of June 2019 must be given for. But
salaries also included an Rs. 2,000 advance
● Furniture depreciation using a written-down
payment. Unpaid office expenses total Rs. 8,000.
method of 10% (WDM).
● A prepayment of Rs 2,000 has been made for
● On various debtors, a 5% allowance for
insurance.
questionable debts must be made.
● Rs. 6,000 for stock used for personal purposes
● A total of Rs. 3,000 in outstanding salaries for
and Rs. 60,000 for closing stock

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Trading, Profit & Loss A/c, & Balance Sheet
73
Trading, Profit & Loss A/c, & Balance Sheet
Final Account - Numerical (3)

Sinha grill industries has the following trial balance on 31st December.

74
Trading, Profit & Loss A/c, & Balance Sheet
75
Trading, Profit & Loss A/c, & Balance Sheet
76
Trading, Profit & Loss A/c, & Balance Sheet
 As on 31st December, 2016

77
Trading, Profit & Loss A/c, & Balance Sheet
Final Account - Numerical (4)

Create Hitesh Kumar’s Trading and Profit and Loss Account and Balance Sheet as on March 31, 2017 with
the following balances:

The Value of the closing stock was 2,000,000.

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Trading, Profit & Loss A/c, & Balance Sheet
79
Trading, Profit & Loss A/c, & Balance Sheet
Importance of Final Accounts to recover manufacturing tools and that
corporations rented to strengthen its financial
● These are referred to and are normally prepared position.
at the end of the fiscal year. They serve the
● To gain a clear and comprehensive image of
purpose of maintaining account records.
the present financial situation of the company,
● Their goal is to assess the results of various financial managers prepare corporate balance
revenues and outlays throughout the course of sheets and final accounts.
the year and the resulting profit or loss.
● Shareholders can assess the financial health of
● Financial analytics reports for businesses may a corporation using final accounts and balance
show that branch heads purchased equipment sheets.

Summary

● A financial statement that lists the revenues, expenditures, and expenses incurred over a given time period
is called a profit and loss (P&L) statement.

● Along with the balance sheet and the cash flow statement, every publicly traded firm also releases a P&L
statement quarterly and annually.

● The P&L statement, balance sheet, and cash flow statement when combined offer a thorough analysis of
a company’s total financial performance.

● The cash method or accrual method of accounting are both used to create statements.

● Comparing P&L statements from various accounting periods is crucial because any alterations over time
have more significance than the raw data.
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Trading, Profit & Loss A/c, & Balance Sheet
● An organisation’s assets, liabilities, and shareholder equity are listed on a balance sheet, which is a financial
statement.

● One of the three primary financial statements used to assess a company is the balance sheet.

● It offers a snapshot of the assets and liabilities of a corporation as of the publication date.

● The assets on the balance sheet are equal to the total of the liabilities plus the shareholders’ equity.

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Trading, Profit & Loss A/c, & Balance Sheet
 Unit 8

Cash Flow Statements

Learning Objectives Introduction

By the end of this unit, you will be A financial document called the cash flow statement
able to understand: (CFS) gauges how effectively a business manages its
● Intro. To cash flow statement cash position, or how successfully it generates cash to

● Cash flow statement - structure cover its debt payments and finance its operating costs.
CFS is considered to be the third financial statement. We’ll
outline the CFS’s structure and application to company
analysis in this article.

Intro. to Cash Flow Statement

The cash flow statement lets you keep track of incoming

and departing cash by displaying the source of that
money. An organization’s operational, investment, and
financial operations all generate cash flow. The statement
also provides information on investments, business-
related expenses, and cash withdrawals at a specific
point in time. The knowledge you obtain from the cash
flow statement helps managers make wise decisions for
managing business operations.

Businesses typically strive for a healthy cash flow

because, without it, they risk having to borrow money to
keep the business afloat.

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Cash Flow Statements
Cash Flow Statement - Structure Receipts from the sale of loans, debt, or equity
instruments are included in a trading portfolio or
The following is included in the CFS: investment firm because it is a business activity.

● Amount of money in hand for operating costs. 2. Investing Activities’ Cash Flow

● Funds received as a result of investments.

All of the ways that a company’s investments make
● Financial activities produce cash flow. and spend money are referred to as “investment
● Activities other than cash must be disclosed. activities.” Transactions involving the purchase,
sale, or financing of assets, as well as mergers and
acquisitions, fall under this category (M&A). Cash
from investments is produced through changes in
assets, investments, and machinery.

Cash flow statements from the investment are often

seen as cash-out items since money is frequently
used to purchase fresh machinery, structures, etc.
like marketable securities. The sale of an asset is
1. Revenue from Operations regarded as a cash-in for purposes of calculating
the amount of money a company has made through
Operating operations on the CFS include all sources an investment.
and applications of corporate funding. A company’s
net profit is a measure of how much money it makes 3. Revenue from Financing Activities
from the sale of its goods and/or services.
Money on hand reflects the financial contributions
Some examples of possible operational tasks made to the company by a number of parties,
include the following: including shareholders, banks, and investors. This
category includes the repayment of debt principal
● Receipts for the sale of goods and services. as well as payments for stock acquisitions (loans).
● Interest on loans.
Examples of cash flow statements and cash-out
● Payment of income taxes.
transactions that a business can carry out include
● Suppliers of products and services required for capital raising and dividend payments. To put it
the production of goods and services. another way, a firm obtains a specific sum of money
● Employee compensation, including salaries and when it issues public bonds. On the other hand,
wages. the company’s cash reserves are being reduced
as a result of interest payments to bondholders.
● Monthly rental payment.
Although interest is a cash-out cost, it is shown as
● Any additional costs incurred when conducting an operating expense rather than a finance expense
business. on the balance sheet.

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Cash Flow Statements
CFS-Numerical (1) the Statement of Profit and Loss account. During
the year, trade payables climbed by Rs. 60,000 and
Anmol Ltd. calculated a net profit of 5,00,000 for the trade receivables by Rs. 40,000. Use the indirect
fiscal year that ended on March 31, 2014. For the method to calculate the cash flow from operating
year, depreciation totaled Rs. 2,00,000. Assets were operations.
sold for a profit of Rs.50,000, which was added to
Solution:
Cash Flow Statement

CFS-Numerical (2)

The Ganga Limited Profit and Loss is showen below.

Profit and Loss statement of Ganga Ltd. for the year ended March 31,2015

Additional details: (ii) During the course of the year, prepaid expenses
rose by Rs 5,000.
(1) During the year, trade receivables fall by Rs
30,000. (iii) Trade creditors experience a year-over-year
decline of Rs 15,00.

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Cash Flow Statements
(iv) The amount of unpaid expenditures rose by Rs Use the indirect method to calculate net cash
3,000 throughout the course of the year. provided by operations for the fiscal year that ended
on March 31, 2015.
(v) Depreciation of Rs 25,000 was included in
operating costs.
Solution:
Cash Flow Statement from Operating Activities of Ganga Ltd. as on March 31, 2015

Summary

● A cash flow statement lists all of the cash and cash equivalents that come into and go out of a business.

● A company’s cash management, especially how successfully it earns cash, is highlighted by the CFS.

● The balance sheet and income statement are enhanced by this financial statement.

● Cash from three sources, including operating, investing, and financing activities, makes up the bulk of the
CFS.

● The direct approach and the indirect method are the two ways to compute cash flow.

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Cash Flow Statements
 Unit 9

Depreciation

Learning Objectives Introduction

By the end of this unit, you will be Depreciation is an accounting technique for spreading
able to understand: out the expense of a tangible item. It enables businesses
● Introduction to Depreciation to purchase assets over a predetermined length of time

● Causes & Need of Depreciation and generate income from those assets.

● Methods- Depreciation
Introduction to Depreciation

Depreciation is the process by which assets lose value over

time until their worth is zero or insignificant. Almost every
permanent asset, such as office furniture, computers,
machinery, buildings, etc., can depreciate over time. The
value of land, a fixed asset that appreciates (increases)
over time, is one that is not subject to depreciation.

Two key components make up depreciation. The first

factor is the asset’s value dropping over time. The second
consideration is spreading out the initial cost of an
expensive asset over the time you utilize it.

The projected useful life of an asset, or how long it may

be utilized, determines the number of years over which it
is depreciated.

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Depriciation
Causes & Need for Depreciation ● Sinking Fund Method

● Production Unit method

Firstly we will understand the causes of depreciation.
1. Straight-Line Method
● Wear and Tear

● Time Dilation: It is a user-friendly approach. It is the method that is

most frequently utilized. The Original Cost Method,
● Discontinuity
Fixed Instalment Method, and Equal Instalment
● Weariness Method are further names for it. According to this
● Useless procedure, the residual value is subtracted from the
asset’s cost
Need for Depreciation
Formula:
● To determine the true working outcome,
Depreciation (Cost of Assets - Residual Value)/
● To understand the real worth of an asset,
Useful Life of the Asset
● To set aside money for replacement

● To Present True Position Depreciation Rate Formula (Amount of

Depreciation/ Original Cost of the Assets) 100
● To Reduce Tax Liability

2. Written Down Value Method

It is sometimes referred to as the diminishing

balance method or reducing balance method, is
a method of figuring out depreciation in which a
defined percentage of depreciation is applied to
the asset’s declining value each year. The asset’s
salvage value is not considered when calculating
depreciation using the declining balance technique.
This strategy results in a yearly decrease in
Methods of Depreciation
depreciation.

There are several ways to calculate depreciation

Formula:
in terms of accountancy. According to the need,
a corporation can use any of these approaches to
Depreciation = Rate of Depreciation Book Value /
determine depreciation.
100

● Straight-line method
3. Double Declining Balance Method Formula
● Written down Value method
Depreciation = 2 X SLDP X BV Where SLDP is
● Annuity method
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Depriciation
Straight-line Depreciation Percentage BV is Book Formula:
Value
Depreciation Value = (Cost of Asset- Residual
4. Annuity Method Value) Present value of one rupee at sinking fund
tables at a particular interest rate
The asset’s depreciation is calculated using the
annuity method of depreciation by figuring out 6. Production Unit Method
its rate of return. With this approach, the asset is
viewed as an investment. It considers the internal The number of units that the machine has produced
rates of return on the asset’s cash inflows and over the course of a year is taken into account by the
outflows. The annuity method’s depreciation cost production unit technique. How much a machine or
formula is as follows: equipment has been used over the course of a year
determines the depreciation cost. According to this
Depreciation = (Cost of Asset - Residual Value) method, the formula for depreciation is as follows:
Annuity Factor
Formula:
5. Sinking Fund
Depreciation = ((Estimated total Cost- Residual
This method of calculating depreciation is a method Value)/ Estimated Total Output) Actual Output
where enough money is accumulated at the end to during the year
replace the asset after its useful life is through. Here,
a sinking fund account that is invested in different Depreciation - Numerical (1)
government bonds and securities is charged with
the amount of depreciation. The asset is replaced Mr. Das has a car that depreciates over five years
by the interest from these securities. and is bought for Rs. 17,000 will decline at a rate of
Rs. 3,000 per year and have a salvage value of Rs.
2000. Calculate Scrap Value of the car by Straight
line method.

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Depriciation
Depreciation - Numerical (2) of Rs. 1,000, a salvage value of Rs. 100, and usable
life of 5 years. Calculate depreciation using the
An asset owned by a company has an original cost Written down value method. The percentage is 40%

Summary

● The expense of using a tangible item and the benefit received over the course of its useful life is linked
through depreciation.

● Depreciation can take many different forms, including accelerated and straight-line depreciation.

● The whole amount of depreciation recorded on an asset up until a certain date is referred to as accumulated
depreciation.

● A balance sheet asset’s carrying value is its previous cost less all amassed depreciation.

● Salvage value is the carrying value of an item after all deductions for depreciation have been made.

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Depriciation
 Unit 10

Introduction to Accounting
Standards
Learning Objectives Introduction

By the end of this unit, you will be

To ensure that all organizations adhere to a common
able to understand:
set of accounting regulations, the world’s governing and
● Meaning & needs of accounting
accounting bodies produce Accounting Standards (AS),
standards
which are accounting principles. As a result, there will
● Accounting standards issued by be even more consistency in the procedure businesses
ICAI use to create their financial statements—including the
establishment of accounting standards.

A nation’s whole economy can adhere to the same set

of accounting rules and language because accounting
standards are applied throughout the entire nation. Thus,
a standard, accurate, and precise method for creating
financial statements and records will be adopted by all
business units and organizations in that country.

Indian Accounting Standards are published in India by the

Institute of Chartered Accountants of India (ICAI) (IAS).
These accounting guidelines were changed to fit the
Indian economy after being adapted from GAAP. These
standards’ nomenclature and numbers are comparable
to the IFRS and Indian accounting principles.

By establishing uniformity in its principles, accounting

standards resolve accounting issues in their detailing,

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Introduction to Accounting Standards
treatment, regulations, and directives. They are quite Comparison between two organizations that use
thorough and detailed, preventing any accounting- various accounting systems and formats is very
related misunderstandings. Who issues Indian challenging.
accounting principles is also covered in this article.
3. Helps Auditors

The auditors’ ability to do their jobs is aided

by accounting rules. It streamlines their work
and makes it simple for them to carry out their
responsibilities. Different standards, guidelines,
and rules have been set by accounting standards
for businesses to follow in their accounting system.

4. Helps to Simplify and Inform About Accounting

One key benefit of accounting standards is the

Meaning & Needs of Accounting
overall accounting information. It offers uniform
Standards
guidelines for all accounting transactions. It takes
away all of the accounting process’s intricacy.
The language of business is accounting. Another
way to put it is that all other organizations speak
5. Prevents Fraud and Manipulation
accounting. Accounting provides access to all
financial data, including the type of financial activity,
The effective use of accounting standards helps
financial status, financial results, current trends,
to guard against accounting system fraud. Frauds
and future prospects.
and the manipulation of any accounting data could
hurt the organization.
Needs of Accounting Standards

Different accounting rules and principles are

1. Ensures that the Accounting System is Uniform
established by accounting standards. The
entire accounting process is governed by these
Accounting Standards are the ones that contribute
accounting principles. It is imperative that these
to standardization across the board in accounting.
principles be followed; they are not optional.
One significant benefit of accounting rules is
this. The treatment of accounting transactions
6. Gives Financial Statements Reliability
is governed by the same rules and guidelines as
accounting standards.
Financial statements are a crucial resource for
learning about companies. For information,
2. Simple Financial Statement Comparison
investors and other stakeholders rely on these
declarations. These individuals rely only on this
Comparing various financial statements has
information when making significant judgments.
become easier because of accounting standards.

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Introduction to Accounting Standards
7. Measures the Effectiveness of Management Cash Flow Statement that divides cash flows over
the course of the period into operating, investing,
Determining management accountability is made and financing activities.
simple by accounting rules. It makes it simple to
evaluate the management team’s performance and ICAI’S AS-4: Contingencies and Events Occurring
make any recommendations. After Balance Sheet Date

Overview of Accounting Standards This Standard addresses how to handle unforeseen

Issued by ICAI circumstances and things that happen beyond the
balance sheet date.
In India, the Accounting Standards Board (ASB)
of the Institute of Chartered Accountants of AS-5 of the ICAI: Net Profit or Loss for the
India (ICAI) issues the Accounting Standards Period, Items from Prior Periods, and Changes to
for Non-Corporate Entities, including Small and Accounting Principles
Medium Sized Enterprises (SMEs), to establish
uniform standards for the preparation of financial It is mandatory for an organization when it comes to
statements in accordance with Indian GAAP for disclosing changes in accounting policies, account
better understanding of the users. for changes in accounting estimates, and display
profit or loss from ordinary activities, extraordinary
ICAI’S AS-1: Disclosure of Accounting Policies items, and prior period items in the Statement of
Profit and Loss.
To enable meaningful comparison of financial
statements of different enterprises/periods, AS-1 Construction Contracts, ICAI’s AS-7
addresses the disclosure of major accounting
policies used in producing and presenting financial This Standard specifies how construction contracts
statements by way of a separate statement or notes should be recorded in contractors’ financial
constituting part of such financial statements. statements.

Inventory Valuation according to ICAI’S AS-2 AS-9 of the ICAI: Revenue Recognition (as of
January 2, 2022)
This Standard addresses how inventories are
valued for accounting purposes, including how This Standard addresses the criteria for recognizing
much they cost and if they have been written down revenue in an enterprise’s Statement of Profit
to their net realizable value. and Loss. The Standard is concerned with the
recognition of income from the sale of goods,
CFS: ICAI’S AS-3 the provision of services, the payment of interest,
royalties, and dividends that arises within the
This Standard focuses on the disclosure of data normal course of an enterprise’s operations.
regarding historical changes in an organization’s
cash and cash equivalents through the use of a

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Introduction to Accounting Standards
ICAI’S AS-10: Property, Plant, and Equipment Employee benefit plan accounting and reporting
are not covered.
The purpose of this Standard is to specify how
property, plant, and equipment should be treated in Borrowing Costs (as of 01/02/2022), ICAI AS-16
accounting (PPE).
This Standard should be utilized in accounting for
The Effects of Changes in Foreign Exchange Rates: borrowing costs. The actual or imputed cost of
ICAI’s AS-11 owners’ equity, including preference share capital
not designated as a liability, is not covered by this
The principles of accounting for foreign currency Standard.
transactions and foreign operations are outlined in
AS 11, including how to determine the appropriate AS-17 of the ICAI: Segment Reporting
exchange rate to use and how to account for the
financial impact of exchange rate changes in the The purpose of this Standard is to set guidelines
financial statements. for disclosing financial data on the many business
segments, goods, and services an organization
Government Grants, according to ICAI’s AS-12 offers, as well as the various geographic regions in
which it conducts business.
This Standard covers accounting for grants from
the government. Other names for government
gifts include subsidies, monetary incentives, duty
drawbacks, etc.

ICAI’S AS-13: Accounting for Investments

This Standard addresses the accounting for

investments in businesses’ financial statements as
well as necessary disclosures.

ICAI’S AS-14: Accounting for Amalgamations AS-18 of the ICAI: Related Party Disclosures

The accounting for mergers and the handling of The reporting related party relationships and
any resulting goodwill or reserves are covered by transactions between a reporting enterprise and
this standard. its related parties should adhere to this Standard.
The provisions of this Standard apply to the
Employee Benefits, ICAI’S AS-15 consolidatedfinancial statements provided by
a holding company as well as to the financial
This Standard’s goal is to specify how employee statements of each reporting firm.
benefits should be recorded in the employer’s books,
with the exception of share-based compensation.

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Introduction to Accounting Standards
Leases, According to ICAI’S AS-19 Standard should be used to account for investments
in associates.
This Standard aims to establish the proper
accounting principles and disclosures for lessees Discontinuing Operations ICAI’s AS-24
and lessors with regard to finance leases and
operating leases. By separating information about ceasing operations
from information about ongoing operations, AS
AS-20 of the ICAI: Earnings Per Share 24 aims to establish standards for reporting
information about ceasing operations, improving
The standards outlined in AS 20 for calculating and the ability of users of financial statements to
presenting profits per share will make it easier to forecast an enterprise’s cash flows, ability to
compare performance across enterprises for the generate earnings, and financial position. All of an
same period as well as between accounting periods enterprise’s ceasing operations are subject to AS
for the same enterprise. 24.

Consolidated Financial Statements According to ICAI’S AS-25: Interim Financial Reporting

ICAI’s AS-21
If a business is obligated to publish an interim
This Standard’s goal is to establish guidelines and financial report or chooses to do so, this Standard
practices for creating and presenting consolidated is applicable. AS 25 aims to define the minimum
financial statements. These statements are requirements for an interim financial report as well
designed to illustrate financial information about a as the rules for recognition and measurement in
parent company and any subsidiaries as a single complete or consolidated financial statements for
economic unit, including the group’s assets under an interim period.
management, its liabilities, and the outcomes the
group achieves with those assets. AS-26: Intangible Assets from the ICAI

ICAI’S AS-22: Accounting for Taxes on Income The accounting treatment for intangible assets is
outlined in AS 26. (i.e. identifiable non-monetary
Since the taxable income and the accounting asset, without physical substance, held for use in
income may differ greatly for a variety of reasons, the production or supply of goods or services, for
making it difficult to match taxes with revenue for rental to others, or for administrative purposes).
a period, the goal of this Standard is to specify the
accounting treatment of taxes on income. As of January 2, 2022, ICAI’S AS-27: Financial
Reporting of Interests in Joint Ventures
ICAI’s AS-23: Accounting for Investments in
Associates In order to present joint venture assets, liabilities,
income, and expenses in the financial statements
When a shareholder prepares and presents of venturers and investors, AS 27 lays out rules
consolidated financial statements (CFS), this and methods for accounting for interests in joint

97
Introduction to Accounting Standards
ventures. addresses the impairment of all assets.

ICAI’s AS-28: Impairment of Assets ICAI’S AS-29: Provisions, Contingent Liabilities,

and Contingent Assets
To ensure that an enterprise’s assets are carried
at no more than their recoverable amount, AS 28 The goal of AS 29 is to make sure that the right
lays out the processes that must be followed. recognition criteria and measurement bases are
When the carrying value of an asset exceeds the used for provisions and contingent liabilities, and
amount that may be recovered through use or sale, that the notes to the financial statements contain
the asset is said to be impaired, and AS 28 requires enough information to help readers understand the
the organization to recognize an impairment loss in nature, timing, and amount of these liabilities. This
such circumstances. It should be emphasized that Standard also aims to establish suitable accounting
unless specifically excluded from its scope, AS 28 for contingent assets.

Summary

● An accounting standard is a collection of procedures and guidelines used to standardize bookkeeping and
other accounting operations over time and across different businesses.

● All aspects of an entity’s financial picture, including its assets, liabilities, income, outlays, and shareholders’
equity, are subject to accounting standards.

● Accounting standards are relied upon by banks, investors, and regulatory bodies to guarantee that data
regarding a certain organization is correct and up-to-date.

● Accounting is frequently referred to as the language of business because it informs others of the company’s
financial situation.

● The same syntax and grammar rules apply here as they do in every language. The Accounting Standards
are these regulations in the context of accounting (AS).

● They serve as a nation’s foundation for accounting and reporting norms and regulations.

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Introduction to Accounting Standards
 Unit 11

Introduction to Accounting
Standards
Learning Objectives Introduction

By the end of this unit, you will be

Company accounts are regarded as a summary of the
able to understand:
financial operations of a business over a period of 12
● Introduction to shares
months. The Balance Sheet, the Profit and Loss Statement,
● Types of shares and the Cash Flow Statement are the three financial

● Difference b/w equity & statements that are annually prepared for Companies

preference shares House and HM Revenue & Customs. (“Company Profit

Sharing Accounts”), any employer payments to earlier
● What is a debenture
plans, and any revenue or earnings related to such
● Types of debentures Company Contributions and earlier plan contributions.
● Difference b/w shares & Types of Shares
debentures
Introduction to Shares

In Section 2(84) of the Companies Act of 2013, “share” is

defined as a share in the share capital of a corporation,
which includes stock. The share capital of a firm is
divided into fractional shares. Such a thing is referred to
as a Share. It confers ownership rights on the possessor
over the company.

Issue of Shares Through the issue of shares, a firm

distributes new shares to the general public. The business
releases prospectuses collect applications and then
distributes them to the general public. Shares can be sold

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Company Accounts
for par value, a premium, or a discount. The extra But these dividends aren’t set in stone. Limited to
money is known as the premium if a corporation their investment amount, equity shareholders also
issues shares at a price higher than the shares’ share in any losses incurred by the business. Equity
face value. Shares are referred to as being issued shares may be further divided in accordance with:
at a discount if they are sold for less than their face
value. The share issue is clearly depicted in the ● Definition
graphic below. ● Returns

● Share Capital

Classification on the Basis of Share Capital

1. Authorised Share Capital

The most capital a corporation may issue is known

as authorized share capital. It might occasionally
be raised. A corporation must follow certain
Types of Shares
procedures and pay the necessary fees to the

There are two other categories of shares. Which appropriate authorities in order to do this.

are:
2. Issued Share Capital
● Shares of Equity
The fraction of authorized capital that a corporation
● Shares of preference.
sells to investors is referred to as the “issued share

Their differences are determined by their capital.”

profitability, voting privileges, and handling during

3. Subscribed Share Capital
a liquidation.

The portion of issued capital that investors accept

Equity Shares
and agree to is known as subscribed share capital.

These are also referred to as ordinary shares and

4. Paid-up capital
make up the majority of the shares that a specific
corporation issues. Investors routinely exchange
This term describes the amount of the subscribed
equity shares on stock markets because they are
capital that the investors have already paid. Issued,
transferable. You have the right to vote on matters
subscribed, and paid capital are synonyms because
affecting the company as an equity shareholder,
the majority of businesses accept the entire
and you also have the right to dividend payments.
subscription amount at once.

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Company Accounts
Classification on the Basis of Definition 3. Value Shares

1. Bonus Shares These kinds of shares are sold on the stock market
at prices that are below their true value. Investors
The term “bonus shares” refers to extra shares that can anticipate an increase in price over time, giving
are given as a gift or bonus to current shareholders. them a higher share price.

2. Rights Shares Preference Shares

A firm can issue new shares to its current owners In comparison to regular shareholders, preferential
at a predetermined price and within a specific time shareholders are given preference in receiving
frame before making them available for trade on a company’s profits. Additionally, preferred
stock markets. shareholders are compensated before common
shareholders in the event of a company’s insolvency.
3. Sweat Equity Shares The many share types that fall under this category
are as follows:
If you have made a significant contribution to the
company as an employee, the corporation may 1. Preference Shares that are Cumulative and Non-
choose to reward you by issuing sweat equity Cumulative
shares.
A cumulative preference share is one that is carried
4. Voting And Non-Voting Shares forward and accumulated when a corporation
does not pay dividends for a specific year. These
Although the majority of shares have voting accumulated dividends are paid first when the
privileges, the business may grant shareholders business experiences future financial success.
differential or no voting privileges.
2. Participating and Non-Participating Preference
Classification on the Basis of Returns Shares

1. Dividend Shares: In this, shareholders are eligible for a share of

any earnings that remain after dividends have
A business has the option to prorate dividend been distributed to equity shareholders. These
payments by issuing new shares in place of cash. stockholders are therefore eligible to receive
dividends in addition to the set payout in years
2. Growth Shares when the company has generated greater earnings.
After the equity shareholders have been paid, other
These kinds of shares are linked to businesses that
investors are not eligible for sharing the profits.
experience rapid growth. While such businesses
Therefore, if a corporation has any excess profit, it
might not pay dividends, the value of their stocks
won’t receive any further dividends. They will only
rises quickly, giving investors financial gains.
receive their annual set dividend distribution.

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Company Accounts
3. Preference Shares that are Convertible and 4. Preference Shares that are Redeemable and
Non-Convertible Non-Redeemable

In this case, the shareholders cannot convert The issuing business may claim or purchase
these shares into common equity shares. Specific preference shares that are redeemable. This could
requirements must be completed in order to do this. be done at a predetermined cost and moment.
The right to convert non-convertible preference These shares are perpetual since they don’t have
shares into equity shares does not exist. a maturity date. Companies are therefore not
required to pay any money after a set time.

Difference Between Equity & Preference Shares

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Company Accounts
What is a Debenture? 1. Secured Debentures

Every firm needs money to maintain its operations. Debentures that are secured by firm asset assets
The majority of businesses raise capital by issuing are known as secured debentures. This indicates
publicly traded shares. For businesses that aren’t that a charge is placed on the asset in the event that
ready to go public, it may not be practical. especially the debentures are not repaid as agreed. Therefore,
those businesses that have recently been founded. if the business lacks the means to pay back the
Another typical method of getting money is by debentures, the asset in question will be sold to
borrowing. Businesses can borrow money by cover the debt. The fee may be floating, meaning it
issuing bonds and debentures. We’ll talk about applies to all of the firm’s assets or fixed, meaning
debentures’ many facets in this article. it applies to a single asset or assets.

The Latin word “debate,” which means to borrow or 2. Unsecured Debentures

loan, is the source of the English term “debenture.”
Written debt instruments known as debentures are These are neither fixed nor floating, and they are
issued by businesses with their common seal. They not secured by any charge against the company’s
resemble loan certificates in certain ways. assets. Such debentures are often not issued by
Indian corporations.
The public receives debentures as a contract
to repay money borrowed from them. These 3. Redeemable Debentures
debentures have a fixed term and fixed interest rate,
and they may be paid annually or semi-annually. Like These bonds are those that must be repaid in full

stock shares, debt obligations are likewise made or in installments, depending on the duration of a

available to the general public. Actually, the most business that has been in operation. Debentures

popular method of borrowing for big businesses is may be redeemed at par or at a premium.

through debentures.
4. Non-Redeemable Debentures

Debentures that are not redeemable are also known

as perpetual debentures because the corporation
makes no effort to recoup any funds obtained via
the issuance of such debentures. These debentures
must be repaid when an enterprise shuts down or
when a considerable period of time has passed
(expired).
Types of Debentures
5. Partly Convertible Debentures
A firm may issue a variety of debentures, depending
on the security, term, convertibility, etc. Let’s They may be partially converted into equity shares by
examine a few of these debentures in more detail. the issuing business. When issuing the instrument,

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Company Accounts
the corporation chooses the conversion ratio and become equal partners in the business.
the conversion date. The holders are granted the
same privileges as the company’s creditors and 7. Non-Convertible Debentures
shareholders.
The standard debt instrument that does not let
6. Fully Convertible Debentures holders to convert their debt into equity is called a
non-convertible debenture. Such products typically
When the instrument is issued, the conversion time have greater interest rates than their conventional
and rate are chosen. After conversion, the holders counterparts. As a result, these instruments
continue to be debt-based.

Difference Betweenshares & Debentures

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Company Accounts
Summary

● Investors that trade funds for these units to reflect equity ownership in a company or financial asset are
the owners of shares.

● Voting rights and potential profits from price growth and dividends are made possible by common shares.

● Preferred shares don’t promise price growth but can be redeemed for a good deal and pay out dividends
on a regular basis.

● The majority of businesses have stock, but stock exchanges only list the shares of businesses that are
publicly traded.

● Debentures are a sort of financial instrument that typically have terms longer than 10 years and are not
secured by any kind of collateral.

● Only the issuer’s creditworthiness and reputation are used to support debentures.

● Debentures are commonly issued by both businesses and governments to raise cash or money.

● While some debentures have the option to convert to equity shares, others do not.

● Personality of an investor guides the choice of investments. Both shares and debentures are excellent
investment choices, but each has its own set of benefits and drawbacks. In order to raise money from the
market, corporations use both.

● Although stocks are regarded as a high-risk investment, they also provide investors with a bigger return.
Debentures offer guaranteed returns while being low risk relative to other investment options. For risk
reduction and portfolio diversity, you can combine the two.

● A company’s financial actions for a whole year are consolidated in its accounts. It consists of the Profit &
Loss Account, Balance Sheet, and Cash Flow Statement.

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Company Accounts
 Unit 12

Cost Accounting

Learning Objectives Introduction

By the end of this unit, you will be
The growth of accounting as a tool of industrial management
able to understand:
was challenged by the industrial revolution in England. This
● Introduction to cost accounting called for the creation of costing methodologies as a guide for
● Scope of cost accounting in supply managerial action. Cost accounting places a strong emphasis
chain on estimating and managing costs. It is mostly focused on
● Cost accounting objectives the price of manufacturing processes. Additionally, gathering
● Essentials of cost accounting and interpreting cost data, both real and prospective, is one of
● Elements of cost the main tasks of cost accounting. This aids management in
● Components of cost both controlling present operations and making future plans.

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Cost Accounting
Introduction to Cost Accounting It is a science in that it is a body of methodical
knowledge that a cost accountant must possess in
Cost accounting arose to remedy the inadequacies order to carry out his tasks and responsibilities in a
of financial accounts. It’s 20th-century technology. professional manner. It is an art because it requires
Cost accounting tracks a good, service, or activity’s a cost accountant’s skill and expertise in applying
cost. It considers both estimated and real costs. cost accounting principles to various managerial
Cost accounting is a systematic and logical challenges such as price fixing, cost control,
technique accountants use to aggregate costs and more. Practice refers to a cost accountant’s
and assign them to commodities or departments ongoing efforts in the field of cost accounting. A
for efficient administration. Cost accounting’s cost accountant needs enough practical experience
standard and marginal costing techniques enable to deal with the complexities because theoretical
cost control and profit planning. Cost accounting is knowledge alone is insufficient.
a management information system that analyses
past, present, and future data for managerial Cost accounting covers a wide range of topics.
decision-making. Costing, cost accounting, cost control, and cost
audit is some of these. Below is a description of
The word “cost accounting” is broad. It refers to them:
and encompasses the rules, customs, methods,
and procedures used by businesses to organize Costing
and manage how their resources are used. It’s Costing estimates costs. According to a definition,
described as the science, art, and practice of cost it’s “the classification, documentation, and
control and the determination of profitability through allocation of expenditures for assessing costs,
the use of costing and cost accounting concepts, linking spending to sales value, and determining
methodologies, and procedures. It also includes profitability.” Costing consists of concepts and
the dissemination of data obtained from them guidelines used to compute two costs: (a) the cost
for managerial decision-making Cost accounting of manufacturing a good, like a chemical or TV, and
is thus the science, the art, and the practice of a (b) the cost of supplying a service, like electricity or
cost accountant, according to C.I.M.A. London. transportation.

Cost Accounting

Cost accounting is a system for calculating and

managing the costs of goods and services. “The use
of accounting and costing concepts, procedures,
and strategies in evaluating costs and examining
savings and/or excesses as compared with prior
experience or with standards,” is how it is defined.

Cost accounting refers to the formal accounting

system by which costs are determined, whereas

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Cost Accounting
costing merely refers to cost discovery, which can be
done through memorandum statements, arithmetic
processes, and so on. Simply put, costing is the
process of determining a product’s price, while
cost accounting is the process of determining a
product’s price utilizing double-entry bookkeeping
techniques as the foundation. However, the terms
cost accounting and costing are sometimes used
synonymously.

Cost Control: The goal of cost control is to keep

costs within set parameters. To put it another way, Cost accounting is a unique field of study. Cost

cost control entails requiring actual costs to match accounting is a separate field of knowledge and a

projected expenditures. The two methods most discipline unto itself, despite being regarded as a

frequently used for cost control are budgetary subset of financial accounting. It is a disciplined

control and standard costing. In lessons 13 and 14, body of knowledge with its own ideas, rules, and

respectively, these topics will be covered in further customs.

detail.
• Cost accounting is a science since it is a

Cost Audits: Cost audits apply auditing ideas and methodical body of knowledge with a set of

practices to cost accounting. It verifies the cost principles that a cost accountant needs to

accounting plan and cost accounts. It ensures understand in order to do his duties correctly.

that cost accounting is accurately recorded and Anyone can understand the fundamentals of

compiled and that set rules are followed. cost accounting, and these fundamentals can
aid in making future predictions. But because
Scope of Cost Accounting in Supply the precision of costing varies and how these
Chain principles are used differs from person to person,
costing is not a pure science like mathematics,
Cost accounting is not just for businesses involved physics, or chemistry. It is a subjective method
in manufacturing. In actuality, there are a lot more that varies in importance depending on the
uses for it. Cost accounting should be used in all situation.
operations, including manufacturing and non- • Cost accounting is an art because it requires
manufacturing, where money is exchanged. Cost a cost accountant to be able to apply cost
accounting techniques are used by wholesale accounting principles to a variety of managerial
and retail enterprises, banks and insurance firms, issues. Practice refers to an accountant’s ongoing
railroads, airlines, shipping, and road transport efforts in the subject of cost accounting. A cost
corporations, hotels, hospitals, schools, colleges, accountant may also offer data for managerial
and universities to run efficiently. The management decision-making and maintain statistical records
only needs to acknowledge the relevance of these as part of their work.
ideas and methods in their own areas of expertize.

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Cost Accounting
• If the work is left unfinished, cost accounting The management must be aware of opportunities
calculates the cost of the incomplete task or for cost savings, waste reduction, and greater
job. Additionally, it offers advice and control productivity. In order to survive and continue
mechanisms for top, medium, and lower levels to expand, the organization must fight. Before
of management. beginning any plan to reduce prices, managers
should be aware of the true cost of their products.
• A career in cost accounting exists. Cost
An effective costing strategy makes this possible.
accounting has emerged as one of the significant
professions that have grown more difficult in
Price fixing is aided by cost accounting. Cost to
recent years. These two facts make this opinion
the producer is significant even though the law of
clear. The formation of numerous professional
supply and demand governs the product’s pricing.
bodies came first. Second, many students have
In the event that the producer is able to adjust or
enrolled in various institutions in order to gain
modify the price charged, he can consult his costing
expensive degrees and memberships that would
records for the necessary guidance.
enable them to support themselves.

Cost accounting aids in directing production in

Cost accounting is a crucial tool for management.
the appropriate directions. The management can
In order to help management maintain effective
distinguish between profitable and non-profitable
control over warehouses and inventories, boost
activities thanks to accurate costing data; earnings
organizational productivity, and reduce waste and
can be maximized by focusing on profitable
losses, it provides accurate costing information.
operations and removing non-profitable ones.

When there is a decline in trade or increased

Data for the periodic profit and loss account is
competition, cost accounting is helpful. The
provided by cost accounting. Adequate costing
organization cannot afford to have wastages that
records give the management the information they
go unchecked during times of economic downturn.
may need to prepare the profit and loss account
and balance sheet at the intervals they may wish.

Efficiency may be determined and improved thanks

to costing accounting. If the various production
procedures are closely examined, losses resulting
from material waste, employee idle time, improper
supervision, etc. will be revealed. Efficiency can be
measured, costs can be managed, and efficiency
may be increased in a number of ways.

Inventory control is aided by cost accounting.

The management-required control over material
inventories, works-in-progress and finished goods is
provided by cost accounting. Installing an effective

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Cost Accounting
costing system therefore greatly benefits investors, ● Determining Selling Price
banks, and other financial institutions who have
In cost accounting, the goal of figuring out what
a stake in the company concern’s success. The
things cost is crucial. When determining the
costing records can be used as a foundation for
selling price of a product, both the overall cost
their assessment of the enterprise’s profitability
and the cost per unit are significant factors.
and prospects for the future.
Information on manufacturing and selling
costs is provided by cost accounting. Before
Employees are vitally interested in the business that
determining the selling price, the management
their employer runs while they are working there.
must take into account several other aspects,
Implementing a successful costing system offers
including the product’s quality, the state of the
numerous advantages. Employees benefit from
market, the area of distribution, the quantity that
steady work and improved compensation through
can be supplied, etc. However, the cost of the
incentives, bonus programs, and similar initiatives.
product is a key issue.
An effective costing system helps businesses
● Controlling Cost
succeed, which helps businesses succeed, which
helps businesses succeed, which helps businesses Utilizing strategies like budgetary control,
succeed, which helps businesses succeed, which standard costing, and inventory management,
helps businesses succeed, and so on. cost accounting assists in achieving the goal
of cost control. At the beginning of the period,
A country’s total economic development happens
a budget is created for each cost component
as a result of increased manufacturing efficiency.
(material, labor, and expense), and the actual
Cost management, waste reduction, and efficiency
expenses incurred are then contrasted with the
improvement facilitated the growth of the sector
budget. The business is more effective as a
and, consequently, the entire country.
result.

Cost Accounting Objectives ● Providing Information for Decision-Making

Cost accounting assists management by

The management’s informational requirements,
supplying data for managerial choices and the
the goals of cost accounting, and the methods and
creation of operational procedures.
instruments employed in cost accounting analysis
are all interconnected. The following are the primary ● Accounting Cost for Ascertaining the cost profit

goals of cost accounting: By matching costs to revenues, cost accounting

• Determining selling price assists in determining the cost profit or loss of

any activity on an objective basis.
• Controlling cost
● Facilitating Preparation of Financial and Other
• Providing information for decision-making
Statements
• Accounting cost for ascertaining the
Statements may be produced quickly as needed
costing profit
by management thanks to costing accounting.
• Facilitating preparation of financial and other To suit the demands of management, financial
statements statements are often prepared once a year or
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Cost Accounting
 half a year. Reviewing production, sales, and thorough instructions. To ensure the accuracy
operating outcomes are crucial for management and relevance of the information entered on
in order to run the company with maximum the forms, users should receive appropriate
efficiency. Daily, weekly, or monthly statements training.
of units produced, total cost, and analysis are
• Every entry on the forms should be reviewed and
provided by cost accounting. A cost accounting
signed by an examiner.
system offers real-time data on the stock of raw
• It is important to assign responsibility for creating
materials, semi-finished goods, and finished
and communicating cost reports to different
goods. The preparation of financial statements
management levels on a regular basis and to
is aided by this.
issue the appropriate instructions.
Essentials of Cost Accounting
• All parties involved in the management should
The costing system must blend nicely with pledge their full cooperation. There shouldn’t be
the business’s overall structure. Normally, no much staff resistance.
organizational changes need to be undertaken to
• The expense of maintaining the costing system
support a costing system. To ensure an efficient
should be reasonable given the benefits it
costing system, however, alterations in the setup
provides.
may be necessary.
• Design the system appropriately to enable
It is important to thoroughly research all key
effective cost control
technical factors before implementing effective
.
cost control measures (such as the nature and
Elements of Cost
method of manufacturing and the many product
variants). The fundamental component of a cost is one of
its components. Cost generally consists of three
• For the advantage of individuals using a costing
components, which are described below.
system, the size, layout, and organizational
structure of the factory should be accurately ● Material
represented.
The term “material” refers to the raw material
• It is important to explicitly outline the steps that used to create the production. Both direct and
must be taken for the acquisition, reception, indirect methods are possible.
storage, and distribution of commodities.

• It is important to specify the systems for ● Direct Material

controlling labor and paying wages. It describes those components that are easily
• It is important to outline the standards for hiring traceable to certain physical units and become
employees and allocating overhead. a crucial component of the finished output.
Thus, direct materials consist of:
• To ensure economy, forms and records of initial
entry should be properly created. • Every item acquired especially for a specific
task or procedure
• Get the forms printed. They should come with

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Cost Accounting
 • Components that were bought or made ● Expenses

• Basic packaging materials (e.g., wrapping, and • Direct Expenses

cardboard boxes.)
These are costs that can be utterly, readily,
• The material being transferred between and directly connected to a task, procedure, or
processes operation. Chargeable expenses and production
expenses are other names for direct costs.
● Indirect Material
Examples of such costs include the price of a
Indirect materials are any materials utilized special layout, design, or set of drawings; the
for purposes unrelated to the business that is cost of renting specialized equipment needed
not easily ascribed to precise physical units. for a specific contract; the cost of maintaining
Indirect materials include things like grease, specialized tools required for a contract task;
printing and stationery supplies, consumable etc.
goods, and oil.
• Indirect Expenses

● Labour “Indirect expenses” are costs that can’t be

Human labor is needed to transform raw easily ascribed to production and aren’t

materials into final goods. Work is the term for indirect materials or salaries. Consider rent,

such human endeavor. Both direct and indirect taxes, insurance, depreciation, repairs and

labor is possible. maintenance, power, lighting, and heating.

● Direct Labor Components of Cost

It’s the pay given to employees whose time can A fixed asset’s gross book value is its historical cost
be simply and affordably attributed to physical or a sum that has been substituted for historical cost
units. Direct labor or wages refer to the salary in the accounting records or financial statements.
paid to workers who directly perform the service This number is known as net book value when it is
when a corporation delivers a service rather displayed after cumulative depreciation.
than a product, such as bus drivers, conductors,
When calculating the cost of a fixed asset, trade
etc.
discounts and rebates are subtracted from the
purchase price before adding import tariffs, other
● Indirect Labor
non-refundable taxes or levies, and any directly
Indirect labor, often known as indirect wages, related costs for putting the asset in working order
is labor used to complete tasks necessary for for its intended use.
the production of commodities or the provision
Due to exchange rate fluctuations, price changes,
of services. Simply put, indirect earnings are
duty modifications, or other comparable reasons,
those that cannot be linked to a specific task,
the cost of a fixed asset may alter after it has been
procedure, or operation. Pay for storekeepers,
acquired or constructed.
foremen, supervisors, inspectors, and internal
transport workers, are some examples of The costs associated with project startup and
indirect labor. commissioning, including those associated

136
Cost Accounting
with test runs and experimental production, are A cost sheet is a declaration that lists the
typically capitalized as an indirect component components that go into the price of goods or
of construction costs. All costs incurred during services. It displays the total cost breakdown by
the period between the time a project is prepared stages and the cost per output unit over time. It is
to begin commercial production and the time typically generated to achieve three goals: to offer
commercial production actually starts are added to a summary of the cost classification, to prepare
the profit and loss statement. cost estimates for use in the future, and to make it

easier to compare costs with earlier cost sheets to Add: Expenses involved in the purchases of raw
identify cost trends. material

The following is an example of a cost sheet’s Less: Closing stock of raw materials
format:
Work-in-progress as of the cost sheet’s preparation.
Specimen Cost Sheet It includes laborr, materials, and overhead. As seen
in the sample cost sheet, work-in-progress may be
Treatment of Stock
displayed after the prime cost or factory overheads.
Three items are referred to as stock: unfinished When opening and closing stock of finished goods
goods, work-in-progress, and raw materials. The are indicated, adjustments must be made. As
following method is used to determine the value of illustrated in the sample cost sheet, this is done
raw materials: by subtracting the closing stock of finished goods

Opening the raw material supply and adding the opening stock to the current cost of
production.
Add: Purchases
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Cost Accounting
Summary

Financial accounting or traditional accounting is no longer able to fulfil the needs of all parties. Financial
accounting is unable to deliver the amount of analytical information required by the internal management
systems of business concerns. Consequently, management 149 accounting and cost accounting—two
additional types of accounts—have developed to meet the objectives of management. Simply said, cost
accounting aims to ascertain costs through a formal accounting system, whereas management accounting
serves the objectives of management. Cost sheets are a declaration that lists the components that go into
the cost of goods or services. Costs can be categorised on a variety of bases.

138
Cost Accounting
 Unit 13
Marginal Costing

Learning Objectives Introduction

By the end of this unit, you will be Every business manager constantly faces decisions about
able to: pricing, product mix, and profitability. One of the most

• Explain the concepts of marginal useful tools for making these decisions is marginal costing,

cost and marginal costing a method that helps businesses understand the impact of
changes in cost and volume on profits. Marginal costing
• Explain profit volume ratio and its
focuses on distinguishing between variable and fixed costs,
applications
and using this information to guide short-term decision-
• Identify various managerial making. It allows managers to determine the minimum
usage of marginal costing and its sales volume required to break even and helps identify the
limitations most profitable products or services.

Marginal costing treats fixed costs as period costs that

remain constant regardless of production levels, while
only variable costs are considered in decision-making.
Absorption costing, on the other hand, incorporates both
variable and fixed costs into the product’s cost.

139 Accounting for Managers

 Concept of Marginal Cost profit. Marginal costing bases decisions on the
contribution each product or service makes to
Marginal cost refers to the additional cost incurred
the company.
when producing one more unit of a product or
service. It is derived purely from variable costs, Key Features of Marginal Costing:
as fixed costs do not change with production
• Variable Costs as Key Drivers: Only variable
levels. Marginal cost provides a clear picture of the
costs are assigned to products. These costs
immediate impact of production changes, making
vary depending on production levels and include
it a vital tool for decisions like pricing, production
materials, labour, and other direct costs.
scaling, and product line expansion.
• Fixed Costs as Period Costs: At the conclusion
Example of Marginal Cost
of the period, we deduct fixed costs (such as
Consider a company that produces mobile phone rent and administrative salaries) from the total
cases. If it costs ₹100 to produce one case and contribution, rather than attributing them to the
an additional case requires only ₹80 more in raw products themselves.
materials and labour (while fixed costs remain
• Contribution Margin Focus: The emphasis is on
unchanged), the marginal cost of producing one
maximizing the contribution margin, which is the
more case is ₹80. This figure excludes rent, salaries,
excess revenue over variable costs.
and other fixed costs that do not vary
with production. • Decision-Making Tool: Marginal costing is a
widely used decision-making tool for short-
Formula: Marginal Cost = Change in Total Cost /
term decisions like pricing, product mix, and
Change in Quantity Produced
production planning.
Marginal cost plays a crucial role in determining
Formula for Contribution Margin:
whether it is profitable to increase production. If the
product’s selling price exceeds the marginal cost, Contribution Margin = Sales Price per Unit − Variable
the business is contributing to covering fixed costs Cost per Unit
and earning profit on every additional unit sold. Example of Marginal Costing:
Concept of Marginal Costing Assume a company produces a product with a
Marginal costing is an accounting technique that selling price of ₹500 and variable costs of ₹300 per
uses marginal cost as the basis for decision- unit. The contribution margin per unit is:
making. This method treats fixed costs as period Contribution Margin = 500 – 300 = ₹ 200
costs that the contribution margin must cover,
rather than assigning them to specific products This ₹200 per unit is available to cover the

or services. company’s fixed costs and eventually contribute

to profits. The company can use this information
The contribution margin is the difference between to determine the number of units required to break
the sales price of a product and its variable costs. even or achieve profit targets.
It represents the portion of sales revenue that
can be used to cover fixed costs and generate

140 Accounting for Managers

Marginal Costing Equation and Profit (or Loss) = (Contribution Margin per Unit ×
Contribution Margin Units Sold) − Fixed Costs

In marginal costing, the focus is on determining Where:

how much of the sales revenue is available to cover
• Sales Revenue = Price per unit × Units sold
fixed costs and eventually contribute to profits.
The contribution margin plays a central role in • Variable Costs = Variable cost per unit ×
this process and is critical for understanding how Units sold
various levels of sales will affect profitability. • Contribution Margin = Sales price per
Marginal Costing Equation: unit - Variable cost per unit

The marginal costing equation helps managers • Fixed Costs are constant and do not depend on
assess the relationship between costs, volume, and production levels.
profit. This equation is based on the principle that Example of Marginal Costing Equation:
only variable costs change with production levels,
while fixed costs remain constant within a certain A company manufactures 1,000 units of a product,

range of activity. The marginal costing equation is with a selling price of ₹500 per unit and variable

used to calculate the profit or loss for a given level costs of ₹300 per unit. Fixed costs for the period are

of sales. ₹150,000.

Marginal Costing Equation: 1. Sales Revenue: 500 × 1,000 = ₹ 500,000

Profit (or Loss) = Sales Revenue − (Variable Costs + Variable Costs: 300 × 1,000 = ₹ 300,000

Fixed Costs) 2. Contribution Margin: 500 – 300 = ₹ 200

This can also be expressed as:

141 Accounting for Managers

 Profit (or Loss): CMR = (Contribution Margin per Unit/Sales Price per
Unit) × 100
Using the marginal costing equation:
Example of Contribution Margin:
Profit = 500,000 − (300,000 + 150,000) = ₹ 50,000
Let’s consider a product with the following data:
The company has made a profit of ₹50,000 by
selling 1,000 units. • Selling Price per Unit: ₹400

Contribution Margin: • Variable Cost per Unit: ₹250

The contribution margin is one of the most 1. Contribution Margin per Unit: 400 – 250 = ₹ 150
important figures in marginal costing because it
Each unit sold contributes ₹150 toward covering
shows how much of the revenue from each sale
fixed costs and generating profit.
is available to cover fixed costs and contribute
to profit. In essence, it signifies the amount of Contribution Margin Ratio: (150/400) × 100=37.5
sales revenue that remains after deducting all
This means that 37.5% of every rupee of sales
variable costs.
contributes to covering fixed costs and profit.
Key Points:
Significance of Contribution Margin:
• Contribution Margin per Unit: This is the
The contribution margin is a powerful metric for
remaining amount after deducting variable
managers because it directly shows how sales,
costs from each unit’s selling price. It tells the
pricing, and cost control impact the profitability
company how much each unit sold contributes
of the business. The following are key decision-
to covering fixed costs and generating profit.
making areas where contribution margin plays a
Contribution Margin per Unit = Sales Price per Unit − significant role:
Variable Cost per Unit
• Pricing Decisions: By understanding the
• Total Contribution Margin: This represents contribution margin, managers can determine
the total contribution from all units sold. It is the lowest price they can charge for a product
the sum of the contribution margins of each without incurring a loss. Managers should price
unit sold. The total contribution margin is used the product to ensure the contribution margin
to cover fixed costs first, and any remaining covers both variable and fixed costs, while also
amount contributes to profit. allowing for profit.

Total Contribution Margin = Contribution Margin per • Product Mix Decisions: In a multi-product
Unit × Total Units Sold environment, managers can prioritise products
with a higher contribution margin. This helps
• Contribution Margin Ratio (CMR): This is the
to maximise profits by focussing on products
percentage of each sales rupee that contributes
that contribute more to covering fixed costs and
to covering fixed costs and profits. The higher
generating profit.
the contribution margin ratio, the more effective
the company is in covering its fixed costs and • Profit Planning and Forecasting: Contribution
making a profit. margin analysis is used to project profits

142 Accounting for Managers

 for different levels of sales. Managers can larger portion of sales revenue is available to cover
forecast how much profit will be generated fixed costs and generate profit. A lower P/V ratio
from different sales volumes and adjust their shows that variable costs consume a larger portion
strategies accordingly. of sales, leaving less available to cover fixed costs
and profits.
• Break-Even Analysis: The contribution margin
is used to calculate the break-even point, which Importance of P/V Ratio:
tells the business how many units need to be
• Measuring Profitability: The P/V ratio shows
sold to cover all costs and avoid a loss.
how efficiently a company converts its sales
into profit. A higher P/V ratio indicates that the
company can generate more profit from each
Profit-Volume (P/V) Ratio
unit of sales after covering variable costs.
The Profit-Volume Ratio (P/V Ratio), also known as
• Decision-Making Tool: It helps managers
the Contribution Margin Ratio (CMR), is a key metric
assess how changes in sales volume, selling
in marginal costing that shows the relationship
price, or costs affect profitability. For instance,
between the contribution margin and sales revenue.
if the P/V ratio is high, a small increase in sales
It expresses the percentage of each rupee of
can lead to a significant rise in profit.
sales that contributes to covering fixed costs and
generating profit. • Product Comparison: You can use the P/V ratio
to compare the profitability of different products
The P/V ratio provides insights into how efficiently a
in a multi-product environment. Prioritize
company can convert sales into profit, making it an
products with a higher P/V ratio as they are
essential tool for analysing profitability and making
decisions regarding pricing, product mix, and generally more profitable.
cost control. • Sensitivity Analysis: The P/V ratio aids in
Formula for Profit-Volume Ratio (P/V Ratio): the sensitivity analysis process. Managers
can assess how sensitive their profits are to
P/V Ratio = (Contribution Margin/Sales Revenue)
changes in sales, prices, or costs. For example,
× 100
a company with a high P/V ratio may experience
Where: significant profit changes with small fluctuations
in sales volume.
• Contribution Margin = Sales Revenue –
Variable Costs

• Sales Revenue = Total revenue generated Example of P/V Ratio Calculation:

from sales
Let’s assume a company sells a product for ₹400
Alternatively, if you are working on a per-unit basis: per unit, with variable costs of ₹250 per unit. The
fixed costs are ₹100,000.
P/V Ratio = (Selling Price per Unit − Variable Cost
per Unit) * 100 Selling Price per Unit Step 1 – Calculate the Contribution Margin per
Unit:
Interpretation: A higher P/V ratio means that a

143 Accounting for Managers

 Contribution Margin per Unit = Selling Price per Unit Example: A company has fixed costs of ₹100,000
− Variable Cost per Unit Contribution Margin per Unit and wants to achieve a profit of ₹50,000. With a P/V
= 400 – 250 = ₹ 150 ratio of 37.5%, the required sales to achieve this
profit would be:
Step 2 – Calculate the P/V Ratio:
Required Sales = (100,000 + 50,0000)/0.375 =
P/V Ratio = (150/400) × 100 = 37.5% ₹400,000
This means that 37.5% of the sales revenue Therefore, the company needs to generate ₹400,000
contributes toward covering fixed costs and in sales to cover its fixed costs and achieve a profit
generating profit. of ₹50,000.
Application of P/V Ratio in Decision-Making: • Break-Even Analysis: The P/V ratio is closely
• Improving Profitability: By increasing related to break-even analysis, as it helps
the P/V ratio, a company can improve determine the sales volume required to break
profitability. Either increasing the selling price even. The formula for calculating the break-even
or reducing variable costs can achieve this. sales revenue using the P/V ratio is:
For instance, if a company finds a cheaper
Break-Even Sales Revenue = Fixed Costs/ P/V Ratio
supplier for raw materials, it will reduce the
variable costs, increasing the P/V ratio and, Example: Using the same data from above (fixed
ultimately, profitability. costs = ₹100,000 and P/V ratio = 37.5%):
• Sales Target to Achieve Desired Profit: The P/V Break-Even Sales Revenue = 100,0000/0.375 = ₹
ratio can also be used to determine the sales
266,667
required to achieve a desired level of profit. The
formula to calculate the required sales is: The company must generate sales of ₹266,667 to
break even.
Required Sales = Fixed Costs + Desired Profit/
P/V Ratio

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• Profit Planning: The P/V ratio helps in planning competitive while ensuring that all variable and fixed
for various levels of profits by assessing how costs are covered.
changes in sales will affect profitability. For
• Accepting or Rejecting a Special Order: A
example, if the company wants to increase
common application of marginal costing is
profits, it can project the required sales volume
deciding whether to accept or reject a specific
based on the P/V ratio.
order that is below the regular selling price.
Managerial Usage of Marginal Costing Marginal costing assists in evaluating whether
the contribution margin from the special order is
Marginal costing provides a valuable tool for
sufficient to justify accepting the order, provided
managers to make a variety of short-term business
decisions. Since it focuses on variable costs and it covers variable costs and contributes to fixed
contribution margin, marginal costing simplifies costs without affecting regular sales.
the decision-making process, particularly when
Example: A company produces widgets at a variable
evaluating scenarios where fixed costs are not
cost of ₹150 per unit. Its usual selling price is ₹250
impacted by the decision in question. Below are key
per unit. The company receives a one-time special
managerial applications of marginal costing, along
order for 500 widgets at ₹180 per unit. Fixed costs
with relevant examples.
are already covered by regular operations, so the
• Fixing Prices: In marginal costing, pricing decision hinges on whether the ₹180 price will at
decisions are often guided by the contribution least cover the variable costs.
margin. This means that as long as the selling
price is above the variable costs, the business • Contribution Margin per Unit (Special Order):
can continue to cover its fixed costs and 180 −150 = ₹ 30
contribute to profits.
Since the special order contributes ₹30 per unit
Example: A company manufactures a product with toward covering fixed costs (which are already
a variable cost of ₹300 per unit. The company wants covered by regular sales), the company can accept
to set a price that ensures a contribution margin the special order, as it results in additional profit.
sufficient to cover fixed costs of ₹100,000 per
Managerial Implications: Managers can accept
month. If the company plans to sell 1,000 units, the
orders at lower-than-usual prices if fixed costs are
minimum selling price can be calculated as:
already covered, ensuring incremental profit. This
• Fixed Costs per Unit: 100,000/1,000 = ₹ 100 strategy can help utilize idle capacity or enter new
markets without compromising regular sales.
• Minimum Selling Price: 300 (Variable Cost) +
100 (Fixed Costs per Unit) = ₹ 400 • Profit Planning: Marginal costing is an
effective tool for planning how much profit
Therefore, the company should set a price of at
can be generated at various levels of activity.
least ₹400 to cover both variable and fixed costs.
By understanding the relationship between
Managerial Implications: Managers can set prices contribution margin, fixed costs, and sales
above this minimum level to maximize profits. volume, managers can plan for profit targets.
Marginal costing helps ensure that the price is

145 Accounting for Managers

 Example: A company has fixed costs of ₹200,000 managers to compare the relevant costs for each
and a contribution margin of ₹100 per unit. The option (variable costs vs. purchase price) and make
company wants to generate a profit of ₹100,000. an informed decision. Fixed costs are ignored in the
The required sales volume to achieve this profit can short term, as they remain constant regardless of
be calculated as: the decision.
Required Contribution Margin: • Sales Mix Decision: When a company produces
Fixed Costs + Desired Profit = 200,000 + 100,000 = ₹ multiple products, marginal costing helps
300,000 determine the optimal product mix to maximize
overall profitability. The product with the
Required Units Sold: 300,000/100 = 3,000 units
highest contribution margin should generally
The company must sell 3,000 units to cover fixed be prioritized, provided there are no constraints
costs and achieve its profit goal of ₹100,000. such as limited production capacity.

Managerial Implications: Managers can use Example: A company produces two products:
marginal costing to set sales targets and determine Product A and Product B. The contribution margin
the level of production needed to meet profit for Product A is ₹60 per unit, and for Product B,
objectives. It helps managers plan marketing and
it is ₹40 per unit. Both products use the same
production efforts to achieve the required sales
resources, but the company has limited capacity. To
volume.
maximize profitability, the company should prioritize
• Make or Buy Decision: Marginal costing is the production of Product A, as it has a higher
used to evaluate whether a company should contribution margin.
produce a component in-house or purchase it
However, if Product B requires significantly less
from an external supplier. This decision is based
on comparing the variable cost of production time or resources to produce, the company must
with the purchase price, while fixed costs also consider other constraints, such as available
remain unaffected. production hours or material availability.

Example: A company produces a component for Managerial Implications: Marginal costing helps
₹200 per unit, which includes ₹150 in variable costs managers focus on products that generate the
and ₹50 in fixed costs allocated to production. An highest contribution margin per unit. Sales mix
external supplier offers to sell the component at decisions help optimize the use of limited resources,
₹180 per unit. The company needs 1,000 units. ensuring maximum profitability.

• In-house Variable Cost per Unit: ₹150 • Decision on Shutdown or Continuing

Operations: Marginal costing helps managers
• Purchase Price per Unit: ₹180
decide whether to temporarily shut down
Since the variable cost of producing the component operations or continue production during
in-house is lower than the purchase price (₹150 < periods of low demand. If a company can cover
₹180), the company should continue to produce the its variable costs and make some contribution
component in-house. toward fixed costs, it may be better to continue
operations rather than shut down completely.
Managerial Implications: Marginal costing allows

146 Accounting for Managers

Example: A company faces a temporary drop in approach is suitable for short-term decision-
demand for its product. The selling price per unit is making, it may not be appropriate for long-term
₹250, and the variable cost is ₹180 per unit. Fixed decisions where fixed costs are significant.
costs for the period are ₹50,000. The company
Impact: Over time, fixed costs like rent, salaries,
expects to sell only 400 units during the slowdown.
and depreciation become significant expenses
• Contribution Margin per Unit: 250 – 180 = ₹ 70 that require recovery. In the long run, ignoring them
in pricing and production decisions could lead
• Total Contribution: 70 × 400 = ₹28,000
to under-pricing or the selection of unprofitable
Since the total contribution of ₹28,000 helps cover products. This limitation is especially problematic
part of the fixed costs (even though it does not fully in industries with high fixed costs, where allocating
cover them), the company may decide to continue fixed costs to products is crucial for accurate
operations rather than shut down. Shutting down profitability analysis.
would mean bearing the full fixed costs of ₹50,000
• Limited Use in Long-Term Decision-Making:
without any contribution.
Short-term decisions like pricing, special orders,
Managerial Implications: Marginal costing helps or product mix decisions primarily use marginal
managers decide whether to shut down during costing. It does not take into account long-term
tough periods or continue operations with reduced factors such as fixed asset investment, product
profits. It provides a framework for assessing lifecycle costs, or market fluctuations.
whether continuing production will contribute
Impact: In long-term decision-making, such as
positively to covering fixed costs.
capital investment, new product development,
These managerial uses of marginal costing help or market expansion, fixed costs and capital
businesses optimize decision-making in a variety expenditures play a vital role. Marginal costing does
of scenarios, ensuring profitability and efficient use not account for these costs, making it less suitable
of resources. for these decisions. Strategic decisions that require
consideration of all costs, including fixed costs and
Limitations of Marginal Costing
overheads, require other costing methods such as
While marginal costing is a valuable tool for short- absorption costing or activity-based costing (ABC).
term decision-making, it has several limitations that
managers should be aware of. These limitations
stem primarily from the fact that marginal costing
focuses solely on variable costs and contribution
margins, frequently ignoring other important factors
in the decision-making process. The key limitations
of marginal costing are listed below:

• Ignore fixed costs in decision-making: One of

the major limitations of marginal costing is that
it treats fixed costs as period costs and excludes
them from product cost calculations. While this

147 Accounting for Managers

 • Not Suitable for External Financial Reporting: to selling prices.
Marginal costing is not acceptable under
By assuming linear relationships, marginal costing
Generally Accepted Accounting Principles
can oversimplify decision-making and overlook
(GAAP) or International Financial Reporting
important cost behaviours at different levels
Standards (IFRS) for external financial reporting.
of activity.
External stakeholders, such as investors,
creditors, and regulatory authorities, require a • Does Not Consider Opportunity Costs: Marginal
complete view of both variable and fixed costs in costing focuses exclusively on the contribution
financial statements. margin and ignores opportunity costs—the
potential benefits that are forfeited when one
Impact: For external financial reporting, companies
option is chosen over another. In many decision-
must use absorption costing, which includes both
making scenarios, opportunity costs can be
variable and fixed costs in product costing. Only
significant and should be considered alongside
internal decision-making processes can utilize
marginal costs.
marginal costing, thereby restricting its application.
The exclusion of fixed costs from product cost Impact: For example, in a make-or-buy decision,
calculations may lead to discrepancies when marginal costing will only compare the variable cost
reconciling internal management reports with of production with the purchase price. It may ignore
financial reports prepared for external use. the opportunity cost of using in-house resources
for other profitable activities. Ignoring opportunity
• Assumes Linear Relationships: Marginal
costs can lead to suboptimal decisions, especially
costing assumes a linear relationship between
when companies have multiple options for using
costs, revenue, and production levels.
their resources.
Specifically, it assumes that:
• Inaccurate for Multi-Product Environments with
• Variable costs per unit remain constant
Shared Resources: In companies that produce
regardless of the level of production.
multiple products, marginal costing can struggle
• Fixed costs remain constant within a certain to accurately allocate shared resources (such as
range of production. overhead costs, facilities, or machinery) between
different products. Managers may overlook the
• Selling prices do not change with changes in
shared costs of producing multiple products in
production levels.
the same facility, as they do not allocate fixed
In reality, these relationships may not always costs to specific products.
be linear.
Impact: This limitation can lead to misleading
Impact: As production levels change, variable costs decisions about product mix or pricing, especially
may increase due to inefficiencies or economies when shared resources are significant. For example,
of scale. Fixed costs might change at certain two products may appear equally profitable based
production levels due to capacity constraints, on their contribution margins, but one product may
necessitating additional investment in equipment, be more costly to produce due to its higher demand
labour, or space. Changes in demand, competition, on shared resources.
or market conditions may necessitate adjustments

148 Accounting for Managers

• Assumes fixed costs are constant: Marginal costing assumes that fixed costs remain constant within
a relevant range of production. However, in practice, fixed costs may change as production levels
increase or decrease. For instance, expanding production may require additional investment in fixed
assets, such as equipment or factory space, which would increase fixed costs.

Impact: If fixed costs increase beyond a certain level of production, decisions based solely on marginal
costing might underestimate the full cost of expansion or contraction. Managers need to be cautious when
relying on marginal costing for decisions involving large changes in production capacity.

• Inconsistent Treatment of Semi-Variable Costs: Marginal costing clearly distinguishes between

variable and fixed costs, but it does not always account for semi-variable costs, which contain both
fixed and variable components. Examples of semi-variable costs include utilities and maintenance
costs, which may have a fixed monthly fee plus a variable component based on usage.

Impact: Marginal costing may not accurately represent semi-variable costs, leading to imprecise decision-
making, particularly in businesses where such costs are significant. To appropriately account for semi-
variable costs in decision-making, a more detailed analysis of cost behaviour is required.

Summary
While marginal costing is a useful tool for short-term decision-making and analysing the impact of variable
costs on profitability, it has limitations that make it less suitable for long-term or complex decisions.
Managers need to supplement marginal costing with other costing methods, such as absorption costing or
activity-based costing, to ensure accurate and comprehensive decision-making in various scenarios.

149 Accounting for Managers

 Unit 14
Break Even Point (BEP) Analysis

Learning Objectives Introduction

By the end of this unit, you will be In the world of business, understanding profitability is
able to: essential for making sound financial decisions. A key tool

• Explain the concept of break-even that helps businesses assess whether they are operating

point (BEP) and its importance in at a profit, or a loss is Break-Even Analysis. This analysis

business decision-making helps determine the point at which a business’s revenues

are exactly equal to its total costs, meaning there is no
• Calculate the break-even point
profit or loss—this is known as the Break-Even Point (BEP).
in units and revenue, using
Understanding the break-even point allows companies
key financial metrics such as
to make informed decisions about pricing, budgeting,
fixed costs, variable costs, and
and production levels to avoid financial losses and
contribution margin
achieve profitability.
• Visualize the break-even point and
Break-even analysis not only helps businesses set
interpret the break-even chart to
targets but also acts as a foundation for profit planning
assess cost-revenue relationships
and risk management. By calculating the break-even
• Apply break-even analysis to real- point, businesses can assess the minimum level of
world scenarios such as pricing activity required to avoid a loss and make strategic
strategies, budgeting, and profit decisions accordingly.
planning

• Evaluating the impact of changes

in costs, pricing, and sales on
profitability

150 Accounting for Managers

BEP Analysis and variable costs, businesses can make
better decisions regarding cost control
BEP analysis is a financial technique that calculates
and management.
the point where total revenue equals total costs,
resulting in neither a profit nor a loss. The primary • Budgeting and Forecasting: BEP analysis is a
goal of BEP analysis is to determine the sales fundamental tool for creating accurate budgets
volume needed to cover all costs. It provides insight and sales forecasts, helping businesses to set
into the relationship between fixed costs, variable realistic financial targets.
costs, and sales revenue.
Break-Even Point analysis is a vital tool for
Key Components: businesses to measure their financial health and
make decisions that optimise profitability.
• Fixed Costs: These are costs that remain
constant, regardless of the volume of goods Calculation of BEP: The Break-Even Point (BEP) can
or services produced. Examples include rent, be calculated in two ways: in terms of units (how
salaries, and equipment depreciation. Fixed many units need to be sold) and in terms of revenue
costs must be covered before a business can (how much sales revenue needs to be generated).
become profitable. The formulas rely on the relationship between fixed
costs, variable costs, and contribution margin.
• Variable Costs: These costs vary directly with
the level of production or sales. They include Formula for BEP in Units:
expenses like raw materials, labour, and utilities.
The BEP in units tells you the number of units that
• Total Revenue: The income generated from must be sold to cover all costs.
selling goods or services. It is calculated as the
BEP (Units) = Fixed Costs / Contribution Margin
selling price per unit multiplied by the number of
per Unit
units sold.
Where:
• Contribution Margin: The difference between
the selling price of a product and its variable • Fixed Costs: Costs that remain constant
costs. This margin helps to cover fixed costs regardless of production volume.
and contribute to profit. • Contribution Margin per Unit: The amount left
Importance of BEP: after subtracting variable costs from the selling
price per unit.
• Profitability Planning: BEP analysis helps
businesses plan for the minimum sales required Contribution Margin per Unit = Selling Price per Unit
to avoid losses and achieve profitability. − Variable Cost per Unit

• Pricing Strategy: It aids in determining Formula for BEP in Revenue:

the optimal price for products or services The BEP in revenue tells you how much total sales
by understanding the impact of pricing revenue is required to cover all costs.
on profitability.
BEP (Revenue) = Fixed Costs/ Contribution
• Cost Management: By separating fixed Margin Ratio

151 Accounting for Managers

 Where:

• Contribution Margin Ratio (CMR): The

percentage of each sales rupee available to cover
fixed costs and contribute to profit.

CMR = Contribution Margin per Unit/Selling Price per

Unit

Example: A company sells a product for ₹500 per

unit. The variable cost per unit is ₹300, and the fixed
costs are ₹200,000 per month. Calculate:

1. The Break-Even Point in units.

2. The Break-Even Point in revenue.

Solution:

Step 1: Calculate Contribution Margin per Unit:

Contribution Margin per Unit = 500 – 300 = ₹ 200

Step 2: Calculate BEP in Units:

BEP (Units) = 200,000 / 200 = 1,000 units

The company needs to sell 1,000 units to break even.

Step 3: Calculate Contribution Margin Ratio:

CMR = 200 / 500 = 0.40 or 40%

Step 4: Calculate BEP in Revenue:

BEP (Revenue) = 200,0000/0.40 = ₹ 500,000

The company must generate ₹500,000 in sales revenue to break even.

Graphical Representation of BEP (Break-Even Chart):

A Break-Even Chart is a graphical representation that shows the relationship between total costs, total
revenue, and the number of units sold. The point where the total revenue line intersects the total cost line is
the Break-Even Point, indicating the volume of sales at which the company neither makes a profit nor incurs
a loss.

Key Elements of the Break-Even Chart:

• X-Axis (Horizontal Axis): Represents the number of units sold or produced.

• Y-Axis (Vertical Axis): Represents the monetary value (costs and revenue).

152 Accounting for Managers

• Total Revenue Line: A line starting from the The graph above represents the Break-Even Chart
origin that slopes upward as more units are sold. based on the example provided. Here’s how to
It represents the income generated from selling interpret it:
products.
• Total Costs (Red Line): This line starts at
• Total Cost Line: A line that starts at the level of ₹200,000 (the fixed costs) and increases as
fixed costs and slopes upward as variable costs variable costs are added for each unit sold.
are added with each unit produced. It represents
• Total Revenue (Green Line): This line starts at
the total cost (fixed + variable) incurred at
the origin and increases as more units are sold,
different sales levels.
reflecting the sales revenue.
• Break-Even Point: The point where the total
• Break-Even Point (Blue Dashed Line): The
revenue line intersects the total cost line. This is
point where the total revenue line intersects the
the point where the company covers all its costs,
total cost line. In this case, the break-even point
making no profit and no loss.
occurs at 1,000 units, or ₹500,000 in revenue.
Break-Even Chart Example:
This visual representation helps businesses easily
Here is a graphical representation based on the identify the sales volume needed to cover all costs.
earlier example:
Uses and Impact of Break-Even Analysis:
• Selling Price per Unit = ₹500 Application in Pricing, Budgeting, and

• Variable Cost per Unit = ₹300 Profit Planning

Break-even analysis is not just a theoretical tool;

• Fixed Costs = ₹200,000
it plays a vital role in practical business decision-
• Break-Even Point = 1,000 units (or ₹500,000 making. Understanding the break-even point helps
revenue) businesses manage risk and make strategic choices
that lead to profitability. In this section, we will
Graphical Representation:
explore how break-even analysis can be applied in
pricing, budgeting, and profit planning.

Application of Break-Even Analysis in Pricing

Pricing is a critical aspect of business strategy, and

break-even analysis helps businesses set prices that
cover costs and contribute to profits. By calculating
the break-even point, businesses can assess
whether their current pricing strategy is sufficient to
cover both fixed and variable costs.

Break-Even Chart

153 Accounting for Managers

 How Break-Even Analysis Impacts Pricing • Setting Sales Targets: Break-even analysis helps
Decisions businesses set realistic sales targets based on
how many units need to be sold or how much
• Setting Minimum Prices: Break-even analysis
revenue must be generated to cover costs.
allows companies to determine the minimum
price they can charge to avoid losses. If the price • Cost Control: By understanding the break-even
falls below this threshold, the business won’t point, companies can set cost limits and ensure
generate enough revenue to cover its fixed and that their budgeting reflects the need to manage
variable costs. fixed and variable costs effectively.

• Evaluating Price Changes: Businesses can use • Capacity Planning: Break-even analysis allows
break-even analysis to evaluate how changes businesses to plan for future growth and
in pricing impact their break-even point. For capacity expansion by assessing the additional
example, reducing the selling price to increase fixed costs and the corresponding increase in
demand might require a higher sales volume to sales required to break even.
break even, which might not always be feasible.
Example: A manufacturing company is planning
• Competitive Pricing: In competitive markets, to invest ₹100,000 in new equipment, which will
understanding the break-even point helps increase its fixed costs. By calculating the break-
businesses ensure that they are pricing their even point, the company can determine how many
products competitively while still covering costs. additional units must be sold to cover the higher
fixed costs. This allows the company to include the
Example: A company sells a product at ₹600, with
new equipment’s cost in its budget and adjust its
variable costs of ₹350 per unit and fixed costs of
sales targets accordingly.
₹200,000. After calculating the break-even point, the
company realizes that if it lowers the price to ₹550 Application of Break-Even Analysis in Profit
to match a competitor, the number of units required Planning
to break even increases significantly. The company
Profit planning involves setting goals for how much
must then decide if the market demand will support
profit a business intends to achieve and developing
the higher sales volume needed to break even at the
strategies to reach those goals. Break-even analysis
lower price.
plays a crucial role in profit planning by helping
Application of Break-Even Analysis in Budgeting businesses understand how different levels of sales
and cost structures impact profitability.
Budgeting involves setting financial goals and
planning for future expenses and revenues. Break- How Break-Even Analysis Impacts Profit Planning:
even analysis provides a foundation for creating
• Setting Profit Targets: Break-even analysis
accurate budgets by helping businesses understand
can be extended to calculate the sales volume
how sales levels affect their ability to cover costs
required to achieve a specific profit target. This
and generate profit.
helps businesses set realistic goals for profit
How Break-Even Analysis Impacts Budgeting: and sales.

154 Accounting for Managers

• Analysing Cost Structures: By analysing the Example: A company has fixed costs of ₹300,000
fixed and variable cost structures, businesses and a contribution margin of ₹200 per unit. The
can identify opportunities to reduce costs and company wants to achieve a profit of ₹100,000. The
improve profit margins. For example, reducing required sales volume to achieve this profit can be
variable costs increases the contribution margin, calculated as:
lowering the break-even point and leading to
Required Sales (Units) = 300,000 + 100,000/ 200 =
higher profits at the same sales volume.
2,000 units

This means the company must sell 2,000 units to

• Scenario Planning: Break-even analysis can cover its fixed costs and earn a profit of ₹100,000.
be used to model different scenarios, such as
changes in variable costs, pricing strategies,
or fixed cost investments, and their impact on Summary
profitability. This helps businesses prepare for
Break-even analysis is a powerful tool that has
different market conditions and adjust their
wide-ranging applications in pricing, budgeting, and
strategies accordingly.
profit planning. It helps businesses make informed
Formula for Sales to Achieve a Desired Profit: decisions by providing clarity on how sales volume,
cost structures, and pricing strategies affect
To calculate the sales volume needed to achieve a
profitability. By understanding the break-even point,
desired level of profit, the following formula is used:
companies can set realistic financial goals, optimize
Required Sales (Units) = (Fixed Costs + Desired their pricing strategies, manage costs effectively,
Profit)/ Contribution Margin per Unit and ensure they remain on a path to profitability.

155 Accounting for Managers

 Unit 15
Overview of Fintech

Learning Objectives Introduction and Background of Fintech

By the end of this unit, you will be Fintech, short for Financial Technology, refers to the use of
able to: technology to enhance, streamline, and disrupt traditional

• Explain the core concepts of financial services. It involves the development of new

fintech and its impact on financial business models and platforms that provide financial

services, particularly in areas like services in a faster, cheaper, and more accessible way.

payments, blockchain technology, Fintech spans a wide range of sectors, including banking,

and AI payments, insurance, wealth management, and even

regulatory compliance (RegTech).
• Analyze the integration of fintech
in modern accounting practices, Fintech companies leverage cutting-edge technologies like
focussing on the role of cloud- blockchain, artificial intelligence (AI), machine learning, big
based systems, automation, and data analytics, and cloud computing to deliver innovative
blockchain solutions that challenge established financial institutions.
The goal of Fintech is to simplify financial transactions,
• Apply fintech innovations to real-
enhance customer experiences, and reduce costs for both
world scenarios, understanding
businesses and consumers.
their potential to enhance financial
decision-making, reporting, and
fraud prevention in businesses

156 Accounting for Managers

Historical Context innovation while ensuring consumer protection.
Initiatives like Open Banking in the UK and the
The fintech industry began to take shape in the
European Union’s PSD2 (Payment Services
aftermath of the 2008 global financial crisis, when
Directive 2) have empowered consumers to
traditional financial institutions struggled to regain
control their financial data and allowed new
public trust. This opened the door for startups and
players to enter the market.
tech-driven firms to provide more transparent and
efficient financial services. However, the roots of • Financial Inclusion: Fintech has played a critical
Fintech can be traced back further, with the advent role in increasing financial inclusion, particularly
of online banking in the 1990s and PayPal’s rise as in emerging markets. With mobile banking and
one of the first global digital payment platforms in digital wallets, people who were previously
the early 2000s. unbanked or underbanked now have access to
financial services.
The real Fintech boom came in the 2010s, when
venture capitalists and investors began to pour
significant amounts of money into tech-driven
Key Areas and Trends in Fintech
financial startups. During this period, mobile
banking, peer-to-peer lending, cryptocurrencies, and Fintech is rapidly transforming multiple areas within
digital wallets began to gain mainstream attention, the financial services industry, driven by innovations
signalling a fundamental shift in the way financial in technology and changing consumer expectations.
services were delivered. The following are some of the most impactful areas
and trends in the Fintech space:
The Fintech Revolution
a. Payments Systems
Several key factors have driven the
Fintech revolution: Payments are one of the most visible and rapidly
evolving areas in Fintech. Digital payment solutions,
• Advancements in Technology: The widespread
which are faster, more secure, and accessible to a
use of smartphones, the rise of the internet, and
global audience, are replacing the traditional cash-
breakthroughs in data processing have enabled
based and card-based payment systems.
Fintech companies to offer more efficient and
accessible financial services. Key Trends in Payment Systems:

• Changing Consumer Expectations: Consumers, • Mobile Payments: Mobile payments have

particularly millennials and Gen Z, expect transformed how people transact, offering
instant, on-demand services. They are looking convenient, secure, and contactless options.
for financial solutions that are as simple to use With the rise of smartphones, mobile wallets
as apps like Uber or Amazon, which has driven and payment apps have become commonplace
the adoption of digital banking and payment for both in-store and online transactions.
solutions.
Example:
• Regulatory Changes: Governments and
• Google Pay and Apple Pay are widely used
regulatory bodies have responded to the rise
mobile wallets that allow users to make
of Fintech by creating frameworks that support

157 Accounting for Managers

 payments via smartphones. These services use especially attractive for remittances and
Near Field Communication (NFC) technology to business transactions.
enable contactless payments, making it easier
• Real-Time Payments: Real-time payment
for consumers to pay by simply tapping their
systems allow money transfers to happen
devices at point-of-sale terminals.
instantly, enabling businesses and consumers to
• In countries like India, Paytm has revolutionized settle transactions faster. This has a significant
mobile payments, allowing consumers to pay impact on industries like e-commerce and
bills, transfer money, and shop online using a peer-to-peer (P2P) payments, where speed and
digital wallet that links to their bank accounts convenience are crucial.
or credit cards. Paytm’s rise during India’s
Example:
demonetization period in 2016 highlighted
how Fintech can adapt to economic shifts • In the UK, the Faster Payments Service (FPS)
and provide critical infrastructure for digital allows individuals and businesses to send and
payments. receive payments in real-time, reducing the time
for bank transfers from several days to just a
• Cross-Border Payments: Traditionally, cross-
few seconds.
border payments through banks have been
slow, expensive, and prone to delays. Fintech • Zelle, a real-time payment platform in the US,
companies have streamlined this process, allows users to send money instantly using only
reduced fees and made international transfers an email address or phone number. It’s widely
faster and more transparent. integrated with major banks like Chase, Bank
of America, and Wells Fargo, making it easy for
Example:
users to transfer money without needing third-
• Wise (formerly TransferWise) is a prime example party apps.
of how Fintech companies are improving cross-
b. Blockchain Technology:
border payments. Wise offers transparent,
low-cost international money transfers by Blockchain is one of the most transformative
matching currency exchanges between different technologies in Fintech. It offers a decentralized,
users instead of relying on traditional bank secure, and transparent way to conduct financial
infrastructure. This peer-to-peer exchange transactions. Blockchain has applications beyond
method reduces transaction fees and eliminates just cryptocurrencies, with its potential to disrupt
the need for intermediaries, allowing users to industries ranging from banking to supply chain
transfer money internationally at a fraction of management.
the cost charged by banks.
3 Key Trends in Blockchain:
• Ripple is another Fintech company leveraging
1. Cryptocurrencies: Cryptocurrencies, such as
blockchain technology to facilitate fast and
Bitcoin and Ethereum, are digital currencies that
secure cross-border payments. Ripple’s XRP
operate on blockchain technology. They allow
Ledger allows for instant currency transfers
for decentralized transactions without the need
between different currencies with lower
for intermediaries like banks. Cryptocurrencies
fees than traditional methods, making it

158 Accounting for Managers

 have introduced new ways to think about money, Example:
transactions, and financial sovereignty.
• In real estate, smart contracts can be used to
Example: automate the sale of a property. Once the buyer
transfers the agreed amount in cryptocurrency,
• Bitcoin is the most well-known cryptocurrency
the contract is executed, and ownership of the
and has grown from a niche interest to a globally
property is automatically transferred to the
recognized asset class. Bitcoin operates on
buyer. This reduces the need for intermediaries
a decentralized network, meaning no central
like notaries, lawyers, or escrow agents, making
authority (such as a bank or government)
the process faster and more cost-effective.
controls it. People can buy, sell, and trade
Bitcoin internationally without the need for bank • Aave, a decentralized lending platform, uses
intermediaries, reducing transaction costs and smart contracts to automatically issue and
speeding up processes. repay loans in the cryptocurrency world
without the need for banks or other traditional
• Ethereum, another popular cryptocurrency, takes
lenders. The smart contract enforces the loan
blockchain further by enabling smart contracts,
agreement, ensuring the terms are met without
which are self-executing contracts where the
human intervention.
terms of the agreement are directly written into
the code. This technology has applications in 3. Decentralized Finance (DeFi): DeFi is a rapidly
various sectors, such as real estate, legal, and growing sector of blockchain-based financial
supply chains, where trustless transactions can services. DeFi platforms offer decentralized
save time and reduce costs. alternatives to traditional banking services like
lending, borrowing, and trading, which operate
2. Smart Contracts: Smart contracts are self-
without central authorities or intermediaries.
executing contracts that automatically enforce
the terms of an agreement without the need Example: Uniswap, a decentralized exchange, allows
for third parties. These contracts operate on users to trade cryptocurrencies directly with one
blockchain technology, ensuring transparency another through smart contracts without relying on
and trust between parties. centralized exchanges. This offers more autonomy
and security for users by removing intermediaries.

C. Artificial Intelligence (AI) in Financial Reporting:

Artificial Intelligence (AI) is becoming a vital

tool in financial reporting, offering significant
improvements in data analysis, fraud detection, and
predictive modelling. AI-driven tools help automate
time-consuming tasks and provide real-time
insights, making financial reporting more accurate,
efficient, and actionable. AI is increasingly integrated
into accounting and financial reporting processes,
improving efficiency and decision-making for

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 businesses. Example: Mastercard and Visa have implemented
AI-powered fraud detection systems that monitor
3 Key Trends in AI for Financial Reporting:
millions of transactions in real-time. These systems
1. Automated Data Processing: AI tools can use machine learning algorithms to identify unusual
process and categorize massive amounts of transaction patterns, such as sudden high-value
financial data much faster and with fewer errors purchases or purchases made in different countries
than human workers. This automation improves within a short time frame. If a potential fraudulent
the accuracy of financial reporting and frees up transaction is detected, the system can flag or block
accountants and finance professionals to focus the transaction automatically, reducing the risk
on higher-level strategic tasks. of fraud.

Example: Xero and QuickBooks, cloud-based Impact on Accounting:

accounting platforms, use AI to automatically
Integration of Fintech in Modern Accounting
categorize expenses, reconcile bank transactions,
Practices
and generate financial reports. This reduces the
amount of manual data entry required, ensuring The integration of Fintech into modern accounting
faster and more accurate reporting. AI also has significantly changed how businesses manage
helps identify discrepancies in financial data, their financial data, perform audits, and comply with
flagging potential issues before they become regulations. Technologies like artificial intelligence
significant problems. (AI), blockchain, and cloud computing are
revolutionizing accounting processes, making them
2. Predictive Analytics: AI-powered tools can
more efficient, accurate, and secure.
analyse historical financial data and use
predictive analytics to forecast future trends. a. Cloud-Based Accounting: One of the most
These insights help businesses plan better by significant impacts of Fintech on accounting
anticipating changes in revenue, expenses, and is the widespread adoption of cloud-based
market conditions. accounting software. Cloud technology allows
businesses to store and access financial
Example: Kabbage, a Fintech company, uses
data online, reducing the need for expensive
AI-driven predictive analytics to evaluate the
hardware and software installations. With
creditworthiness of small businesses seeking loans.
cloud accounting, businesses can manage their
By analysing real-time data on sales, customer
finances in real-time from anywhere, enabling
reviews, and business performance, Kabbage can
better collaboration and decision-making.
assess the risk of lending more accurately than
traditional credit models based on static data like Example: Xero and QuickBooks are leading cloud-
credit scores. based accounting platforms that allow businesses
to perform a wide range of tasks, such as invoicing,
3. Fraud Detection: AI systems excel at identifying
expense tracking, payroll, and financial reporting, all
patterns in large datasets and flagging
through a secure online interface. These platforms
anomalies that could indicate fraud. Financial
offer real-time access to financial data, which is
institutions use AI to monitor transactions in
especially beneficial for businesses with multiple
real-time and detect suspicious activities.
locations or remote teams.

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Benefits: systems are less prone to human error,
ensuring greater accuracy in financial reporting
• Accessibility: Financial data can be accessed
and compliance.
from anywhere, allowing accountants, auditors,
and management teams to collaborate • Predictive Analytics: AI can analyse historical
seamlessly, regardless of location. financial data and predict future trends,
helping businesses with cash flow forecasting,
• Cost Efficiency: Cloud-based accounting
budgeting, and decision-making.
reduces the need for costly IT infrastructure, as
businesses no longer need to maintain servers c. Blockchain in Accounting: Blockchain
or software licenses. technology offers a secure, transparent,
and immutable way of recording financial
• Automatic Updates: Cloud platforms
transactions. By creating a decentralized ledger,
automatically update their software, ensuring
blockchain enables accountants to verify
that businesses are always using the
and trace transactions in real-time, which is
latest versions and are compliant with the
particularly useful for auditing and compliance.
latest regulations.
The technology has the potential to reduce fraud
b. Automation and Artificial Intelligence (AI) and errors while increasing transparency in
in Accounting: Automation and AI have financial reporting.
streamlined many routine accounting tasks,
Example: PwC and other major accounting firms
reducing the time spent on manual data entry,
are exploring the use of blockchain for auditing
reconciliations, and reporting. AI-powered
and financial reporting. Blockchain provides an
accounting systems can analyse large datasets,
immutable audit trail, which allows auditors to
detect patterns, and provide real-time insights
verify the accuracy of financial transactions without
into business performance, all while minimizing
needing to rely on third-party confirmations.
human error.
Benefits:
Example: Botkeeper, an AI-driven bookkeeping
platform, automates the categorization of • Transparency: Every transaction recorded on
transactions, reconciles bank accounts, and the blockchain is visible to all participants in the
generates financial statements with minimal human network, creating a permanent and transparent
input. By using machine learning algorithms, the record that cannot be altered retroactively.
system learns from past transactions and becomes
• Fraud Prevention: Blockchain’s decentralized
more accurate over time.
nature makes it extremely difficult for bad actors
Benefits: to alter or manipulate financial records, reducing
the risk of fraud.
• Time Savings: Automation allows accountants
to focus on more strategic tasks by reducing the • Streamlined Audits: Blockchain allows
time spent on repetitive activities like data entry auditors to verify financial records instantly,
and invoice processing. reducing the time and costs associated with
traditional audits.
• Increased Accuracy: AI-driven accounting

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 d. Real-Time Financial Reporting and Decision- Example: Zoho Books is a cloud accounting
Making: Fintech solutions have transformed platform that uses advanced encryption to protect
the speed at which financial reports can be financial data. The platform also offers role-based
generated. Traditional accounting systems access controls and two-factor authentication,
often require month-end or quarter-end closing ensuring that only authorized users can access
processes, but with Fintech tools like AI- sensitive financial information.
powered reporting systems and cloud platforms,
Benefits:
businesses can now access real-time financial
data, enabling faster and more informed • Data Protection: With encryption and blockchain,
decision-making. financial data is protected from tampering,
hacking, and data breaches.
Example: Sage Intacct is a cloud financial
management platform that provides real-time • Compliance with Regulations: Fintech solutions
reporting and analytics. It enables businesses to often come with built-in security features that
generate financial statements and dashboards help businesses comply with regulations such
instantly, giving management teams immediate as GDPR (General Data Protection Regulation)
insights into their company’s performance. and PCI-DSS (Payment Card Industry Data
Security Standard).
Benefits:
• Reduced Risk of Cybercrime: With the rise
• Faster Decision-Making: Real-time access
of cyberattacks, Fintech’s advanced security
to financial data allows businesses to make
protocols help safeguard financial information
quicker decisions regarding budgeting, cash
and reduce the risk of financial fraud.
flow, and investments.

• Improved Forecasting: By analysing up-to-date

financial data, businesses can more accurately Summary
forecast future financial trends and adjust their
The integration of Fintech into accounting practices
strategies accordingly.
has revolutionized the industry by improving
• Enhanced Compliance: Real-time reporting also efficiency, accuracy, and security. Technologies
ensures that businesses can quickly comply with like cloud computing, AI, and blockchain have
regulatory requirements by generating accurate automated routine tasks, enhanced data security,
and timely financial reports. and provided real-time insights that enable
businesses to make more informed financial
e. Enhanced Security in Accounting: Fintech has
decisions. As Fintech continues to evolve, its
improved the security of accounting systems by
impact on accounting will only grow, creating more
integrating advanced security measures such
opportunities for innovation in financial reporting,
as encryption, multi-factor authentication (MFA),
auditing, and compliance.
and blockchain. These technologies ensure
that sensitive financial data is protected from
cyberattacks and unauthorized access.

162 Accounting for Managers

 Unit 16
Digitalisation in Accounting System

Learning Objectives Introduction

By the end of this unit, you will be Digitalisation in accounting refers to the transformation
able to: of traditional manual processes into automated, real-time

• Explain the importance of systems using advanced digital tools and technologies.

digitalization in accounting This shift from paper-based systems to digital platforms

is enabling businesses to streamline their accounting
• Identify key digital tools such as
operations, increase accuracy, and make faster, more
cloud and ERP
informed decisions.
• Analyse the benefits and
In the digital age, accounting is no longer confined to
challenges of digital adoption in
spreadsheets and manual data entry. With technologies
accounting
like cloud computing, automation, and artificial intelligence
• Assess future trends in accounting, (AI), businesses can now automate routine tasks, reduce
including the role of AI, blockchain, human error, and provide real-time insights into financial
and robotic process automation performance. This evolution has not only made accounting
(RPA) more efficient but has also transformed how organisations
approach financial management and reporting.

163 Accounting for Managers

Importance of Digitalization in Accounting to evolve from basic record-keeping to
sophisticated platforms that provide deep
Digitalisation has revolutionized the accounting
insights into financial health.
profession in several ways:
• Demand for Real-Time Financial Information:
• Real-Time Data Access: Businesses can access
In today’s fast-paced business environment,
financial data instantly, allowing for real-time
companies need up-to-the-minute data to make
decision-making. Whether it’s tracking cash flow
informed financial decisions. Digital accounting
or generating reports, financial information is
systems provide real-time updates, allowing for
available on-demand.
proactive financial management.
• Enhanced Accuracy: By automating repetitive
• Cost Savings: Automating routine accounting
and complex tasks, digital tools reduce the
tasks reduces labour costs and minimizes
likelihood of human errors that are common in
the need for expensive infrastructure. Cloud-
manual accounting, such as data entry mistakes
based accounting solutions, for instance,
or calculation errors.
eliminate the need for costly hardware and
• Increased Efficiency: Automation tools software installations.
streamline processes such as billing,
• Scalability: As businesses grow, their
invoicing, payroll, and tax preparation, freeing
accounting needs become more complex. Digital
up time for accountants to focus on more
systems can easily scale to accommodate
strategic activities like financial analysis and
increased data volume and more intricate
advisory services.
financial reporting requirements, without the
• Collaboration: Digital tools facilitate better need for major upgrades.
collaboration between accountants, auditors,
Benefits and Challenges of Digitalization in
and business stakeholders. Cloud-based
Accounting
systems allow multiple users to access
and work on the same financial data from The digital transformation of accounting systems
different locations, improving communication has brought significant benefits to businesses,
and coordination. making accounting processes more efficient and
accurate. However, the adoption of digital tools
• Compliance and Reporting: Digital systems
also presents certain challenges that organizations
can automatically track changes in financial
must navigate to fully capitalize on these benefits.
regulations and ensure that businesses remain
This section covers the advantages and potential
compliant. Additionally, generating financial
obstacles in digitizing accounting systems,
reports is faster and more accurate, reducing the
particularly in terms of efficiency, accuracy, and
workload on accounting teams.
challenges in digital adoption.
Key Drivers of Digitalization in Accounting:
a. Benefits of Digitalization in Accounting
• Technological Advancements: The rapid
1. Increased Efficiency: Digital tools streamline
development of cloud computing, automation,
repetitive and time-consuming accounting
and AI has enabled accounting systems
tasks, such as data entry, invoicing, and payroll

164 Accounting for Managers

 processing. Automation reduces the manual a clear audit trail and ensure that financial
workload for accountants, enabling them to data remains consistent and accurate across
focus on higher-level activities like financial all systems.
analysis and strategic planning. Example: Cloud-
3. Real-Time Data Access and Collaboration:
based accounting platforms automatically
Digital accounting platforms, especially cloud-
generate financial reports and statements,
based systems, allow for real-time access to
drastically reducing the time needed for month-
financial data from anywhere. This enables
end or year-end closures. This not only increases
accountants, managers, and auditors to
operational efficiency but also improves the
collaborate more effectively and make decisions
accuracy and timeliness of financial information.
based on up-to-date financial information.
Key Benefits: Example: A cloud accounting system allows
both internal finance teams and external
• Automation of Routine Tasks: Tasks like data
auditors to work on the same set of financial
entry, reconciliation, and billing are automated,
data simultaneously, improving collaboration
freeing up time for accountants to focus on
and reducing the need for back-and-forth
more critical, value-added activities.
communication during audits.
• Faster Financial Reporting: Digital systems
Key Benefits:
allow businesses to generate reports instantly,
enabling quicker decision-making and reducing • Improved Collaboration: Teams can work
delays in financial analysis. together in real-time, even from different
locations, ensuring that everyone is using the
2. Enhanced Accuracy: Digital accounting
most current data.
systems significantly reduce human errors,
particularly in areas like data entry, calculations, • On-Demand Financial Insights: Real-time
and reconciliations. By automating these access to financial data helps businesses stay
tasks, businesses can maintain higher levels agile and responsive to changes in their financial
of accuracy in their financial records, which position.
is crucial for decision-making, compliance,
b. Challenges in Digital Adoption in Accounting
and reporting. Example: Automated
systems can reconcile bank accounts daily, 1. Cost of Implementation: While digital
ensuring that discrepancies are flagged and accounting systems can lead to long-term
corrected immediately, without the need for savings, the initial costs of implementation can
manual intervention. be significant. Businesses may need to invest
in new software, train employees, and upgrade
Key Benefits:
their IT infrastructure to support the new
• Error Reduction: Automation minimizes the digital tools. Example: Implementing an ERP
risk of manual errors in financial data, such as system like SAP or Oracle NetSuite can require
miscalculations or incorrect entries, leading to substantial upfront investment, particularly for
more reliable financial reports. small or medium-sized businesses.

• Improved Data Integrity: Digital tools provide

165 Accounting for Managers

Challenges: Challenges:

• High Initial Costs: The upfront investment in • Data Security: Digital systems must be equipped
software, hardware, and employee training can with robust security features, such as encryption,
be prohibitive for smaller businesses. multi-factor authentication (MFA), and regular
backups, to prevent data breaches.
• Ongoing Maintenance: Digital systems require
ongoing updates, maintenance, and support, • Compliance with Regulations: Businesses must
which can increase operational costs. ensure that their digital accounting systems
comply with relevant data protection regulations,
2. Resistance to Change: The shift from traditional
such as GDPR or PCI-DSS.
accounting methods to digital systems can
be met with resistance from employees who 4. Integration with Existing Systems: Integrating
are accustomed to manual processes. This new digital accounting systems with existing IT
reluctance to adopt new technologies can infrastructure can be complex, particularly if a
hinder the successful implementation of digital business is using outdated systems or software
accounting systems. Example: Accountants who that is not compatible with modern digital tools.
have been using manual spreadsheets for years Example: A business using legacy accounting
may be resistant to transitioning to a cloud- software may face challenges integrating it with
based system, requiring additional training and a new ERP or cloud-based platform, leading to
change management initiatives. data silos or inefficiencies.

Challenges: Challenges:

• Training and Education: Employees may need • Compatibility Issues: Integrating digital
to be trained on new systems and processes, accounting tools with legacy systems can be
which can take time and resources. difficult, requiring custom solutions or significant
changes to the existing infrastructure.
• Cultural Resistance: Some employees may be
resistant to adopting digital tools, particularly if • Data Migration: Migrating data from old
they are comfortable with traditional methods. systems to new digital platforms can be time-
consuming and may involve the risk of data loss
3. Security and Privacy Concerns: With the
or corruption.
increasing reliance on digital tools and cloud-
based platforms, the security of sensitive
financial data is a major concern. Cyberattacks,
data breaches, and unauthorized access
to financial information can have severe
consequences for businesses. Example: A data
breach in a cloud accounting system could
expose sensitive financial information, leading
to financial loss or reputational damage for the
business.

166 Accounting for Managers

Future Trends: The Role of AI, Xero, a popular cloud-based accounting
Blockchain, and RPA in Accounting software, incorporates AI-powered predictive
analytics to help businesses anticipate cash
As digitalization in accounting continues to evolve,
flow shortages and take proactive measures.
several advanced technologies are shaping the
future of how businesses manage financial data • Fraud Detection: AI systems can monitor
and reporting. Artificial Intelligence (AI), Blockchain, transactions in real time to detect anomalies
and Robotic Process Automation (RPA) are at and flag potentially fraudulent activities. By
the forefront of these changes, offering new continuously learning from new data, AI systems
possibilities for automation, transparency, and improve their ability to identify suspicious
efficiency in accounting processes. transactions and prevent fraud. Example:
Mastercard’s AI system detects unusual
A. AI in Accounting
spending patterns in real time, alerting users
AI is transforming the way accounting tasks are and preventing unauthorized transactions before
performed by automating repetitive processes, they happen.
analysing large datasets, and providing valuable
Future Impact of AI:
insights for decision-making. AI algorithms can
detect patterns in financial data, predict outcomes, • Advanced Financial Analysis: AI will allow
and even recommend actions, allowing businesses businesses to gain deeper insights into financial
to make faster and more accurate decisions. performance by analysing large datasets and
uncovering trends that are difficult to detect
Key Applications of AI in Accounting:
through manual processes.
• Automated Data Entry and Processing: AI-
• Automated Audits: AI will be increasingly used
powered systems can automatically capture and
in auditing to automate compliance checks,
process financial data from invoices, receipts,
validate financial statements, and identify risks,
and other documents, reducing manual entry
making audits faster and more reliable.
work. This improves the speed and accuracy of
data entry and frees up accountants to focus b. Blockchain in Accounting
on higher-level tasks. Example: KPMG’s Ignite
Blockchain is a distributed ledger technology that
platform uses AI to automate data extraction
allows for secure, transparent, and tamper-proof
and validation, reducing the time it takes to
recording of transactions. In accounting, blockchain
process large volumes of financial data and
has the potential to revolutionize how financial
improving overall accuracy.
transactions are recorded, audited, and verified
• Predictive Analytics: AI can analyse historical by providing an immutable ledger that eliminates
financial data to predict future trends, such as the need for intermediaries and reduces the risk
cash flow, revenue projections, and expense of fraud.
patterns. This helps businesses forecast
Key Applications of Blockchain in Accounting:
financial performance and make more informed
budgeting and investment decisions. Example: • Secure and Transparent Recordkeeping:

167 Accounting for Managers

 Blockchain provides a decentralized and Future Impact of Blockchain:
transparent ledger that allows all participants
• Immutable Audit Trails: Blockchain will enable
to verify transactions in real-time. This ensures
businesses to maintain transparent and tamper-
that financial records are accurate, secure,
proof audit trails, making financial audits more
and immune to tampering. Example: PwC is
efficient and reliable.
exploring blockchain-based solutions to improve
audit transparency and accuracy. Blockchain’s • Decentralized Financial Systems: As blockchain
immutable ledger enables auditors to verify adoption grows, more financial systems will
transactions in real-time, reducing the need for move towards decentralized models, reducing
manual reconciliation. reliance on intermediaries like banks and third-
party auditors.
• Smart Contracts: Blockchain enables the use
of smart contracts, which are self-executing c. Robotic Process Automation (RPA) in
contracts with the terms of the agreement Accounting
written into code. These contracts automatically
Robotic Process Automation (RPA) involves
execute transactions when predefined
using software robots (bots) to automate routine,
conditions are met, reducing the need for
rule-based tasks in accounting. Unlike AI, which
intermediaries and lowering transaction costs.
learns and adapts, RPA follows predefined rules
• Real-Time Audits: Blockchain’s real-time, to complete repetitive processes, making it ideal
transparent ledger allows auditors to track for tasks such as data entry, reconciliations, and
financial transactions instantly. This could report generation.
eliminate the need for traditional post-period
Key Applications of RPA in Accounting:
audits and significantly speed up the auditing
process. Example: EY has been piloting • Automating Repetitive Tasks: RPA bots can
blockchain-based audit solutions to provide handle tasks like extracting data from invoices,
real-time transaction verification, improving the processing payments, and reconciling accounts,
accuracy and speed of financial audits. freeing up time for accountants to focus on

168 Accounting for Managers

 more complex and strategic activities. Example: UiPath, a leading RPA provider, helps businesses
automate tasks such as invoice processing and account reconciliations, reducing the time and labor
required for these repetitive tasks.

• Financial Report Generation: RPA can automatically generate and distribute financial reports by pulling
data from various sources, formatting the reports, and sending them to the relevant stakeholders.
This ensures that reports are generated quickly and consistently. Example: Large accounting firms
like Deloitte use RPA to automate the generation of financial statements and reports, streamlining the
reporting process and reducing errors.

• Tax Compliance Automation: RPA bots can be programmed to monitor tax regulations, ensure
compliance with tax filing requirements, and prepare tax returns automatically, reducing the risk
of errors and non-compliance. Example: KPMG uses RPA to automate its tax compliance services,
ensuring that clients meet regulatory requirements while reducing the time spent on tax filings.

Future Impact of RPA:

• Scalable Automation: As businesses grow, RPA systems can scale alongside them, automating more
complex processes and handling higher volumes of transactions.

• Increased Efficiency: With RPA handling repetitive tasks, accounting teams can focus more on strategic
analysis, financial planning, and decision-making, increasing overall efficiency.

Summary
The future of accounting is being shaped by advanced technologies like AI, Blockchain, and RPA, which are
automating routine tasks, improving transparency, and enhancing the accuracy of financial reporting. These
technologies are not only making accounting more efficient and secure but are also transforming the way
businesses approach financial management. As digitalization continues to evolve, the role of accountants
will shift from manual data processing to more strategic, analytical functions, driving innovation in the
financial services industry.

169 Accounting for Managers