Accountancy

Financial Accounting
Part I
Textbook for Class XI

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 11110 – Accountancy
Financial Accounting Part-I ISBN 81-7450-507-5
Textbook for Class XI

First Edition ALL RIGHTS RESERVED

February 2006 Phalguna 1927
 No part of this publication may be reproduced, stored in a retrieval
Reprinted system or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording or otherwise without the prior
October 2006, October 2007 permission of the publisher.
January 2009, January 2010  This book is sold subject to the condition that it shall not, by way of
January 2011, June 2012 trade, be lent, re-sold, hired out or otherwise disposed of without
April 2013, December 2013 the publisher’s consent, in any form of binding or cover other than
that in which it is published.
April 2015, December 2015
March 2017, February 2018  The correct price of this publication is the price printed on this page,
Any revised price indicated by a rubber stamp or by a sticker or by
February 2019, August 2019 any other means is incorrect and should be unacceptable.
and January 2021
OFFICES OF THE PUBLICATION
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 Foreword

The National Curriculum Framework (NCF), 2005, recommends that

children’s life at school must be linked to their life outside the school. This
principle marks a departure from the legacy of bookish learning which
continues to shape our system and causes a gap between the school,
home and community. The syllabi and textbooks developed on the basis of
NCF signify an attempt to implement this basic idea. They also attempt to
discourage rote learning and the maintenance of sharp boundaries between
different subject areas. We hope these measures will take us significantly
further in the direction of a child-centred system of education outlined in
the National Policy on Education (1986).
The success of this effort depends on the steps that school principals
and teachers will take to encourage children to reflect on their own
learning and to pursue imaginative activities and questions. We must
recognise that, given space, time and freedom, children generate new
knowledge by engaging with the information passed on to them by
adults. Treating the prescribed textbook as the sole basis of examination
is one of the key reasons why other resources and sites of learning are
ignored. Inculcating creativity and initiative is possible if we perceive
and treat children as participants in learning, not as receivers of a fixed
body of knowledge.
These aims imply considerable change in school routines and
mode of functioning. Flexibility in the daily time-table is as necessary
as rigour in implementing the annual calendar so that the required
number of teaching days are actually devoted to teaching. The methods
used for teaching and evaluation will also determine how effective this
textbook proves for making children’s life at school a happy experience,
rather than a source of stress or boredom. Syllabus designers have
tried to address the problem of curricular burden by restructuring and
reorienting knowledge at different stages with greater consideration
for child psychology and the time available for teaching. The textbook
attempts to enhance this endeavour by giving higher priority and space
to opportunities for contemplation and wondering, discussion in small
groups, and activities requiring hands-on experience.
The National Council of Educational Research and Training (NCERT)
appreciates the hard work done by the textbook development committee

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 iv

responsible for this book. We wish to thank the Chairperson of the

advisory group in Social Sciences Professor Hari Vasudevan and the
Chief Advisor for this book, Professor R.K. Grover, (Retd.) Director,
School of Management Studies (IGNOU), New Delhi for guiding the work
of this committee. Several teachers contributed to the development
of this textbook; we are grateful to their principals for making this
possible. We are indebted to the institutions and organisations which
have generously permitted us to draw upon their resources, material
and personnel. We are especially grateful to the members of the National
Monitoring Committee, appointed by the Department of Secondary and
Higher Education, Ministry of Human Resource Development under the
Chairpersonship of Professor Mrinal Miri and Professor G.P. Deshpande,
for their valuable time and contribution. As an organisation committed
to the systemic reform and continuous improvement in the quality of
its products, NCERT welcomes comments and suggestions which will
enable us to undertake further revision and refinement.

Director
New Delhi National Council of Educational
20 December 2005 Research and Training

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 Rationalisation of Content in
the Textbooks

In view of the COVID-19 pandemic, it is imperative to

reduce content load on students. The National Education
Policy 2020, also emphasises reducing the content load
and providing opportunities for experiential learning with
creative mindset. In this background, the NCERT has
undertaken the exercise to rationalise the textbooks across
all classes. Learning Outcomes already developed by the
NCERT across classes have been taken into consideration
in this exercise.
Contents of the textbooks have been rationalised in
view of the following:
• Overlapping with similar content included in other
subject areas in the same class
• Similar content included in the lower or higher class in
the same subject
• Difficulty level
• Content, which is easily accessible to students without
much interventions from teachers and can be learned
by children through self-learning or peer-learning
• Content, which is irrelevant in the present context
This present edition, is a reformatted version after
carrying out the changes given above.

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 Textbook Development Committee

Chairperson, Advisory Committee for Textbooks in Social Sciences at

Upper Primary Level
Hari Vasudevan, Professor, Department of History, University of
Calcutta, Kolkata
Chief Advisor
R. K. Grover, Professor, (Retd.), School of Management Studies, IGNOU,
New Delhi.
Members
A.K. Bansal, Reader, PGDAV College, Nehru Nagar, New Delhi.
Amit Singhal, Lecturer, Ramjas College, Delhi University, Delhi.
Ashwini Kumar Kala, PGT Commerce, Hiralal Jain Senior Secondary
School, Sadar Bazar, Delhi.
D.K Vaid, Professor, Department of Education in Social Sciences and
Humanities, NCERT, New Delhi.
Deepak Sehgal, Reader, Deen Dayal Upadhaya College, Delhi University,
Delhi.
H.V. Jhamb, Reader, Khalsa College, Delhi University, Delhi.
Ishwar Chand, PGT Commerce, Government Sarvodaya Bal Vidyalaya,
West Patel Nagar, New Delhi.
K. Sambasiva Rao, Professor, Department of Commerce, Andhra
University, Visakhapatnam.
M. Srinivas, Professor, Department of Commerce, College for Women,
Osmania University, Hyderabad.
P.K. Gupta, Reader, Department of Management Studies, Jamia Millia
Islamia, New Delhi.
Rajesh Bansal, PGT Commerce, Rohtagi A.V. Senior Secondary School,
Nai Sarak, Delhi.
S.K. Sharma, Reader, Khalsa College, Delhi University, Delhi.
S.S. Sehrawat, Assistant Commissioner, Kendriya Vidyalaya Sangathan,
Chandigarh.

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 viii

Savita Shangari, PGT Commerce, Gyan Bharati School, Saket, New Delhi.
Shiv Juneja, PGT Commerce, Nirankari Boys Senior Secondary School,
Paharganj, Delhi.
Sushil Kumar, PGT Commerce, Government Sarvodaya Bal Vidyalaya,
Kailash Puri, Delhi.
Vanita Tripathi, Lecturer, Department of Commerce, Delhi School of
Economics, Delhi University, Delhi.

Member-Coordinator
Shipra Vaidya, Professor, Department of Education in Social Sciences
NCERT, New Delhi.

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 Acknowledgements

The National Council of Educational Research and Training acknowledges

the valuable contributions of the Textbook Development Committee which
took considerable pains in the development and review of manuscript as well.
Special thanks are due to the Head, Department of Education in
Social Sciences, NCERT for constant support, during the development of
this book. We also acknowledge the contribution of all teachers of commerce
who developed the extra learning material for QR codes in the textbook.
The Council acknowledges the Contribution of Sanjeev Kumar,
Vice Principal, Government Boys Senior Secondary School, Mata Sundari
Road for reviewing and updating this textbook.
The Contribution of APC-Office, administration of DESS, Publication
Department and Secretariat of NCERT in bringing out this book are also
duly acknowledged.

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 Contents

Foreword
iii
Rationalisation of Content in the Textbooks
v
Chapter 1 Introduction to Accounting 1
1.1 Meaning of Accounting 2
1.2 Accounting as a Source of Information 7
1.3 Objectives of Accounting 12
1.4 Role of Accounting 14
1.5 Basic Terms in Accounting 16
Chapter 2 Theory Base of Accounting 25
2.1 Generally Accepted Accounting Principles 26
2.2 Basic Accounting Concepts 27
2.3 Systems of Accounting 36
2.4 Basis of Accounting 36
2.5 Accounting Standards 37
Chapter 3 Recording of Transactions - I 46
3.1 Business Transactions and Source Document 46
3.2 Accounting Equation 50
3.3 Using Debit and Credit 52
3.4 Books of Original Entry 60
3.5 The Ledger 72
3.6 Posting from Journal 75
Chapter 4 Recording of Transactions - II 99
4.1 Cash Book 100
4.2 Purchases (Journal) Book 125
4.3 Purchases Return (Journal) Book 127
4.4 Sales (Journal) Book 129
4.5 Sales Return (Journal) Book 131
4.6 Journal Proper 139
4.7 Balancing the Accounts 141

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 xii
Chapter 5 Bank Reconciliation Statement 160
5.1 Need for Reconciliation 161
5.2 Preparation of Bank Reconciliation Statement 166
Chapter 6 Trial Balance and Rectification of Errors 180
6.1 Meaning of Trial Balance 180
6.2 Objectives of Preparing the Trial Balance 181
6.3 Preparation of Trial Balance 184
6.4 Significance of Agreement of Trial Balance 189
6.5 Searching of Errors 191
6.6 Rectification of Errors 192
Chapter 7 Depreciation, Provisions and Reserves 226
7.1 Depreciation 226
7.2 Depreciation and other Similar Terms 230
7.3 Causes of Depreciation 230
7.4 Need for Depreciation 231
7.5 Factors Affecting the Amount of Depreciation 232
7.6 Methods of Calculating Depreciation Amount 234
7.7 Straight Line Method and Written Down Method: 238
A Comparative Analysis
7.8 Methods of Recording Depreciation 240
7.9 Disposal of Asset 249
7.10 Effect of any Addition or Extension to the 259
Existing Asset
7.11 Provisions 262
7.12 Reserves 264
7.13 Secret Reserve 268

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 Introduction to Accounting 1

O ver the centuries, accounting has remained

confined to the financial record-keeping
functions of the accountant. But, today’s rapidly
changing business environment has forced the
accountants to reassess their roles and functions
both within the organisation and the society. The
role of an accountant has now shifted from that of a
mere recorder of transactions to that of the member
Learning Objectives providing relevant information to the decision-
After studying this chapter
making team. Broadly speaking, accounting today
you will be able to: is much more than just book-keeping and the
• state the meaning and preparation of financial reports. Accountants are
need of accounting; now capable of working in exciting new growth
• discuss accounting as areas such as: forensic accounting (solving crimes
a source of information;
such as computer hacking and the theft of large
• identify the internal
and external users of amounts of money on the internet); e-commerce
accounting information; (designing web-based payment system); financial
• explain the objectives planning, environm­­ental accounting, etc. This
of accounting;
realisation came due to the fact that accounting is
• describe the role of
accounting; capable of providing the kind of information that
• explain the basic terms managers and other interested persons need in order
used in accounting. to make better decisions. This aspect of accounting

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 2 Accountancy

gradually assumed so much importance that it has now been raised to the
level of an information system. As an information system, it collects data
and communicates economic information about the organisation to a wide
variety of users whose decisions and actions are related to its performance.
This introductory chapter therefore, deals with the nature, need and scope of
accounting in this context.

1.1 Meaning of Accounting

In 1941, The American Institute of Certified Public Accountants (AICPA) had
defined accounting as the art of recording, classifying, and summarising in a
significant manner and in terms of money, transactions and events which are,
in part at least, of financial character, and interpreting the results thereof’.
With greater economic development resulting in changing role of accounting,
its scope, became broader. In 1966, the American Accounting Association (AAA)
defined accounting as ‘the process of identifying, measuring and communicating
economic information to permit informed judgments and decisions by users
of information’.

Fig. 1.1 : Showing the process of accounting

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 Introduction to Accounting 3

In 1970, the Accounting Principles Board of AICPA also emphasised that

the function of accounting is to provide quantitative information, primarily
financial in nature, about economic entities, that is intended to be useful in
making economic decisions.
Accounting can therefore be defined as the process of identifying, measuring,
recording and communicating the required information relating to the economic
events of an organisation to the interested users of such information. In order
to appreciate the exact nature of accounting, we must understand the following
relevant aspects of the definition:
• Economic Events
• Identification, Measurement, Recording and Communication
• Organisation
• Interested Users of Information

Box 1
History and Development of Accounting

Accounting enjoys a remarkable heritage. The history of accounting is as old as

civilisation. The seeds of accounting were most likely first sown in Babylonia and Egypt
around 4000 B.C. who recorded transactions of payment of wages and taxes on clay
tablets. Historical evidences reveal that Egyptians used some form of accounting for
their treasuries where gold and other valuables were kept. The incharge of treasuries
had to send day wise reports to their superiors known as Wazirs (the prime minister)
and from there month wise reports were sent to kings. Babylonia, known as the city of
commerce, used accounting for business to uncover losses taken place due to frauds
and lack of efficiency. In Greece, accounting was used for apportioning the revenues
received among treasuries, maintaining total receipts, total payments and balance of
government financial transactions. Romans used memorandum or daybook where in
receipts and payments were recorded and wherefrom they were posted to ledgers on
monthly basis. (700 B.C to 400 A.D). China used sophisticated form of government
accounting as early as 2000 B.C. Accounting practices in India could be traced back
to a period when twenty three centuries ago, Kautilya, a minister in Chandragupta’s
kingdom wrote a book named Arthashasthra, which also described how accounting
records had to be maintained.

Luca Pacioli’s, a Franciscan friar (merchant class), book Summa de

Arithmetica, Geometria, Proportion at Proportionality (Review of Arithmetic and Geometric
proportions) in Venice (1494) is considered as the first book on double entry book-
keeping. A portion of this book contains knowledge of business and book-keeping.

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 4 Accountancy

However, Pacioli did not claim that he was the inventor of double entry book-keeping
but spread the knowledge of it. It shows that he probably relied on then–current book-
keeping manuals as the basis for his masterpiece. In his book, he used the present
day popular terms of accounting Debit (Dr.) and Credit (Cr.). These were the concepts
used in Italian terminology. Debit comes from the Italian debito which comes from
the Latin debita and debeo which means owed to the proprietor. Credit comes from
the Italian credito which comes from the Latin ‘credo’ which means trust or belief (in
the proprietor or owed by the proprietor. In explaining double entry system, Pacioli
wrote that ‘All entries… have to be double entries, that is if you make one creditor,
you must make some debtor’. He also stated that a merchants responsibility include
to give glory to God in their enterprises, to be ethical in all business activities and to
earn a profit. He discussed the details of memorandum, journal, ledger and specialised
accounting procedures.

1.1.1 Economic Events

Business organisations involves economic events. An economic event is known
as a happening of consequence to a business organisation which consists
of transactions and which are measurable in monetary terms. For example,
purchase of machinery, installing and keeping it ready for manufacturing is
an event which comprises number of financial transactions such as buying
a machine, transportation of machine, site preparation for installation of
a machine, expenditure incurred on its installation and trial runs. Thus,
accounting identifies bunch of transactions relating to an economic event. If an
event involves transactions between an outsider and an organisation, these are
known as external events. The following are the examples of such transactions:
• Sale of merchandise to the customers.
• Rendering services to the customers by ABC Limited.
• Purchase of materials from suppliers.
• Payment of monthly rent to the landlord.
An internal event is an economic event that occurs entirely between the
internal wings of an enterprise, e.g., supply of raw material or components by
the stores department to the manufacturing department, payment of wages to
the employees, etc.

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 Introduction to Accounting 5

1.1.2 Identification, Measurement, Recording and Communication

Identification : It means determining what transactions to record, i.e., to identity
events which are to be recorded. It involves observing activities and selecting
those events that are of considered financial character and relate to the
organisation. The business transactions and other economic events therefore
are evaluated for deciding whether it has to be recorded in books of account.
For example, the value of human resources, changes in managerial policies or
appointment of personnel are important but none of these are recorded in books
of account. However, when a company makes a sale or purchase, whether on
cash or credit, or pays salary it is recorded in the books of account.
Measurement : It means quantification (including estimates) of business
transactions into financial terms by using monetary unit, viz. rupees and paise
as a measuring unit. If an event cannot be quantified in monetary terms, it
is not considered for recording in financial accounts. That is why important
items like the appointment of a new managing director, signing of contracts or
changes in personnel are not shown in the books of accounts.
Recording : Once the economic events are identified and measured in financial
terms, these are recorded in books of account in monetary terms and in a
chronological order. Recording is done in a manner that the necessary financial
information is summarised as per well-established practice and is made
available as and when required.
Communication : The economic events are identified, measured and recorded
in order that the pertinent information is generated and communicated in
a certain form to management and other internal and external users. The
information is regularly communicated through accounting reports. These
reports provide information that are useful to a variety of users who have an
interest in assessing the financial performance and the position of an enterprise,
planning and controlling business activities and making necessary decisions
from time to time. The accounting information system should be designed in
such a way that the right information is communicated to the right person at
the right time. Reports can be daily, weekly, monthly, or quarterly, depending
upon the needs of the users. An important element in the communication
process is the accountant’s ability and efficiency in presenting the relevant
information.

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 6 Accountancy

1.1.3 Organisation
Organisation refers to a business enterprise, whether for profit or not-for-profit
motive. Depending upon the size of activities and level of business operation,
it can be a sole-proprietory concern, partnership firm, cooperative society,
company, local authority, municipal corporation or any other association of
persons.

1.1.4 Interested Users of Information

Accounting is a means by which necessary financial information about business
enterprise is communicated and is also called the language of business. Many
users need financial information in order to make important decisions. These
users can be divided into two broad categories: internal users and external
users. Internal users include: Chief Executive, Financial Officer, Vice President,
Business Unit Managers, Plant Managers, Store Managers, Line Supervisors,
etc. External users include: present and potential Investors (shareholders),
Creditors (Banks and other Financial Institutions, Debenture-holders and
other Lenders), Tax Authorities, Regulatory Agencies (Department of Company
Affairs, Registrar of Companies, Securities Exchange Board of India, Labour
Unions, Trade Associations, Stock Exchange and Customers, etc. Since the
primary function of accounting is to provide useful information for decision-
making, it is a means to an end, with the end being the decision that is helped
by the availability of accounting information. You will study about the types
of accounting information and its users later in this chapter.

Box 2
Why do the Users Want Accounting Information?

• The owners/shareholders use them to see if they are getting a satisfactory return
on their investment, and to assess the financial health of their company/business.

• The directors/managers use them for making both internal and external
comparisons in their attempts to evaluate the performance. They may compare the
financial analysis of their company with the industry figures in order to ascertain
the company’s strengths and weaknesses. Management is also concerned with
ensuring that the money invested in the company/organisation is generating an

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 Introduction to Accounting 7

adequate return and that the company/organisation is able to pay its debts and
remain solvent.

• The creditors (lenders) want to know if they are likely to get paid and look
particularly at liquidity, which is the ability of the company/organisation to pay
its debts as they become due.

• The prospective investors use them to assess whether or not to invest their money
in the company/organisation.

• The government and regulatory agencies such as Registrar of companies, Custom

departments IRDA, RBI, etc. require information for the payment of various taxes
such as Value Added Tax (VAT), Income Tax (IT), Customs and Excise duties for
protecting the interests of investors, creditors(lenders), and also to satisfy the legal
obligations imposed by The Companies Act 2013 and SEBI from time-to-time.

1.2 Accounting as a Source of Information

As discussed earlier, accounting is a definite processes of interlinked activities,
(refer figure 1.1) that begins with the identification of transactions and ends
with the preparation of financial statements. Every step in the process of
accounting generates information. Generation of information is not an end
in itself. It is a means to facilitate the dissemination of information among
different user groups. Such information enables the interested parties to take
appropriate decisions. Therefore, dissemination of information is an essential
function of accounting. To be useful, the accounting information should
ensure to:
• provide information for making economic decisions;
• serve the users who rely on financial statements as their principal source
of information;
• provide information useful for predicting and evaluating the amount,
timing and uncertainty of potential cash-flows;
• provide information for judging management’s ability to utilise resources
effectively in meeting goals;
• provide factual and interpretative information by disclosing underlying
assumptions on matters subject to interpretation, evaluation, prediction,
or estimation; and
• provide information on activities affecting the society.

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 8 Accountancy

Test Your Understanding - I

Complete the following sentences with appropriate words:

(a) Information in financial reports is based on .....................

(b) Internal users are the ..................... of the business entity.
(c) A ..................... would most likely use an entities financial report to determine
whether or not the business entity is eligible for a loan.
(d) The Internet has assisted in decreasing the ..................... in issuing financial
reports to users.
(e) ..................... users are groups outside the business entity, who uses the
information to make decisions about the business entity.
(f) Information is said to be relevent if it is ......................
(g) The process of accounting starts with ............ and ends with ............
(h) Accounting measures the business transactions in terms of ............ units.
(i) Identified and measured economic events should be recording in ............ order.

The role of an accountant in generating accounting information is to observe,

screen and recognise events and transactions to measure and process them,
and thereby compile reports comprising accounting information that are
communicated to the users. These are then interpreted, decoded and used by
management and other user groups. It must be ensured that the information
provided is relevant, adequate and reliable for decision-making. The apparently
divergent needs of internal and external users of accounting information have
resulted in the development of sub-disciplines within the accounting discipline
namely, financial accounting, cost accounting and management accounting (refer
box 3).
Financial accounting assists keeping a systematic record of financial
transactions the preparation and presentation of financial reports in order
to arrive at a measure of organisational success and financial soundness. It
relates to the past period, serves the stewardship function and is monetary in
nature. It is primarily concerned with the provision of financial information to
all stakeholders.
Cost accounting assists in analysing the expenditure for ascertaining the
cost of various products manufactured or services rendered by the firm and

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 Introduction to Accounting 9

fixation of prices thereof. It also helps in controlling the costs and providing
necessary costing information to management for decision-making.
Management accounting deals with the provision of necessary accounting
information to people within the organisation to enable them in decision-making,
planning and controlling business operations. Management accounting draws
the relevant information mainly from financial accounting and cost accounting
which helps the management in budgeting, assessing profitability, taking pricing
decisions, capital expenditure decisions and so on. Besides, it generates other
information (quantitative and qualitative, financial and non-financial) which
relates to the future and is relevant for decision-making in the organisation.
Such information includes: sales forecast, cash flows, purchase requirement,
manpower needs, environmental data about effects on air, water, land, natural
resources, flora, fauna, human health, social responsibilities, etc.
As a result, the scope of accounting has become so vast, that new areas
like human resource accounting, social accounting, responsibility accounting
have also gained prominance.

Let’s Do It

Many People in today’s society think of an accountant as simply a glorified book-keeper.

But the role of an accountant is continually changing. Discuss in the classroom what
really the role of accounting is?

1.2.1 Qualitative Characteristics of Accounting Information

Qualitative characteristics are the attributes of accounting information which
tend to enhance its understandability and usefulness. In order to assess
whether accounting information is decision useful, it must possess the
characteristics of reliability, relevance, understandability and comparability.

Reliability
Reliability means the users must be able to depend on the information.
The reliability of accounting information is determined by the degree of
correspondence between what the information conveys about the transactions
or events that have occurred, measured and displayed. A reliable information
should be free from error and bias and faithfully represents what it is meant
to represent. To ensure reliability, the information disclosed must be credible,
verifiable by independent parties use the same method of measuring, and be
neutral and faithful (refer figure 1.3).

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 10 Accountancy

Box 3
Branches of Accounting

The economic development and technological advancements have resulted in an

increase in the scale of operations and the advent of the company form of business
organisation. This has made the management function more and more complex and
increased the importance of accounting information. This gave rise to special branches
of accounting. These are briefly explained below :
Financial accounting : The purpose of this branch of accounting is to keep a record
of all financial transactions so that:
(a) the profit earned or loss sustained by the business during an accounting period
can be worked out,
(b) the financial position of the business as at the end of the accounting period
can be ascertained, and
(c) the financial information required by the management and other interested
parties can be provided.
Cost Accounting : The purpose of cost accounting is to analyse the expenditure so as
to ascertain the cost of various products manufactured by the firm and fix the prices.
It also helps in controlling the costs and providing necessary costing information to
management for decision-making.
Management Accounting : The purpose of management accounting is to assist the
management in taking rational policy decisions and to evaluate the impact of its
decisons and actions.

Relevance
To be relevant, information must be available in time, must help in prediction
and feedback, and must influence the decisions of users by :
(a) helping them form prediction about the outcomes of past, present or
future events; and/or
(b) confirming or correcting their past evaluations.

Understandability
Understandability means decision-makers must interpret accounting
information in the same sense as it is prepared and conveyed to them. The
qualities that distinguish between good and bad communication in a message
are fundamental to the understandability of the message. A message is said

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 Introduction to Accounting 11

Qualitative Characteristics of Accounting Information

Decision Makers
(Users of Accounting Information)

Understandability

Decision Usefulness

Relevance Reliability

Timeliness

Dedicative Feedback Verifiability Faithfulness

Value Value

Neutrality

Comparability

Fig. 1.3 : The qualitative characteristics of accounting information

to be effectively communicated when it is interpreted by the receiver of the

message in the same sense in which the sender has sent. Accountants should
present the comparable information in the most intenlligible manner without
sacrificing relevance and reliability.

Comparability
It is not sufficient that the financial information is relevant and reliable at a
particular time, in a particular circumstance or for a particular reporting entity.
But it is equally important that the users of the general purpose financial reports
are able to compare various aspects of an entity over different time period and

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 12 Accountancy

with other entities. To be comparable, accounting reports must belong to a

common period and use common unit of measurement and format of reporting.

Test Your Understanding - II

You are a senior accountant of Ramona Enterprises Limited. What three steps would
you take to make your company’s financial statements understandable and decision
useful?
1. ——————————————————————————————
2. ——————————————————————————————
3. ——————————————————————————————

[Hint : Refer to qualitative characteristics of accounting information]

1.3 Objectives of Accounting

As an information system, the basic objective of accounting is to provide useful
information to the interested group of users, both external and internal. The
necessary information, particularly in case of external users, is provided in
the form of financial statements, viz., profit and loss account and balance
sheet. Besides these, the management is provided with additional information
from time to time from the accounting records of business. Thus, the primary
objectives of accounting include the following:

1.3.1 Maintenance of Records of Business Transactions

Accounting is used for the maintenance of a systematic record of all financial
transactions in book of accounts. Even the most brilliant executive or manager
cannot accurately remember the numerous amount of varied transactions
such as purchases, sales, receipts, payments, etc. that takes place in business
everyday. Hence, a proper and complete records of all business transactions
are kept regularly. Moreover, the recorded information enables verifiability and
acts as an evidence.

1.3.2 Calculation of Profit and Loss

The owners of business are keen to have an idea about the net results of their
business operations periodically, i.e. whether the business has earned profits or
incurred losses. Thus, another objective of accounting is to ascertain the profit

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 Introduction to Accounting 13

earned or loss sustained by a business during an accounting period which can

be easily workout with help of record of incomes and expenses relating to the
business by preparing a profit or loss account for the period. Profit represents
excess of revenue (income), over expenses. If the total revenue of a given period
is ` 6,00,000 and total expenses are ` 5,40,000 the profit will be equal to
` 60,000(` 6,00,000 – ` 5,40,000). If however, the total expenses exceed the
total revenue, the difference reflects the loss.

1.3.3 Depiction of Financial Position

Accounting also aims at ascertaining the financial position of the business
concern in the form of its assets and liabilities at the end of every accounting
period. A proper record of resources owned by business organisation (Assets)
and claims against such resources (Liabilities) facilitates the preparation of a
statement known as balance sheet position statement.
1.3.4 Providing Accounting Information to its Users
The accounting information generated by the accounting process is
communicated in the form of reports, statements, graphs and charts to the
users who need it in different decision situations. As already stated, there are
two main user groups, viz. internal users, mainly management, who needs
timely information on cost of sales, profitability, etc. for planning, controlling
and decision-making and external users who have limited authority, ability and
resources to obtain the necessary information and have to rely on financial
statements (Balance Sheet, Profit and Loss account). Primarily, the external
users are interested in the following:
• Investors and potential investors-information on the risks and return on
investment;
• Unions and employee groups-information on the stability, profitability and
distribution of wealth within the business;
• Lenders and financial institutions-information on the creditworthiness of
the company and its ability to repay loans and pay interest;
• Suppliers and creditors-information on whether amounts owed will be
repaid when due, and on the continued existence of the business;
• Customers-information on the continued existence of the business and
thus the probability of a continued supply of products, parts and after
sales service;

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 14 Accountancy

• Government and other regulators- information on the allocation of

resources and the compliance to regulations;
• Social responsibility groups, such as environmental groups-information
on the impact on environment and its protection;
• Competitors-information on the relative strengths and weaknesses of their
competition and for comparative and benchmarking purposes. Whereas the
above categories of users share in the wealth of the company, competitors
require the information mainly for strategic purposes.

Test Your Understanding - III

Which stakeholder g roup…­ would be most interested in

_____________________________ (a) the VAT and other tax liabilities of the firm­
_____________________________­ (b) the potential for pay awards and bouns deals­
­_____________________________ (c) the ethical or environmental activities of the firm­
­_____________________________ (d) whether the firm has a long-term future­
_____________________________­ (e) profitability and share performance­
_____________________________­ (f) the ability of the firm to carry on providing a
service or producing a product.

1.4 Role of Accounting

For centuries, the role of accounting has been changing with the changes
in economic development and increasing societal demands. It describes and
analyses a mass of data of an enterprise through measurement, classification
and summarisation, and reduces those date into reports and statements,
which show the financial condition and results of operations of that enterprise.
Hence, it is regarded as a language of business. It also performs the service
activity by providing quantitative financial information that helps the users in
various ways. Accounting as an information system collects and communicates
economic information about an enterprise to a wide variety of interested
parties. However, accounting information relates to the past transactions and
is quantitative and financial in nature, it does not provide qualitative and non-
financial information. These limitations of accounting must be kept in view
while making use of the accounting information.

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 Introduction to Accounting 15

Test Your Understanding - IV

Tick the Correct Answer

1. Which of the following is not a business transaction?
a. Bought furniture of `10,000 for business
b. Paid for salaries of employees ` 5,000
c. Paid sons fees from her personal bank account ` 20,000
d. Paid sons fees from the business ` 2,000
2. Deepti wants to buy a building for her business today. Which of the following is the
relevant data for his decision?
a. Similar business acquired the required building in 2000 for ` 10,00,000
b. Building cost details of 2003
c. Building cost details of 1998
d. Similar building cost in August, 2005 ` 25,00,000
3. Which is the last step of accounting as a process of information?
a. Recording of data in the books of accounts
b. Preparation of summaries in the form of financial statements
c. Communication of information
d. Analysis and interpretation of information
4. Which qualitative characteristics of accounting information is reflected when
accounting information is clearly presented?
a. Understandability
b. Relevance
c. Comparability
d. Reliability
5. Use of common unit of measurement and common format of reporting promotes;
a. Comparability
b. Understandability
c. Relevance
d. Reliability

Box 4
Different Roles of Accounting

 As a language – it is perceived as the language of business which is used to

communicate information on enterprises;
 As a historical record- it is viewed as chronological record of financial transactions
of an organisation at actual amounts involved;
 As current economic reality- it is viewed as the means of determining the true income
of an entity namely the change of wealth over time;

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 16 Accountancy

 As an information system – it is viewed as a process that links an information source

(the accountant) to a set of receivers (external users) by means of a channel of
communication;
 As a commodity- specialised information is viewed as a service which is in demand
in society, with accountants being willing to and capable of providing it.

1.5 Basic Terms in Accounting

1.5.1 Entity
Entity means a reality that has a definite individual existence. Business entity
means a specifically identifiable business enterprise like Super Bazaar, Hire
Jewellers, ITC Limited, etc. An accounting system is always devised for a specific
business entity (also called accounting entity).

1.5.2 Transaction
An event involving some value between two or more entities. It can be a purchase
of goods, receipt of money, payment to a creditor, incurring expenses, etc. It
can be a cash transaction or a credit transaction.

1.5.3 Assets
Assets are economic resources of an enterprise that can be usefully expressed
in monetary terms. Assets are items of value used by the business in its
operations. For example, Super Bazar owns a fleet of trucks, which is used
by it for delivering foodstuffs; the trucks, thus, provide economic benefit to
the enterprise. This item will be shown on the asset side of the balance sheet
of Super Bazaar. Assets can be broadly classified into two types: current and
Non-current (Figure 1.4).

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 Introduction to Accounting 17

Figure 1.4 : Classification of Assets

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 18 Accountancy

1.5.4 Liabilities

Liabilities are obligations or debts that an enterprise has to pay at some time
in the future. They represent creditors’ claims on the firm’s assets. Both small
and big businesses find it necessary to borrow money at one time or the other,
and to purchase goods on credit. Super Bazar, for example, purchases goods for
` 10,000 on credit for a month from Fast Food Products on March 25, 2005.
If the balance sheet of Super Bazaar is prepared as at March 31, 2005, Fast
Food Products will be shown as creditors on the liabilities side of the balance
sheet. If Super Bazaar takes a loan for a period of three years from Delhi State
Co-operative Bank, this will also be shown as a liability in the balance sheet of
Super Bazaar. Liabilities are classified as current and non-current (Figure 1.5).

Liabilities

Non-Current Current
Liabilities Liabilities

Deferred Tax Other Long Long Terms Short Term Trade Short Term
Long Term Term Other Current
Liabilities Provisions Borrowings Payables Provisions
Borrowings Liabilities Liabilities
(Net)

Figure 1.5 : Classification of Liabilities

Box 5

Distinction between current and non-current items:

1. Current assets or liabilities are involved in operating cycle.
2. Current assets or liabilities are realised/settled within 12 months.
3. Current items are primarily for trading.
4. Current items are cash or cash equivalent.

1.5.5 Capital
Amount invested by the owner in the firm is known as capital. It may be brought
in the form of cash or assets by the owner for the business entity capital is
an obligation and a claim on the assets of business. It is, therefore, shown as
capital on the liabilities side of the balance sheet.

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 Introduction to Accounting 19

1.5.6 Sales
Sales are total revenues from goods or services sold or provided to customers.
Sales may be cash sales or credit sales.

1.5.7 Revenues
These are the amounts of the business earned by selling its products or
providing services to customers, called sales revenue. Other items of revenue
common to many businesses are: commission, interest, dividends, royalities,
rent received, etc. Revenue is also called income.

1.5.8 Expenses
Costs incurred by a business in the process of earning revenue are known as
expenses. Generally, expenses are measured by the cost of assets consumed
or services used during an accounting period. The usual items of expenses are:
depreciation, rent, wages, salaries, interest, cost of heater, light and water,
telephone, etc.

1.5.9 Expenditure
Spending money or incurring a liability for some benefit, service or property
received is called expenditure. Purchase of goods, purchase of machinery,
purchase of furniture, etc. are examples of expenditure. If the benefit of
expenditure is exhausted within a year, it is treated as an expense (also called
revenue expenditure). On the other hand, the benefit of an expenditure lasts
for more than a year, it is treated as an asset (also called capital expenditure)
such as purchase of machinery, furniture, etc.

1.5.10 Profit
The excess of revenues of a period over its related expenses during an accounting
year is profit. Profit increases the investment of the owners.

1.5.11 Gain
A profit that arises from events or transactions which are incidental to business
such as sale of fixed assets, winning a court case, appreciation in the value of
an asset.

1.5.12 Loss
The excess of expenses of a period over its related revenues its termed as loss.
It decreases in owner’s equity. It also refers to money or money’s worth lost

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 20 Accountancy

(or cost incurred) without receiving any benefit in return, e.g., cash or goods
lost by theft or a fire accident, etc. It also includes loss on sale of fixed assets.

1.5.13 Discount
Discount is the deduction in the price of the goods sold. It is offered in two
ways. Offering deduction of agreed percentage of list price at the time selling
goods is one way of giving discount. Such discount is called ‘trade discount’.
It is generally offered by manufactures to wholesellers and by wholesellers
to retailers. After selling the goods on credit basis the debtors may be given
certain deduction in amount due in case if they pay the amount within the
stipulated period or earlier. This deduction is given at the time of payment on
the amount payable. Hence, it is called as cash discount. Cash discount acts
as an incentive that encourages prompt payment by the debtors.

1.5.14 Voucher
The documentary evidence in support of a transaction is known as voucher.
For example, if we buy goods for cash, we get cash memo, if we buy on credit,
we get an invoice; when we make a payment we get a receipt and so on.

1.5.15 Goods
It refers to the products in which the business unit is dealing, i.e. in terms of
which it is buying and selling or producting and selling. The items that are
purchased for use in the business are not called goods. For example, for a
furniture dealer purchase of chairs and tables is termed as goods, while for
other it is furniture and is treated as an asset. Similarly, for a stationery merchant,
stationery is goods, whereas for others it is an item of expense (not purchases)

1.5.16 Drawings
Withdrawal of money and/or goods by the owner from the business for personal
use is known as drawings. Drawings reduces the investment of the owners.

1.5.17 Purchases
Purchases are total amount of goods procured by a business on credit and on
cash, for use or sale. In a trading concern, purchases are made of merchandise
for resale with or without processing. In a manufacturing concern, raw materials
are purchased, processed further into finished goods and then sold. Purchases
may be cash purchases or credit purchases.

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 Introduction to Accounting 21

1.5.18 Stock
Stock (inventory) is a measure of something on hand-goods, spares and other
items in a business. It is called Stock in hand. In a trading concern, the stock
on hand is the amount of goods which are lying unsold as at the end of an
accounting period is called closing stock (ending inventory). In a manufacturing
company, closing stock comprises raw materials, semi-finished goods and
finished goods on hand on the closing date. Similarly, opening stock (beginning
inventory) is the amount of stock at the beginning of the accounting period.

1.5.19 Debtors
Debtors are persons and/or other entities who owe to an enterprise an amount
for buying goods and services on credit. The total amount standing against such
persons and/or entities on the closing date, is shown in the balance sheet as
sundry debtors on the asset side.

1.5.20 Creditors
Creditors are persons and/or other entities who have to be paid by an enterprise
an amount for providing the enterprise goods and services on credit. The total
amount standing to the favour of such persons and/or entities on the closing
date, is shown in the Balance Sheet as sundry creditors on the liabilities side.

Test Your Understanding - V

Mr. Sunrise started a business for buying and selling of stationery with ` 5,00,000 as
an initial investment. Of which he paid `1,00,000 for furniture, ` 2,00,000 for buying
stationery items. He employed a sales person and clerk. At the end of the month he
paid ` 5,000 as their salaries. Out of the stationery bought he sold some stationery for
`1,50,000 for cash and some other stationery for `1,00,000 on credit basis to Mr.Ravi.
Subsequently, he bought stationery items of `1,50,000 from Mr. Peace. In the first
week of next month there was a fire accident and he lost ` 30,000 worth of stationery.
A part of the machinery, which cost ` 40,000, was sold for ` 45,000.
From the above, answer the following :
1. What is the amount of capital with which Mr. Sunrise started business.
2. What are the fixed assets he bought?
3. What is the value of the goods purchased?
4. Who is the creditor and state the amount payable to him?
5. What are the expenses?
6. What is the gain he earned?

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 22 Accountancy

7. What is the loss he incurred?

8. Who is the debtor? What is the amount receivable from him?
9. What is the total amount of expenses and losses incurred?
10. Determine if the following are assets, liabilities, revenues, expenses or none of the
these: sales, debtors, creditors, salary to manager, discount to debtors, drawings
by the owner.

Summary with Reference to Learning Objectives

1. Meaning of Accounting : Accounting is a process of identifying, measuring, recording

the business transactions and communicating thereof the required information to the
interested users.
2. Accounting as a source of information : Accounting as a source of information system
is the process of identifying, measuring, recording and communicating the economic
events of an organisation to interested users of the information.
3. Users of accounting information : Accounting plays a significant role in society by
providing information to management at all levels and to those having a direct financial
interest in the enterprise, such as present and potential investors and creditors.
Accounting information is also important to those having indirect financial interest, such
as regulatory agencies, tax authorities, customers, labour unions, trade associations,
stock exchanges and others.
4. Qualitative characteristics of Accounting : To make accounting information decision
useful, it should possess the following qualitative characteristics.
• Reliability • Understandability
• Relevance • Comparability
5. Objective of accounting : The primary objectives of accounting are to :
• maintain records of business;
• calculate profit or loss;
• depict the financial position; and
• make information available to various groups and users.
6. Role of accounting : Accounting is not an end in itself. It is a means to an end. It plays
the role of a :
• Language of a business
• Historical record
• Current economic reality
• Information system
• Service to users

Questions for Practice

Short Answers
1. Define accounting.
2. State the end product of financial accounting.
3. Enumerate main objectives of accounting.

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 Introduction to Accounting 23

4. Who are the users of accounting information.

5. State the nature of accounting information required by long-term lenders.
6. Who are the external users of information?
7. Enumerate information needs of management.
8. Give any three examples of revenues.
9. Distinguish between debtors and creditors; profit and gain
10. ‘Accounting information should be comparable’. Do you agree with this statement.
Give two reasons.
11. If the accounting information is not clearly presented, which of the qualitative
characteristic of the accounting information is violated?
12. “The role of accounting has changed over the period of time”- Do you agree? Explain.
13. Giving examples, explain each of the following accounting terms :
• Fixed assets • Revenue • Expenses
• Short-term liability • Capital
14. Define revenues and expenses?
15. What is the primiary reason for the business students and others to familiarise
themselves with the accounting discipline?
Long Answers
1. What is accounting? Define its objectives.
2. Explain the factors which necessitated systematic accounting.
3. Describe the informational needs of external users.
4. What do you mean by an asset and what are different types of assets?
5. Explain the meaning of gain and profit. Distinguish between these two terms.
6. Explain the qualitative characteristics of accounting information.
7. Describe the role of accounting in the modern world.

Checklist to Test Your Understanding

Test Your Understanding – I
(a) Economic Transactions (b) Management/Employees (c) Creditor
(d) Time-gap (e) External (f) Free from bias
(g) Identifying the transactions and communicating information
(h) Monetary (i) Chronological
Test Your Understanding - II
1. Reliability, i.e. Verifiability, Faithfulness, Nutrality
2. Relevance, i.e. Timeliness
3. Understandability and Comparibility
Test Your Understanding - III
(a) Government and other regulators
(b) Management
(c) Social responsibility groups
(d) Lenders

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 24 Accountancy

(e) Suppliers and Creditors

(f) Customers
Test Your Understanding - IV
1. (c) 2. (a) 3. (c) 4. (a) 5. (a)
Test Your Understanding - V
1. ` 5,00,000 2. ` 1,00,000, 3. ` 2,00,000
4. Mr. Reace, ` 1,50,000 5. ` 5,000 6. ` 5,000
7. ` 30,000 8. Mr. Ravi, ` 1,00,000 9. ` 35,000
10. Assets : debtors; Liabilities : creditors; drawings; Revenues : sales expenses,
discount, salary.

Activity 1 : Tick () the appropriate one:

Items Curren Non-Current Current Non-Current
Assets Assets Liabilities Liabilities
Machinery
Sundry Creditors
Cash at Bank
Goodwill
Bills Payable
Land & Building
Furniture
Computer Software
Motor Vehicles
Inventory
Investments
Loan from Bank
Sundry Debtors
Patents
Air-Conditioners
Loose tools

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 Theory Base of Accounting 25

Theory Base of Accounting 2

A s discussed in the previous chapter, accounting

is concerned with the recording, classifying
and summaris­ing of financial transactions and
events and interpreting the results thereof. It
aims at providing information about the financial
performance of a firm to its various users such as
owners, managers employees, investors, creditors,
suppliers of goods and services and tax authorities
and help them in taking important decisions. The
Learning Objectives investors, for example, may be interested in knowing
After studying this chapter,
the extent of profit or loss earned by the firm during
you will be able to: a given period and compare it with the performance
• identify the need for of other similar enterprises. The suppliers of credit,
theory base of acco- say a banker, may, in addition, be interested in
unting; liquidity position of the enterprise. All these people
• explain the nature of look forward to accounting for appropriate, useful
Generally Accepted and reliable information.
Accounting Principles For making the accounting information
(GAAP); meaningful to its internal and external users, it is
• state the meaning and important that such information is reliable as well
purpose of the basic as comparable. The comparability of information
accounting concepts;
is required both to make inter-firm comparisons,
• l i s t the accounting
i.e. to see how a firm has performed as compared
standards issued by
Institute of Chartered to the other firms, as well as to make inter-period
Accountants of India; comparison, i.e. how it has performed as compared
• describe the systems of to the previous years. This becomes possible
accounting; and only if the information provided by the financial
• describe the basis of statements is based on consistent accounting
accounting. policies, principles and practices. Such consistency
is required throughout the process of identifying the

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 26 Accountancy

events and transactions to be accounted for, measuring them, communicating

them in the book of accounts, summarising the results thereof and reporting
them to the interested parties. This calls for developing a proper theory base
of accounting.
The importance of accounting theory need not be over-emphasised as no
discipline can develop without a sound theoretical base. The theory base of
accounting consists of principles, concepts, rules and guidelines developed over
a period of time to bring uniformity and consistency to the process of accounting
and enhance its utility to different users of accounting information. Apart from
these, the Institute of Chartered Accountants of India, (ICAI), which is the
regulatory body for standardisation of accounting policies in the country has
issued Accounting Standards which are expected to be uniformly adhered to,
in order to bring consistency in the accounting practices. These are discussed
in the sections to follow.

2.1 Generally Accepted Accounting Principles

In order to maintain uniformity and consistency in accounting records, certain
rules or principles have been developed which are generally accepted by the
accounting profession. These rules are called by different names such as
principles, concepts, conventions, postulates, assumptions and modifying
principles.
The term ‘principle’ has been defined by AICPA as ‘A general law or rule
adopted or professed as a guide to action, a settled ground or basis of conduct
or practice’. The word ‘generally’ means ‘in a general manner’, i.e., pertaining
to many persons or cases or occasions. Thus, Generally Accepted Accounting
Principles (GAAP) refers to the rules or guidelines adopted for recording
and reporting of business transactions, in order to bring uniformity in the
preparation and the presentation of financial statements. For example, one of
the important rule is to record all transactions on the basis of historical cost,
which is verifiable from the documents such as cash receipt for the money paid.
This brings in objectivity in the process of recording and makes the accounting
statements more acceptable to various users.
The Generally Accepted Accounting Principles have evolved over a long
period of time on the basis of past experiences, usages or customs, statements
by individuals and professional bodies and regulations by government agencies
and have general acceptability among most accounting professionals. However,
the principles of accounting are not static in nature. These are constantly
influenced by changes in the legal, social and economic environment as well
as the needs of the users.
These principles are also referred as concepts and conventions. The term
concept refers to the necessary assumptions and ideas which are fundamental

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 Theory Base of Accounting 27

to accounting practice, and the term convention connotes customs or traditions

as a guide to the preparation of accounting statements. In practice, the same
rules or guidelines have been described by one author as a concept, by another
as a postulate and still by another as convention. This at times becomes
confusing to the learners. Instead of going into the semantics of these terms,
it is important to concentrate on the practicability of their usage. From the
practicability view point, it is observed that the various terms such as principles,
postulates, conventions, modifying principles, assumptions, etc. have been
used inter-changeably and are referred to as Basic Accounting Concepts in the
present chapter.

2.2 Basic Accounting Concepts

The basic accounting concepts are referred to as the fundamental ideas or
basic assumptions underlying the theory and practice of financial accounting
and are broad working rules for all accounting activities and developed by the
accounting profession. The important concepts have been listed as below:

• Business entity; • Matching;

• Money measurement; • Full disclosure;
• Going concern; • Consistency;
• Accounting period; • Conservatism (Prudence);
• Cost • Materiality;
• Dual aspect (or Duality); • Objectivity.
• Revenue recognition (Realisation);

2.2.1 Business Entity Concept

The concept of business entity assumes that business has a distinct and
separate entity from its owners. It means that for the purposes of accounting,
the business and its owners are to be treated as two separate entities. Keeping
this in view, when a person brings in some money as capital into his business,
in accounting records, it is treated as liability of the business to the owner. Here,
one separate entity (owner) is assumed to be giving money to another distinct
entity (business unit). Similarly, when the owner withdraws any money from the
business for his personal expenses(drawings), it is treated as reduction of the
owner’s capital and consequently a reduction in the liabilities of the business.
The accounting records are made in the book of accounts from the point of view
of the business unit and not that of the owner. The personal assets and liabilities
of the owner are, therefore, not considered while recording and reporting the
assets and liabilities of the business. Similarly, personal transactions of the
owner are not recorded in the books of the business, unless it involves inflow
or outflow of business funds.

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2.2.2 Money Measurement Concept

The concept of money measurement states that only those transactions and
happenings in an organisation which can be expressed in terms of money
such as sale of goods or payment of expenses or receipt of income, etc., are
to be recorded in the book of accounts. All such transactions or happenings
which can not be expressed in monetary terms, for example, the appointment
of a manager, capabilities of its human resources or creativity of its research
department or image of the organisation among people in general do not find
a place in the accounting records of a firm.
Another important aspect of the concept of money measurement is that the
records of the transactions are to be kept not in the physical units but in the
monetary unit. For example, an organisation may, on a particular day, have
a factory on a piece of land measuring 2 acres, office building containing 10
rooms, 30 personal computers, 30 office chairs and tables, a bank balance of
`5 lakh, raw material weighing 20-tons, and 100 cartons of finished goods.
These assets are expressed in different units, so can not be added to give any
meaningful information about the total worth of business. For accounting
purposes, therefore, these are shown in money terms and recorded in rupees
and paise. In this case, the cost of factory land may be say ` 2 crore; office
building ` 1 crore; computers `15 lakh; office chairs and tables ` 2 lakh; raw
material ` 33 lakh and finished goods ` 4 lakh. Thus, the total assets of the
enterprise are valued at ` 3 crore and 59 lakh. Similarly, all transactions are
recorded in rupees and paise as and when they take place.
The money measurement assumption is not free from limitations. Due to the
changes in prices, the value of money does not remain the same over a period
of time. The value of rupee today on account of rise in prices is much less than
what it was, say ten years back. Therefore, in the balance sheet, when we add
different assets bought at different points of time, say building purchased in
1995 for ` 2 crore, and plant purchased in 2005 for ` 1 crore, we are in fact
adding heterogeneous values, which can not be clubbed together. As the change
in the value of money is not reflected in the book of accounts, the accounting
data does not reflect the true and fair view of the affairs of an enterprise.

2.2.3 Going Concern Concept

The concept of going concern assumes that a business firm would continue to
carry out its operations indefinitely, i.e. for a fairly long period of time and would
not be liquidated in the foreseeable future. This is an important assumption
of accounting as it provides the very basis for showing the value of assets in
the balance sheet.

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 Theory Base of Accounting 29

An asset may be defined as a bundle of services. When we purchase an asset,

for example, a personal computer, for a sum of ` 50,000, what we are buying
really is the services of the computer that we shall be getting over its estimated
life span, say 5 years. It will not be fair to charge the whole amount of ` 50,000,
from the revenue of the year in which the asset is purchased. Instead, that
part of the asset which has been consumed or used during a period should be
charged from the revenue of that period. The assumption regarding continuity
of business allows us to charge from the revenues of a period only that part of
the asset which has been consumed or used to earn that revenue in that period
and carry forward the remaining amount to the next years, over the estimated
life of the asset. Thus, we may charge ` 10,000 every year for 5 years from the
profit and loss account. In case the continuity assumption is not there, the
whole cost (` 50,000 in the present example) will need to be charged from the
revenue of the year in which the asset was purchased.
2.2.4 Accounting Period Concept
Accounting period refers to the span of time at the end of which the financial
statements of an enterprise are prepared, to know whether it has earned profits
or incurred losses during that period and what exactly is the position of its assets
and liabilities at the end of that period. Such information is required by different
users at regular interval for various purposes, as no firm can wait for long to know
its financial results as various decisions are to be taken at regular intervals on
the basis of such information. The financial statements are, therefore, prepared
at regular interval, normally after a period of one year, so that timely information
is made available to the users. This interval of time is called accounting period.
The Companies Act 2013 and the Income Tax Act require that the income
statements should be prepared annually. However, in case of certain situations,
preparation of interim financial statements become necessary. For example, at
the time of retirement of a partner, the accounting period can be different from
twelve months period. Apart from these companies whose shares are listed on
the stock exchange, are required to publish quarterly results to ascertain the
profitability and financial position at the end of every three months period.

Test Your Understanding - I

Choose the Correct Answer

1. During the life-time of an entity accounting produce financial statements in
accordance with which basic accounting concept:
(a) Conservation
(b) Matching
(c) Accounting period
(d) None of the above

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2. When information about two different enterprises have been prepared presented in
a similar manner the information exhibits the characteristic of:
(a) Verifiability
(b) Relevance
(c) Reliability
(d) None of the above
3. A concept that a business enterprise will not be sold or liquidated in the near future
is known as :
(a) Going concern
(b) Economic entity
(c) Monetary unit
(d) None of the above
4. The primary qualities that make accounting information useful for decision-making
are :
(a) Relevance and freedom from bias
(b) Reliability and comparability
(c) Comparability and consistency
(d) None of the above

2.2.5 Cost Concept

The cost concept requires that all assets are recorded in the book of accounts
at their purchase price, which includes cost of acquisition, transportation,
installation and making the asset ready to use. To illustrate, on June 2005,
an old plant was purchased for ` 50 lakh by Shiva Enterprise, which
is into the business of manufacturing detergent powder. An amount of
` 10,000 was spent on transporting the plant to the factory site. In addition,
` 15,000 was spent on repairs for bringing the plant into running position
and ` 25,000 on its installation. The total amount at which the plant will
be recorded in the books of account would be the sum of all these, i.e.
` 50,50,000.
The concept of cost is historical in nature as it is something, which has
been paid on the date of acquisition and does not change year after year.
For example, if a building has been purchased by a firm for ` 2.5 crore, the
purchase price will remain the same for all years to come, though its market
value may change. Adoption of historical cost brings in objectivity in recording
as the cost of acquisition is easily verifiable from the purchase documents. The
market value basis, on the other hand, is not reliable as the value of an asset
may change from time to time, making the comparisons between one period
to another rather difficult.
However, an important limitation of the historical cost basis is that it does
not show the true worth of the business and may lead to hidden profits. During
the period of rising prices, the market value or the cost at (which the assets can

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be replaced are higher than the value at which these are shown in the book of
accounts) leading to hidden profits.

2.2.6 Dual Aspect Concept

Dual aspect is the foundation or basic principle of accounting. It provides the
very basis for recording business transactions into the book of accounts. This
concept states that every transaction has a dual or two-fold effect and should
therefore be recorded at two places. In other words, at least two accounts will
be involved in recording a transaction. This can be explained with the help of
an example. Ram started business by investing in a sum of ` 50,00,000. The
amount of money brought in by Ram will result in an increase in the assets
(cash) of business by ` 50,00,000. At the same time, the owner’s equity or capital
will also increase by an equal amount. It may be seen that the two items that
got affected by this transaction are cash and capital account.
Let us take another example to understand this point further. Suppose the
firm purchase goods worth ` 10,00,000 on cash. This will increase an asset
(stock of goods) on the one hand and reduce another asset (cash) on the other.
Similarly, if the firm purchases a machine worth ` 30,00,000 on credit from
Reliable Industries. This will increase an asset (machinery) on the one hand
and a liability (creditor) on the other. This type of dual effect takes place in case
of all business transactions and is also known as duality principle.
The duality principle is commonly expressed in terms of fundamental
Accounting Equation, which is as follows :

Assets = Liabilities + Capital

In other words, the equation states that the assets of a business are
always equal to the claims of owners and the outsiders. The claims also called
equity of owners is termed as Capital(owners’ equity) and that of outsiders, as
Liabilities(creditors equity). The two-fold effect of each transaction affects in
such a manner that the equality of both sides of equation is maintained.
The two-fold effect in respect of all transactions must be duly recorded
in the book of accounts of the business. In fact, this concept forms the core
of Double Entry System of accounting, which has been dealt in detail, in
chapter 3.
2.2.7 Revenue Recognition (Realisation) Concept
The concept of revenue recognition requires that the revenue for a business
transaction should be included in the accounting records only when it is
realised. Here arises two questions in mind. First, is termed as revenue and
the other, when the revenue is realised. Let us take the first one first. Revenue
is the gross inflow of cash arising from (i) the sale of goods and services by an

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enterprise; and (ii) use by others of the enterprise’s resources yielding interest,
royalties and dividends. Secondly, revenue is assumed to be realised when a
legal right to receive it arises, i.e. the point of time when goods have been sold
or service has been rendered. Thus, credit sales are treated as revenue on the
day sales are made and not when money is received from the buyer. As for
the income such as rent, commission, interest, etc. these are recongnised on
a time basis. For example, rent for the month of March 2017, even if received
in April 2017, will be taken into the profit and loss account of the financial
year ending March 31, 2017 and not into financial year beginning with April
2017. Similarly, if interest for April 2017 is received in advance in March
2017, it will be taken to the profit and loss account of the financial year ending
March 2018.
There are some exceptions to this general rule of revenue recognition. In
case of contracts like construction work, which take long time, say 2-3 years
to complete, proportionate amount of revenue, based on the part of contract
completed by the end of the period is treated as realised. Similarly, when goods
are sold on hire purchase, the amount collected in installments is treated as
realised.

2.2.8 Matching Concept

The process of ascertaining the amount of profit earned or the loss incurred
during a particular period involves deduction of related expenses from the
revenue earned during that period. The matching concept emphasises exactly
on this aspect. It states that expenses incurred in an accounting period should
be matched with revenues during that period. It follows from this that the
revenue and expenses incurred to earn these revenues must belong to the
same accounting period.
As already stated, revenue is recognised when a sale is complete or service
is rendered rather when cash is received. Similarly, an expense is recognised
not when cash is paid but when an asset or service has been used to generate
revenue. For example, expenses such as salaries, rent, insurance are recognised
on the basis of period to which they relate and not when these are paid.
Similarly, costs like depreciation of fixed asset is divided over the periods during
which the asset is used.
Let us also understand how cost of goods are matched with their sales
revenue. While ascertaining the profit or loss of an accounting year, we should
not take the cost of all the goods produced or purchased during that period
but consider only the cost of goods that have been sold during that year. For
this purpose, the cost of unsold goods should be deducted from the cost of the

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goods produced or purchased. You will learn about this aspect in detail in the
chapter on financial statement.
The matching concept, thus, implies that all revenues earned during
an accounting year, whether received during that year, or not and all costs
incurred, whether paid during the year, or not should be taken into account
while ascertaining profit or loss for that year.
2.2.9 Full Disclosure Concept
Information provided by financial statements are used by different groups
of people such as investors, lenders, suppliers and others in taking various
financial decisions. In the corporate form of organisation, there is a distinction
between those managing the affairs of the enterprise and those owning it.
Financial statements, however, are the only or basic means of communicating
financial information to all interested parties. It becomes all the more important,
therefore, that the financial statements makes a full, fair and adequate
disclosure of all information which is relevant for taking financial decisions.
The principle of full disclosure requires that all material and relevant facts
concerning financial performance of an enterprise must be fully and completely
disclosed in the financial statements and their accompanying footnotes. This
is to enable the users to make correct assessment about the profitability and
financial soundness of the enterprise and help them to take informed decisions.
To ensure proper disclosure of material accounting information, the Indian
Companies Act 1956 has provided a format for the preparation of profit and
loss account and balance sheet of a company, which needs to be compulsorily
adhered to, for the preparation of these statements. The regulatory bodies like
SEBI, also mandates complete disclosures to be made by the companies, to
give a true and fair view of profitability and the state of affairs.

2.2.10 Consistency Concept

The accounting information provided by the financial statements would be
useful in drawing conclusions regarding the working of an enterprise only when
it allows comparisons over a period of time as well as with the working of other
enterprises. Thus, both inter-firm and inter-period comparisons are required
to be made. This can be possible only when accounting policies and practices
followed by enterprises are uniform and are consistent over the period of time.
To illustrate, an investor wants to know the financial performance of an
enterprise in the current year as compared to that in the previous year. He may
compare this year’s net profit with that in the last year. But, if the accounting
policies adopted, say with respect to depreciation in the two years are different,
the profit figures will not be comparable. Because the method adopted for the

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valuation of stock in the past two years is inconsistent. It is, therefore, important
that the concept of consistency is followed in preparation of financial statements
so that the results of two accounting periods are comparable. Consistency
eliminates personal bias and helps in achieving results that are comparable.
Also the comparison between the financial results of two enterprises would
be meaningful only if same kind of accounting methods and policies are adopted
in the preparation of financial statements.
However, consistency does not prohibit change in accounting policies.
Necessary required changes are fully disclosed by presenting them in the
financial statements indicating their probable effects on the financial results
of business.

2.2.11 Conservatism Concept

The concept of conservatism (also called ‘prudence’) provides guidance for
recording transactions in the book of accounts and is based on the policy of
playing safe. The concept states that a conscious approach should be adopted
in ascertaining income so that profits of the enterprise are not overstated. If
the profits ascertained are more than the actual, it may lead to distribution of
dividend out of capital, which is not fair as it will lead to reduction in the capital
of the enterprise.
The concept of conservatism requires that profits should not to be recorded
until realised but all losses, even those which may have a remote possibility, are
to be provided for in the books of account. To illustrate, valuing closing stock at
cost or market value whichever is lower; creating provision for doubtful debts,
discount on debtors; writing of intangible assets like goodwill, patents, etc. from
the book of accounts are some of the examples of the application of the principle
of conservatism. Thus, if market value of the goods purchased has fallen down,
the stock will be shown at cost price in the books but if the market value has
gone up, the gain is not to be recorded until the stock is sold. This approach
of providing for the losses but not recognising the gains until realised is called
conservatism approach. This may be reflecting a generally pessimist attitude
adopted by the accountants but is an important way of dealing with uncertainty
and protecting the interests of creditors against an unwanted distribution of
firm’s assets. However, deliberate attempt to underestimate the value of assets
should be discouraged as it will lead to hidden profits, called secret reserves.

2.2.12  Materiality Concept

The concept of materiality requires that accounting should focus on material
facts. Efforts should not be wasted in recording and presenting facts, which
are immaterial in the determination of income. The question that arises here is
what is a material fact. The materiality of a fact depends on its nature and the

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amount involved. Any fact would be considered as material if it is reasonably

believed that its knowledge would influence the decision of informed user
of financial statements. For example, money spent on creation of additional
capacity of a theatre would be a material fact as it is going to increase the
future earning capacity of the enterprise. Similarly, information about any
change in the method of depreciation adopted or any liability which is likely to
arise in the near future would be significant information. All such information
about material facts should be disclosed through the financial statements and
the accompanying notes so that users can take informed decisions. In certain
cases, when the amount involved is very small, strict adherence to accounting
principles is not required. For example, stock of erasers, pencils, scales, etc. are
not shown as assets, whatever amount of stationery is bought in an accounting
period is treated as the expense of that period, whether consumed or not. The
amount spent is treated as revenue expenditure and taken to the profit and
loss account of the year in which the expenditure is incurred.

2.2.13 Objectivity Concept

The concept of objectivity requires that accounting transaction should be
recorded in an objective manner, free from the bias of accountants and others.
This can be possible when each of the transaction is supported by verifiable
documents or vouchers. For example, the transaction for the purchase of
materials may be supported by the cash receipt for the money paid, if the
same is purchased on cash or copy of invoice and delivery challan, if the same
is purchased on credit. Similarly, receipt for the amount paid for purchase of
a machine becomes the documentary evidence for the cost of machine and
provides an objective basis for verifying this transaction. One of the reasons
for the adoption of ‘Historical Cost’ as the basis of recording accounting
transaction is that adherence to the principle of objectivity is made possible
by it. As stated above, the cost actually paid for an asset can be verified from
the documents but it is very difficult to ascertain the market value of an asset
until it is actually sold. Not only that, the market value may vary from person
to person and from place to place, and so ‘objectivity’ cannot be maintained if
such value is adopted for accounting purposes.

Test Your Understanding - II

Fill in the correct word:

1. Recognition of expenses in the same period as associated revenues is called
_______________concept.
2. The accounting concept that refers to the tendency of accountants to resolve
uncertainty and doubt in favour of understating assets and revenues and
overstating liabilities and expenses is known as _______________.

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 36 Accountancy

3. Revenue is generally recongnised at the point of sale denotes the concept

of _______________.
4. The _______________concept requires that the same accounting method should be
used from one accounting period to the next.
5. The_______________concept requires that accounting transaction should be free
from the bias of accountants and others.

2.3 Systems of Accounting

The systems of recording transactions in the book of accounts are generally
classified into two types, viz. Double entry system and Single entry system.
Double entry system is based on the principle of “Dual Aspect” which states
that every transaction has two effects, viz. receiving of a benefit and giving of
a benefit. Each transaction, therefore, involves two or more accounts and is
recorded at different places in the ledger. The basic principle followed is that
every debit must have a corresponding credit. Thus, one account is debited
and the other is credited.
Double entry system is a complete system as both the aspects of a
transaction are recorded in the book of accounts. The system is accurate and
more reliable as the possibilities of frauds and mis-appropriations are
minimised. The arithmetic inaccuracies in records can mostly be checked by
preparing the trial balance. The system of double entry can be implemented
by big as well as small organisations.
Single entry system is not a complete system of maintaining records of
financial transactions. It does not record two-fold effect of each and every
transaction. Instead of maintaining all the accounts, only personal accounts and
cash book are maintained under this system. In fact, this is not a system but a
lack of system as no uniformity is maintained in the recording of transactions.
For some transactions, only one aspect is recorded, for others, both the aspects
are recorded. The accounts maintained under this system are incomplete and
unsystematic and therefore, not reliable. The system is, however, followed by
small business firms as it is very simple and flexible (you will study about them
in detail later in this book).

2.4 Basis of Accounting

From the point of view the timing of recognition of revenue and costs, there
can be two broad approaches to accounting. These are:
(i) Cash basis; and
(ii) Accrual basis.
Under the cash basis, entries in the book of accounts are made when cash is
received or paid and not when the receipt or payment becomes due. Let us say,

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for example, if office rent for the month of December 2014, is paid in January
2015, it would be recorded in the book of account only in January 2015.
Similarly sale of goods on credit in the month of January 2015 would not
be recorded in January but say in April, when the payment for the same is
received. Thus this system is incompatible with the matching principle, which
states that the revenue of a period is matched with the cost of the same period.
Though simple, this method is inappropriate for most organisations as profit
is calculated as a difference between the receipts and disbursement of money
for the given period rather than on happening of the transactions.
Under the accrual basis, however, revenues and costs are recognised in the
period in which they occur rather when they are paid. A distinction is made
between the receipt of cash and the right to receive cash and payment of cash
and legal obligation to pay cash. Thus, under this system, the monitory effect
of a transaction is taken into account in the period in which they are earned
rather than in the period in which cash is actually received or paid by the
enterprise. This is a more appropriate basis for the calculation of profits as
expenses are matched against revenue earned in relation thereto. For example,
raw material consumed are matched against the cost of goods sold.

2.5 Accounting Standards

Accounting standards are written policy documents covering the aspects of
recognition, measurement, treatment, presentation and disclosure of accounting
transactions in financial statements. Accounting standard is an authoritative
statement issued by ICAI, a professional body of accounting in our country. The
objective of accounting standard is to bring uniformity in different accounting
policies in order to eliminate non comparability of financial statements for
enhancing reliability of financial statements. Secondly, the accounting standard
provides a set of standard accounting policies, valuation norms and disclosure
requirements. In addition to improving credibility of accounting data, accounting
standard enhances comparability of financial statements, both intra and inter
enterprises. Such comparisons are very effective and widely used for assessment
of firms’ performance by the users of accounting.

Need for Accounting Standards

Accounting extends information to various users of information. Accounting
information can serve the interest of different users only if it possesses
uniformity and full disclosure of relevant information. There can be alternate
accounting treatment and valuation norms which may be used by any business
entity. Accounting standard facilitate the scope of those alternatives which
fulfil the basic qualitative characteristics of true and fair financial statement.

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 38 Accountancy

Benefits of Accounting Standards

1. Accounting standard helps in eliminating variations in accounting
treatment to prepare financial statements.
2. Accounting standard may call for disclosures of certain information
which may not be required by law, but such information might be useful
for general public, investors and creditors.
3. Accounting standard facilitate comparability between financial
statements of inter and intra companies.

Limitations of Accounting Standards

1. Accounting standard makes choice between different alternate
accounting treatments difficult to apply.
2. It is rigidly followed and fails to extend flexibility in applying accounting
standards.
3. Accounting standard cannot override the statue. The standards are
required to be farmed within the ambit of prevailing status.

Goods and Services Tax

(One Country One Tex)
GST is a destination based tax on consumption of goods and services. It
is proposed to be levied at all stages right from manufacture up to final
consumption with credit of taxes paid at previous stages available as setoff. In
a nutshell, only value addition will be taxed and burden of tax is to be borne
by the final consumer. The concept of destination based tax on consumption
implies has the tax would accrue to the taxing authority which has jurisdiction
over the place of consumption which is also termed as place of supply.
GST has a dual aspect with the Centre and States simultaneously levying
on a common tax base. There are three main components of GST which are
CGST, SGST, CGST means Central Goods and Services Tax. Taxes collected
under CGST will constitute the revenues of the Central Government . The
present central taxes like central excise duty, additional excise duty, special
excise duty, central sales tax etc., will be subsumed under CGST. SGST means
State Good and Services Tax. A collection of SGST is the revenue of the State
Government. With GST all state taxes like VAT, entertainment tax, luxury tax,
entry tax etc, will be merged with GST. For example, Ramesh a dealer in Punjab
sell goods to Seema in Punjab worth ` 10,000. If the GST rate is 18%, i.e., 9%
CGST and 9% SGST, ` 900 will go to Central Government and 900 will go to
Punjab Government.
IGST means Integrated Goods and Services Tax. Revenue collected under
IGST is divided between Central and State Government as per the rates specified

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by the Government. IGST is charged on transfer of goods and services from one
state to another. Import of goods and services are also covered under IGST. For
example, if the goods are transferred from Madhya Pradesh to Rajasthan then
this transaction will attract IGST. Lets extend the above example to understand
SGST. If Ramesh in Madhya Pradesh sell goods to Anand in Rajasthan worth
` 1,000,000. Applicable GST late is 18% i.e., 9% CGST and 9% SGST. In this
case, the dealer will charge 18,000 as IGST and will go the Central Government.

India is a federal country where both the Centre and the States
have been assigned the powers to levy and collect taxes through
appropriate legislation. Both the levels of government have
distinct responsibilities to perform according to the division of
powers prescribed in the Constitution for which they need to
rise resources. A dual GST will, therefore, be in keeping with the
Constitutional requirement of fiscal federalism. Hence, Centre
will levy and administer CGST & IGST while respective states will
levy and administer SGST. The Constitution of India has been
amended for this purpose.

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Characteristics of Goods and Services Tax

1. GST is a common law and procedure throughout the country under
single administration.
2. GST is a destination based tax and levied at a single point at the time
of consumption of goods and services by the end consumer.
3. GST is a comprehensive levy and collection on both goods and services
at the same rate with benefit of input tax credit or subtraction of value.
4. Minimum number of rates of tax does not exceed two.
5. There is no scope for levy of cess, resale tax, additional tax, turnover
tax etc.
6. There is no multiple levy of tax on goods and services, such as sales
tax, entry tax, octroi, entertainment tax or luxury tax etc.

Do it yourself
State how the GST rates will be applicable if CGST is 9%, SGST is 9% and
IGST 18% in each of the following situations:
1. Goods worth ` 10,000 is sold by a Manufacturer 1 in Maharashtra to
a Dealer A in Maharastra.
2. Dealer A sell goods worth ` 25,000 to Dealer B in Gujarat.
3. Dealer B sell goods to Sunita in Gujarat worth ` 30,000.
4. Sunita sell goods to Ravindra in Rajasthan worth ` 65,000.

Advantages
1. Introduction of GST has resulted in the abolition of multiple types of
taxes in goods and services.
2. GST widens the tax base and increased revenue to Centre and State
thereby reducing administrative cost for the Government.
3. GST has reduced compliance cost and increases voluntary compliance.
4. GST has affected rates of tax to the maximum of two floor rates.
5. GST has removed the cascading effect on taxation.
6. GST will result in enhancing manufacturing and distribution system
affecting the cost of production of goods and services and consequently
the demand and production of goods and services will increase.
7. It will eventually promote economic efficiency and sustainable long term
economic growth as GST is neutral to business processes, business
models, organisational structure and geographical location.
8. GST would help to extend competitive edge in international market for
goods and services produced in the country leading to increased exports.

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 Theory Base of Accounting 41

GST

Intra-State Inter-State
Movement Movement

IGST
CGST SGST

GST levied by the GST levied by the GST levied by the Centre
Centre State and States Concurrently

Key Terms Introduced in the Chapter

• Cost • Going concern • Accounting period
• Matching • Comparibility • Money measurement
• Materiality • Full discloser • Accounting concept
• Objectivity • Generally accepted • Accounting Principles (GAAP)
• Consistency • Revenue Relisation • GAAP
• Dual aspect • Operating guidelines • GST
• Conservatism(Prudence)

Summary with Reference to Learning Objectives

1. Generally Accepted Accounting Principles (GAAP): Generally Accepted Accounting
principles refer to the rules or guidelines adopted for recording and reporting of business
transactions in order to bring uniformity in the preparation and presentation of financial
statements. These principles are also referred to as concepts and conventions. From the
practicality view point, the various terms such as principles, postulates, conventions
modifying principles, assumptions, etc. have been used interchangeably and are referred
to as basic accounting concepts, in the present book.
2. Basic Accounting Concepts: The basic accounting concepts are referred to as the
fundamental ideas or basic assumptions underlying the theory and practice of financial
accounting and are broad working rules of accounting activities.
3. Business Entity: This concept assumes that business has distinct and separate entity
from its owners. Thus, for the purpose of accounting, business and its owners are to
be treated as two separate entities.

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4. Money Measurement: The concept of money measurement states that only those
transactions and happenings in an organisation, which can be expressed in terms of
money are to be recorded in the book of accounts. Also, the records of the transactions
are to be kept not in the physical units but in the monetary units.
5. Going Concern: The concept of going concern assumes that a business firm would
continue to carry out its operations indefinitely (for a fairly long period of time) and
would not be liquidated in the near future.
6. Accounting Period: Accounting period refers to the span of time at the end of which the
financial statements of an enterprise are prepared to know whether it has earned profits
or incurred losses during that period and what exactly is the position of its assets and
liabilities, at the end of that period.
7. Cost Concept: The cost concept requires that all assets are recorded in the book
of accounts at their cost price, which includes cost of acquisition, transportation,
installation and making the asset ready for the use.
8. Dual Aspect: This concept states that every transaction has a dual or two-fold effect on
various accounts and should therefore be recorded at two places. The duality principle
is commonly expressed in terms of fundamental accounting equation, which is:
Assets = Liabilities + Capital
9. Revenue Recognition: Revenue is the gross in-flow of cash arising from the sale of goods
and services by an enterprise and use by others of the enterprise resources yielding
interest royalities and divididends. The concept of revenue recognition requires that the
revenue for a business transaction should be considered realised when a legal right to
receive it arises.
10. Matching: The concept of matching emphasises that expenses incurred in an accounting
period should be matched with revenues during that period. It follows from this that
the revenue and expenses incurred to earn these revenue must belong to the same
accounting period.
11. Full Disclosure: This concept requires that all material and relevant facts concerning
financial performance of an enterprise must be fully and completely disclosed in the
financial statements and their accompanying footnotes.
12. Consistency: This concepts states that accounting policies and practices followed by
enterprises should be uniform and consistent one the period of time so that results are
composable. Comparability results when the same accounting principles are consistently
being applied by different enterprises for the period under comparison, or the same
firm for a number of periods.
13. Conservatism: This concept requires that business transactions should be recorded in
such a manner that profits are not overstated. All anticipated losses should be accounted
for but all unrealised gains should be ignored.
14. Materiality: This concept states that accounting should focus on material facts. If the
item is likely to influence the decision of a reasonably prudent investor or creditor, it
should be regarded as material, and shown in the financial statements.
15. Objectivity: According to this concept, accounting transactions should be recorded in
the manner so that it is free from the bias of accountants and others.

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 Theory Base of Accounting 43

16. Systems of Accounting: There are two systems of recording business transactions,
viz. double entry system and single entry system. Under double entry system every
transaction has two-fold effects where as single entry system is known as incomplete
records.
17. Basis of Accounting: The two broad approach of accounting are cash basis and accrual
basis. Under cash basis transactions are recorded only when cash are received or paid.
Whereas under accrual basis, revenues or costs are recognises when they occur rather
than when they are paid.
18. Accounting Standards: Accounting standards are written statements of uniform
accounting rules and guidelines in practice for preparing the uniform and consistent
financial statements. These standards cannot over ride the provisions of applicable
laws, customs, usages and business environment in the country.
19. GST is a destination tax on the consumption of goods and services levied at all stages
right from manufacturing up to the final consumption with credit of taxes paid at
previous stages.

Questions for Practice

Short Answers
1. Why is it necessary for accountants to assume that business entity will remain a going
concern?
2. When should revenue be recognised? Are there exceptions to the general rule?
3. What is the basic accounting equation?
4. The realisation concept determines when goods sent on credit to customers are to
be included in the sales figure for the purpose of computing the profit or loss for the
accounting period. Which of the following tends to be used in practice to determine
when to include a transaction in the sales figure for the period. When the goods have
been:
a. dispatched    b. invoiced    c. delivered    d. paid for
Give reasons for your answer.
5. Complete the following worksheet:
(i) If a firm believes that some of its debtors may ‘default’, it should act on this by
making sure that all possible losses are recorded in the books. This is an example
of the ___________ concept.
(ii) The fact that a business is separate and distinguishable from its owner is best
exemplified by the ___________ concept.
(iii) Everything a firm owns, it also owns out to somebody. This co-incidence is
explained by the ___________ concept.
(iv) The ___________ concept states that if straight line method of depreciation is used
in one year, then it should also be used in the next year.
(v) A firm may hold stock which is heavily in demand. Consequently, the market
value of this stock may be increased. Normal accounting procedure is to ignore
this because of the ___________.

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 44 Accountancy

(vi) If a firm receives an order for goods, it would not be included in the sales figure
owing to the ___________.
(vii) The management of a firm is remarkably incompetent, but the firms accountants
can not take this into account while preparing book of accounts because of
___________ concept.
Long Answers
1. ‘The accounting concepts and accounting standards are generally referred to as the
essence of financial accounting’. Comment.
2. Why is it important to adopt a consistent basis for the preparation of financial
statements? Explain.
3. Discuss the concept-based on the premise ‘do not anticipate profits but provide for all
losses’.
4. What is matching concept? Why should a business concern follow this concept? Discuss.
5. What is the money measurement concept? Which one factor can make it difficult to
compare the monetary values of one year with the monetary values of another year?

Activity 1
Ruchica’s father is the sole proprietor of ‘Friends Gifts’, a firm engaged in the sale of
gift items. In the process of preparing financial statements, the accountant of the firm
Mr. Goyal fell ill and had to proceed on leave. Ruchica’s father was urgently in need of the
statements as these had to be submitted to the bank, in pursuance of a loan of ` 5 lakh
applied for the expansion of the business of the firm. Ruchica who is studying Accounting
in her school, volunteered to complete the work. On scrutinising the accounts, the banker
found that the value of building bought a few years back for ` 7 lakh has been shown in the
books at ` 20 lakh, which is its present market value. Similarly, as compared to the last year,
the method of valuation of stock was changed, resulting in value of goods to be about 15 per
cent higher. Also, the whole amount of ` 70,000 spent on purchase of personal computer
(expected life 5 years) during the year had been charged to the profits of the current year.
The banker did not rely on the financial data provided by Ruchica. Advise Ruchica for the
mistakes committed by her in the preparation of financial statements in the context of basic
concepts in accounting.

Activity 2
A customer has filed a suit against a trader who has supplied poor quality goods to him.
It is known that the court judgment will be in favour of the customer and the trader will
be required to pay the damages. However, the amount of legal damages is not known with
certainity. The accounting year has already been ended and the books are now finalised to
ascertain true profit or loss. The accountant of the trader has advised him not to consider
the expected loss on account of payment of legal damages because the amount is not certain
and the final judgment of the court is not yet out. Do you think the accountant is right in
his approach.

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 Theory Base of Accounting 45

Checklist to Test Your Understanding

Test Your Understanding - I
1. (c)     2. (d)     3. (a)     4. (b)
Test Your Understanding - II
1. Matching 2. Conservatism 3. Revenue Realisation
4. Consistency 5. Objectivity

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46 Accountancy

Recording of Transactions-I 3

I n chapter 1 and 2, while explaining the

development and importance of accounting as a
source of disseminating the financial information
along with the discussion on basic accounting
concepts that guide the recording of business
transactions, it has been indicated that accounting
involves a process of identifying and analysing the
business transactions, recording them, classifying
L EARNING O BJECTIVES and summarising their effects and finally
communicating it to the interested users of
After studying this accounting information.
chapter, you will be able
to: In this chapter, we will discuss the details of each
• describe the nature of
step involved in the accounting process. The first
transaction and source step involves identifying the transactions to be
documents; recorded and preparing the source documents
• explain the prepa- which are in turn recorded in the basic book of
ration of accounting original entry called journal and are then posted to
vouchers; individual accounts in the principal book called
• apply accounting ledger.
equation to explain the
effect of transactions; 3.1 Business Transactions and Source Document
• record transactions
using rules of debit After securing good percentage in your previous
and credit; examination, as promised, your father wishes to
• explain the concept of buy you a computer. You go to the market along
book of original entry with your father to buy a computer. The dealer gives
and recording of a cash memo along with the computer and in
transactions in journal; exchange your father makes cash payment of
• explain the concept of ` 35,000. Purchase of computer for cash is an
ledger and posting of example of a transaction, which involves reciprocal
journal entries to the
exchange of two things: (i) payment of cash,
ledger accounts.
(ii) delivery of a computer. Hence, the transaction

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Recording of Transactions - I 47

involves this aspect, i.e. Give and Take. Payment of cash involves give aspect
and delivery of computer is a take aspect. Thus, business transactions are
exchanges of economic consideration between parties and have two-fold effects
that are recorded in at least two accounts.
Business transactions are usually evidenced by an appropriate documents
such as Cash memo, Invoice, Sales bill, Pay-in-slip, Cheque, Salary slip, etc. A
document which provides evidence of the transactions is called the Source
Document or a Voucher. At times, there may be no documentary for certain items
as in case of petty expenses. In such case voucher may be prepared showing the
necessary details and got approved by appropriate authority within the firm. All
such documents (vouchers) are arranged in chronological order and are serially
numbered and kept in a separate file. All recording in books of account is done
on the basis of vouchers.

Transaction Voucher
Name of Firm :
Voucher No :
Date :
Debit account :
Credit account:
Amount (``) :
Narration :

Authorised By : Prepared By :

Fig. 3.1 : Showing specimen transaction voucher

3.1.1 Preparation of Accounting Vouchers

Accounting vouchers may be classified as cash vouchers, debit vouchers, credit
vouchers, journal vouchers, etc. There is no set format of accounting vouchers.
A specimen of a simple transaction voucher is used in practice is shown in
figure 3.1.
These must be preserved in any case till the audit of the accounts and tax
assessments for the relevant period are completed. Now a days, accounting is
computerised and the necessary accounting vouchers showing the code
number and name of the accounts to be debited and credited are prepared for
the purpose of necessary recording of transactions. A transaction with one
debit and one credit is a simple transaction and the accounting vouchers
prepared for such transaction is known as Transaction Voucher, the format of

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48 Accountancy

which is shown in figure 3.1. Voucher which records a transaction that entails
multiple debits/credits and one credit/debit is called compound voucher.
Compound voucher may be: (a) Debit Voucher o7r (b) Credit Voucher; the
specimen is shown in figure 3.2.

Debit Voucher
Name of Firm :
Voucher No : Date :
Credit Account :
Amount :

Debit Accounts

S. No. Code Account Name Amount Narration (i.e. Explanation)

`

Authorised By : Prepared By :

Credit Voucher
Name of Firm :
Voucher No : Date :
Debit Account :
Amount :

Credit Accounts

S. No. Code Account Name Amount Narration (i.e. Explanation)

`

Authorised By : Prepared By :

Fig. 3.2 : Showing debit and credit vouchers

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Recording of Transactions - I 49

Transactions with multiple debits and multiple credits are called complex
transactions and the accounting voucher prepared for such transaction is
known as Complex Voucher/ Journal Voucher. The format of a complex
transaction voucher is shown in figure 3.3.
Journal Voucher
Name of Firm :
Voucher No : Date :

Debit Accounts

S. No. Code Account Name Amount Narration (i.e. Explanation)

`

Credit Accounts

S. No. Code Account Name Amount Narration (i.e. Explanation)

`

Authorised By : Prepared By :

Fig. 3.3 : Showing specimen of complex transaction voucher

The design of the accounting vouchers depends upon the nature, requirement
and convenience of the business. There is no set format of an accounting
voucher. To distinguish various vouchers, different colour papers and different
fonts of printing are used. Some of the specimen of the accounting vouchers
are given in the earlier pages. An accounting voucher must contain the following
essential elements :
• It is written on a good quality paper;
• Name of the firm must be printed on the top;
• Date of transaction is filled up against the date and not the date of recording
of transaction is to be mentioned;
• The number of the voucher is to be in a serial order;
• Name of the account to be debited or credited is mentioned;

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• Debit and credit amount is to be written in figures against the amount;

• Description of the transaction is to be given account wise;
• The person who prepares the voucher must mention his name along with
signature; and
• The name and signature of the authorised person are mentioned on the
voucher.

3.2 Accounting Equation

Accounting equation signifies that the assets of a business are always equal
to the total of its liabilities and capital (owner’s equity). The equation reads as
follows:
A=L+C
Where,
A = Assets
L = Liabilities
C = Capital
The above equation can also be presented in the following forms as its
derivatives to enable the determination of missing figures of Capital(C) or
Liabilities(L).
(i) A – L = C
(ii) A – C = L
Since, the accounting equation depicts the fundamental relationship among
the components of the balance sheet, it is also called the Balance Sheet
Equation. As the name suggests, the balance sheet is a statement of assets,
liabilities and capital.
At any point of time resources of the business entity must be equal to the
claims of those who have financed these resources. The proprietors and
outsiders provide the resources of the business. The claim of the proprietors
is called capital and that of the outsides is known as liabilities. Each element
of the equation is the part of balance sheet, which states the financial position
of the business on a particular date. When we analyse the transactions, we
actually try to know that how balance sheet of a business entity gets affected.
Asset side of the balance sheet is the list of assets, which the business
entity owns. The liabilities side of the balance sheet is the list of owner’s
claims and outsider’s claims, i.e., what the business entity owes. The equality
of the assets side and the liabilities side of the balance sheet is an undeniable
fact and this justifies the name of accounting equation as balance sheet
equation also.

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For example, Rohit started business with a capital of ` 5,00,000. From the
accounting point of view, the resources of this business entity is in the form of
cash, i.e., ` 5,00,000. Sources of this business entity is the contribution by
Rohit (Proprietor) ` 5,00,000 as Capital .
(For the purpose of understanding we will refer this example as example 1,
throughout the chapter) .
If we put this information in the form of equality of resources and sources,
the picture would emerge somewhat as follows:
Books of Rohit
Balance Sheet as at ..........
Liabilities Amount Assets Amount
` `
Capital 5,00,000 Cash in hand 5,00,000
5,00,000 5,00,000

In the above balance sheet, the total assets are equal to the liabilities of
the business. Since, the business has not yet started its activities and has not
earned any profits; the amount invested in business is still ` 5,00,000. In case
any profits are earned, it will increase the invested amount in business. On the
other hand, if business suffers any losses, it will decrease the invested amount
in business.
We will now analyse the transactions listed in example 1 and its effect on
different elements and you will observe that the accounting equation always
remain balanced:

Example 1.
1. Opened a bank account in State Bank of India with an amount of
` 4,80,000.
Analysis of transaction: This transaction increases the cash at bank (assets)
and decreases cash (asset) by ` 4,80,000.
2. Bought furniture for ` 60,000 and cheque was issued on the same day.
Analysis of transaction: This transaction increases furniture (assets) and
decreases bank (assets) by ` 60,000.
3. Bought plant and machinery for the business for ` 1,25,000 and an advance
of ` 10,000 in cash is paid to M/s Ramjee Lal.
Analysis of transaction: This transaction increases plant and machinery
(assets) by ` 1,25,000, decreases cash by ` 10,000 and increases liabilities
(M/s Ramjee lal as creditor) by ` 1,15,000.

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52 Accountancy

4. Goods purchased from M/s Sumit Traders for ` 55,000.

Analysis of transaction: This transaction increases goods (assets) and
increases liabilities (M/s Sumit Traders as creditors) by ` 55,000.
5. Goods costing ` 25,000 sold to Rajani Enterprises for ` 35,000.
Analysis of transaction: This transaction decreases stock of goods (assets)
by ` 25,000 and increases assets (Rajani Enterprises as debtors
` 35,000) and capital (with the profit of ` 10,000)
The final equation as per the above analysis table can be summarised in the
form of a balance sheet as under:
Balance Sheet as at.....2017
Liabilities Amount Assets Amount
` `
Outsider’s Claims (Creditors) 1,70,000 Cash 10,000
Capital 5,10,000 Bank 4,20,000
Debtors 35,000
Stock 30,000
Furniture 60,000
Plant & Machinery 1,25,000
6,80,000 6,80,000

In terms of accounting equation

A=L+C
` 6,80,000 = ` 1,70,000 + ` 5,10,000

3.3 Using Debit and Credit

As already stated every transaction involves give and take aspect. In double
entry accounting, every transaction affects and is recorded in at least two
accounts. When recording each transaction, the total amount debited must equal
to the total amount credited. In accounting, the terms — debit and credit indicate
whether the transactions are to be recorded on the left hand side or right hand
side of the account. In its simplest form, an account looks like the letter T. Because
of its shape, this simple form called a T-account (refer
figure 3.4). Notice that the T format has a left side and a right side for recording
increases and decreases in the item. This helps in ascertaining the ultimate
position of each item at the end of an accounting period. For example, if it is
an account of a customer all goods sold shall appear on the left (debit) side of
customer’s account and all payments received on the right side. The difference
between the totals of the two sides called balance shall reflect the amount due
to the customer. In a T account, the left side is called debit (often abbreviated
as Dr.) and the right side is known as credit (often abbreviated as Cr.). To

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 Recording of Transactions - I
The summary of effects of transactions on accounting equation is in the following analysis table:

(Figures in rupees)

Transaction Cash Bank Assets Goods Furniture Plant and Total Liabilities Capital Total
No. Debtors (Stock) Machinery Assets

5,00,000 5,00,000 ....... 5,00,000 5,00,000

1. (4,80,000) 4,80,000 ....... ....... .......

Post Trans. 20,000 4,80,000 5,00,000 5,00,000 5,00,000
Equation
2. ....... (60,000) 60,000 ....... ....... .......
Post Trans. 20,000 4,20,000 60,000 5,00,000 5,00,,000 5,00,000
Equation
3. (10,000) 1,25,000 1,15,000 1,15,000 1,15,000
Post Trans. 10,000 4,20,000 60,000 1,25,000 6,15,000 1,15,000 5,00,000 6,15,000
Equation
4. 55,000 55,000 55,000 55,000
Post Trans. 10,000 4,20,000 55,000 60,000 1,25,000 6,70,000 1,70,000 5,00,000 6,70,000
Equation
5. 35,000 (25,000) 10,000 10,000 10,000
Final 10,000 4,20,000 35,000 30,000 60,000 1,25,000 6,80,000 1,70,000 5,10,000 6,80,000
Equation

53
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54 Accountancy

enter amount on the left side of an account is to debit the account. To enter
amount on the right side is to credit the account.
Account Title

(Left Side) (Right Side)

Fig. 3.4 : Showing T-account

3.3.1 Rules of Debit and Credit

All accounts are divided into five categories for the purposes of recording the
transactions: (a) Asset (b) Liability (c) Capital (d) Expenses/Losses, and (e)
Revenues/Gains.
Two fundamental rules are followed to record the changes in these accounts:
(1) For recording changes in Assets/Expenses (Losses):
(i) “Increase in asset is debited, and decrease in asset is credited.”
(ii) “Increase in expenses/losses is debited, and decrease in expenses/
losses is credited.”
(2) For recording changes in Liabilities and Capital/Revenues (Gains):
(i) “Increase in liabilities is credited and decrease in liabilities is debited.”
(ii) “Increase in capital is credited and decrease in capital is debited.”
(iii) “Increase in revenue/gain is credited and decrease in revenue/gain
is debited.”
The rules applicable to the different kinds of accounts have been
summarised in the following chart:

Rules of Debit and Credit

Asset Liabilities
(Increase) (Decrease) (Decrease) (Increase)
+ – – +
Debit Credit Debit Credit
Capital

(Decrease) (Increase) Expenses/Losses

– +
Debit Credit (Increase) (Decrease)
Revenues/Gains + –
Debit Credit
(Decrease) (Increase)
– +
Debit Credit

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Recording of Transactions - I 55

The transactions in Example 1 on page 46 will help you to learn how to

apply these debit and credit rules. Observe the analysis table given on page 48
carefully to be sure that you understand before you go on to the next one. To
illustrate different kinds of events, three more transactions have been added
(transactions 7 to 9).
1. Rohit started business with cash ` 5,00,000
Analysis of Transaction : The transaction increases cash on one hand and increases
capital on the other hand. Increases in assets are debited and increases in capital
are credited. Therefore record the transaction with debit to Cash and credit to Rohit’s
Capital.
Cash Account Capital Account
(1) 5,00,000 (1) 5,00,000

(6) 10,000

2. Opened a bank account with an amount of ` 4,80,000

Analysis of Transaction: The transaction increases the cash at bank on one hand
and decreases cash in hand on the other hand. Increases in assets are debited and
a decreases in assets are credited. Therefore, record the transactions with debit to
Bank account and credit to Cash account.

Cash Account Bank Account

(1) 5,00,000 (2) 4,80,000 (2) 4,80,000

3. Bought furniture for ` 60,000 and issued cheque for the same
Analysis of Transaction : This transaction increases furniture (assets) on one hand
and decreases bank (assets) on the other hand by ` 60,000. Increases in assets are
debited and decreases are credited. Therefore record the transactions with debit to
Furniture account and credit to Bank account.
Furniture Account Bank Account

(1) 60,000 (2) 4,80,000 (3) 60,000

4. Bought Plant and Machinery from Ramjee lal for the business for - ` 1,25,000
and an advance of ` 10,000 in cash is given.
Analysis of Transaction : This transaction increases plant and machinery (assets) by
` 1,25,000, decreases cash by ` 10,000 and increases liabilities (M/s Ramjee Lal as
creditor) by ` 1,15,000. Increases in assets are debited whereas decreases in assets
are credited. On the other hand increases in liabilities are credited. Therefore, record
the transaction with debit to furniture account and with credit to Cash and Ramjee
Lal’s account.

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56 Accountancy

Cash Account Plant and Machinery Account

(1) 5,00,000 (2) 4,80,000 (4) 1,25,000

(4) 10,000

Ramjee Lal’s Account

(4) 1,15,000

5. Goods purchased from Sumit Traders for ` 55,000

Analysis of transaction : This transaction increases purchases (expenses) and
increases liabilities (M/s Sumit Traders as creditors) by ` 55,000. Increases in expenses
are debited and increases in liabilities are credited. Therefore record the transaction
with debit to Purchases account and credit to Sumit Traders account.
Purchases Account Sumit Traders Account

(5) 55,000 (5) 55,000

6. Goods costing ` 25,000 sold to Rajani Enterprises for ` 35,000

Analysis of transaction : This transaction increases sales (Revenue) and increases
assets (Rajani Enterprises as debtors). Increases in assets are debited and increases
in revenue are credited. Therefore record the entry with credit to Sales account and
debit to Rajani Enterprises account.

Sales Account Rajani Enterprises Account

(6) 35,000 (6) 35,000

7. Paid the monthly store rent ` 2,500 in cash

Analysis of transaction : The payment of rent is an expense which decreases capital
thus, are recorded as debits. Credit cash to record decrease in assets.

Rent Account Cash Account

(7) 2,500 (7) 5,00,000 (2) 4,80,000

(4) 10,000
(7) 2,500

8. Paid ` 5,000 as salary to the office employees

Analysis of transaction : The payment of salary is an expense which decreases capital
thus, are recorded as debits. Credit Cash to record decrease in assets.

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Recording of Transactions - I 57

Salary Account Cash Account

(8) 5,000 (1) 5,00,000 (2) 4,80,000
(4) 10,000
(7) 2,500
(8) 5,000

9. Received cheque as full payment from Rajani Enterprises and deposited same
day into bank
Analysis of transaction : This transaction increase assets (Bank) on the one hand and
decreases assets (Rajani Enterprises as debtors) on the other hand. Increase in assets
is debited whereas decrease in assets is credited. Therefore record the entry with debit
to Bank account and credit to Rajani Enterprises account.

Rajani Enterprises Account Bank’s Account

(6) 35,000 (9) 35,000 (2) 4,80,000 (3) 60,000

(9) 35,000

Test Your Understanding - I

1. Double entry accounting requires that :

(i) All transactions that create debits to asset accounts must create credits to
liability or capital accounts;
(ii) A transaction that requires a debit to a liability account require a credit to an
asset account;
(iii) Every transaction must be recorded with equal debits equal total credits.
2. State different kinds of transactions that increase and decrease capital.
3. Does debit always mean increase and credit always mean decrease?
4. Which of the following answers properly classifies these commonly used accounts:
(1) Building (2) Wages (3) Credit sales (4) Credit purchases (5) Electricity charges
due but not yet paid (outstanding electricity bills) (6) Godown rent paid in
advance (prepaid godown rent) (7) Sales (8) Fresh capital introduced (9) Drawings
(10) Discount paid
Assets Liabilities Capital Revenue Expense
(i) 5,4, 3, 9,6 2,10 8,7
(ii) 1, 6 4, 5 8 7, 3 2,9,10
(iii) 2,10,4 4,6 8 7,5 1,3,9

Illustration 1
Analyse the effect of each transaction on assets and liabilities and show that the both
sides of Accounting Equation (A = L + C) remains equal :
(i) Introduced ` 8,00,000 as cash and ` 50,000 by stock.

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58 Accountancy

(ii) Purchased plant for ` 3,00,000 by paying ` 15,000 in cash and balance at a
later date.
(iii) Deposited ` 6,00,000 into the bank.
(iv) Purchased office furniture for ` 1,00,000 and made payment by cheque.
(v) Purchased goods worth ` 80,000 for cash and for ` 35,000 in credit.
(vi) Goods amounting to ` 45,000 was sold for ` 60,000 on cash basis.
(vii) Goods costing to ` 80,000 was sold for ` 1,25,000 on credit.
(viii) Cheque issued to the supplier of goods worth ` 35,000.
(ix) Cheque received from customer amounting to ` 75,000.
(x) Withdrawn by owner for personal use ` 25,000.
Solution
Transaction (i) It affects Cash and Inventory on the assets side and Capital on the other
hand. There is increase in cash by ` 8, 00,000 and Inventory of goods by ` 50,000 on assets
side of the equation. Capital is increased by ` 8, 50,000.
`
Assets = Liabilities + Capital
Cash + Inventory(Stock)
8,00,000 + 50,000 = 8,50,000

Total 8,50,000 = 8,50,000

Transaction (ii) It affects Cash and Plant and Machinery on the assets side and liabilities
on the other side of the equation. There is an increase in plant and machinery by
` 3, 00,000 and decrease in cash by ` 15,000. Liability to pay to the supplier of plant and
machinery increases by ` 2,85,000.
`
Assets = Liabilities + Capital
Cash +Inventory + Plant and Machinery
8,00,000 + 50,000 = 8,50,000
(15,000) 3,00,000 = 2,85,000
7,85,000 + 50,000 +3,00,000 = 2,85,000 + 8,50,000

Total 11,35,000 = 11,35,000

Transaction (iii) It affects assets side only. The composition of the asset side changes.
Cash decreases by ` 6,00,000 and by the same amount bank increases.
`
Assets = Liabilities+ Capital
Cash + Inventory + Plant and + Bank =
Machinery
7,85,000 + 5,0000 + 3,00,000 = 2,85,000 + 8,50,000
(6,00,000) + 6,00,000
1,85,000 + 50,000 + 3,00,000 + 6,00,000 = 2,85,000 + 8,50,000

Total 11,35,000 = 11,35,000

Transaction (iv) It affects assets side only. The composition of the asset side changes.
Furniture increases by ` 1,00,000 and by the same amount bank decreases.

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Recording of Transactions - I 59

`
Assets = Liabilities + Capital
Cash + Inventory + Plant and + Bank + Furniture
Machinery
1,85,000+ 50,000 + 3,00,000 + 6,00,000 = 2,85,000 + 8,50,000
(1,00,000) + 1,00,000
1,85,000+ 50,000 +3,00,000 +5,00,000 +1,00,000 = 2,85,000+ 8,50,000

Total 11,35,000 = 11,35,000

Transaction (v) It affects Cash and Inventory on the assets side and liability on the other
side. There is decrease in cash by ` 80,000 and increase of inventory of goods by
` 1,15,000 on the assts side of the equation. Liabilities increases by ` 35,000.
`
Assets = Liabilities + Capital
Cash + Inventory +Plant and + Bank + Furniture
Machinery
1,85,000 + 50,000 + 3,00,000 + 5,00,000 + 1,00,000 = 2,85,000 + 8,50,000
(80,000) + 1,15,000 = 35,000
1,05,000 + 1,65,000 +3,00,000 +5,00,000 + 1,00,000 = 3,20,000 + 8,50,000

Total 11,70,000 = 11,70,000

Transaction (vi) It affects Cash and Inventory on the assets side and capital on the other
side. There is an increase in cash by ` 60,000 and decrease in inventory of goods by
` 45,000 on the assets side of the equation. Capital increases by ` 15,000.
`
Assets = Liabilities + Capital
Cash + Inventory + Plant and + Bank + Furniture
Machinery
1,05,000 + 1,65,000 + 3,00,000 + 5,00,000 + 1,00,000 = 3,20,000 + 8,50,000
60,000 + (45,000) + 15,000
1,65,000 + 1,20,000 +3,00,000 +5,00,000 + 1,00,000 = 3,20,000 + 8,65,000

Total 11,85,000 = 11,85,000

Transaction (vii) It affects Debtors and Inventory on the assets side and capital on the
other side. There is increase in debtors by ` 1, 25,000 and decrease in Inventory of goods by
` 80,000 on the assets side of the equation. Capital increases by Rs.45, 000.
`
Assets = Liabilities + Capital
Cash + Inventory +Plant and + Bank + Furniture + Debtors
Machinery
1,65,000 + 1,20,000 + 3,00,000 + 5,00,000 + 1,00,000 = 3,20,000 + 8,65,000
(80,000) + 1,25,000 = + 45,000
1,65,000 + 40,000 +3,00,000 +5,00,000 + 1,00,000 + 1,25,000 = 3,20,000 + 9,10,000
Total 12,30,000 = 12,30,000

Transaction (viii) It affects Bank on the assets side on one side and liability on the other
side. There is decrease in bank by ` 35,000 on the assets side and liability also decreases by
` 35,000.

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60 Accountancy

`
Assets = Liabilities + Capital
Cash + Inventory +Plant and + Bank + Furniture + Debtors
Machinery
1,65,000 + 40,000 + 3,00,000 + 5,00,000 + 1,00,000 + 1,25,000 = 3,20,000 + 9,10,000
(35,000) = (35,000)
1,65,000 + 40,000 + 3,00,000 +4,65,000 + 1,00,000 + 1,25,000= 2,85,000 + 9,10,000

Total 11,95,000 = 11,95,000

Transaction (ix) It affects assets side only. The composition of the assets side changes.
Bank increases by ` 75,000 and by the same amount Debtors decreases.
`
Assets = Liabilities + Capital
Cash + Inventory +Plant and + Bank + Furniture + Debtors
Machinery
1,65,000 + 40,000 + 3,00,000 + 4,65,000 + 1,00,000 + 1,25,000 = 2,85,000 + 9,10,000
+ 75,000 (75,000)
1,65,000 + 40,000 + 3,00,000 + 5,40,000 + 1,00,000 + 50,000 = 2,85,000 + 9,10,000

Total 11,95,000 = 11,95,000

Transaction (x) It affects Cash on the asset side and Capital on the other hand. There
is decrease in Cash by ` 25,000 on the assets side whereas capital decreases
by ` 25,000.
`
Assets = Liabilities + Capital
Cash + Inventory +Plant and + Bank + Furniture + Debtors
Machinery
1,65,000 + 40,000 + 3,00,000 + 5,40,000 + 1,00,000 + 50,000 = 2,85,000 + 9,10,000
(25,000) + (25,000)
1,40,000+ 40,000 +3,00,000 +5,40,000 + 1,00,000 + 50,000 = 2,85,000 + 8,85,000

Total 11,95,000 = 11,95,000

3.4 Books of Original Entry

In the preceding pages, you learnt about debits and credits and observed how
transactions affect accounts. This process of analysing transactions and recording
their effects directly in the accounts is helpful as a learning exercise. However, real
accounting systems do not record transactions directly in the accounts. The book in
which the transaction is recorded for the first time is called journal or book of original
entry. The source document, as discussed earlier, is required to record the transaction
in the journal. This practice provides a complete record of each transaction in one
place and links the debits and credits for each transaction. After the debits and
credits for each transaction are entered in the journal, they are transferred to the
individual accounts. The process of recording transactions in journal is called
journalising. Once the journalising process is completed, the journal entry provides

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a complete and useful description of the event’s effect on the organisation. The process
of transferring journal entry to individual accounts is called p o s t i n g.
This sequence causes the journal to be called the Book of Original Entry and
the ledger account as the Principal Book of entry. In this context, it should be
noted that on account of the number and commonality of most transactions,
the journal is subdivided into a number of books of original entry as follows:
(a) Journal Proper
(b) Cash book
(c) Other day books:
(i) Purchases (journal) book
(ii) Sales (journal) book
(iii) Purchase Returns (journal) book
(iv) Sale Returns (journal) book
(v) Bills Receivable (journal) book
(vi) Bills Payable (journal) book
In this chapter you will learn about the process of journalising and their
posting into ledger. The cash book and other day books are dealt in detail in
chapter 4.

3.4.1 Journal
This is the basic book of original entry. In this book, transactions are recorded
in the chronological order, as and when they take place. Afterwards,
transactions from this book are posted to the respective accounts. Each
transaction is separately recorded after determining the particular account to
be debited or credited. The format of Journal is shown is figure 3.5

Journal
Date Particulars L.F. Debit Credit
Amount Amount
` `

Fig. 3.5 : Showing the format of journal

The first column in a journal is Date on which the transaction took place. In
the Particulars column, the account title to be debited is written on the first line
beginning from the left hand corner and the word ‘Dr.’ is written at the end of the
column. The account title to be credited is written on the second line leaving
sufficient margin on the left side with a prefix ‘To’. Below the account titles, a

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62 Accountancy

brief description of the transaction is given which is called Narration. Having

written the Narration a line is drawn in the Particulars column, which indicates
the end of recording the specific journal entry. The column relating to Ledger
Folio records the page number of the ledger book on which relevant account is
appears. This column is filled up at the time of posting and not at the time of
making journal entry.
The Debit amount column records the amount against the account to be
debited and similarly the Credit Amount column records the amount against
the account to be credited. It may be noted that, the number of transactions
is very large and these are recorded in number of pages in the journal book.
Hence, at the end of each page of the journal book, the amount columns are
totaled and carried forward (c/f) to the next page where such amounts are
recorded as brought forward (b/f) balances.
The journal entry is the basic record of a business transaction. It may be
simple or compound. When only two accounts are involved to record a
transaction, it is called a simple journal entry.
For Example, Goods Purchased on credit for Rs.30,000 from M/s Govind Traders
on December 24, 2017, involves only two accounts: (a) Purchases A/c (Goods), (b)
Govind Traders A/c (Creditors). This transaction is recorded in the journal as
follows :
Journal
Date Particulars L.F. Debit Credit
Amount Amount
` `
2014
Dec.24 Purchases A/c Dr. 30,000
To Govind Traders A/c 30,000
(Purchase of goods- in-trade from
Govind Traders)

It will be noticed that although the transaction results in an increase in stock

of goods, the account debited is purchases, not goods. In fact, the goods account
is divided into five accounts, viz. purchases account, sales account, purchases
returns account, sales returns account, and stock account. When the number of
accounts to be debited or credited is more than one, entry made for recording the
transaction is called compound journal entry. That means compound journal
entry involves multiple accounts. For example, Office furniture is purchased from
Modern Furniture’s on July 4, 2017 for ` 25,000 and ` 5,000 is paid by cash
immediately and balance of ` 20,000 is still payable. It increases furniture (assets)
by ` 25,000, decreases cash (assets) by ` 5,000 and increases liability by ` 20,000.
The entry made in the journal on July 4, 2017 is :

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Recording of Transactions - I 63

Journal
Date Particulars L.F. Debit Credit
Amount Amount
` `

2017 Office Furniture A/c Dr. 25,000

July 4 To Cash A/c 5,000
To Modern Furniture A/c 20,000
(Purchase of office furniture from
Modern Furnitures)

Now refer to example 1on page 46 again and observe how the transactions
listed are recorded in the journal:
Books of Rohit
Journal
Date Particulars L.F. Debit Credit
Amount Amount
` `
Cash A/c Dr. 5,00,000
To Capital A/c 5,00,000
(Business started with cash)
Bank A/c Dr. 4,80,000
To Cash A/c 4,80,000
(Opened bank account with State
Bank of India)
Furniture A/c Dr. 60,000
To Bank A/c 60,000
(Purchased furniture and made
payment through bank)
Plant and Machinery A/c Dr. 1,25,000
To Cash A/c 10,000
To Ramjee Lal 1,15,000
(Bought Plant and Machinery from
M/s Ramjee Lal, made an advance
payment by cash for ` 10,000 and
balance at the later date)
Purchases A/c Dr. 55,000
To M/s Sumit Traders A/c 55,000
(Goods bought on credit)
Rajani Enterprises A/c Dr. 35,000
To Sales A/c 35,000
(Goods sold on profit)
Total 12,55,000 12,55,000

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64 Accountancy

Illustration 2.
Soraj Mart furnishes the following information :
Transactions during the month of April, 2017 are as under :

Date Details
01.4.2017 Business started with cash ` 1,50,000.
01.4.2017 Goods purchased form Manisha ` 36,000.
01.4.2017 Stationery purchased for cash ` 2,200.
02.4.2017 Open a bank account with SBI for ` 35,000.
02.4.2017 Goods sold to Priya for ` 16,000.
03.4.2017 Received a cheque of ` 16,000 from Priya.
05.4.2017 Sold goods to Nidhi ` 14,000.
08.4.2017 Nidhi pays ` 14,000 cash.
10.4.2017 Purchased goods for ` 20,000 on credit from Ritu.
14.4.2017 Insurance paid by cheque ` 6,000.
18.4.2017 Paid rent ` 2,000.
20.4.2017 Goods costing ` 1,500 given as charity.
24.4.2017 Purchased office furniture for ` 11,200.
29.4.2017 Cash withdrawn for household purposes ` 5000.
30.4.2017 Interest received cash ` 1,200.
30.4.2017 Cash sales ` 2,300.
30.4.2017 Commission paid ` 3,000 by cehque.
30.4.2017 Telephone bill paid by cheque ` 2,000.
30.4.2017 Payment of salaries in cash ` 12,000.

Journalise the transactions.

Solution

Books of Saroj Mart

Journal
Date Particulars L.F. Debit Credit
Amount Amount
` `
2017
Apr.01 Cash A/c Dr. 1,50,000
To Capital A/c 1,50,000
(Business started with cash)
Apr.01 Purchases A/c Dr. 36,000
To Manisha A/c 36,000
(Goods purchase on credit)
Apr.01 Stationery A/c Dr. 2,200
To Cash A/c 2,200
(Purchase of stationery for cash)
Total c/f 1,88,200 1,88,200

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Recording of Transactions - I 65

Total b/f 1,88,200 1,88,200

Apr.02 Bank A/c Dr. 35,000
To Cash A/c 35,000
(Opened a bank account with SBI)
Apr.02 Priya A/c Dr. 16,000
To Sales A/c 16,000
(Goods sold to Priya On Credit)
Apr.03 Bank A/c Dr. 16,000
To Priya A/c 16,000
(Cheque Received from Priya)
Apr.05 Nidhi A/c Dr. 14,000
To Sales A/c 14,000
(Sale of goods to Nidhi on credit)
Apr.08 Cash A/c Dr. 14,000
To Nidhi A/c 14,000
(Cash received from Nidhi)
Apr.10 Purchases A/c Dr. 20,000
To Ritu A/c 20,000
(Purchase of goods on credit)
Apr.14 Insurance Premium A/c Dr. 6,000
To Bank A/c 6,000
(Payment of Insurance premium by
cheque)
Apr.18 Rent A/c Dr. 2,000
To Cash A/c 2,000
(Rent paid)
Apr.20 Charity A/c Dr. 1,500
To Purchases A/c 1,500
(Goods given as charity)
Apr.24 Furniture A/c Dr. 11,200
To Cash A/c 11,200
(Purchase of office furniture)
Apr.29 Drawings A/c Dr. 5,000
To Cash A/c 5,000
(With drawl of cash from the business
for personal use of the proprietor)
Apr.30 Cash A/c Dr. 1,200
To Interest received A/c 1,200
(Interest received)
Apr.30 Cash A/c Dr. 2,300
To Sales A/c 2,300
(Sale of goods for cash)
Total c/f 3,32,400 3,32,400

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66 Accountancy

Total c/f 3,32,400 3,32,400

Apr.30 Commission A/c Dr. 3,000
To Bank A/c 3,000
(Commission paid by cheque)
Apr.30 Telephone expenses A/c Dr. 2,000
To Cash A/c 2,000
(Payment of telephone bill)
Apr.30 Salaries A/c Dr. 12,000
To Cash A/c 12,000
(Payment of salary to the office persons)
Total 3,49,400 3,49,400

Illustration 3
Prove that the accounting equation is satisfied in all the following transactions of Sita
Ram house by preparing the analysis table. Also record the transactions in Journal.
(i) Business commenced with a capital of ` 6,00,000.
(ii) ` 4,50,000 deposited in a bank account.
(iii) ` 2,30,000 Plant and Machinery Purchased by paying ` 30,000 cash immediately.
(iv) Purchased goods worth ` 40,000 for cash and ` 45,000 on account.
(v) Paid a cheque of ` 2, 00,000 to the supplier for Plant and Machinery.
(vi) ` 70,000 cash sales (of goods costing ` 50,000).
(vii) Withdrawn by the proprietor ` 35,000 cash for personal use.
(viii) Insurance paid by cheque of ` 2,500.
(ix) Salary of ` 5,500 outstanding.
(x) Furniture of ` 30,000 purchased in cash.

Solution
Journal
Date Particulars L.F. Debit Credit
Amount Amount
` `
(i) Cash A/c Dr. 6,00,000
To Capital A/c 6,00,000
(Business started with cash)
(ii) Bank A/c Dr. 4,50,000
To Cash A/c 4,50,000
(Cash deposited into the bank)
Total c/f 10,50,000 10,50,000

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Recording of Transactions - I 67

Total c/f 10,50,000 10,50,000

(iii) Plant and Machinery A/c Dr. 2.30,000
To Cash A/c 30,000
To Creditors A/c 2,00,000
(Purchase of plant and machinery by
paying ` 30,000 cash and balance
on a later date)
(iv) Purchases A/c Dr. 85,000
To Cash A/c 40,000
To Creditors A/c 45,000
(Bought goods for cash as well as on
credit)
(v) Creditor’s A/c Dr. 2,00,000
To Bank A/c 2,00,000
(Payment made to the supplier of plant
and machinery)
(vi) Cash A/c Dr. 70,000
To Sales A/c 70,000
(Sold goods on profit)
(vii) Drawings A/c Dr. 35,000
To Cash A/c 35,000
(Withdrew cash for personal use)
(viii) Insurance A/c Dr. 2,500
To Bank A/c 2,500
(Paid insurance by cheque)
(ix) Salary A/c Dr. 5,500
To Outstanding salary A/c 5,500
(Salary outstanding)
(x) Furniture A/c Dr. 30,000
To Cash A/c 30,000
(Furniture purchased for cash)

Total 17,08,000 17,08,000

Test Your Understanding - II

State the title of the accounts affected, type of account and the account to be debited
and account to be credited :
`
1. Bhanu commenced business with cash 1,00,000
2. Purchased goods on credit from Ramesh 40,000
3. Sold goods for cash 30,000
4. Paid salaries 3,000
5. Furniture purchased for cash 10,000

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 68
Statement showing the effect of various transaction on accounting equation
(Figures in rupees)
No. Cash Bank Stock Fur- Plant and Total = Non-trade Trade Capital Total
niture Machinery Creditors Creditors

1 6,00,000 6,00,000 = 6,00,000 6,00,000

6,00,000 - - - - 6,00,000 = - - 6,00,000 6,00,000
2 (4,50,000) 4,50,000
1,50,000 4,50,000 -- -- - 6,00,000 = - - 6,00,000 6,00,000
3 (30,000) - - - 2,30,000 2,00,000 2,00,000 - - 2,00,000
1,20,000 4,50,000 - - 2,30,000 8,00,000 = 2,00,000 - 600,000 8,00,000
4 (40,000) - 85,000 - - 45,000 - 45,000 - 45,000
80,000 4,50,000 85,000 - 2,30,000 8,45,000 = 2,00,000 45,000 600,000 8,45,000
5 - (2,00,000) - - - (2,00,000) (2,00,000) - - (2,00,000)
80,000 2,50,000 85,000 - 2,30,000 6,45,000 = - 45,000 6,00,000 20,000
6 70,000 - (50,000) - - 20,000 - - 20,000 20,000
1,50,000 2,50,000 35,000 - 2,30,000 6,65,000 = - 45,000 6,20,000 6,65,000
7 (35,000) - - (35,000) (35,000) (35,000)
1,15,000 2,50,000 35,000 - 2,30,000 6,30,000 = - 45,000 5,85,000 6,30,000
8 (2,500) (2,500) (2,500) (2,500)
1,15,000 2,47,500 35,000 - 2,30,000 6,27,500 = - 45,000 5,82,500 6,27,500
9 5,500 - (5,500)
1,15,000 2,47,500 35,000 - 2,30,000 6,27,500 = 5,500 45,000 5,77,000 6,27,500
10 (30,000) - - 30,000 - - - - -

85,000 2,47,500 35,000 30,000 2,30,000 6,27,500 = 5,500 45,000 5,77,000 6,27,500

Accountancy
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Recording of Transactions - I 69

6. Borrowed from bank 50,000

7. Sold goods to Sarita 10,000
8. Cash paid to Ramesh on account 20,000
9. Rent paid 1,500

Transaction Name of Accounts Type of Accounts Affected Accounts

No. Affected (Assets, Liabilities Capital, Increase/Decrease
Revenues and Expenses)
1 2 1 2 1 2
1.
2.
3.
4.
5.
6.
7.
8.
9.

Accounting Entries under Goods and Services Tax

Illustration : 4
Record necessary Journal entries assuming CGST @ 5% and SGST @ 5% and all transactions
are occurred within Delhi)
i. Shobit bought goods ` 1,00,000 on credit
ii. He sold them for ` 1,35,000 in the same state on credit
iii. He paid for Railway transport ` 8,000
iv. He bought computer printer for ` 10,000
v. Paid postal charges ` 2000

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70 Accountancy

Solution
Journal
Date Particulars L.F. Debit Credit
Amount Amount
` `
(i) Purchases A/c Dr. 1,00,000
Input CGST A/c Dr. 5,000
Input SGST A/c Dr. 5,000
To Creditors A/c
(Being Goods bought on credit) 1,10,000
(ii) Debtors A/c Dr. 1,48,500
To Sales A/c 1,35,000
To Output CGST A/c 6,750
To Output SGST A/c 6,750
(Being Goods sold on credit)
(iii) Transport Charges A/c Dr. 8,000
Input CGST A/c Dr. 400
Input SGST A/c Dr. 400
To Bank A/c 8,800
(Being tranport charges paid)
(iv) Computer printer A/c Dr. 10,000
Input CGST A/c Dr. 500
Input SGST A/c Dr. 500
To Bank A/c 11,000
(Being Computer-Printer bought)
(v) Postal charges A/c Dr. 2,000
Input CGST A/c Dr. 100
Input SGST A/c Dr. 100
To Bank A/c 2,200
(Being Paid for Portage)
(vi) Output CGST A/c Dr. 6,7503
Output SGST A/c Dr. 6,7504
To Input CGST A/c 6,0001
To Input SGST A/c 6,0002
To Electronic Cash Ledger A/c 1,500
(Being GST set off and balance paid)
Working Notes :-
Total Input CGST = ` 5,000 + ` 400 + `500 + `100 = `6,0001
Total Input SGST = ` 5,000 + ` 400 + `500 + `100 = `6,0002
Total Output CGST = ` 6,7503
Total Output SGST = ` 6,7504
Net CGST Payable = ` 6,750 - `6,000 = `750
Net SGST Payable = ` 6,750 - `6,000 = `750
Illustration : 5
Record necessary Journal entries in the books of Suman of Bihar assuming CGST @ 9%
and SGST @ 9% :
a. Bought goods ` 3,50,000 from Jharkhand.
b. Sold goods for ` 2,00,000 Uttar Pradesh.
c. Sold goods for ` 4,00,000 locally.
d. Paid Insurance premium ` 30,000.
e. Bought furniture for office ` 50,000.
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Recording of Transactions - I 71

Solution
Books of Suman
Journal
Date Particulars L.F. Debit Credit
Amount Amount
` `
(i) Purchases A/c Dr. 3,50,000
Input IGST A/c Dr. 63,000
To Bank A/c 4,13,000
(Being goods bought)
(ii) Bank A/c Dr. 2,36,000
To Sales A/c 2,00,000
To Output IGST A/c 36,000
(Being goods sold outside the state)
(iii) Debtors A/c Dr. 4,72,000
To Sales A/c 4,00,000
To Output CGST A/c 36,000
To Output SGST A/c 36,000
(Being goods sold on credit locally)
(iv) Insurance Premium A/c Dr. 30,000
Input CGST A/c Dr. 2,700
Input SGST A/c Dr. 2,700
To Bank A/c 35,400
(Being insurance premium paid)
(v) Furniture A/c Dr. 50,000
Input CGST A/c Dr. 4,500
Input SGST A/c Dr. 4,500
To Bank A/c 59,000
(Being furniture bought)
(vi) Output CGST A/c Dr. 34,200
To Input CGST A/c 7,200
To Input IGST A/c 27,000
(Being set off against CGST ouput
made)
(vii) Output SGST A/c Dr. 7,200
To Input SGST A/c 7,200
(Being set off against SGST output
made)
(viii) Output IGST A/c Dr. 36,200
To Input IGST A/c 36,000
(Being set off against SGST output
made)
(ix) Output CGST A/c Dr. 1,800
Output SGST A/c 28,800
To Electronic Cash Ledger A/c 30,600
(Being final payment made)

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72 Accountancy

Working Notes :

Calculation Sheet
Particulars CGST SGST IGST
Output liability 36,000 36,000 36,000
Loss : Input tax Credit
CGST 7,200
SGST 7,200
IGST 27,000 36,000
Amount Payable 1,800 28,800 NIL

• Any IGST credit will first be applied to set off IGST and then CGST. Balance,
if any, will be applied to set off SGST.

3.5 The Ledger

The ledger is the principal book of accounting system. It contains different accounts
where transactions relating to that account are recorded. A ledger is the collection of all
the accounts, debited or credited, in the journal proper and various special journal
(about which you will learn in chapter 4). A ledger may be in the form of bound register,
or cards, or separate sheets may be maintained in a loose leaf binder. In the ledger, each
account is opened preferably on separate page or card.

Utility
A ledger is very useful and is of utmost importance in the organisation. The net
result of all transactions in respect of a particular account on a given date can
be ascertained only from the ledger. For example, the management on a particular
date wants to know the amount due from a certain customer or the amount the
firm has to pay to a particular supplier, such information can be found only in
the ledger. Such information is very difficult to ascertain from the journal because
the transactions are recorded in the chronological order and defies classification.
For easy posting and location, accounts are opened in the ledger in some definite
order. For example, they may be opened in the same order as they appear in the
profit and loss account and in balance sheet. In the beginning, an index is also
provided. For easy identification, in big organisations, each account is also
allotted a code number.
Format of the account is shown in figure 3.6.

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Recording of Transactions - I 73

Name of the Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `

Fig. 3.6 : Showing format of a ledger

According to this format the columns will contain the information as given below:
An account is debited or credited according to the rules of debit and credit
already explained in respect of each category of account.
Title of the account : The Name of the item is written at the top of the format as
the title of the account. The title of the account ends with suffix ‘Account’.
Dr./Cr. : Dr. means Debit side of the account that is left side and Cr. means
Credit side of the account, i.e. right side.
Date : Year, Month and Date of transactions are posted in chronological order in
this column.
Particulars : Name of the item with reference to the original book of entry is
written on debit/credit side of the account.
Journal Folio : It records the page number of the original book of entry on which
relevant transaction is recorded. This column is filled up at the time of posting.
Amount : This column records the amount in numerical figure, corresponding
to what has been entered in the amount column of the original book of entry.

Test Your Understanding - III

Choose the Correct Answer :
1. The ledger folio column of journal is used to:
(a) Record the date on which amount posted to a ledger account.
(b) Record the number of ledger account to which information is posted.
(c) Record the number of amounts posted to the ledger account.
(d) Record the page number of the ledger account.
2. The journal entry to record the sale of services on credit should include:
(a) Debit to debtors and credit to capital.
(b) Debit to cash and Credit to debtors.
(c) Debit to fees income and Credit to debtors.
(d) Debit to debtors and Credit to fees income.
3. The journal entry to record purchase of equipment for ` 2,00,000 cash and a
balance of ` 8,00,000 due in 30 days include:
(a) Debit equipment for ` 2,00,000 and Credit cash ` 2,00,000.

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74 Accountancy

(b) Debit equipment for ` 10,00,000 and Credit cash ` 2,00,000 and creditors ` 8,00,000.
(c) Debit equipment ` 2,00,000 and Credit debtors ` 8,00,000.
(d) Debit equipment ` 10,00,000 and Credit cash ` 10,00,000.
4. When an entry is made in journal:
(a) Assets are listed first.
(b) Accounts to be debited listed first.
(c) Accounts to be credited listed first.
(d) Accounts may be listed in any order.
5. If a transaction is properly analysed and recorded:
(a) Only two accounts will be used to record the transaction.
(b) One account will be used to record transaction.
(c) One account balance will increase and another will decrease.
(d) Total amount debited will equals total amount credited.
6. The journal entry to record payment of monthly bill will include:
(a) Debit monthly bill and Credit capital.
(b) Debit capital and Credit cash.
(c) Debit monthly bill and Credit cash.
(d) Debit monthly bill and Credit creditors.
7. Journal entry to record salaries will include:
(a) Debit salaries Credit cash.
(b) Debit capital Credit cash.
(c) Debit cash Credit salary.
(d) Debit salary Credit creditors.

Distinction between Journal and Ledger

The Journal and the Ledger are the most important books of the double entry
mechanism of accounting and are indispensable for an accounting system.
Following points of comparison are worth noting :
1. The Journal is the book of first entry (original entry); the ledger is the
book of second entry.
2. The Journal is the book for chronological record; the ledger is the book
for analytical record.
3. The Journal, as a book of source entry, gets greater importance as
legal evidence than the ledger.
4. Transaction is the basis of classification of data within the Journal;
Account is the basis of classification of data within the ledger.
5. Process of recording in the Journal is called Journalising; the process
of recording in the ledger is known as Posting.

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3.5.1 Classification of Ledger Accounts

We have seen earlier that all ledger accounts are put into five categories namely,
assets, liabilities, capital, revenues/gains and expense losses. All these accounts
may further be put into two groups, i.e. permanent accounts and temporary
accounts. All permanent accounts are balanced and carried forward to the next
accounting period. The temporary accounts are closed at the end of the
accounting period by transferring them to the trading and profit and loss account.
All permanent accounts appears in the balance sheet. Thus, all assets, liabilities
and capital accounts are permanent accounts and all revenue and expense
accounts are temporary accounts. This classification is also relevant for preparing
the financial statements.
3.6 Posting from Journal
Posting is the process of transferring the entries from the books of original entry
(journal) to the ledger. In other words, posting means grouping of all the
transactions in respect to a particular account at one place for meaningful
conclusion and to further the accounting process. Posting from the journal is
done periodically, may be, weekly or fortnightly or monthly as per the
requirements and convenience of the business.
The complete process of posting from journal to ledger has been discussed below:
Step 1 : Locate in the ledger, the account to be debited as entered in the journal.
Step 2 : Enter the date of transaction in the date column on the debit side.
Step 3 : In the ‘Particulars’ column write the name of the account through which
it has been debited in the journal. For example, furniture sold for cash ` 34,000.
Now, in cash account on the debit side in the particulars column ‘Furniture’ will
be entered signifying that cash is received from the sale of furniture. In Furniture
account, in the ledger on the credit side is the particulars column, the word,
cash will be recorded. The same procedure is followed in respect of all the entries
recorded in the journal.
Step 4 : Enter the page number of the journal in the folio column and in the journal
write the page number of the ledger on which a particular account appears.
Step 5 : Enter the relevant amount in the amount column on the debit side.
It may be noted that the same procedure is followed for making the entry on the
credit side of that account to be credited. An account is opened only once in the
ledger and all entries relating to a particular account is posted on the debit or
credit side, as the case may be.
We will now see how the transactions listed in example on page 46-47 are
posted to different accounts from the journal.

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Cash Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
Capital 5,00,000 Bank 4,80,000
Plant and 10,000
Machinery

Capital Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
Cash 5,00,000

Bank Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
Cash 4,80,000 Furniture 60,000

Furniture Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
Bank 60,000

Plant and Machinery Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
Cash 10,000
Ramjee lal 1,15,000

Ramjee Lal’s Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
Plant and 1,15,000
Machinery

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Purchases Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
Sumit 55,000
Traders

Sumit Traders Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
Purchases 55,000

Rajani Enterprises Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
Sales 35,000

Sales Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
Rajani Enter 35,000
prises

Test Your Understanding - IV

Fill in the blanks:

1. Issued a cheque for `8,000 to pay rent. The account to be debited is ............
2. Collected ` 35,000 from debtors. The account to be credited is ............
3. Purchased office stationary for ` 18,000. The account to be credited is ...........
4. Purchased new machine for ` 1,70,000 and issued cheque for the same.
The account to be debited is ............
5. Issued cheque for ` 70,000 to pay off on of the creditors. The account to
be debited is ............
6. Returned damaged office stationary and received ` 50,000. The account
to be credited is ............
7. Provided services for ` 65,000 on credit. The account to be debited is ...........

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Illustration 4
Journalise the following transactions of M/s Mallika Fashion House and post the entries
to the Ledger:
Date Details Amount
2017 `
June 05 Business started with cash 2,00,000
June 08 Opened a bank account with Syndicate Bank 80,000
June 12 Goods purchased on credit from M/s Gulmohar Fashion House 30,000
June 12 Purchase office machines, paid by cheque 20,000
June 18 Rent paid by cheque 5,000
June 20 Sale of goods on credit to M/s Mohit Bros 10,000
June 22 Cash sales 15,000
June 25 Cash paid to M/s Gulmohar Fashion House 30,000
June 28 Received a cheque from M/s Mohit Bros 10,000
June 30 Salary paid in cash 6,000
Solution
(i) Recording the transactions
Books of Mallika Fashion House
Journal
Date Particulars L.F. Debit Credit
Amount Amount
` `
2017
June 05 Cash A/c Dr. 2,00,000
To Capital A/c 2,00,000
(Business started with cash)
June 08 Bank A/c Dr. 80,000
To Cash A/c 80,000
(Opened a current account with
syndicate bank)
June 12 Purchases A/c Dr. 30,000
To Gulmohar Fashion House A/c 30,000
(Goods purchased on credit)
June 12 Office Machines A/c Dr. 20,000
To Bank A/c 20,000
(Office machine purchased)
June 18 Rent A/c Dr. 5,000
To Bank A/c 5,000
(Rent paid)
June 20 Mohit Bros A/c Dr. 10,000
To Sales A/c 10,000
(Goods sold on credit)
Total c/f 3,45,000 3,45,000

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Total b/f 3,45,000 3,45,000

June 22 Cash A/c Dr. 15,000
To Sales A/c 15,000
(Goods sold for cash)
June 25 Gulmohar Fashion House A/c Dr. 30,000
To Cash A/c 30,000
(Cash paid to Gulmohar
Fashion House)
June 28 Bank A/c Dr. 10,000
To Mohit Bros A/c 10,000
(Payment received in full and
final settlement)
June 30 Salary A/c Dr. 6,000
To Cash A/c 6,000
(Monthly salary paid)
Total 4,06,000 4,06,000

(ii) Posting in the Ledger Book

Cash Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017 2017
June 5 Capital 2,00,000 June 8 Bank 80,000
June 22 Sales 15,000 June 25 Gulmohar 30,000
Fashion House
June 30 Salary 6,000

Capital Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
June 5 Cash 2,00,000

Bank Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017 2017
June 08 Cash 80,000 June 12 Office Machines 30,000
June 28 Mohit Bros. 10,000 June 18 Rent 5,000

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Purchases Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017 2017
June 12 Gulmohar 30,000
Fashion House

Gulmohar Fashion House Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017 2017
June 25 Cash 30,000 June 12 Purchases 30,000

Office Machines Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
June 12 Bank 20,000

Rent Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
June 18 Bank 5,000

Mohit Bros. Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017 2017
June 20 Sales 10,000 June 28 Cash 10,000

Sales Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017 2017
June 20 June 20 Mohit Bros. 10,000
June 22 Cash 15,000

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Salary Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
June 30 Cash 6,000

Illustration 5
Journalise the following transactions of M/s Time Zone and post them to the ledger accounts :
Date Details Amount
2017 `
Dec. 01 Business started with cash 1,20,000
Dec. 02 Opened a bank account with ICICI 4,00,00
Dec. 04 Goods purchased for cash 12,000
Dec. 10 Paid cartage 500
Dec. 12 Goods sold on credit to M/s Lara India 25,000
Dec. 14 Cash received from M/s Lara India 10,000
Dec. 16 Goods returned from Lara India 3,000
Dec. 18 Paid trade expenses 700
Dec. 19 Goods purchased on credit from Taranum 32,000
Dec. 20 Cheque received from M/s Lara India for final settlement 11,500
and deposited sameday into bank
Dec. 22 Goods returned to Taranum 1,500
Dec. 24 Paid for stationery 1,200
Dec. 26 Cheque given to Taranum on account 20,000
Dec. 28 Paid rent by cheque 4,000
Dec. 29 Drew cash for personal use 10,000
Dec. 30 Cash sales 12,000
Dec. 31 Goods sold to M/s Rupak Traders 11,000
Solution
Books of Time Zone
Journal
Date Particulars L.F. Debit Credit
Amount Amount
` `
2017
Dec. 01 Cash A/c Dr. 1,20,000
To Capital A/c 1,20,000
( Business started with cash)
02 Bank A/c Dr. 40,000
To Cash A/c 40,000
(Opened a current account with
ICICI bank)
04 Purchases A/c Dr. 12,000
To Cash A/c 12,000
(Goods purchased for cash)
Total c/f 1,72,000 1,72,000

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Total b/f 1,72,000 1,72,000

10 Cartage A/c Dr. 500
To Cash A/c 500
(Cartage paid)
12 Lara India A/c Dr. 25,000
To Sales A/c 25,000
(Goods sold on credit)
14 Cash A/c Dr. 10,000
To Lara India A/c 10,000
(Cash received from Lara India)
16 Sales Return A/c Dr. 3,000
To Lara India A/c 3,000
(Goods returned from Lara India)
18 Trade Expenses A/c Dr. 700
To Cash A/c 700
(Trade expenses paid)
19 Purchases A/c Dr. 32,000
To Tranum’s A/c 32,000
(Goods purchased on credit)
20 Bank A/c Dr. 11,500
Discount A/c Dr. 500
To Lara India A/c 12,000
(Cheque received for final settlement)
22 Taranum’s A/c Dr. 1,500
To Purchase Return’s A/c 1,500
(Goods returned to Tranum)
24 Stationery A/c Dr. 1,200
To Cash A/c 1,200
(Cash paid for stationery)
26 Taranum’s A/c Dr. 20,000
To Bank A/c 20,000
(Cheque given to Tranum)
28 Rent A/c Dr. 4,000
To Bank A/c 4,000
(Rent paid by cheque)
29 Drawings A/c Dr. 10,000
To Cash A/c 10,000
(Cash withdrawn for personal use)
30 Cash A/c Dr. 12,000
To Sales A/c 12,000
(Goods sold for cash)
31 Rupak Trader A/c Dr. 11,000
To Sales A/c 11,000
(Goods sold on credit)
Total 3,14,900 3,14, 900

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Posting in the Ledger Book :

Cash Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017 2017
Dec. 01 Capital 1,20,000 Dec. 02 Bank 40,000
Dec. 14 Lara India 10,000 Dec. 04 Purchase 12,000
Dec. 30 Sales 12,000 Dec. 10 Cartage 500
Dec. 18 Trade 700
Expenses
Dec. 24. Stationery 1,200
Dec. 29 Drawings 1,000

Capital Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
Dec.01 Cash 1,20,000

Bank Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017 2017
Dec.02 Cash 40,000 Dec.26 Taranum’s 20,000
Dec.20 Lara India 11,500 Dec.28 Rent 4,000

Purchases Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
Dec.04 Cash 12,000
Dec.19 Taranum 32,000

Cartage Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
Dec.10 Cash 500

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84 Accountancy

Lara India Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017 2017
Dec.12 Sales 25,000 Dec. 14 Cash 10,000
Dec. 16 Sales return 3,000
Dec. 20 Bank 11,500
Discount 500

Sales Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
Dec.12 Lara India 25,000
Dec.30 Cash 12,000
Dec.31 Rupak Traders 11,000

Sales Return Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
Dec.16 Lara India 3,000

Trade Expenses Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
Dec.18 Cash 700

Taranum Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017 2017
Dec.22 Purchase 1,500 Dec.19 Purchase 32,000
Return
Dec.26 Bank 20,000

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Recording of Transactions - I 85

Discount Paid Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
Dec.20 Lara India 500

Purchases Return Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
Dec.22 Taranum 1,500

Stationery Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
Dec. Cash 1,200

Rent Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
Dec. 28 Bank 4,000

Drawings Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
Dec. 29 Cash 10,000

Rupak Traders Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017
Dec. 31 Sales 11,000

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86 Accountancy

Test Your Understanding - V

Select Right Answer:
1. Voucher is prepared for:
(i) Cash received and paid
(ii) Cash/Credit sales
(iii) Cash/Credit purchase
(iv) All of the above
2. Voucher is prepared from:
(i) Documentary evidence
(ii) Journal entry
(iii) Ledger account
(iv) All of the above
3. How many sides does an account have?
(i) Two
(ii) Three
(iii) one
(iv) None of These
4. A purchase of machine for cash should be debited to:
(i) Cash account
(ii) Machine account
(iii) Purchase account
(iv) None of these
5. Which of the following is correct?
(i) Liabilities = Assets + Capital
(ii) Assets = Liabilities – Capital
(iii) Capital = Assets – Liabilities
(iv) Capital = Assets + Liabilities.
6. Cash withdrawn by the Proprietor should be credited to:
(i) Drawings account
(ii) Capital account
(iii) Profit and loss account
(iv) Cash account
7. Find the correct statement:
(i) Credit a decrease in assets
(ii) Credit the increase in expenses
(iii) Debit the increase in revenue
(iv) Credit the increase in capital
8. The book in which all accounts are maintained is known as:
(i) Cash Book
(ii) Journal
(iii) Purchases Book
(iv) Ledger
9. Recording of transaction in the Journal is called:
(i) Casting
(ii) Posting
(iii) Journalising
(iv) Recording

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Key Terms Introduced in the Chapter

• Source Documents • Credit

• Accounting Equation • Debit
• Books of Original Entry • Account
• Journalising and Posting • Ledger
• Double Entry Book Keeping· • Journal

Summary with Reference to Learning Objectives

1. Meaning of source documents : Various business documents such as invoice,

bills, cash memos, vouchers, which form the basis and evidence of a business
transaction recorded in the books of account, are called source documents.
2. Meaning of accounting equation : A statement of equality between debits and
credits signifying that the assets of a business are always equal to the total
liabilities and capital.
3. Rules of debit and credit : An account is divided into two sides. The left side of
an account is known as debit and the credit. The rules of debit and credit
depend on the nature of an account. Debit and Credit both represent either
increase or decrease, depending on the nature of an account. These rules are
summarised as follows :
Name of an account Debit Credit
Assets Increase Decrease
Liabilities Decrease Increase
Capital Decrease Increase
Revenues Decrease Increase
Expenses increase Decrease
4. Books of Original entry : The transactions are first recorded in these books in
a chronological order. Journal is one of the books of original entry. The process
of recording entries in the journal is called journalising.
5. Ledger : A book containing all accounts to which entries are transferred from
the books of original entry. Posting is process of transferring entries from
books of original entry to the ledger.

Questions for Practice

Short Answers
1. State the three fundamental steps in the accounting process.
2. Why is the evidence provided by source documents important to accounting?
3. Should a transaction be first recorded in a journal or ledger? Why?
4. Are debits or credits listed first in journal entries? Are debits or credits indented?
5. Why are some accounting systems called double accounting systems?
6. Give a specimen of an account.

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88 Accountancy

7. Why are the rules of debit and credit same for both liability and capital?
8. What is the purpose of posting J.F numbers that are entered in the journal at
the time entries are posted to the accounts.
9. What entry (debit or credit) would you make to: (a) increase revenue (b) decrease
in expense, (c) record drawings (d) record the fresh capital introduced by the
owner.
10. If a transaction has the effect of decreasing an asset, is the decrease recorded
as a debit or as a credit? If the transaction has the effect of decreasing a
liability, is the decrease recorded as a debit or as a credit?

Long Answers
1. Describe the events recorded in accounting systems and the importance of
source documents in those systems?
2. Describe how debits and credits are used to analyse transactions.
3. Describe how accounts are used to record information about the effects of
transactions?
4. What is a journal? Give a specimen of journal showing at least five entries.
5. Differentiate between source documents and vouchers.
6. Accounting equation remains intact under all circumstances. Justify the
statement with the help of an example.
7. Explain the double entry mechanism with an illustrative example.

Numerical Questions

Analysis of Transactions
1. Prepare accounting equation on the basis of the following :
(a) Harsha started business with cash
`2,00,000
(b) Purchased goods from Naman for cash
` 40,000
(c) Sold goods to Bhanu costing `10,000/-
` 12,000
(d) Bought furniture on credit
` 7,000
(Ans: Asset = cash ` 1,60,000 + Goods ` 30,000 + Debtors ` 12,000 +
Furniture ` 7,000 = ` 2,09,000; Liabilities = Creditors ` 7,000 + Capital
` 2,02,000 = ` 2,09,000)
2. Prepare accounting equation from the following:
(a) Kunal started business with cash
`2,50000
(b) He purchased furniture for cash
` 35,000
(c) He paid commission
` 2,000

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Recording of Transactions - I 89

(d) He purchases goods on credit ` 40,000

(e) He sold goods (Costing `20,000) for cash ` 26,000
(Ans: Asset = Cash ` 2,39,000 + Furniture ` 35,000 + Goods ` 20,000 =
` 2,94,000; Liabilities = Creditors ` 40,000 + Capital ` 2,54,000= ` 2,94,000)
3. Mohit has the following transactions, prepare accounting equation:
(a) Business started with cash ` 1,75,000
(b) Purchased goods from Rohit ` 50,000
(c) Sales goods on credit to Manish (Costing ` 17,500) ` 20,000
(d) Purchased furniture for office use ` 10,000
(e) Cash paid to Rohit in full settlement ` 48,500
(f) Cash received from Manish ` 20,000
(g) Rent paid ` 1,000
(h) Cash withdrew for personal use ` 3,000
(Ans: Cash ` 1,32,500 + Goods ` 32,500 + Furniture ` 10,000
= ` 1,75,000; Liabilition = Capital ` 1,75,000)
4. Rohit has the following transactions :
(a) Commenced business with cash `1,50,000
(b) Purchased machinery on credit ` 40,000
(c) Purchased goods for cash ` 20,000
(d) Purchased car for personal use ` 80,000
(e) Paid to creditors in full settlement ` 38,000
(f) Sold goods for cash costing ` 5,000 ` 4,500
(g) Paid rent ` 1,000
(h) Commission received in advance ` 2,000
Prepare the Accounting Equation to show the effect of the above transactions
on the assets, liabilities and capital.
(Ans: Assets = Cash ` 17,500 + Machine ` 40,000 + Goods ` 15,000
= ` 72,500; Liabilities = Commission ` 2,000 + Capital ` 70,500
= ` 72,500)
5. Use accounting equation to show the effect of the following transactions of
M/s Royal Traders:
(a) Started business with cash `1,20,000
(b) Purchased goods for cash ` 10,000
(c) Rent received ` 5,000
(d) Salary outstanding ` 2,000
(e) Prepaid Insurance ` 1,000
(f) Received interest ` 700

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(g) Sold goods for cash (Costing ` 5,000) ` 7,000

(h) Goods destroyed by fire ` 500
(Ans: Assets = Cash ` 1,21,200 + Goods ` 4,500 + Prepaid insurance
` 1,000; Liabilities = Outstanding salary ` 2,000 + Capital ` 1,25,200)
6. Show the accounting equation on the basis of the following transaction:
(a) Udit started business with:
(i) Cash ` 5,00,000
(ii) Goods ` 1,00,000
(b) Purchased building for cash ` 2, 00,000
(c) Purchased goods from Himani ` 50,000
(d) Sold goods to Ashu (Cost ` 25,000) ` 36, 000
(e) Paid insurance premium ` 3,000
(f) Rent outstanding ` 5,000
(g) Depreciation on building ` 8,000
(h) Cash withdrawn for personal use ` 20,000
(i) Rent received in advance ` 5,000
(j) Cash paid to himani on account ` 20,000
(k) Cash received from Ashu ` 30,000
(Ans : Assets = Cash ` 2,92,000 + Goods ` 1,25,000 + Building
` 1,92,000 + Debtors ` 6,000 = 6,15,000: Laibilities = Creditors
` 30,000 + Outstanding Rent ` 5,000 + Accounts receiavable ` 5,000 + Capital
` 5,75,000 = ` 6,15,000)
7. Show the effect of the following transactions on Assets, Liabilities and
Capital through accounting equation:
(a) Started business with cash ` 1,20,000
(b) Rent received ` 10,000
(c) Invested in shares ` 50,000
(d) Received dividend ` 5,000
(e) Purchase goods on credit from Ragani ` 35,000
(f) Paid cash for house hold Expenses ` 7,000
(g) Sold goods for cash (costing `10,000) ` 14,000
(h) Cash paid to Ragani ` 35,000
(i) Deposited into bank ` 20,000
(Ans: Assets = Cash ` 37,000 + Shares ` 50,000 + Goods ` 25,000 + Bank
` 20,000 = ` 1,32,000; Liabilities = Capital ` 1,32,000)
8. Show the effect of following transaction on the accounting equation:
(a) Manoj started business with
(i) Cash ` 2,30,000
(ii) Goods ` 1,00,000
(iii) Building ` 2,00,000

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Recording of Transactions - I 91

(b) He purchased goods for cash ` 50,000

(c) He sold goods (costing `20,000) ` 35,000
(d) He purchased goods from Rahul ` 55,000
(e) He sold goods to Varun (Costing ` 52,000) ` 60,000
(f) He paid cash to Rahul in full settlement ` 53,000
(g) Salary paid by him ` 20,000
(h) Received cash from Varun in full settlement ` 59,000
(i) Rent outstanding ` 3,000
(j) Prepaid Insurance ` 2,000
(k) Commission received by him ` 13, 000
(l) Amount withdrawn by him for personal use ` 20,000
(m) Depreciation charge on building ` 10,000
(n) Fresh capital invested ` 50,000
(o) Purchased goods from Rakhi ` 10,000
(Ans: Assets = Cash ` 2,42,000 + Goods ` 1,43,000 +Building `1,90,000 +
Prepaid Insurouce ` 2,000 = ` 5,77,000; Liabilities = Outstanding Rent ` 3,000
+ Creditor ` 10,000 + Capital ` 5,64,000 = ` 5,77,000)

9. Transactions of M/s Vipin Traders are given below.

Show the effects on Assets, Liabilities and Capital with the help of accounting
Equation.
(a) Business started with cash ` 1,25,000
(b) Purchased goods for cash ` 50,000
(c) Purchase furniture from R.K. Furniture ` 10,000
(d) Sold goods to Parul Traders (Costing ` 7,000 vide `9,000
bill no. 5674)
(e) Paid cartage ` 100
(f) Cash Paid to R.K. furniture in full settlement ` 9,700
(g) Cash sales (costing `10,000) ` 12,000
(h) Rent received ` 4,000
(i) Cash withdrew for personal use ` 3,000
(Ans: Asset = cash ` 78,200 + Goods ` 33,000 + Furniture ` 10,000 Debtors
` 9,000 = ` 1,30,200; Liabilities = Capital ` 1,30,200)
10. Bobby opened a consulting firm and completed these transactions during
November, 2017:
(a) Invested ` 4,00,000 cash and office equipment with ` 1,50,000 in a
business called Bobbie Consulting.
(b) Purchased land and a small office building. The land was worth
` 1,50,000 and the building worth ` 3, 50,000. The purchase price was

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92 Accountancy

paid with ` 2,00,000 cash and a long term note payable for
` 3,00,000.
(c) Purchased office supplies on credit for ` 12,000.
(d) Bobbie transferred title of motor car to the business. The motor car
was worth ` 90,000.
(e) Purchased for ` 30,000 additional office equipment on credit.
(f) Paid ` 75,00 salary to the office manager.
(g) Provided services to a client and collected ` 30,000
(h) Paid ` 4,000 for the month’s utilities.
(i) Paid supplier created in transaction c.
(j) Purchase new office equipment by paying ` 93,000 cash and trading in
old equipment with a recorded cost of ` 7,000.
(k) Completed services of a client for ` 26,000. This amount is to be paid
within 30 days.
(l) Received ` 19,000 payment from the client created in transaction k .
(m) Bobby withdrew ` 20,000 from the business.
Analyse the above stated transactions and open the following T-accounts:
Cash, client, office supplies, motor car, building, land, long term payables,
capital, withdrawals, salary, expense and utilities expense.

Journalising
11. Journalise the following transactions in the books of Himanshu:
2017 `
Dec.01 Business started with cash 75,000
Dec.07 Purchased goods for cash 10,000
Dec.09 Sold goods to Swati 5,000
Dec.12 Purchased furniture 3,000
Dec.18 Cash received from Swati In full settlement 4,000
Dec.25 Paid rent 1,000
Dec.30 Paid salary 1,500
12. Enter the following Transactions in the Journal of Mudit :
2017 `
Jan.01 Commenced business with cash 1,75,000
Jan.01 Building 1,00,000
Jan.02 Goods purchased for cash 75,000
Jan.03 Sold goods to Ramesh 30,000
Jan.04 Paid wages 500
Jan.06 Sold goods for cash 10,000
Jan.10 Paid for trade expenses 700

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Recording of Transactions - I 93

Jan.12 Cash received from Ramesh 29,500

Discount allowed 500
Jan.14 Goods purchased for Sudhir 27,000
Jan.18 Cartage paid 1,000
Jan.20 Drew cash for personal use 5,000
Jan.22 Goods use for house hold 2,000
Jan.25 Cash paid to Sudhir 26,700
Discount allowed 300
13. Journalise the following transactions:
2017 `
Dec. 01 Hema started business with cash 1,00,000
Dec. 02 Open a bank account with SBI 30,000
Dec. 04 Purchased goods from Ashu 20,000
Dec.06 Sold goods to Rahul for cash 15,000
Dec.10 Bought goods from Tara for cash 40,000
Dec.13 Sold goods to Suman 20,000
Dec.16 Received cheque from Suman 19,500
Discount allowed 500
Dec.20 Cheque given to Ashu on account 10,000
Dec.22 Rent paid by cheque 2,000
Dec.23 Deposited into bank 16,000
Dec.25 Machine purchased from Parigya 10,000
Dec.26 Trade expenses 2,000
Dec.28 Cheque issued to Parigya 10,000
Dec.29 Paid telephone expenses by cheque 1,200
Dec.31 Paid salary 4,500
14. Jouranlise the following transactions in the books of Harpreet Bros.:
(a) `1,000 due from Rohit are now bad debts.
(b) Goods worth `2,000 were used by the proprietor.
(c) Charge depreciation @ 10% p.a for two month on machine costing
`30,000.
(d) Provide interest on capital of ` 1,50,000 at 6% p.a. for 9 months.
(e) Rahul become insolvent, who owed is ` 2,000 a final dividend of
60 paise in a rupee is received from his estate.
15. Prepare Journal from the transactions given below :
(a) Cash paid for installation of machine ` 500
(b) Goods given as charity ` 2,000

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94 Accountancy

(c) Interest charge on capital @7% p.a. when total ` 70,000

capital were
(d) Received `1,200 of a bad debts written-off last year.
(e) Goods destroyed by fire ` 2,000
(f) Rent outstanding ` 1,000
(g) Interest on drawings ` 900
(h) Sudhir Kumar who owed me ` 3,000 has failed to pay the amount. He
pays me a compensation of 45 paise in a rupee.
(i) Commission received in advance ` 7,000

Posting
16. Journalise the following transactions, post to the ledger:
2017 `
Nov. 01 Business started with (i) Cash 1,50,000
(ii) Goods 50,000
Nov. 03 Purchased goods from Harish 30,000
Nov. 05 Sold goods for cash 12,000
Nov. 08 Purchase furniture for cash 5,000
Nov. 10 Cash paid to Harish on account 15,000
Nov. 13 Paid sundry expenses 200
Nov. 15 Cash sales 15,000
Nov. 18 Deposited into bank 5,000
Nov. 20 Drew cash for personal use 1,000
Nov. 22 Cash paid to Harish in full settlement of account 14,700
Nov. 25 Good sold to Nitesh 7,000
Nov. 26 Cartage paid 200
Nov. 27 Rent paid 1,500
Nov. 29 Received cash from Nitesh 6,800
Discount allowed 200
Nov. 30 Salary paid 3,000
17. Journalise the following transactions is the journal of M/s Goel
Brothers and post them to the ledger.
2017 `
Jan. 01 Started business with cash 1,65,000
Jan. 02 Opened bank account in PNB 80,000
Jan. 04 Goods purchased from Tara 22,000
Jan. 05 Goods purchased for cash 30,000
Jan. 08 Goods sold to Naman 12,000
Jan. 10 Cash paid to Tara 22,000

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Recording of Transactions - I 95

Jan. 15 Cash received from Naman 11,700

Discount allowed 300
Jan. 16 Paid wages 200
Jan. 18 Furniture purchased for office use 5,000
Jan. 20 withdrawn from bank for personal use 4,000
Jan. 22 Issued cheque for rent 3,000
Jan. 23 goods issued for house hold purpose 2,000
Jan. 24 drawn cash from bank for office use 6,000
Jan. 26 Commission received 1,000
Jan. 27 Bank charges 200
Jan. 28 Cheque given for insurance premium 3,000
Jan. 29 Paid salary 7,000
Jan. 30 Cash sales 10,000
18 Give journal entries of M/s Mohit traders, Post them to the Ledger
from the following transactions :
August 2017 `
1. Commenced business with cash 1,10,000
2. Opened bank account with H.D.F.C. 50,000
3. Purchased furniture 20,000
7. Bought goods for cash from M/s Rupa Traders 30,000
8. Purchased good from M/s Hema Traders 42,000
10. Sold goods for cash 30,000
14. Sold goods on credit to M/s. Gupta Traders 12,000
16. Rent paid 4,000
18. Paid trade expenses 1,000
20. Received cash from Gupta Traders 12,000
22. Goods return to Hema Traders 2,000
23. Cash paid to Hema Traders 40,000
25. Bought postage stamps 100
30. Paid salary to Rishabh 4,000
19. Journalise the following transaction in the Books of the M/s Bhanu
Traders and Post them into the Ledger.
December, 2017 `
1. Started business with cash 92,000
2. Deposited into bank 60,000
4. Bought goods on credit from Himani 40,000
6. Purchased goods from cash 20,000
8. Returned goods to Himani 4,000
10. Sold goods for cash 20,000
14. Cheque given to Himani 36,000

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96 Accountancy

17. Goods sold to M/s Goyal Traders. 3,50,000

19. Drew cash from bank for personal use 2,000
21. Goyal traders returned goods 3,500
22. Cash deposited into bank 20,000
26. Cheque received from Goyal Traders 31,500
28. Goods given as charity 2,000
29. Rent paid 3,000
30. Salary paid 7,000
31. Office machine purchased for cash 3,000
20. Journalise the following transaction in the Book of M/s Beauti
traders. Also post them in the ledger.
Dec. 2017 `
1. Started business with cash 2,00,000
2. Bought office furniture 30,000
3. Paid into bank to open an current account 1,00,000
5. Purchased a computer and paid by cheque 2,50,000
6. Bought goods on credit from Ritika 60,000
8. Cash sales 30,000
9. Sold goods to Karishna on credit 25,000
12. Cash paid to Mansi on account 30,000
14. Goods returned to Ritika 2,000
15. Stationery purchased for cash 3,000
16. Paid wages 1,000
18. Goods returned by Karishna 2,000
20. Cheque given to Ritika 28,000
22. Cash received from Karishna on account 15,000
24. Insurance premium paid by cheque 4,000
26. Cheque received from Karishna 8,000
28. Rent paid by cheque 3,000
29. Purchased goods on credit from Meena Traders 20,000
30. Cash sales 14,000
21. Journalise the following transaction in the books of Sanjana and
post them into the ledger :
January, 2017 `
1. Cash in hand 6,000
Cash at bank 55,000
Stock of goods 40,000
Due to Rohan 6,000
Due from Tarun 10,000

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Recording of Transactions - I 97

3. Sold goods to Karuna 15,000

4. Cash sales 10,000
6. Goods sold to Heena 5,000
8. Purchased goods from Rupali 30,000
10. Goods returned from Karuna 2,000
14. Cash received from Karuna 13,000
15. Cheque given to Rohan 6,000
16. Cash received from Heena 3,000
20. Cheque received from Tarun 10.000
22. Cheque received from to Heena 2,000
25. Cash given to Rupali 18,000
26. Paid cartage 1,000
27. Paid salary 8,000
28. Cash sale 7,000
29. Cheque given to Rupali 12,000
30. Sanjana took goods for Personal use 4,000
31. Paid General expense 500
22. Record journal entries for the following transactions in the books of
Anudeep of Delhi:
(a) Bought goods ` 2,00,000 from Kanta of Delhi (CGST @ 9%, SGST @ 9%)
(b) Bought goods ` 1,00,000 for cash from Rajasthan (IGST @ 12%)
(c) Sold goods ` 1,50,000 to Sudhir of Punjab (IGST @ 18%)
(d) Paid for Railway Transport ` 10,000 (CGST @ 5%, SGST @ 5%)
(e) Sold goods ` 1,20,000 to Sidhu of Delhi (CGST @ 9%, SGST @ 9%)
(f) Bought Air-Condition for office use ` 60,000 (CGST @ 9%, SGST @ 9%)
(g) Sold goods ` 1,50,000 for cash to Sunil to Uttar Pradesh (IGST 18%)
(h) Bought Motor Cycle for business use ` 50,000 (CGST 14%, SGST @ 14%)
(i) Paid for Broadband services ` 4,000 (CGST @ 9%, SGST @ 0%)
(j) Bought goods ` 50,000 from Rajesh, Delhi (CGST @ 9%, SGST @ 9%)

Checklist to Test Your Understanding

Test Your Understanding - I
1. (iii), 2 (Capital increases by net profit and fresh capital introduced, decreases by drawings
and net loss), 3 (No), 4 (ii)
Test Your Understanding - II
1. Cash account and capital account, Assets and Liabilities, Assest increase
and capital increase.
2. Purchase account and Remesh account, Expenses and Liabilities, Expenses
and Liabilities increases.

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98 Accountancy

3. Cash account and sales account, Assets and Revenues, Assets and Revenues
increases.
4. Salaries account and cash account, Expense and Assets, Expenses increases A s s e t s
decreases.
5. Furniture account and Cash account, Asset increases Asset decreases.
6. Loan account and Bank, Liability and Asset, Liabilities increases Asset
decreases.
7. Sarita account and Sales account, Asset and Revenue, Assets decreases
Revenue decreases.
8. Ramesh account and Cash, liabilities and Assets, Liabilities decreases Assets
increases.
9. Rent account and Cash account, Expense and Assets, Expenses increases Assets
decreases.
Test Your Understanding - III
1(d), 2(d), 3(b), 4(b), 5(d), 6(c), 7(a)
Test your understanding - IV
1. Rent 2. Debtors 3. Cash
4. Machine 5. Creditors 6. Office stationary
7. Debtors
Test Your Understanding - V
1 (iv), 2 (i), 3 (i), 4 (ii), 5 (iii), 6 (iv), 7 (iv), 8 (iv), 9 (iii).

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160 Accountancy

Bank Reconciliation Statement 5

I n chapter 4, you have learnt that

the business organisations keep a record of their
cash and bank transactions in a cash book. The
cash book also serves the purpose of both the cash
account and the bank account and shows the
balance of both at the end of the period.
Once the cash book has been balanced, it is
usual to check its details with the records of the
firm’s bank transactions as recorded by the bank.
To enable this check, the cashier needs to ensure
that the cash book is completely up to date and a
recent bank statement (or a bank passbook) has
been obtained from the bank. A bank statement
or a bank passbook is a copy of a bank account as
LEARNING OBJECTIVES shown by the bank records. This enable the bank
After studying this customers to check their funds in the bank
chapter, you will be able regularly and update their own records of
to : transactions that have occurred. An illustrative
• state the meaning and bank passbook of a current account is shown in
need for the preparation figure 5.1.
of bank reconciliation
statement; The amount of balance shown in the passbook
• identify causes of or the bank statement must tally with the balance
difference between as shown in the cash book. But in practice, these
bank balance as per are usually found to be different. Hence, we have
cash book and pass to ascertain the causes for such difference. It will
book;
be observed that a bank statement/passbook
• prepare the bank
reconciliation statement;
shows all deposits in the credit column and
• ascertain the correct withdrawals in the debit column. Thus, if deposits
bank balance as per exceed withdrawals it shows a credit balance and
cash book; if withdrawals exceed deposits it will show a debit
balance (overdraft).

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Bank Reconciliation Statement 161

5.1 Need for Reconciliation

It is generally experienced that when a comparison is made between the bank
balance as shown in the firm’s cash book, the two balances do not tally.
Hence, we have to first ascertain the causes of difference thereof and then
reflect them in a statement called Bank Reconciliation Statement to reconcile
(tally) the two balances.
In order to prepare a bank reconciliation statement we need to have a
bank balance as per the cash book and a bank statement as on a particular
day along with details of both the books. If the two balances differ, the entries
in both the books are compared and the items on account of which the
difference has arisen are ascertained with the respective amounts involved so
that the bank reconciliation statement may be prepared. Its format shown in
figure 5.5.

Particulars Amount
`
Balance as per cash book .......
Add: Cheques issued but not presented .......
Interest credited by the bank .......
.......
Less: Cheques deposited but not credited by the bank .......
Bank charges not recorded in the cash book .......
Balance as per the passbook xxxx

Fig. 5.2 : Proforma of bank reconciliation statement

It can also be prepared with two amount columns one showing additions (+
column) and another showing deductions (-column). For convenience, we usually
adopt this treatment.

Particulars Amount Amount

` `
(+) (–)
Balance as per cash book ......
Cheques issued but not presented ` ......
Interest credited by the bank ......
Cheque deposited but not credited by the bank ......
Bank charges not recorded in the cash book ......
Balance as per the passbook. xxxx

Fig. 5.3 : Proforma of bank reconcitiation statement (table form)

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 162
DHERENDRA NATIONAL BANK MULTI-MODULE PACKAGE DATE : 30/09/2016
CONNAUGHT PLACE STATEMENT OF ACCOUNT OP.ID : GK
FROM 01/08/2016 TO 30/09/2016 PAGE NO. : 1
ACCOUNT NO. 03355
NAME : DEV PANDIT
KHADWAI, RUNAKUTA, DELHI-34

DATE PARTICULARS CHEQUE DEBIT CREDIT BALANCE + REMARKS

No. ` P. ` P. ` P.

Opening 50,782.30 +
Balance :
04/08/2016 DELHI PLA 356376 35,000.00 15,782.30 +
07/08/2016 TO SELF 356377 10,000.00 5,782.30 +
13/08/2016 BY CLG 10,673,00 16,455,30 +
13/08/2016 BY CLG 9,143.00 25,598.30 +
17/08/2016 TO SELF 356378 20,000.00 5,598.30 +
21/08/2016 BY CLG 25,808.00 31,406.30 +
26/08/2016 BY CLG 32,949.00 64,355,30 +
02/09/2016 To SELF 356381 30,000.00 34,355.30 +
04/09/2016 DELHI PLASTIC 356382 10,000.00 24,355.30 +
08/09/2016 ICICI 657755 6,074.00 18,281.30 +
09/09/2016 BY CLG 3,146.00 21,427.30 +
13/09/2016 TO SELF 356380 9,500,00 11,927.30 +
15/09/2016 BY CLG 5,320.00 17,247.30 +
15/09/2016 BY CLG 18,564.00 35,811.30 +
16/09/2016 TO SERVICE CHARGES 120.00 35,691.30 +
21/09/2016 TO SELF 356383 20,000.00 15,691.30 +
25/09/2016 TO SELF 356385 10,000.00 5,691.30 +
27/09/2016 BY CLG 16,198.00 21,889.30 +

FOR DHERENDRA NATIONAL BANK

ACCOUNTANT/MANAGER

Accountancy
Fig. 5.1 : Specimen of bank statement (current account)

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Bank Reconciliation Statement 163

Reconciliation of the cash book and the bank passbook balances amounts
to an explanation of differences between them. The differences between the
cash book and the bank passbook is caused by:
• timing differences on recording of the transactions.
• errors made by the business or by the bank.

5.1.1 Timing Differences

When a business compares the balance of its cash book with the balance
shown by the bank passbook, there is often a difference, which is caused
by the time gap in recording the transactions relating either to payments
or receipts. The factors affecting time gap includes :

5.1.1(a) Cheques issued by the bank but not yet presented for payment
When cheques are issued by the firm to suppliers or creditors of the firm,
these are immediately entered on the credit side of the cash book. However,
the receiving party may not present the cheque to the bank for payment
immediately. The bank will debit the firm’s account only when these cheques
are actually paid by the bank. Hence, there is a time lag between the issue of
a cheque and its presentation to the bank which may cause the difference
between the two balances.

5.1.1(b) Cheques paid into the bank but not yet collected
When firm receives cheques from its customers (debtors), they are
immediately recorded in the debit side of the cash book. This increases
the bank balance as per the cash book. However, the bank credits the
customer account only when the amount of cheques are actually realised.
The clearing of cheques generally takes few days especially in case of
outstation cheques or when the cheques are paid-in at a bank branch
other than the one at which the account of the firm is maintained. This
leads to a cause of difference between the bank balance shown by the
cash book and the balance shown by the bank passbook.

5.1.1(c) Direct debits made by the bank on behalf of the customer

Sometimes, the bank deducts amount for various services from the account
without the firm’s knowledge. The firm comes to know about it only when
the bank statement arrives. Examples of such deductions include: cheque
collection charges, incidental charges, interest on overdraft, unpaid cheques
deducted by the bank – i.e., stopped or bounced, etc. As a result, the balance
as per passbook will be less than the balance as per cash book.

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164 Accountancy

5.1.1(d) Amounts directly deposited in the bank account

There are instances when debtors (customers) directly deposits money into firm’s
bank account. But, the firm does not receive the intimation from any source till
it receives the bank statement. In this case, the bank records the receipts in the
firm’s account at the bank but the same is not recorded in the firm’s cash book.
As a result, the balance shown in the bank passbook will be more than the
balance shown in the firm’s cash book.

5.1.1(e) Interest and dividends collected by the bank

When the bank collects interest and dividend on behalf of the customer, then these
are immediately credited to the customers account. But the firm will know about
these transactions and record the same in the cash book only when it receives a
bank statement. Till then the balances as per the cash book and passbook will
differ.

5.1.1(f) Direct payments made by the bank on behalf of the customers

Sometimes the customers give standing instructions to the bank to make some
payment regularly on stated days to the third parties. For example, telephone
bills, insurance premium, rent, taxes, etc. are directly paid by the bank on behalf
of the customer and debited to the account. As a result, the balance as per the
bank passbook would be less than the one shown in the cash book.

5.1.1(g) Cheques deposited/bills discounted dishonoured

If a cheque deposited by the firm is dishonoured or a bill of exchange drawn by
the business firm is discounted with the bank is dishonoured on the date of
maturity, the same is debited to customer’s account by the bank. As this
information is not available to the firm immediately, there will be no entry in
the firm’s cash book regarding the above items. This will be known to the firm
when it receives a statement from the bank. As a result, the balance as per
the passbook would be less than the cash book balance.

5.1.2 Differences Caused by Errors

Sometimes the difference between the two balances may be accounted for by
an error on the part of the bank or an error in the cash book of the business.
This causes difference between the bank balance shown by the cash book
and the balance shown by the bank statement.

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Bank Reconciliation Statement 165

5.1.2(a) Errors committed in recording transaction by the firm

Omission or wrong recording of transactions relating to cheques issued, cheques
deposited and wrong totalling, etc., committed by the firm while recording entries
in the cash book cause difference between cash book and passbook balance.

5.1.2(b) Errors committed in recording transactions by the bank

Omission or wrong recording of transactions relating to cheques deposited
and wrong totalling, etc., committed by the bank while posting entries in the
passbook also cause differences between passbook and cash book balance.

Test Your Understanding - I

I. Read the following transactions and identify the cause of difference on the basis of
time gap or errors made by business firm/bank. Put a sign (ü ) for the correct
cause.

S.No. Transactions Time Gap Errors

made by
business/
bank
1. Cheques issued to customers but not
presented for payment.
2. Cheque amounting to ` 5,000 issued
to M/s. XYZ but recorded as ` 500
in the cash book.
3. Interest credited by the bank but yet
not recorded in the cash book.
4. Cheque deposited into the bank but
not yet collected by the bank.
5. Bank charges debited to firm’s current
account by the bank.

II. Fill in the blanks :

(i) Passbook is a copy of.............as it appears in the ledger of the bank.
(ii) When money is with drawn from the bank, the bank ............. the account of
the customer.
(iii) Normally, the cash book shows a debit balance, passbook shows
.............balance.
(iv) Favourable balance as per the cash book means .............balance in the bank
column of the cash book.

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166 Accountancy

(v) If the cash book balance is taken as starting point the items which make the
cash book balance smaller than the passbook must be .............for the purpose
of reconciliation.
(vi) If the passbook shows a favourable balance and if it is taken as the starting
point for the purpose of bank reconciliation statement then cheques issued
but not presented for payment should be .............to find out cash balance.
(vii) When the cheques are not presented for payment, favourable balance as per
the cash book is .............than that of the passbook.
(viii) When a banker collects the bills and credits the account passbook overdraft
shows .............balance.
(ix) If the overdraft as per the passbook is taken as the starting point, the cheques
issued but not presented are to be .............in the bank reconciliation
statement.
(x) When the passbook balance is taken as the starting point items which makes
the passbook balance .............than the balance in the cash book must be
deducted for the purpose of reconciliation.

5.2 Preparation of Bank Reconciliation Statement

After identifying the causes of difference, the reconciliation may be done in
the following two ways:
(a) Preparation of bank reconciliation statement without adjusting cash book
balance.
(b) Preparation of bank reconciliation statement after adjusting cash book
balance.
It may be noted that in practice, the bank reconciliation statement is
prepared after adjusting the cash book balance, about which you will study
later in the chapter.

5.2.1 Preparation of Bank Reconciliation Statement without adjusting Cash

Book Balance
To prepare bank reconciliation statement, under this approach, the balance
as per cash book or as per passbook is the starting item. The debit balance as
per the cash book means the balance of deposits held at the bank. Such a
balance will be a credit balance as per the passbook. Such a balance exists
when the deposits made by the firm are more than its withdrawals. It indicates
the favourable balance as per cash book or favourable balance as per the
passbook. On the other hand, the credit balance as per the cash book indicates
bank overdraft. In other words, the excess amount withdrawn over the amount
deposited in the bank. It is also known as unfavourable balance as per cash
book or unfavourable balance as per passbook.

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Bank Reconciliation Statement 167

We may have four different situations while preparing the bank reconciliation
statement. These are :
1. When debit balance (favourable balance) as per cash book is given and
the balance as per passbook is to be ascertained.
2. When credit balance (favourable balance) as per passbook is given and
the balance as per cash book is to be ascertained.
3. When credit balance as per cash book (unfavourable balance/overdraft
balance) is given and the balance as per passbook is to ascertained.
4. When debit balance as per passbook (unfavourable balance/overdraft
balance) is given and the cash book balance as per is to ascertained.

5.2.1(a) Dealing with favourable balances

The following steps may be initiated to prepare the bank reconciliation
statement:
(i) The date on which the statement is prepared is written at the top, as
part of the heading.
(ii) The first item in the statement is generally the balance as shown by the
cash book. Alternatively, the starting point can also be the balance as
per passbook.
(iii) The cheques deposited but not yet collected are deducted.
(iv) All the cheques issued but not yet presented for payment, amounts
directly deposited in the bank account are added.
(v) All the items of charges such as interest on overdraft, payment by bank
on standing instructions and debited by the bank in the passbook but
not entered in cash book, bills and cheques dishonoured etc. are
deducted.
(vi) All the credits given by the bank such as interest on dividends collected,
etc. and direct deposits in the bank are added.
(vii) Adjustment for errors are made according to the principles of rectification
of errors. (The rectification of errors has been discussed in detail in
chapter 6.)
(viii) Now the net balance shown by the statement should be same as shown
by the passbook.
It may be noted that treatment of all items shall be the reverse of the above
if we adjust passbook balance as the starting point. (see illustration 3)
The following solved illustrations will help you understand dealing with
favourable balance as per cash book and passbook.

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168 Accountancy

Illustration 1
From the following particulars of Mr. Vinod, prepare bank reconciliation statement as on
March 31, 2017.
1. Bank balance as per cash book ` 50,000.
2. Cheques issued but not presented for payment ` 6,000.
3. The bank had directly collected dividend of ` 8,000 and credited to bank account
but was not entered in the cash book.
4. Bank charges of ` 400 were not entered in the cash book.
5. A cheques for ` 6,000 was deposited but not collected by the bank.

Solution
Bank Reconciliation Statement of Mr. Vinod as on March 31, 2017
Particulars + –
` `

1. Balance as per cash book 50,000

2. Cheques issued but not presented for payment 6,000
3. Dividends collected by the bank 8,000
4. Cheque deposited but not credited by the bank 6,000
5. Bank charges debited by the bank 400
6. Balance as per passbook. 57,600

64,000 64,000

Illustration 2
From the following particulars of Anil & Co. prepare a bank reconciliation statement as
on August 31, 2017.
1. Balance as per the cash book ` 54,000.
2. ` 100 bank incidental charges debited to Anil & Co. account, which is not recorded
in cash book.
3. Cheques for ` 5,400 is deposited in the bank but not yet collected by the bank.
4. A cheque for ` 20,000 is issued by Anil & Co. not presented for payment.

Solution
Bank Reconciliation Statement of Anil & Co. as on August 31, 2017
Particulars (+) (–)
Amount Amount
` `
1. Balance as per cash book 54,000 -
2. Cheqeus issued but not presented for payment 20,000 -
3. Cheques deposited but not credited by the bank - 5,400
4. Bank incidental charges debited by the bank - 100
5. Balance as per passbook - 68,500
74,000 74,000

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Bank Reconciliation Statement 169

Illustration 3
The bank passbook of M/s. Boss & Co. showed a balance of ` 45,000 on May 31, 2017.
1. Cheques issued before May 31, 2017, amounting to ` 25,940 had not been presented
for encashment.
2. Two cheques of ` 3,900 and ` 2,350 were deposited into the bank on May 31 but the
bank gave credit for the same in June, 2017.
3. There was also a debit in the passbook of ` 2,500 in respect of a cheque dishonoured
on 31.5.2017. Prepare a bank reconciliation statement as on
May 31, 2017.

Solution
Bank Reconciliation Statement of Bose & Co as on May 31, 2017
Particulars (+) (–)
Amount Amount
` `
1. Balance as per passbook 45,000
2. Cheques deposited but not collected by the bank 6,250
(` 3,900+ ` 2,350)
3. Cheque dishonoured recorded only in passbook 2,500
4. Cheques issued but not presented for payment 25,940
5. Balance as per cash book 27,810
53,750 53,750

5.2.1(b) Dealing with overdrafts

So far we have dealt with bank reconciliation statement where bank balances
has been positive – i.e., there has been money in the bank account. However,
businesses sometimes have overdrafts at the bank. Overdrafts are where the
bank account becomes negative and the businesses in effect have borrowed
from the bank. This is shown in the cash book as a credit balance. In the
bank statement, where the balance is followed by Dr. (or sometimes OD) means
that there is an overdraft and called debit balance as per passbook.
An overdraft is treated as negative figure on a bank reconciliation statement.
The following solved illustration will help you understand the preparation of
bank reconciliation statement when there is an overdraft.

Illustration 4
On March 31, 2017, Rakesh had on overdraft of ` 8,000 as shown by his cash book.
Cheques amounting to ` 2,000 had been paid in by him but were not collected by the bank.
He issued cheques of ` 800 which were not presented to the bank for payment. There was
a debit in his passbook of ` 60 for interest and ` 100 for bank charges. Prepare bank
reconciliation statement.

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170 Accountancy

Solution
Bank Reconciliation Statement of Rakesh as on April 01, 2017

Particulars (+) (–)

Amount Amount
` `
1. Overdraft as per cash book 8,000
2. Cheques deposited but not yet collectedcharged by the bank 2,000
3. Bank charges 60
4. Cheques issued but not presented for payment 800 100
5. Balance as per bank passbook (overdraft) 9,360
10,160 10,160

Illustration 5
On March 31, 2017 the bank column of the cash book of Agrawal Traders showed a credit
balance of ` 1,18,100 (Overdraft). On examining of the cash book and the bank statement,
it was found that :
1. Cheques received and recorded in the cash book but not sent to the bank of collection
` 12,400.
2. Payment received from a customer directly by the bank ` 27,300 but no entry was
made in the cash book.
3. Cheques issued for ` 1,75,200 not presented for payment.
Interest of ` 8,800 charged by the bank was not entered in the cash book. Prepare
bank reconciliation statement.

Solution
Bank Reconciliation Statement of Agarwal Traders as on March 31, 2017
Particulars (+) (–)
Amount Amount
` `
1. Overdraft as per cash book 1,18,100
2. Cheques received and recorded in the cash book but not 12,400
sent to the bank for collection
3. Interest on bank overdraft debited by the bank but not 8,800
entered in the cash book
4. Payment received from the customer directly 27,300
5. Credited in the bank a/c but not entered in the cash book 1,75,200
6. Cheques issued but not presented for payment
7. Balance as per the passbook (favourable balance) 63,200
2,02,500 2,02,500

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Bank Reconciliation Statement 171

Illustration 6
From the following particulars of Asha & Co. prepare a bank reconciliation statement on
December 31, 2017.
`
Overdraft as per passbook 20,000
Interest on overdraft 2,000
Insurance Premium paid by the bank 200
Cheque issued but not presented for payment 6,500
Cheque deposited but not yet cleared 6,000
Wrongly debited by the bank 500
Solution
Bank Reconciliation Statement of Asha & Co as on December 31, 2017
Particulars (+) (–)
Amount Amount
` `
1. Overdraft as per passbook 20,000
2. Interest on overdraft 2,000
3. Insurance premium paid by the bank 200
4. Cheque issued but not presented for payment 6,500
5. Cheques deposited but not yet cleared 6,000
6. Wrongly debited by the bank 500
7. Balance as per the cash book (overdraft) 17,800
26,500 26,500

Illustration 7
From the following particulars, prepare a bank reconciliation statement as on
March 31, 2017.
(a) Debit balance as per cash book is ` 10,000.
(b) A cheque for ` 1,000 deposited but not recorded in the cash book.
(c) A cash deposit of ` 200 was recorded in the cash book as if there is not bank,
column therein.
(d) A cheque issued for ` 250 was recorded as ` 205 in the cash column.
(e) The debit balance of ` 1,500 as on the previous day was brought forward as a credit
balance.
(f) The payment side of the cash book was under cast by ` 100.
(g) A cash discount allowed of ` 112 was recorded as ` 121 in the bank column.
(h) A cheque of ` 500 received from a debtor was recorded in the cash book but not
deposited in the bank for collection.
(i) One outgoing cheque of ` 300 was recorded twice in the cash book.

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172 Accountancy

Solution
Bank Reconciliation statement as on September 30, 2017
Particulars (+) (–)
Amount Amount
` `
1. Debit balance as per cash book 10,000
2. Error in carrying forward 3,000
3. Cheque recorded twice in cash book 300
4. Cheque deposit not record in bank column 200
5. Cheque deposit but not recorded 1,000
6, Under casting of payment side 100
7. Cheque issued but not entered 250
8. A cash discount wrongly recorded in bank column 121
9. Cheque recorded but not deposited 500
10. Credit balance as per passbook 13,529
14,500 14,500

Illustration 8
From the following particulars, prepare the bank reconciliation statement of Shri Krishan
as on March 31, 2017.
(a) Balance as per passbook is ` 10,000.
(b) Bank collected a cheque of ` 500 on behalf of Shri Krishan but wrongly credited it
to Shri Kishan’s account.
(c) Bank recorded a cash book deposit of ` 1,589 as ` 1,598.
(d) Withdrawal column of the passbook under cast by ` 100.
(e) The credit balance of ` 1,500 as on the pass-book was recorded in the debit balance.
(f) The payment of a cheque of ` 350 was recorded twice in the passbook.
(g) The pass-book showed a credit balance for a cheque of ` 1,000 deposited by Shri
Kishan.
Solution
Bank Reconciliation Statement as on March 31, 2017
Particulars (+) (–)
Amount Amount
` `
1. Credit balance as per passbook 10,000
2. Cheque wrongly credited to another customer account 500
3. Error in carrying forward 3,000
4. Cheque recorded twice 350
5. Excess credit for cash deposit 9
6. Under casting of withdrawal column 100
7. Wrong credit 1,000
8. Debit balance as per cash book 12,741
13,850 13,850

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Bank Reconciliation Statement 173

Test Your Understanding - II

Select the Correct Answer:
1. A bank reconciliation statement is prepared by:
(a) Creditors (b) Bank
(c) Account holder in a bank (d) Debtors
2. A bank reconciliation statement is prepared with the balance:
(a) Passbook (b) Cash book
(c) Both passbook and cash book (d) None of these
3. Passbook is a copy of:
(a) Copy of customer Account (b) Bank column of cash book
(c) Cash column of cash book (d) Copy of receipts and payments
4. Unfavourable bank balance means:
(a) Credit balance in passbook (b) Credit balance in cash book
(c) Debit balance in cash book (d) None of these
5. Favourable bank balance means:
(a) Credit balance in the cash book (b) Credit balance in passbook
(c) Debit balance in the cash book (d) Both (b) and (c)
6. A bank reconciliation statement is mainly prepared for:
(a) Reconcile the cash balance of the cash book.
(b) Reconcile the difference between the bank balance shown
by the cash book and bank passbook
(c) Both (a) and (b)
(d) None of these

Test your Understanding - III

State whether each of the following statements is True or False
1. Passbook is the statement of account of the customer maintained by the bank.
2. A business firm periodically prepares a bank reconciliation statement to reconcile
the bank balance as per the cash book with the passbook as these two show
different balances for various reasons.
3. Cheques issued but not presented for payment will reduce the balance as per
the passbook.
4. Cheques deposited but not collected will result in increasing the balance of the
cash book when compared to passbook.
5. Overdraft as per the passbook is less than the overdraft as per cash book when
there are cheques deposited but not collected by the banker.
6. The debit balance of the bank account as per the cash book should be equal to
the credit balance of the account of the business in the books of the bank.
7. Favourable bank balance as per the cash book will be less than the bank passbook
balance when there are unpresented cheques for payment.
8. Direct collections received by the bank on behalf of the customers would increase
the balance as per the bank passbook when compared to the balance as per the
cash book.
9. When payments made by the bank as per the standing instructions of the customer,
the balance in the passbook will be more when compared to the cash book.

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174 Accountancy

Key Terms Introduced in the Chapter

1. Bank Reconciliation Statement
2. Cash book and Passbook

Summary with Reference to Learning Objectives

1. Bank Reconciliation Statement: A statement prepared to reconcile the bank balance
as per cash book with the balance as per passbook or bank statement, by showing the
items of difference between the two accounts.
2. Causes of difference:
– timing of recoding the transaction.
– error made by business or by the bank.
3. Correct cash balance: It may happen that some of the receipts or payments are missing
from either of the books and errors, if any, need to be rectified. This arise the need to
look at the entries/errors recorded in both statements and other information available
and compute the correct cash balance before reconciling the statements.

Questions for Practice

Short Answers
1. State the need for the preparation of bank reconciliation statement?
2. What is a bank overdraft?
3. Briefly explain the statement ‘wrongly debited by the bank’ with the help of an example.
4. State the causes of difference occurred due to time lag.
5. Briefly explain the term ‘favourable balance as per cash book’.
6. Enumerate the steps to ascertain the correct cash book balance.
Long Answers
1. What is a bank reconciliation statement. Why is it prepared?
2. Explain the reasons where the balance shown by the bank passbook does not agree
with the balance as shown by the bank column of the cash book.
3. Explain the process of preparing bank reconciliation statement with amended
cash balance.

Numerical Questions
Favourable balance of cash book and passbook –
1. From the following particulars, prepare a bank reconciliation statement as at March
31, 2017.
(i) Balance as per cash book ` 3,200
(ii) Cheque issued but not presented for payment ` 1,800
(iii) Cheque deposited but not collected upto March 31, 2014 ` 2,000
(iv) Bank charges debited by bank ` 150
(Ans: Balance as per passbook ` 2,850)

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Bank Reconciliation Statement 175

2. On March 31, 2017 the cash book showed a balance of ` 3,700 as cash at
bank, but the bank passbook made up to same date showed that cheques
for ` 700, ` 300 and ` 180 respectively had not presented for payment, Also,
a cheque amounting to ` 1,200 deposited into the account had not been
credited. Prepare a bank reconciliation statement.
(Ans : Balance as per passbook ` 3,680)
3. The cash book shows a bank balance of ` 7,800. On comparing the cash
book with passbook the following discrepancies were noted:
(a) Cheque deposited in bank but not credited ` 3,000
(b) Cheque issued but not yet present for payment ` 1,500
(c) Insurance premium paid by the bank ` 2,000
(d) Bank interest credit by the bank ` 400
(e) Bank charges ` 100
(d) Directly deposited by a customer ` 4,000
(Ans: Balance as per passbook ` 8,600)
4. Bank balance of ` 40,000 showed by the cash book of Atul on December 31,
2016. It was found that three cheques of ` 2,000, ` 5,000 and
` 8,000 deposited during the month of December were not credited in the
passbook till January 02, 2017. Two cheques of ` 7,000 and ` 8,000 issued
on December 28, were not presented for payment till January 03, 2017. In
addition to it bank had credited Atul for ` 325 as interest and had debited
him with ` 50 as bank charges for which there were no corresponding entries
in the cash book.
Prepare a bank reconciliation statement as on December 31, 2016.
(Ans: Balance as per passbook ` 40,275)
5. On comparing the cash book with passbook of Naman it is found that on
March 31, 2014, bank balance of ` 40,960 showed by the cash book differs
from the bank balance with regard to the following:
(a) Bank charges ` 100 on March 31, 2017, are not entered in the cash book.
(b) On March 21, 2017, a debtor paid ` 2,000 into the company’s bank in
settlement of his account, but no entry was made in the cash book of
the company in respect of this.
(c) Cheques totaling ` 12,980 were issued by the company and duly recorded
in the cash book before March 31, 2017, but had not been presented at
the bank for payment until after that date.
(d) A bill for ` 6,900 discounted with the bank is entered in the cash book
without recording the discount charge of ` 800.
(e) ` 3,520 is entered in the cash book as paid into bank on March 31st,
2017, but not credited by the bank until the following day.
(f) No entry has been made in the cash book to record the dishon or on
March 15, 2017 of a cheque for ` 650 received from Bhanu.
Prepare a reconciliation statement as on March 31, 201.
(Ans: Balance as per passbook ` 50,870)

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176 Accountancy

6. Prepare bank reconciliation statement as on December 31, 2017. This day

the passbook of Mr. Himanshu showed a balance of ` 7,000.
(a) Cheques of ` 1,000 directly deposited by a customer.
(b) The bank has credited Mr. Himanshu for ` 700 as interest.
(c) Cheques for ` 3000 were issued during the month of December but of
these cheques for ` 1,000 were not presented during the month of
December.
(Ans: Balance as per cash book ` 3,300).
7. From the following particulars prepare a bank reconciliation statement
showing the balance as per cash book on December 31, 2016.
(a) Two cheques of ` 2,000 and ` 5,000 were paid into bank in October,
2016 but were not credited by the bank in the month of December.
(b) A cheque of ` 800 which was received from a customer was entered in
the bank column of the cash book in December 2016 but was omitted
to be banked in December, 2016.
(c) Cheques for ` 10,000 were issued into bank in November 2016 but not
credited by the bank on December 31, 2016.
(d) Interest on investment ` 1,000 collected by bank appeared in the
passbook.
Balance as per Passbook was ` 50,000
(Ans: Balance as per cash book ` 47,800)
8. Balance as per passbook of Mr. Kumar is 3,000.
(a) Cheque paid into bank but not yet cleared
Ram Kumar ` 1,000
Kishore Kumar ` 500
(b) Bank Charges ` 300
(c) Cheque issued but not presented
Hameed ` 2,000
Kapoor ` 500
(d) Interest entered in the passbook but not entered in the cash book ` 100
Prepare a bank reconciliation statement.
(Ans: Balance as per cash book ` 2,200).
9. The passbook of Mr. Mohit current account showed a credit Balance of
` 20,000 on dated December 31, 2016. Prepare a Bank Reconciliation
Statement with the following information.
(i) A cheque of ` 400 drawn on his saving account has been shown on
current account.
(ii) He issued two cheques of ` 300 and ` 500 on of December 25, but only
the Ist cheque was presented for payment.
(iii) One cheque issued by Mr. Mohit of ` 500 on December 25, but it was
not presented for payment whereas it was recorded twice in the cash
book.
(Ans: Balance as per cash book ` 18,900).

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Bank Reconciliation Statement 177

Unfavourable balance of cash book

10. On Ist January 2017, Rakesh had an overdraft of ` 8,000 as showed by his
cash book. Cheques amounting to ` 2,000 had been paid in by him but were
not collected by the bank by January 01, 2017. He issued cheques of ` 800
which were not presented to the bank for payment up to that day. There
was a debit in his passbook of ` 60 for interest and ` 100 for bank charges.
Prepare bank reconciliation statement for comparing both the balance.
(Ans: Overdraft as per passbook ` 9,360)
11. Prepare bank reconciliation statement.
(i) Overdraft shown as per cash book on December 31, 2017 ` 10,000.
(ii) Bank charges for the above period also debited in the passbook
` 100.
(iii) Interest on overdraft for six months ending December 31, 2017
` 380 debited in the passbook.
(iv) Cheques issued but not incashed prior to December 31, 2017
amounted to ` 2,150.
(v) Interest on Investment collected by the bank and credited in the
passbook ` 600.
(vi) Cheques paid into bank but not cleared before December, 31, 2017
were ` 1,100.
(Ans: overdraft as per passbook ` 8,830).
12. Kumar find that the bank balance shown by his cash book on December
31, 2017 is ` 90,600 (Credit) but the passbook shows a difference due to
the following reason:
A cheque (post dated) for ` 1,000 has been debited in the bank column of
the cash book but not presented for payment. Also, a cheque for
` 8,000 drawn in favour of Manohar has not yet been presented for
payment. Cheques totaling ` 1,500 deposited in the bank have not yet
been collected and cheque for ` 5,000 has been dishonoured.
(Ans: overdraft as per passbook ` 90,100).
13. On December 31, 2017, the cash book of Mittal Bros. Showed an overdraft
of ` 6,920. From the following particulars prepare a Bank Reconciliation
Statement and ascertain the balance as per passbook.
(1) Debited by bank for ` 200 on account of Interest on overdraft and
` 50 on account of charges for collecting bills.
(2) Cheques drawn but not encashed before December, 31, 2017 for
` 4,000.
(3) The bank has collected interest and has credited ` 600 in passbook.
(4) A bill receivable for ` 700 previously discounted with the bank had
been dishonoured and debited in the passbook.
(5) Cheques paid into bank but not collected and credited before
December 31, 2017 amounted ` 6,000.
(Ans: Overdraft as per passbook ` 9,170).

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178 Accountancy

Unfavourable balance of the passbook

14. Prepare bank reconciliation statement of Shri Bhandari as on March
31, 2017
(i) The Payment of a cheque for ` 550 was recorded twice in the passbook.
(ii) Withdrawal column of the passbook under cast by ` 200
(iii) A Cheque of ` 200 has been debited in the bank column of the Cash
Book but it was not sent to bank at all.
(iv) A Cheque of ` 300 debited to Bank column of the cash book was not
sent to the bank.
(v) ` 500 in respect of dishonoured cheque were entered in the passbook
but not in the cash book.
Overdraft as per passbook is ` 20,000.
(Ans: Overdraft as per cash book ` 21,350).
15. Overdraft shown by the passbook of Mr. Murli is ` 20,000. Prepare bank
reconciliation statement on dated March 31, 2017.
(i) Bank charges debited as per passbook ` 500.
(ii) Cheques recorded in the cash book but not sent to the bank for
collection ` 2,500.
(iii) Received a payment directly from customer ` 4,600.
(iv) Cheque issued but not presented for payment ` 6,980.
(v) Interest credited by the bank ` 100.
(vi) LIC paid by bank ` 2,500.
(vii) Cheques deposited with the bank but not collected ` 3,500.
(Ans: Overdraft as per cash book ` 22,680).
16. Raghav & Co. have two bank accounts. Account No. I and Account No. II.
From the following particulars relating to Account No. I, find out the balance
on that account of March 31, 2017 according to the cash book of
the firm.
(i) Cheques paid into bank prior to March 31, 2017, but not credited for
` 10,000.
(ii) Transfer of funds from account No. II to account no. I recorded by
the bank on March 31, 2017 but entered in the cash book after that
date for ` 8,000.
(iii) Cheques issued prior to March 31, 2017 but not presented until after
that date for ` 7,429.
(iv) Bank charges debited by bank not entered in the cash book for
` 200.
(v) Interest Debited by the bank not entered in the cash book ` 580.
(vi) Overdraft as per Passbook ` 18,990.
(Ans: Overdraft as per cash book ` 23,639).
17. Prepare a bank reconciliation statement from the following particulars
and show the balance as per cash book.

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Bank Reconciliation Statement 179

(i) B a l a n c e a s p e r p a s s b o o k o n March 3 1 , 2 0 1 7 o v e r d r a w n
` 20,000.
(ii) Interest on bank overdraft not entered in the cash book ` 2,000.
(iii) ` 200 insurance premium paid by bank has not been entered in the
cash book.
(iv) Cheques drawn in the last week of March 2017, but not cleared till
date for ` 3,000 and ` 3,500.
(v) Cheques deposited into bank on February 2017, but yet to be credited
on dated March 31, 2017 ` 6,000.
(vii) Wrongly debited by bank ` 500.
(Ans: Overdraft as per cash book ` 17,800).
18. The passbook of Mr. Randhir showed an overdraft of ` 40,950 on March 31,
2017.
Prepare bank reconciliation statement on March 31, 2017.
(i) Out of cheques amounting to ` 8,000 drawn by Mr. Randhir on March
27 a cheque for ` 3,000 was encashed on April 2017.
(ii) Credited by bank with ` 3,800 for interest collected by them, but the
amount is not entered in the cash book.
(iii) ` 10,900 paid in by Mr. Randhir in cash and by cheques on March,
31 cheques amounting to ` 3,800 were collected on April, 07.
(iv) A Cheque of ` 780 credited in the passbook on March 28 being
dishonoured is debited again in the passbook on April 01, 2017. There
was no entry in the cash book about the dishonour of the cheque until
April 15.
(Ans: Overdraft as per cash book ` 43,170)

Checklist to Test Your Understanding

Test Your Understanding - I

(I) 1. Time gap 2. Error 3. Time gap
4. Time gap 5. Time gap
(II) (i) Customer account (ii) Debit (iii) Credit
(iv) Debit (v) Added (vi) Deducted
(vii) loss (viii) Loss (ix) Added
(x) Higher

Test Your Understanding - II

1. (b) 2. (c) 3. (a) 4. (a) 5. (c) 6. (b)

Test Your Understanding - III

1. (T) 2. (T) 3. (F) 4. (T) 5. (F) 6. (T) 7. (T) 8. (T) 9. (F)

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180 Accountancy

Trial Balance and Rectification of Errors 6

I n the earlier chapters, you have learnt about the

basic principles of accounting that for every debit
there will be an equal credit. It implies that if the
sum of all debits equals the sum of all credits, it is
LEARNING OBJECTIVES presumed that the posting to the ledger in terms
After studying this chapter, of debit and credit amounts is accurate. The trial
you will be able to : balance is a tool for verifying the correctness of
• state the meaning of debit and credit amounts. It is an arithmetical
trial balance; check under the double entry system which verifies
• enumerate the objectives that both aspects of every transaction have been
of preparing trial
balance ;
recorded accurately. This chapter explains the
meaning and process of preparation of trial balance
• prepare trial balance;
and the types of errors and their rectification.
• explain the types of
errors;
6.1 Meaning of Trial Balance
• state various process
of locating errors ; A trial balance is a statement showing the
• identify the errors which balances, or total of debits and credits, of all the
affect the agreement of accounts in the ledger with a view to verify the
trial balance and those
which do not affect the
arithmatical accuracy of posting into the ledger
agreement of trial accounts. Trial balance is an important statement
balance; in the accounting process as it shows the final
• rectify the errors position of all accounts and helps in preparing the
without preparing final statements. The task of preparing the
suspense account; statements is simplified because the accountant
and
can take the balances of all accounts from the trial
• rectify the errors with balance instead of going through the whole ledger.
suspense account.
It may be noted that the trial balance is usually
prepared with the balances of accounts.

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Trial Balance and Rectification of Errors 181

Trial Balance of ......as on March 31, 2014

Account Title L.F. Debit Credit

Balance Balance
 

Total

Fig. 6.1: Showing format of a trial balance

It is normally prepared at the end of an accounting year. However, an

organisation may prepare a trial balance at the end of any chosen period,
which may be monthly, quarterly, half yearly or annually depending upon its
requirements.
In order to prepare a trial balance following steps are taken:
• Ascertain the balances of each account in the ledger.
• List each account and place its balance in the debit or credit column, as
the case may be. (If an account has a zero balance, it may be included in
the trial balance with zero in the column for its normal balance).
• Compute the total of debit balances column.
• Compute the total of the credit balances column.
• Verify that the sum of the debit balances equal the sum of credit balances.
If they do not tally, it indicate that there are some errors. So one must check
the correctness of the balances of all accounts. It may be noted that all
assets expenses and receivables account shall have debit balances whereas
all liabilities, revenues and payables accounts shall have credit balances
(refer figure 6.2).

6.2 Objectives of Preparing the Trial Balance

The trial balance is prepared to fulfill the following objectives :
1. To ascertain the arithmetical accuracy of the ledger accounts.
2. To help in locating errors.
3. To help in the preparation of the financial statements. (Profit & Loss account
and Balance Sheet).

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Account Title L.F. Debit Credit

Balance Balance
 

• Capital 
• Land and Buildings 
• Plant and Machinery 
• Equipment 
• Furniture and Fixtures 
• Cash in Hand 
• Cash at Bank 
• Debtors 
• Bills Receivable 
• Stock of Raw Materials 
• Stock of Finished Goods 
• Purchases 
• Carriage Inwards 
• Carriage Outwards 
• Sales 
• Sales Return 
• Purchases Return 
• Interest Paid 
• Commission/Discount Received 
• Salaries 
• Long Term Loan 
• Bills Payable 
• Creditors 
• Advances from Customers 
• Drawings 
Total xxx xxx

Fig. 6.2 : Illustrative trial balance

6.2.1 To Ascertain the Arithmetical Accuracy of Ledger Accounts

As stated earlier, the purpose of preparing a trial balance is to asceitain whether
all debits and credit are properly recorded in the ledger or not and that all
accounts have been correctly balanced. As a summary of the ledger, it is a list
of the accounts and their balances. When the totals of all the debit balances

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and credit balances in the trial balance are equal, it is assumed that the posting
and balancing of accounts is arithmetically correct. However, the tallying of the
trial balance is not a conclusive proof of the accuracy of the accounts. It only
ensures that all debits and the corresponding credits have been properly recorded
in the ledger.

6.2.2 To Help in Locating Errors

When a trial balance does not tally (that is, the totals of debit and credit columns
are not equal), we know that at least one error has occured. The error (or errors)
may have occured at one of those stages in the accounting process: (1) totalling
of subsidiary books, (2) posting of journal entries in the ledger, (3) calculating
account balances, (4) carrying account balances to the trial balance, and (5)
totalling the trial balance columns.
It may be noted that the accounting accuracy is not ensured even if the
totals of debit and credit balances are equal because some errors do not affect
equality of debits and credits. For example, the book-keeper may debit a correct
amount in the wrong account while making the journal entry or in posting a
journal entry to the ledger. This error would cause two accounts to have
incorrect balances but the trial balance would tally. Another error is to record
an equal debit and credit of an incorrect amount. This error would give the
two accounts incorrect balances but would not create unequal debits and
credits. As a result, the fact that the trial balance has tallied does not imply
that all entries in the books of original record (journal, cash book, etc.) have
been recorded and posted correctly. However, equal totals do suggest that
several types of errors probably have not occured.

6.2.3 To Help in the Preparation of the Financial Statements

Trial balance is considered as the connecting link between accounting records
and the preparation of financial statements. For preparing a financial
statement, one need not refer to the ledger. In fact, the availability of a tallied
trial balance is the first step in the preparation of financial statements. All
revenue and expense accounts appearing in the trial balance are transferred
to the trading and profit and loss account and all liabilities, capital and assets
accounts are transferred to the balance sheet.
(Preparation of the financial statements is explained in chapters, 9 and 10).

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6.3 Preparation of Trial Balance

Theoritically spreading, a trial balance can be prepared in the following three
ways:
(i) Totals Method
(ii) Balances Method
(iii) Totals-cum-balances Method

6.3.1 Totals method

Under this method, total of each side in the ledger (debit and credit) is ascertained
separately and shown in the trial balance in the respective columns. The total of
debit column of trial balance should agree with the total of credit column in the
trial balance because the accounts are based on double entry system. However,
this method is not widely used in practice, as it does not help in assuming accuracy
of balances of various accounts and and preparation of the fianancial statements.

6.3.2 Balances Method

This is the most widely used method in practice. Under this method trial balance
is prepared by showing the balances of all ledger accounts and then totalling up
the debit and credit columns of the trial balance to assure their correctness. The
account balances are used because the balance summarises the net effect of all
transactions relating to an account and helps in preparing the financial
statements. It may be noted that in trial balance, normally in place of balances
in individual accounts of the debtors, a figure of sundry debtors is shown, and
in place of individual accounts of creditors, a figure of sundry creditors is shown.

6.3.3 Totals-cum-balances Method

This method is a combination of totals method and balances method. Under
this method four columns for amount are prepared. Two columns for writing
the debit and credit totals of various accounts and two columns for writing
the debit and credit balances of these accounts. However, this method is also
not used in practice because it is time consuming and hardly serves any
additional or special purpose.
Let us now learn how will the trial balance be prepared using each of
these methods with the help of the following example:
Mr. Rawat’s ledger shows the following accounts for his business. Help him
in preparing the trial balance using: (i) Totals method,
(ii) Balances method, (iii) Totals-cum-Balances method.

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Trial Balance and Rectification of Errors 185

Rawat’s Capital Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
2014 2014
Dec. 31 Balance c/d 60,000 Jan. 01 Balance b/d 40,000
Cash 20,000
60,000 2015 60,000
Jan. 01 Balance b/d 60,000

Rohan’s Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
2014 2014
Cash 40,000 Jan. 01 Balance b/d 10,000
Dec. 31 Balance c/d 20,000 Purchases 50,000

60,000 2015 60,000

Jan. 1 Balance b/d 20,000

Machinery Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
2014 2014
Dec. 31 Balance b/d 20,000 Depreciation 3,000
Dec. 31 Balance c/d 17,000
20,000 20,000
2015
Jan. 01 Balance b/d 17,000

Rahul’s Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
2014 2014
Jan. 01 Balance b/d 15,000 Cash 55,000
Sales 60,000 Dec. 31 Balance c/d 20,000
2015 75,000 75,000
Jan. 01 Balance b/d 20,000

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Sales Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
2014
Rahul 60,000
Cash 10,000
70,000

Cash Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
2014 2014
Jan. 01 Balanc e b/d 15,000 Rohan 40,000
Capital 20,000 Wages 5,000
Rahul 55,000 Purchases 12,000
Sales 10,000 Dec. 31 Balance c/d 43,000
1,00,000 1,00,000
2015
Jan. 01 Balance b/d 43,000

Wages Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
2014

Cash 5,000
5,000

Depreciation Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
2014
Machinery 3,000

3,000

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Purchases Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
2014
Rohan 50,000
Cash 12,000
62,000

The trial balance under the three methods is illustrated below:

(i) Trial Balance as at March 31, 2014

(Using Totals Method)

Account L.F. Debit Credit

Title Total Total
 
Rawat 60,000
Rohan 40,000 60,000
Machinery 20,000 3,000
Rahul 75,000 55,000
Sales 70,000
Cash 1,00,000 57,000
Wages 5,000
Depreciation 3,000
Purchases 62,000
3,05,000 3,05,000

(ii) Trial Balance as at March 31, 2014

(Using Balances Method)

Account Title L.F. Debit Credit

Balance Balance
 
Rawat’s Capital 60,000
Rohan’s Capital 20,000
Machinery 17,000
Rahul 20,000
Sales 70,000
Cash 43,000
Wages 5,000
Depreciation 3,000
Purchases 62,000
Total 1,50,000 1,50,000

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(iii) Trial Balance as at March 31, 2014

(Using Totals-cum-Balances Method)

Account Title L.F. Debit Credit Debit Credit

Total Total Balance Balance
   
Rawat’s Capital 60,000 60,000
Rohan 40,000 60,000 20,000
Machinery 20,000 3,000 17,000
Rahul 75,000 55,000 20,000
Sales 70,000 70,000
Cash 1,00,000 57,000 43,000
Wages 5,000 5,000
Depreciation 3,000 3,000
Purchases 62,000 62,000
Total 3,05,000 3,05,000 1,50,000 1,50,000

Test Your Understanding - I

Indicate against each amount wheather it is a debit or a credit balance, and prepare
a trial balance as at March 31, 2014 based on the following balances:
Accounts Title Amount

Capital 1,00,000
Drawings 16,000
Machinery 20,000
Sales 2,00,000
Purchases 2,10,000
Sales return 20,000
Purchases return 30,000
Wages 40,000
Goodwill 60,000
Interest received 15,000
Discount allowed 6,000
Bank overdraft 22,000
Bank loan 90,000
Debtors :
Nathu 55,000
Roopa 20,000
Creditors :
Reena 35,000
Ganesh 25,000
Cash 54,000
Stock on April 01, 2013 16,000

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6.4. Significance of Agreement of Trial Balance

It is important for an accountant that the trial balance should tally. Normally a tallied
trial balance means that both the debit and the credit entries have been made correctly
for each transaction. However, as stated earlier, the agreement of trial balance is not
an absolute proof of accuracy of accounting records. A tallied trial balance only proves,
to a certain extent, that the posting to the ledger is arithmetically correct. But it does
not guarantee that the entry itself is correct. There can be errors, which affect the
equality of debits and credits, and there can be errors, which do not affect the equality
of debits and credits. Some common errors include the following:
• Error in totalling of the debit and credit balances in the trial balance.
• Error in totalling of subsidiary books.
• Error in posting of the total of subsidiary books.
• Error in showing account balances in wrong column of the tiral balance, or
in the wrong amount.
• Omission in showing an account balance in the trial balance.
• Error in the calculation of a ledger account balance.
• Error while posting a journal entry: a journal entry may not have been posted
properly to the ledger, i.e., posting made either with wrong amount or on the
wrong side of the account or in the wrong account.
• Error in recording a transaction in the journal: making a reverse entry, i.e.,
account to be debited is credited and amount to be credited is debited, or an
entry with wrong amount.
• Error in recording a transaction in subsidiary book with wrong name or wrong
amount.

6.4.1 Classification of Errors

Keeping in view the nature of errors, all the errors can be classified into the
following four categories:
• Errors of Commission
• Errors of Omission
• Errors of Principle
• Compensating Errors

6.4.2 Errors of Commission

These are the errors which are committed due to wrong posting of transactions,
wrong totalling or wrong balancing of the accounts, wrong casting of the
subsidiary books, or wrong recording of amount in the books of original entry,
etc. For example: Raj Hans Traders paid  25,000 to Preetpal Traders (a supplier
of goods). This transaction was correctly recorded in the cashbook.

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But while posting to the ledger, Preetpal’s account was debited with  2,500
only. This constitutes an error of commission. Such an error by definition is of
clerical nature and most of the errors of commission affect in the trial balance.

6.4.3 Errors of Omission

The errors of omission may be committed at the time of recording the transaction
in the books of original entry or while posting to the ledger. These can be of two
types:
(i) error of complete omission
(ii) error of partial omission
When a transaction is completely omitted from recording in the books of
original record, it is an error of complete omission. For example, credit sales
to Mohan  10,000, not entered in the sales book. When the recording of
transaction is partly omitted from the books, it is an error of partial omission.
If in the above example, credit sales had been duly recorded in the sales book
but the posting from sales book to Mohan’s account has not been made, it
would be an error of partial omission.

6.4.4 Errors of Principle

Accounting entries are recorded as per the generally accepted accounting
principles. If any of these principles are violated or ignored, errors resulting
from such violation are known as errors of principle. An error of principle may
occur due to incorrect classification of expenditure or receipt between capital
and revenue. This is very important because it will have an impact on financial
statements. It may lead to under/over stating of income or assets or liabilities,
etc. For example, amount spent on additions to the buildings should be treated
as capital expenditure and must be debited to the asset account. Instead, if
this amount is debited to maintenance and repairs account, it has been treated
as a revenue expense. This is an error of principle. Similarly, if a credit purchase
of machinery is recorded in purchases book instead of journal proper or rent
paid to the landlord is recorded in the cash book as payment to landlord,
these errors of principle. These errors do not affect the trial balance.

6.4.5 Compensating Errors

When two or more errors are committed in such a way that the net effect of these
errors on the debits and credits of accounts is nil, such errors are called
compensating errors. Such errors do not affect the tallying of the trial balance.
For example, if purchases book has been overcast by  10,000 resulting in
excess debit of  10,000 in purchases account and sales returns book is
undercast by  10,000 resulting in short debit to sales returns account is a

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case of two errors compensating each other’s effect. One plus is set off by the
other minus, the net effect of these two errors is nil and so they do not affect the
agreement of trial balance.

6.5 Searching of Errors

If the trial balance does not tally, it is a clear indication that at least one error
has occured. The error (or errors) needs to be located and corrected before
preparing the financial statements.
If the trial balance does not tally, the accountant should take the following
steps to detect and locate the errors :
• Recast the totals of debit and credit columns of the trial balance.
• Compare the account head/title and amount appearing in the trial balance,
with that of the ledger to detect any difference in amount or omission of an
account.
• Compare the trial balance of current year with that of the previous year to
check additions and deletions of any accounts and also verify whether
there is a large difference in amount, which is neither expected nor
explained.
• Re-do and check the correctness of balances of individual accounts in
the ledger.
• Re-check the correctness of the posting in accounts from the books of
original entry.
• If the difference between the debit and credit columns is divisible by 2,
there is a possibility that an amount equal to one-half of the difference
may have been posted to the wrong side of another ledger account. For
example, if the total of the debit column of the trial balance exceeds by
 1,500, it is quite possible that a credit item of 750 may have been wrongly
posted in the ledger as a debit item. To locate such errors, the accountant
should scan all the debit entries of an amount of  750.
• The difference may also indicate a complete omission of a posting. For
example, the difference of  1,500 given above may be due to omissions of a
posting of that amount on the credit side. Thus, the accountant should verify
all the credit items with an amount of  1,500.
• If the difference is a multiple of 9 or divisible by 9, the mistake could be due
to transposition of figures. For example, if a debit amount of  459 is posted
as  954, the debit total in the trial balance will exceed the credit side by
 495 (i.e. 954 – 459 = 495). This difference is divisible by 9. A mistake due
to wrong placement of the decimal point may also be checked by this method.
Thus, a difference in trial balance divisible by 9 helps in checking the errors
for a transposed mistake.

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6.6 Rectification of Errors

From the point of view of rectification, the errors may be classified into the
following two categories:
(a) errors which do not affect the trial balance.
(b) errors which affect the trial balance.
This distinction is relevant because the errors which do not affect the trial
balance usually take place in two accounts in such a manner that it can be
easily rectified through a journal entry whereas the errors which affect the
trial balance usually affect one account and a journal entry is not possible for
rectification unless a suspense account has been opened. Such errors are rectified
by passing a nullifying entry in the respective account as explained before under
6.6.2.

6.6.1 Rectification of Errors which do not Affect the Trial Balance

These errors are committed in two or more accounts. Such errors are also known
as two sided errors. They can be rectified by recording a journal entry giving the
correct debit and credit to the concerned accounts.
Examples of such errors are – complete omission to record an entry in the
books of original entry; wrong recording of transactions in the book of accounts;
complete omission of posting to the wrong account on the correct side, and
errors of principle.
The rectification process essentially involves:
• Cancelling the effect of wrong debit or credit by reversing it; and
• Restoring the effect of correct debit or credit.
For this purpose, we need to analyse the error in terms of its effect on the
accounts involved which may be:
(i) Short debit or credit in an account; and/or
(ii) Excess debit or credit in an account.
Therefore, rectification entry can be done by:
(i) debiting the account with short debit or with excess credit,
(ii) crediting the account with excess debit or with short credit.
The procedure for rectification for such errors is explained with the help of
following examples:
(a) Credit sales to Mohan  10,000 were not recorded in the sales book. This is an error
of complete omission. Its affect is that Mohan’s account has not been debited and
Sales account has not been credited. Accordingly, recording usual entry for credit
sales will rectify the error.

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Trial Balance and Rectification of Errors 193

Mohan’s A/c Dr. 10,000

To Sales A/c 10,000

(b) Credit sales to Mohan  10,000 were recorded as  1,000 in the sales book.
This is an error of commission. The effect of wrong recording is shown below:

Mohan’s A/c Dr. 1,000

To Sales A/c 1,000

Correct effect should have been:

Mohan’s A/c Dr. 10,000

To Sales A/c 10,000

Now that Mohan’s account has to be given an additional debit of  9,000

and sales account has to be credited with additional amount of  9,000,
rectification entry will be:

Mohan’s A/c Dr. 9,000

To Sales A/c 9,000

(c) Credit sales to Mohan  10,000 were recorded as  12,000. This is an error of
commission. The effect of wrong entry made has been:

Mohan’s A/c Dr. 12,000

To Sales A/c 12,000

Correct effect should have been:

Mohan’s A/c Dr. 10,000

To Sales A/c 10,000

You can see that there is an excess debit of  2,000 in Mohan’s account and
excess credit of  2,000 in sales account.
The, rectification entry will be recorded as follows:

Sales A/c Dr. 2,000

To Mohan‘s A/c 2,000

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(d) Credit sales to Mohan  10,000 was correctly recorded in the sales book but was
posted to Ram’s account. This is an error of commission. The effect of wrong posting
has been:

Ram’s A/c Dr. 10,000

To Sales A/c 10,000

Correct effect should have been :

Mohan’s A/c Dr. 10,000

To Sales A/c 10,000

Notice that there is no error in sales account. But Ram’s account has been
debited with  10,000 instead of Mohan’s account.
Hence rectification entry will be:

Mohan’s A/c Dr. 10,000

To Ram’s A/c 10,000

(e) Rent paid  2,000 was wrongly shown as payment to landlord in the cash
book:
The effect of wrong posting has been:

Landlord’s A/c Dr. 2,000

To Cash A/c 2,000

Correct effect should have been:

Rent A/c Dr. 2,000

To Cash A/c 2,000

Landlord’s account has been wrongly debited instead of Rent account.

Hence, rectification entry will be:

Rent A/c Dr. 2,000

To Landlord’s A/c 2,000

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Test Your Understanding - II

Record the rectification entry for the following transactions:

1. Credit sales to Rajni  5,000 recorded in Purchases book:
This is an error of ..........................................
State the wrong entry recorded in the book of accounts

Correct effect should have been:

The rectification entry will be:

2. Furniture purchased from M/s Rao Furnishigs for  8,000 was entered into the
purchases book.
This is the error of ........................................
State the wrong entry recorded in the book of accounts

Correct effect should have been:

The rectification entry will be:

3. Cash sales to Radhika  15,000 was shown as receipt of commission in the

cash book.
This is the error of ..............................................
State the wrong entry recorded in the book of accounts

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Correct effect should have been:

The rectification entry will be:

4. Cash received from Karim  6,000 posted to Nadeem.

This is the error of ........................................
State the wrong entry recorded in the book of accounts:

Correct effect should have been:

The rectification entry will be:

6.6.2 Rectification of Errors Affecting Trial Balance

The errors which affect only one account can be rectified by giving an exaplanatory
note in the account affected or by recording a journal entry with the help of the
Suspense Account. Suspense Account is explained later in this chapter. Examples
of such errors are error of casting; error of carrying forward; error of balancing;
error of posting to correct account but with wrong amount; error of posting to the
correct account but on the wrong side; posting to the wrong side with the wrong
amount; omitting to show an account in the trial balance.
An error in the books of original entry, if discovered before it is posted to the
ledger, may be corrected by crossing out the wrong amount by a single line and
writing the correct amount above the crossed amount and initialling it. An error
in an amount posted to the correct ledger account may also be corrected in a

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similar way, or by making an additional posting for the difference in amount

and giving an explanatory note in the particulars column. But errors should
never be corrected by erasing or overwriting reduces the authenticity of
accounting records and give an impression that something is being concealed.
A better way therefore is by noting the correction on the appropriate side for
neutralising the effect of the error. Take for example a case where Shyam’s
account was credited short by  190. This will be rectified by an additional
entry for  190 on the credit side of his account as follows.

Shyam’s Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
Difference in 190
amount posted
short on.....

Take another example, purchases book was undercast by  1,000. The effect of
this entry is on purchases account (debit side) where the total of purchases
book is posted

Purchases Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
Undercasting 1,000
purchases
book for the
month of....

Suspense Account
Even if the trial balance does not tally due to the existence of one sided errors,
accountant has to carry forward his accounting process prepare financial
statements. The accountant tallies his trial balance by putting the difference
on shorter side as ‘suspense account’.
The process of opening of suspense account can be understood with the help
of the following example:
Consider the sales book of an organisation.

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Sales Book (Journal)

Date Invoice Name of customers L.F. Amount
No. (Accounts to be debited) 

Ashok traders 20,000

Bimal service centre 10,000
Chopra enterprises 5,000
Diwakar and sons 15,000
50,000

If sales to Diwakar and sons were not posted to his account, ledger will show
the following position:
Ashok Traders Account
Dr. Cr.

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

 
Sales 20,000 Balance c/d 20,000
20,000 20,000

Bimal Service Centre’s Account

Dr. Cr.

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

 
Sales 10,000 Balance c/d 10,000
10,000 10,000

Chopra Enterprises Account

Dr. Cr.

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

 
Sales 5,000 Balance c/d 5,000
5,000 5,000

Sales Account
Cr. Dr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
Sundries 50,000

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Trial Balance and Rectification of Errors 199

The trial balance when prepared on the basis of above balances will not
tally. Its credit column total will amount to  50,000 and debit column total to
 35,000. The trial balance would differ with  15,000. This difference will be
temporarily put to suspense account and trial balance will be made to agree in
the ledger.
In the above case, difference in trial balance has arisen due to one sided
error (omission of posting to Diwakar and sons’s account). In a real situation,
there can be many other such one-sided errors which cause a difference in
trial balance and thus result in opening of the suspense account. Till the all
errors affecting agreement of trial balance are not located it is not possible to
rectify them and tally the trial balance in such a situation, is shown in the
Suspense account, make the total of debit and credit columns and proceed
further with the accounting process.
When the errors are located and the specific accounts and amounts involved
are identified, the amounts are transferred from suspense account to the
relevant accounts thereby closing the suspense account. Thus, suspense
account is not placed in any particular category of accounts and is just a
temporary phenomenon.
While rectifying one-sided errors using suspense account, the following steps
are taken:
(i) Identify the account affected due to error.
(ii) Ascertain the amount of excess debit/credit or short debit/credit in the
affected account.
(iii) If the error has resulted in excess debit or short credit in the affected
account, credit the account with the amount of excess debit or short
credit.
(iv) If the error has resulted in excess credit or short debit in the affected
account, debit the account with the amount of excess credit or short
debit.
(v) Complete the journal entry by debiting or crediting the suspense account
as another account affected otherwise.
We will now discuss the process of rectification using suspense account:
(a) Credit sales to Mohan  10,000 were not posted to his account. This is an
error of partial omission comitted while posting entries of the sales book.
Wrong effect has been:

Mohan’s A/c Dr. Nil

To Sales A/c 10,000

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200 Accountancy

Correct effect should have been:

Mohan’s A/c Dr. 10,000

To Sales A/c 10,000

The rectification entry will be :

Mohan’s A/c Dr. 10,000

To Suspense A/c 10,000

(b) Credit sales to Mohan  10,000 were posted to his account as  7000. This is an
error of commission. Mohan’s account has been debited with  7,000 instead of
 10,000 resulting in short debit of  3,000.
The wrong effect has been:

Mohan’s A/c Dr. 7,000

To Sales A/c 10,000

Correct effect should have been:

Mohan’s A/c Dr. 10,000

To Sales A/c 10,000

Hence, rectification entry will be:

Mohan’s A/c Dr. 3,000

To Suspens A/c 3,000

(c) Credit sales to Mohan  10,000 were posted to his account as  12,000.
This is an error of commission. The wrong effect has been:

Mohan’s A/c Dr. 12,000

To Sales A/c 10,000

Correct effect should have been

Mohan’s A/c Dr. 10,000

To Sales A/c 10,000

The rectification entry will be:

Suspense A/c Dr. 2,000

To Mohan’s A/c 2,000

(d) Purchases book overcast by  1,000. Errors in casting of subsidiary books

affect only those accounts where totals of the subsidiary books involved are

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Trial Balance and Rectification of Errors 201

posted. The accounts of individual parties are not affected. Consider the
following example.

Purchases (Journal) Book

Date Invoice Name of suppliers L.F. Amount
No. (Accounts to be credited) 
Dheru 8,000
Chandraprakash 7,000
Sachin 6,000
21,000
Wrong total 22,000
due to overcasting

Dheru’s Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
Purchases 8,000

Chandraprakash’s Account
Dr. Cr.

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

 
Purchases 7,000

Sachin’s Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
Purchases 6,000

Purchases Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
Sundries 22,000

As you can notice that there is no error in accounts of Dheeru, Chanderprakash and
Sachin. Only purchases account has been debited with  1,000 extra. Hence, rectification
entry will be:

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202 Accountancy

Suspense A/c Dr. 1,000

To Purchases A/c 1,000

6.6.3 Rectification of Errors in the Next Accounting Year

If some errors committed during an accounting year are not located and
rectified before the finalisation of financial statements, suspense account
cannot be closed and its balance will be carried forward to the next accounting
period. When the errors committed in one accounting year are located and
rectified in the next accounting year, profit and loss adjustment account is
debited or credited in place of accounts of expenses/losses and incomes/
gains in order to avoid impact on the income statement of next accounting
period. You will learn about this aspect at an advanced stage of your studies
in accounting.

Box 1
Guiding Principles of Rectification of Errors

1. If error is committed in books of original entry then assume all postings are
done accordingly.
2. If error is at the posting stage then assume that recording in the subsidiary
books has been correctly done.
3. If error is in posting to a wrong account (without mentioning side and amount of
posting) then assume that posting has been done on the right side and with the
right amount.
4. If posting is done to a correct account but with wrong amount (without mentioning
side of posting) then assume that posting has been done on the correct side.
5. If error is posting to a wrong account on the wrong side (without mentioning
amount of posting) then assume that posting has been done with the amount as
per the original recording of the transaction.
6. If error is of posting to a wrong account with wrong amount (without mentioning
the side of posting) then assume that posting has been done on the right side.
7. If posting is done to a correct account on the wrong side (without mentioning
amount of posting) then assume that posting has been done with correct amount
as per original recording.
8. Any error in posting of individual transactions in subsidiaries books relates to
individual account only, the sales account, purchase account, sales return
account or purchases return account are not involved.

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Trial Balance and Rectification of Errors 203

9. If a transaction is recorded in cash book, then the error in posting relates to the
other affected account, not to cash account/bank account
10. If a transaction is recorded through journal proper, then the phrase ‘transaction
was not posted’ indicates error in both the accounts involved, unless stated
otherwise.
11. Error in casting of subsidiary books will affect only that account where total of
the particular book is posted leaving the individual personal accounts unaffected.

Test Your Understanding - III

Show the effect through Journal entries:
1. Credit sales to Mohan  10,000 were posted to his account as  12,000
This is an error of ..................................
The wrong effect has been:

The correct effect should have been:

The rectification entry will be.

2. Cash paid to Neha  2,000 was not posted to her account. This is an error of
..................................
The wrong effect has been:

The correct effect should have been:

The rectification entry will be:

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204 Accountancy

3. Sales returns from Megha  1,600 were posted to her account as  1,000.
This is an error of ..................................
The wrong effect has been:

The correct effect should have been:

The rectification entry will be:

4. Depreciation written off on furniture  1,500 was not posted to depreciation

account. This is an error of ................
The wrong effect has been:

The correct effect should have been:

The rectification entry:

Illustration 1

Rectify the following errors:

Credit purchases from Raghu  20,000
(i) were not recorded.
(ii) were recorded as  10,000.
(iii) were recorded as  25,000.
(iv) were not posted to his account.
(v) were posted to his account as  2,000.
(vi) were posted to Reghav’s account.
(vii) were posted to the debit of Raghu’s account.
(viii) were posted to the debit of Raghav.
(ix) were recorded through sales book.

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Trial Balance and Rectification of Errors 205

Solution

(i)

Purchases A/c Dr. 20,000

To Raghu’s A/c 20,000
(Credit purchases from Raghu omitted to be recorded, now corrected)

(ii)

Purchases A/c Dr. 10,000

To Raghu’s A/c 10,000
(Credit purchases from Raghu recorded as  10,000 instead of  20,000,
now corrected)

(iii)

Raghu’s A/c Dr. 5,000

To Purchases A/c 5,000
(Credit purchases from Raghu recorded as  25,000 instead of
 20,000).

(iv)

Suspense A/c Dr. 20,000

To Raghu’s A/c 20,000
(Credit purchases from Raghu not posted to his account now corrected).

(v)

Suspense A/c Dr. 18,000

To Raghu’s A/c 18,000
(Credit purchases from Raghu  20,000 posted to his account as
 2,000

(vi)

Raghav’s A/c Dr. 20,000

To Raghu’s A/c 20,000
(Credit purchases from Raghu wrongly credited to Raghav, now corrected)

(vii)

Suspense A/c Dr. 40,000

To Raghu’s A/c 40,000
(Credit purchases from Raghu  20,000 wrongly posted to the debit of his
account, now corrected).

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206 Accountancy

(viii)

Suspense A/c Dr. 40,000

To Raghav’s A/c 20,000
To Raghu’s A/c 20,000
(Credited purchases from Raghu  20,000 wrongly debited to Raghav, now
corrected).

(ix)

Sales A/c Dr. 20,000

Purchases A/c Dr. 20,000
To Raghu’s A/c 40,000
(Credit purchases from Raghu wrongly recorded through sales book, now
corrected).

Illustration 2
Rectify the following errors :
Cash sales  16,000
(i) were not posted to sales account.
(ii) were posted as  6,000 in sales account.
(iii) were posted to commission account.
Solution

(i)

Suspense A/c Dr. 16,000

To Sales A/c 16,000
(Cash sales not posted to sales account now rectified)

(ii)

Suspense A/c Dr. 10,000

To Sales A/c 10,000
(Cash sales  16,000 were posted to sales account as  6,000, now rectified)

(iii)

Commission A/c Dr. 16,000

To Sales A/c 16,000
(Cash sales posted to commission account instead of sales account,
now corrected)

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Trial Balance and Rectification of Errors 207

Illustration 3
Depreciation written-off as the machinery  2,000
(i) was not posted at all
(ii) was not posted to machinery account
(iii) was not posted to depreciation account
Solution
(i) It was recorded through journal proper. From journal proper posting to all the
accounts are made individually. Hence, no posting was made to depreciation account
and machinery account. Therefore, rectification entry will be :

Depreciation A/c Dr. 2,000

To Machinery A/c 2,000
(Depreciation on machinery not posted, now corrected)

(ii) In this case posting was not made to machinery account. It is to be assumed that
depreciation account should have been correctly debited. Therefore, rectification
entry shall be :

Suspense A/c Dr. 2,000

To Machinery A/c 2,000
(Depreciation on machinery not posted to Machinery account, now
corrected).

(iii) In this case depreciation account was not been debited. However, machinery account
must have been correctly credited. Therefore, rectification entry shall be :

Depreciation A/c Dr. 2,000

To Suspense A/c 2,000
(Depreciation on machinery not posted to Depreciation account, now
corrected).

Illustration 4
Trial balance of Anurag did not agree. It showed an excess credit  10,000. Anurag put the
difference to suspense account. He located the following errors :
(i) Sales return book over cast by  1,000.
(ii) Purchases book was undercast by  600.
(iii) In the sales book total of page no. 4 was carried forward to page 5 as  1,000 instead
of  1,200 and total of page 8 was carried forward to page 9 as
 5,600 instead of  5,000.
(iv) Goods returned to Ram  1,000 were recorded through sales book.
(v) Credit purchases from M & Co.  8,000 were recorded through sales book.
(vi) Credit purchases from S & Co.  5,000 were recorded through sales book.
However, S & Co. were correctly credited.
(vii) Salary paid  2,000 was debited to employee’s personal account.

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208 Accountancy

Solution
(i)

Suspense A/c Dr. 1,000

To Sales Return A/c 1,000
(Sales returns book overcast by  1,000, now corrected).

(ii)

Purchases A/c Dr. 600

To Suspense A/c 600
(Purchases book undercast by  600, now corrected)

(iii)

Sales A/c Dr. 400

To Suspense A/c 400
(Error in carry forward of sales book, now corrected).

N o t e : Errors in carry forward the total of one page to another during

a period finally affects the total of that book resulting in error of under/overcasting.
In this case, carry forward from page 4 to 5 resulted in undercasting of  200 and
carry forward from page 8 to page 9 resulted in overcasting of  600. Overall
overcasting being  600–200 =  400.

(iv)

Sales A/c Dr. 1,000

To Return Outwards A/c 1,000
(Return Outwards wrongly recorded through sales book, now rectified).

(v)

Purchases A/c Dr. 8,000

Sales A/c Dr. 8,000
To M & Co.’s A/c 16,000
(Credit purchases wrongly recorded through sales book, now rectified).

(vi)

Purchases A/c Dr. 5,000

Sales A/c Dr. 5,000
To Suspense A/c 10,000
(Credit purchases wrongly recorded through sales book, however suppliers
account correctly credited, now rectified).

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Trial Balance and Rectification of Errors 209

(vii)

Salary A/c Dr. 2,000

To Employee’s personal A/c 2,000
(Salary paid wrongly debited to employee’s personal account, now
corrected)

Suspense Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
Difference as per 10,000
trial balance Purchases 600
Sales return 1,000 Sales 400
Purchases 5,000
Sales 5,000
11,000 11,000

Illustration 5
Trial balance of Rahul did not agree. Rahul put the difference to suspense account.
Subsequently, he located the following errors :
(i) Wages paid for installation of Machinery  600 was posted to wages account.
(ii) Repairs to Machinery  400 debited to Machinery account.
(iii) Repairs paid for the overhauling of second hand machinery purchased  1,000 was
debited to Repairs account.
(iv) Own business material  8,000 and wages  2,000 were used for construction of
building. No adjustment was made in the books.
(v) Furniture purchased for  5,000 was posted to purchase account as  500.
(vi) Old machinery sold to Karim at its book value of  2,000 was recorded through sales
book.
(vii) Total of sales returns book  3,000 was not posted to the ledger.
Rectify the above errors and prepare suspense account to ascertain the original
difference in trial balance.
(i)

Machinery A/c Dr. 600

To Wages A/c 600
(Wages paid for installation of machinery wrongly debited to wages account,
now rectified)

(ii)

Repairs A/c Dr. 400

To Machinery A/c 400
(Repairs paid wrongly debited to machinery account now rectified)

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210 Accountancy

(iii)

Machinery A/c Dr. 1,000

To Repairs A/c 1,000
(Repairs for overhauling of second hand machinery purchased, wrongly
debited to repairs account, now rectified).

(iv)

Building A/c Dr. 10,000

To Purchases A/c 8,000
To Wages A/c 2,000
(Material and wages used for construction of Building, not debited to
building account).

(v)

Furniture A/c Dr. 5,000

To Purchases A/c 500
To Suspense A/c 4,500
(Furniture purchased for  5,000 wrongly debited to purchases account as
 500, now rectified).

(vi)

Sales A/c Dr. 2,000

To Machinery 2,000
(Sale of machinery wrongly recorded in sales book, now rectified).

(vii)

Sales Return A/c Dr. 3,000

To Suspense A/c 3,000
(Total of sales returns book not posted to ledger, now rectified).

Suspense Account

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

 
Difference as per 7,500 Furniture 4,500
trial balance Sales return 3.000
7,500 7,500

Hence, original difference in Trial Balance was  7,500 excess on the Credit side.

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Trial Balance and Rectification of Errors 211

Illustration 6
Trial balance of Anant Ram did not agree. It showed an excess credit of  16,000. He put
the difference to suspense account. Subsequently the following errors were located:
(i) Cash received from Mohit  4,000 was posted to Mahesh as  1,000.
(ii) Cheque for  5,800 received from Arnav in full settlement of his account of  6,000,
was dishonoured. No entry was passed in the books on dishonour of the cheque.
(iii)  800 received from Khanna, whose account had previously been written off as bad,
was credited to his account.
(iv) Credit sales to Manav for  5,000 was recorded through the purchases book as
 2,000.
(v) Purchases book undercast by  1,000.
(vi) Repairs on machinery  1,600 wrongly debited to Machinery account as  1,000.
(vii) Goods returned by Nathu  3,000 were taken into stock. No entry was recorded in
the books.

Solution

(i)

Mahesh’s A/c Dr. 1,000

Suspense A/c Dr. 3,000
To Mohit’s A/c 4,000
(Cash received from Mohit  4,000 wrongly posted to Mahesh as 1,000,
now rectified)

(ii)

Arnav’s A/c Dr. 6,000

To Bank A/c 5,800
To Discount Allowed A/c 200
(Cheque received from Arnav for  5,800 in full settlement of his account
of  6,000, dishonoured but no entry made in books, now rectified)

(iii)

Khanna’s A/c Dr. 800

To Bad debts recovered A/c 800
(Bad debts recovered wrongly credited to Khanna’s account, now rectified)

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212 Accountancy

(iv)

Manav’s A/c Dr. 7,000

To Purchases A/c 2,000
To Sales A/c 5,000
(Credit sales to Manav  5,000 wrongly recorded through purchases book
as  2,000, now rectified)

(v)

Purchases A/c Dr. 1,000

To Suspense A/c 1,000
(Purchases book undercast by  1,000)

(vi)

Repairs A/c Dr. 1,600

To Machinery A/c 1,000
To Suspense A/c 600
(Repairs on machinery  1,600 wrongly debited to machinery account as
 1,000, now rectified)

(vii)

Sales Return A/c Dr. 3,000

To Nathu’s A/c 3,000
(Sales return from Nathu not recorded)

Suspense Account
Dr. Cr.

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

 
Difference as per Purchases 1,000
trial balance 16,000 Repairs 600
Mohit 3,000 Balance c/d 17,400
19,000 19,000

Note: Even after rectification of errors suspense account is showing a debit balance
of  17,400. This is due to non-detection of errors affecting trial balance.
Balance of suspense account will be carried forward to the next year and will
be eliminated as and when all the remaining errors affecting trial balance are
located.

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Trial Balance and Rectification of Errors 213

Illustration 7
Trial balance of Kailash did not agree. He put the difference to suspense account. The
following errors were discovered :
(i) Goods withdrawn by Kailash for personal use  500 were not recorded in the books.
(ii) Discount allowed to Ramesh 60 on receiving  2,040 from him was not recorded in
the books.
(iii) Discount received from Rohan  50 on paying  3,250 to him was not posted at all.
(iv)  700 received from Khalil, a debtor, whose account had earlier been written-off as
bad, were credited to his personal account.
(v) Cash received from Govil, a debtor,  5,000 was posted to his account as  500.
(vi) Goods returned to Mahesh  700 were posted to his account as  70.
(vii) Bill receivable from Narayan  1,000 was dishonoured and wrongly debited to
allowances account as  10,000.
Give journal entries to rectify the above errors and prepare suspense account to ascertain
the amount of difference in trial balance.

Solution
(i)

Drawings A/c Dr. 500

To Purchases A/c 500
(Goods withdrawn by proprietor for personal use not recorded, now
rectified).

(ii)

Discount allowed A/c Dr. 60

To Ramesh’s A/c 60
(Discount allowed to Ramesh not recorded, now rectified)

(iii)

Rohan’s A/c Dr. 50

To Discount received A/c 50
(Discount received from Rohan not posted , now corrected)

(iv)

Khalil’s A/c Dr. 700

To Bad debts recovered A/c 700
(Bad debts recovered wrongly credited to debtor’s personal account, now
corrected)

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214 Accountancy

(v)

Suspense A/c Dr. 4,500

To Govil’s A/c 4,500
(Cash received from Govil  5,000 wrongly posted to his account as
 500)

(vi)

Mahesh’s A/c Dr. 630

To Suspense A/c 630
(Goods returned to Mahesh  700 wrongly posted to his account as
 70, now corrected)

(vii)

Narayan’s A/c Dr. 1,000

Suspense A/c Dr. 9,000
To Allowances A/c 10,000
(Bill receivables from Narayan  1,000 wrongly debited to allowances
account as  10,000).

Suspense Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
 
Govil 4,500 Mahesh 630
Allowances 9,000 Difference as per 12,870
trial balance
13,500 13,500

Test Your Understanding - IV

Tick the Correct Answer

(1) Agreement of trial balance is affected by:
(a) One sided errors only.
(b) Two sided errors only.
(c) Both (a) and (b).
(d) None of the above.
(2) Which of the following is not an error of principle:
(a) Purchase of furniture debited to purchases account.
(b) Repairs on the overhauling of second hand machinery purchased debited to
repairs account.

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Trial Balance and Rectification of Errors 215

(c) Cash received from Manoj posted to Saroj.

(d) Sale of old car credited to sales account.
(3) Which of the following is not an error of commission:
(a) Overcasting of sales book.
(b) Credit sales to Ramesh  5,000 credited to his account.
(c) Wrong balancing of machinery account.
(d) Cash sales not recorded in cash book.
(4) Which of following errors will be rectified through suspense account:
(a) Sales return book undercast by  1,000.
(b) Sales return by Madhu  1,000 not recorded.
(c) Sales return by Madhu Rs 1,000. recorded as  100.
(d) Sales return by Madhu  1,000 recorded through purchases returns book
(5) If the trial balance agrees, it implies that:
(a) There is no error in the books.
(b) There may be two sided errors in the book.
(c) There may be one sided error in the books.
(d) There may be both two sided and one sided errors in the books.
(6) If suspense account does not balance off even after rectification of errors it implies
that:
(a) There are some one sided errors only in the books yet to be located.
(b) There are no more errors yet to be located.
(c) There are some two sided errors only yet to be located.
(d) There may be both one sided errors and two sided errors yet to be located.
(7) If wages paid for installation of new machinery is debited to wages Account, it is:
(a) An error of commission.
(b) An error of principle.
(c) A compensating error.
(d) An error of omission.
(8) Trial balance is:
(a) An account.
(b) A statement.
(c) A subsidiary book.
(d) A principal book.
(9) A Trial balance is prepared:
(a) After preparation financial statement.
(b) After recording transactions in subsidiary books.
(c) After posting to ledger is complete.
(d) After posting to ledger is complete and accounts have been balanced,

Key Terms Introduced in the Chapter

• Trial Balance • Compensating Error

• Error of Commission • Error of Principle
• Error Omission • Suspense Account

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216 Accountancy

Summary with Reference to Learning Objectives

1. Meaning of trial balance: A statement showing the abstract of the balance

(debit/credit) of various accounts in the ledger.
2. Objectives of trial balance: The main objectives of preparing the trial balance
are : (i) to ascertain the arithmetical accuracy of the ledger accounts; (ii) to
help in locating errors; and (iii) to help in the preparatioon of the final accounts.
3. Preparation of trial balance by the balance method: In this method, the trial
balance has three columns. The first column is for the head of the account,
the second column for writing the debit balance and the third for the credit
balance of each account in the ledger.
4. Various types of errors:
(i) Errors of commission: Errors caused due to wrong recording of a
transaction, wrong totalling, wrong casting, wrong balancing, etc.
(ii) Errors of Omission: Errors caused due to omission of recording a
transaction entirely or party in the books of account.
(iii) Errors of Principle: Errors arising due to wrong classificatrion of receipts
and payments between revenue and capital receipts and revenue and
capital expenditure.
(iv) Compensating errors: Two or more errors committed in such a way that
they nullify the effect of each other on the debits and credits.
5. Rectification of errors: Errors affecting only one account can be rectified by
giving an explanatory note or by passing a journal entry. Errors which affect
two or more accounts are rectified by passing a journal entry.
6. Meaning and utility of suspense account: An account in which the difference
in the trial balance is put till such time that errors are located and rectified.
It facilitates the preparation of financial statements even when the trial balance
does not tally.
7. Disposal of suspense account: When all the errors are located and rectified
the suspense account stands disposed off.

Questions for Practice

Short Answers
1. State the meaning of a trial balance?
2. Give two examples of errors of principle?
3. Give two examples of errors of commission?
4. What are the methods of preparing trial balance?
5. What are the steps taken by an accountant to locate the errors in the trial
balance?
6. What is a suspense account? Is it necessary that is suspense account will
balance off after rectification of the errors detected by the accountant? If
not, then what happens to the balance still remaining in suspense account?
7. What kinds of errors would cause difference in the trial balance. Also list
examples that would not be revealed by a trial balance?
8. State the limitations of trial balance?

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Long Answers
1. Describe the purpose for the preparation of trial balance.
2. Explain errors of principle and give two examples with measures to rectify
them.
3. Explain the errors of commission and give two examples with measures to
rectify them.
4. What are the different types of errors that are usually committed in recording
business transaction.
5. As an accountant of a company, you are disappointed to learn that the
totals in your new trial balance are not equal. After going through a careful
analysis, you have discovered only one error. Specifically, the balance of
the Office Equipment account has a debit balance of  15,600 on the trial
balance. However, you have figured out that a correctly recorded credit
purchase of pendrive for  3,500 was posted from the journal to the ledger
with a  3,500 debit to Office Equipment and another  3,500 debit to
creditors accounts. Answer each of the following questions and present the
amount of any misstatement :
(a) Is the balance of the office equipment account overstated, understated,
or correctly stated in the trial balance?
(b) Is the balance of the creditors account overstated, understated, or
correctly stated in the trial balance?
(c) Is the debit column total of the trial balance overstated, understated,
or correclty stated?
(d) Is the credit column total of the trial balance overstated, understated,
or correctly stated?
(e) If the debit column total of the trial balance is  2,40,000 before
correcting the error, what is the total of credit column.

Numerical Questions
1. Rectify the following errors:
(i) Credit sales to Mohan  7,000 were not recorded.
(ii) Credit purchases from Rohan  9,000 were not recorded.
(iii) Goods returned to Rakesh  4,000 were not recorded.
(iv) Goods returned from Mahesh  1,000 were not recorded.
2. Rectify the following errors:
(i) Credit sales to Mohan  7,000 were recorded as 700.
(ii) Credit purchases from Rohan  9,000 were recorded as  900.
(iii) Goods returned to Rakesh  4,000 were recorded as  400.
(iv) Goods returned from Mahesh  1,000 were recorded as 100.
3. Rectify the following errors:
(i) Credit sales to Mohan  7,000 were recorded as 7,200.
(ii) Credit purchases from Rohan  9,000 were recorded as  9,900.
(iii) Goods returned to Rakesh  4,000 were recorded as  4,040.
(iv) Goods returned from Mahesh  1,000 were recorded as 1,600.

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4. Rectify the following errors:

(a) Salary paid  5,000 was debited to employee’s personal account.
(b) Rent Paid  4,000 was posted to landlord’s personal account.
(c) Goods withdrawn by proprietor for personal use  1,000 were debited
to sundry expenses account.
(d) Cash received from Kohli  2,000 was posted to Kapur’s account.
(e) Cash paid to Babu  1,500 was posted to Sabu’s account.
5. Rectify the following errors:
(a) Credit Sales to Mohan  7,000 were recorded in purchases book.
(b) Credit Purchases from Rohan  9,00 were recorded in sales book.
(c) Goods returned to Rakesh  4,000 were recorded in the sales return
book.
(d) Goods returned from Mahesh  1,000 were recorded in purchases return
book.
(e) Goods returned from Nahesh  2,000 were recorded in purchases book.
6. Rectify the following errors:
(a) Sales book overcast by  700.
(b) Purchases book overcast by  500.
(c) Sales return book overcast by  300.
(d) Purchase return book overcast by  200.
7. Rectify the following errors:
(a) Sales book undercast by 300.
(b) Purchases book undercast by 400.
(c) Return Inwards book undercast by 200.
(d) Return outwards book undercast by 100.
8. Rectify the following errors and ascertain the amount of difference in trial
balance by preparing suspense account:
(a) Credit sales to Mohan  7,000 were not posted.
(b) Credit purchases from Rohan  9,000 were not posted.
(c) Goods returned to Rakesh  4,000 were not posted.
(d) Goods returned from Mahesh  1,000 were not posted.
(e) Cash paid to Ganesh  3,000 was not posted.
(f) Cash sales  2,000 were not posted.
(Ans: Difference in trial balance  2,000 excess credit).
9. Rectify the following errors and ascertain the amount of difference in trial
balance by preparing suspense account:
(a) Credit sales to Mohan  7,000 were posted as  9,000.
(b) Credit purchases from Rohan  9,000 were posted as  6,000.
(c) Goods returned to Rakesh  4,000 were posted as  5,000.
(d) Goods returned from Mahesh  1,000 were posted as  3,000.
(e) Cash sales  2,000 were posted as  200.
(Ans: Difference in trial balance  5,800 excess debit.)

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10. Rectify the following errors:

(a) Credit sales to Mohan  7,000 were posted to Karan.
(b) Credit purchases from Rohan  9,000 were posted to Gobind.
(c) Goods returned to Rakesh  4,000 were posted to Naresh.
(d) Goods returned from Mahesh  1,000 were posted to Manish.
(e) Cash sales  2,000 were posted to commission account.
11. Rectify the following errors assuming that a suspense account was opened.
Ascertain the difference in trial balance.
(a) Credit sales to Mohan  7,000 were posted to the credit of his account.
(b) Credit purchases from Rohan  9,000 were posted to the debit of his
account as  6,000.
(c) Goods returned to Rakesh  4,000 were posted to the credit of his
account.
(d) Goods returned from Mahesh  1,000 were posted to the debit of his
account as  2,000.
(e) Cash sales  2,000 were posted to the debit of sales account as  5,000.
(Ans: Difference in trial balance  3,000 excess debit).
12. Rectify the following errors assuming that a suspense account was opened.
Ascertain the difference in trial balance.
(a) Credit sales to Mohan  7,000 were posted to Karan as  5,000.
(b) Credit purchases from Rohan  9,000 were posted to the debit of Gobind
as  10,000.
(c) Goods returned to Rakesh  4,000 were posted to the credit of Naresh
as  3,000.
(d) Goods returned from Mahesh  1,000 were posted to the debit of Manish
as  2,000.
(e) Cash sales  2,000 were posted to commission account as  200.
(Ans: Difference in trial balance  14, 800 excess debit).
13. Rectify the following errors assuming that suspense account was opened.
Ascertain the difference in trial balance.
(a) Credit sales to Mohan  7,000 were recorded in Purchase Book. However,
Mohan’s account was correctly debited.
(b) Credit purchases from Rohan  9,000 were recorded in sales book.
However, Rohan’s account was correctly credited.
(c) Goods returned to Rakesh  4,000 were recorded in sales return book.
However, Rakesh’s account was correctly debited.
(d) Goods returned from Mahesh  1,000 were recorded through purchases
return book. However, Mahesh’s account was correctly credited.
(e) Goods returned to Naresh  2,000 were recorded through purchases
book. However, Naresh’s account was correctly debited.
(Ans: Difference in trial balance  6,000 excess debit).

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14. Rectify the following errors :

(a) Furniture purchased for  10,000 wrongly debited to purchases account.
(b) Machinery purchased on credit from Raman for  20,000 was recorded
through purchases book.
(c) Repairs on machinery  1,400 debited to machinery account.
(d) Repairs on overhauling of secondhand machinery purchased  2,000
was debited to Repairs account.
(e) Sale of old machinery at book value of  3,000 was credited to sales account.
15. Rectify the following errors assuming that suspension account was opened.
Ascertain the difference in trial balance.
(a) Furniture purchased for  10,000 wrongly debited to purchase account
as  4,000.
(b) Machinery purchased on credit from Raman for  20,000 recorded
through Purchases Book as  6,000.
(c) Repairs on machinery  1,400 debited to Machinery account as
 2,400.
(d) Repairs on overhauling of second hand machinery purchased  2,000
was debited to Repairs account as  200.
(e) Sale of old machinery at book value  3,000 was credited to sales account
as  5,000.
(Ans : Difference in trial balance  8,800 excess credit).
16. Rectify the following errors :
(a) Depreciation provided on machinery  4,000 was not posted.
(b) Bad debts written off  5,000 were not posted.
(c) Discount allowed to a debtor  100 on receiving cash from him was not
posted.
(d) Discount allowed to a debtor  100 on receiving cash from him was not
posted to discount account.
(e) Bill receivable for  2,000 received from a debtor was not posted.
17. Rectify the following errors :
(a) Depreciation provided on machinery  4,000 was posted as  400.
(b) Bad debts written off  5,000 were posted as  6,000.
(c) Discount allowed to a debtor  100 on receiving cash from him was
posted as  60.
(d) Goods withdrawn by proprietor for personal use  800 were posted as
 300.
(e) Bill receivable for  2,000 received from a debtor was posted as
 3,000.
18. Rectify the following errors assuming that suspense account was opened.
Ascertain the difference in trial balance.
(a) Depreciation provided on machinery  4,000 was not posted to
Depreciation account.

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(b) Bad debts written-off  5,000 were not posted to Debtors account.
(c) Discount allowed to a debtor  100 on receiving cash from him was not
posted to discount allowed account.
(d) Goods withdrawn by proprietor for personal use  800 were not posted
to Drawings account.
(e) Bill receivable for  2,000 received from a debtor was not posted to
Bills receivable account.
(Ans: Difference in trial balance  1,900 excess credit).
19. Trial balance of Anuj did not agree. It showed an excess credit of  6,000. He
put the difference to suspense account. He discovered the following erro
(a) Cash received from Ravish  8,000 posted to his account as
 6,000.
(b) Returns inwards book overcast by  1,000.
(c) Total of sales book  10,000 was not posted to Sales account.
(d) Credit purchases from Nanak  7,000 were recorded in sales Book.
However, Nanak’s account was correctly credited.
(e) Machinery purchased for  10,000 was posted to purchases account as
 5,000. Rectify the errors and prepare suspense account.
(Ans: Total of suspense account  19,000).
20. Trial balance of Raju showed an excess debit of  10,000. He put the difference
to suspense account and discovered the following errors :
(a) Depreciation written-off the furniture  6,000 was not posted to
Furniture account.
(b) Credit sales to Rupam  10,000 were recorded as  7,000.
(c) Purchases book undercast by  2,000.
(d) Cash sales to Rana  5,000 were not posted.
(e) Old Machinery sold for  7,000 was credited to sales account.
(f) Discount received  800 from kanan on playing cash to him was not
posted. Rectify the errors and prepare suspense account.
(Ans: Balance carried forward in suspense account  1,000 (cr.)).
21. Trial balance of Madan did not agree and he put the difference to
suspense account. He discovered the following errors:
(a) Sales return book overcast by  800.
(b) Purchases return to Sahu  2,000 were not posted.
(c) Goods purchased on credit from Narula  4,000 though taken into
stock, but no entry was passed in the books.
(d) Installation charges on new machinery purchased  500 were debited
to sundry expenses account as  50.
(e) Rent paid for residential accommodation of madam (the proprietor)
 1,400 was debited to Rent account as  1,000.
Rectify the errors and prepare suspense account to ascertain the
difference in trial balance.
(Ans: Difference in trial balance  2,050 excess credit).

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22. Trial balance of Kohli did not agree and showed an excess debit of  16,300.
He put the difference to a suspense account and discovered the following
errors:
(a) Cash received from Rajat  5,000 was posted to the debit of Kamal as
 6,000.
(b) Salaries paid to an employee  2,000 were debited to his personal account
as  1200.
(c) Goods withdrawn by proprietor for personal use  1,000 were credited
to sales account as  1,600.
(d) Depreciation provided on machinery  3,000 was posted to Machinery
account as  300.
(e) Sale of old car for  10,000 was credited to sales account as
 6,000. Rectify the errors and prepare suspense account.
(Ans: total of suspense account :  17,700).
23. Give journal entries to rectify the following errors assuming that suspense
account had been opened.
(a) Goods distributed as free sample  5,000 were not recorded in the books.
(b) Goods withdrawn for personal use by the proprietor  2,000 were not
recorded in the books.
(c) Bill receivable received from a debtor  6,000 was not posted to his
account.
(d) Total of Returns inwards book  1,200 was posted to Returns outwards
account.
(e) Discount allowed to Reema  700 on receiving cash from her was
recorded in the books as  70.
(Ans: Difference in trial balance  3,600 excess debit).
24. Trial balance of Khatau did not agree. He put the difference to suspense account
and discovered the following errors :
(a) Credit sales to Manas  16,000 were recorded in the purchases book as
 10,000 and posted to the debit of Manas as  1,000.
(b) Furniture purchased from Noor  6,000 was recorded through purchases
book as  5,000 and posted to the debit of Noor  2,000.
(c) Goods returned to Rai  3,000 recorded through the Sales book as
 1,000.
(d) Old machinery sold for  2,000 to Maneesh recorded through sales
book as  1,800 and posted to the credit of Manish as  1,200.
(e) Total of Returns inwards book  2,800 posted to Purchase account.
Rectify the above errors and prepare suspense account to ascertain the
difference in trial balance.
(Ans: Difference in trial balance  15,000 excess debit).
25. Trial balance of John did not agree. He put the difference to suspense account
and discovered the following errors :
(a) In the sales book for the month of January total of page 2 was carried
forward to page 3 as  1,000 instead of  1200 and total of page 6 was
carried forward to page 7 as  5,600 instead of  5,000.

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(b) Wages paid for installation of machinery  500 was posted to wages
account as  50.
(c) Machinery purchased from R & Co. for  10,000 on credit was entered
in Purchase Book as  6,000 and posted there from to R & Co. as
 1,000.
(d) Credit sales to Mohan  5,000 were recorded in Purchases Book.
(e) Goods returned to Ram  1,000 were recorded in Sales Book.
(f) Credit purchases from S & Co. for  6,000 were recorded in sales book.
However, S & Co. was correctly credited.
(g) Credit purchases from M & Co.  6,000 were recorded in Sales Book as
 2,000 and posted there from to the credit of M & Co. as
 1,000.
(h) Credit sales to Raman  4,000 posted to the credit of Raghvan as
 1,000.
(i) Bill receivable for  1,600 from Noor was dishonoured and posted to
debit of Allowances account.
(j) Cash paid to Mani  5,000 against our acceptance was debited to Manu.
(k) Old furniture sold for  3,000 was posted to Sales account as
 1,000.
(l) Depreciation provided on furniture  800 was not posted.
(m) Material  10,000 and wages  3,000 were used for construction of
building. No adjustment was made in the books.
Rectify the errors and prepare suspense to ascertain the difference in
trial balance.
(Ans : Difference in trial balance  13,850 excess credit).

Checklist to Test Your Understanding

Test your understanding - I
Trial Balance Total  5,17,000
Test your understanding - II

1. Purchases A/c Dr. 5,000

To Rajni’s A/c 5,000

Rajni’s A/c Dr. 5,000

To Sales A/c 5,000

Rajni’s A/c Dr. 10,000

To Sales A/c 5,000
To Purchases A/c 5,000

2. Purchases A/c Dr. 8,000

To Rao’s A/c 8,000

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Furniture A/c Dr. 8,000

To Purchases A/c 8,000

3. Cash A/c Dr. 15,000

To Commission A/c 15,000

Cash A/c Dr. 15,000

To Sales A/c 15,000

Commission A/c Dr. 15,000

To Sales A/c 15,000

4. Cash A/c Dr. 6, 000

To Nadeem’s A/c 6,000

Cash A/c Dr. 6,000

To Karim’s A/c 6,000

Test Your Understanding - III

1. Error of Commission

Mohan’s A/c Dr. 12, 000

To Sales A/c 12,000

Mohan’s A/c Dr. 10,000

To Sales A/c 10,000

Suspense A/c Dr. 2,000

To Mohan’s A/c 2,000

2. Error of Partial omission

xxx A/c Dr. 2,000

To Cash A/c 2,000

Neha’s A/c Dr. 2,000

To Suspense A/c 2,000

Neha’s A/c Dr. 2,000

To Suspense A/c 2,000

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3. Error of Commission

Sales Return A/c Dr. 1,600

To Megha’s A/c 1,600

Sales Returns A/c Dr. 1,600

To Megha’s A/c 1,600

Suspense A/c Dr. 600

To Megha’s A/c 600

4. Error of Commission
xxx Dr. 1,500
To Furniture A/c 1,500

Depreciation A/c Dr. 1,500

To Furniture A/c 1,500

Depreciation A/c Dr. 1,500

To Suspense A/c 1,500

Test Your Understanding - IV

1. (c) 2. (c) 3. (d) 4. (a) 5. (b) 6. (a) 7. (b) 8. (b) 9. (d)

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226 Accountancy

Depreciation, Provisions and Reserves 7

M atching principle requires that the revenue of

a given period is matched against the expenses
for the same period. This ensures ascertainment of
the correct amount of profit or loss. If some cost is
LEARNING OBJECTIVES incurred whose benefit extend to more than one
accounting period, it is not justified to charge the
After studying this chapter, entire cost as expense in the year in which it is
you will be able to :
incurred. In fact, such a cost must be spread over
• explain the meaning of the periods in which it provides benefits.
depreciation and
distinguish it from
Depreciation, on fixed assets, which is the main
amortisation and subject matter of the present chapter, deals with such
depletion; a situation. Further, it may not always be possible
• state the need for to ascertain with certainty the amount of some
charging depreciation particular expense. Recall the principle of
and identify its causes; conservatism (prudence) which requires that instead
• compute depreciation of ignoring such items of costs, adequate provision
using straight line and must be made and charged against profits of the
written down value current period. Moreover, a part of profit may be
methods;
retained in the business in the form of reserves to
• record transactions provide for growth, expansion or meeting certain
relating to depreciation
and disposition of
specific needs of the business in future. This chapter
assets; deals with two distinct topics and hence is being
• explain the meaning presented in two different sections. First section deals
and purpose of creating with depreciation and second section deals with
provisions and reserves; provisions and reserves.
• distinguish between
reserves and provisions;
SECTION – I
• explain the nature of
various types of 7.1 Depreciation
provisions and reserves
including secret reserve. Now you are aware that fixed assets are the assets
which are used in business for more than one

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accounting year. Fixed assets (technically referred to as “depreciable assets”)

tend to reduce their value once they are put to use. In general, the term
“Depreciation” means decline in the value of a fixed assets due to use, passage
of time or obsolescence. In other words, if a business enterprise procures a
machine and uses it in production process then the value of machine declines
with its usage. Even if the machine is not used in production process, we can
not expect it to realise the same sales price due to the passage of time or
arrival of a new model (obsolescence). It implies that fixed assets are subject
to decline in value and this decline is technically referred to as depreciation.
As an accounting term, depreciation is that part of the cost of a fixed asset
which has expired on account of its usage and/or lapse of time. Hence,
depreciation is an expired cost or expense, charged against the revenue of a
given accounting period. For example, a machine is purchased for `1,00,000
on April 01, 2017. The useful life of the machine is estimated to be 10 years. It
implies that the machine can be used in the production process for next 10
years till March 31, 2016. You know that by its very nature, ` 1,00,000 is a
capital expenditure during the year 2017-18. However, when income statement
(Statement of Profit and Loss) is prepared, the entire amount of `1,00,000 can
not be charged against the revenue for the year 2017-18, because of the reason
that the capital expenditure amounting to `1,00,000 is expected to derive benefits
(or revenue) for 10 years and not one year. Therefore, it is logical to charge only
a part of the total cost say `10,000 (one tenth of ` 1,00,000) against the revenue
for the year 2017-18. This part represents the expired cost or loss in the value
of machine on account of its use or passage of time and is referred to as
‘Depreciation’. The amount of depreciation, being a charge against profit, is
debited to Income Statement (Statement of Profit and Loss).

7.1.1 Meaning of Depreciation

Depreciation may be described as a permanent, continuing and gradual
shrinkage in the book value of fixed assets. It is based on the cost of assets
consumed in a business and not on its market value.
According to Institute of Cost and Management Accounting, London (ICMA)
terminology “The depreciation is the diminution in intrinsic value of the asset
due to use and/or lapse of time.”
Accounting Standard-6 issued by The Institute of Chartered Accountants
of India (ICAI) defines depreciation as “a measure of the wearing out, consumption
or other loss of value of depreciable asset arising from use, effluxion of time or
obsolescence through technology and market-change. Depreciation is allocated
so as to charge fair proportion of depreciable amount in each accounting period
during the expected useful life of the asset. Depreciation includes amortisation
of assets whose useful life is pre-determined”.

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Box 1
AS-6 (Revised): Depreciation

• Depreciation is “a measure of the wearing out, consumption or other loss of

value of depreciable asset arising from use, effluxion of time or obsolescence
through technology and market-change. Depreciation is allocated so as to charge
fair proportion of depreciable amount in each accounting period during the
expected useful life of the asset. Depreciation includes amortisation of assets
whose useful life is pre-determined”.
• Depreciation has a significant effect in determining and presenting the financial
position and results of operations of an enterprise. Depreciation is charged in
each accounting period by reference to the extent of the depreciable amount.
• The subject matter of depreciation, or its base, are ‘depreciable’ assets which.
• “are expected to be used during more than one accounting period.
• have a limited useful life; and
• are held by an enterprise for use in production or supply of goods and services,
for rental to others, or for administrative purposes and not for the purpose of
sale in the ordinary course of business.”
• The amount of depreciation basically depends upon three factors, i.e. Cost, Useful
life and Net realisable value.
• Cost of a fixed asset is “the total cost spent in connection with its acquisition,
installation and commissioning as well as for add item or improvement of the
depreciable asset”.
• Useful life of an asset is the “period over which it is expected to be used by the
enterprise”.
• There are two main methods of calculating depreciation amount.
• straight line method
• written down value method
• Selection of appropriate method depends upon the following factors:
• type of the asset
• nature of the use of such asset
• circumstances prevailing in the business.
• The selected depreciation method should be applied consistently from period to
period. Change in depreciation method may be allowed only under specific
circumstances.

Depreciation has a significant effect in determining and presenting the

financial position and results of operations of an enterprise. Depreciation is
charged in each accounting period by reference to the extent of the depreciable
amount. It should be noted that the subject matter of depreciation, or its
base, are ‘depreciable’ assets which:
• “are expected to be used during more than one accounting period;
• have a limited useful life; and
• are held by an enterprise for use in production or supply of goods and
services, for rental to others, or for administrative purposes and not for
the purpose of sale in the ordinary course of business.”

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Depreciation, Provisions and Reserves 229

Examples of depreciable assets are machines, plants, furnitures, buildings,

computers, trucks, vans, equipments, etc. Moreover, depreciation is the
allocation of ‘depreciable amount’, which is the “historical cost”, or other
amount substituted for historical cost less estimated salvage value.
Another point in the allocation of depreciable amount is the ‘expected useful
life’ of an asset. It has been described as “either (i) the period over which a
depreciable asset is expected to the used by the enterprise, or (ii) the number
of production of similar units expected to be obtained from the use of the
asset by the enterprise.”

7.1.2 Features of Depreciation

Above mentioned discussion on depreciation highlights the following features
of depreciation:
1. It is decline in the book value of fixed assets.
2. It includes loss of value due to effluxion of time, usage or obsolescence.
For example, a business firm buys a machine for ` 1,00,000 on April 01,
2017. In the year 2017, a new version of the machine arrives in the market.
As a result, the machine bought by the business firm becomes outdated.
The resultant decline in the value of old machine is caused by obsolescence.
3. It is a continuing process.
4. It is an expired cost and hence must be deducted before calculating taxable
profits. For example, if profit before depreciation and tax is ` 50,000, and
depreciation is ` 10,000; profit before tax will be:
(`)
Profit before depreciation & tax 50,000
(-) Depreciation (10,000)
Profit before tax 40,000
5. It is a non-cash expense. It does not involve any cash outflow. It is the
process of writing-off the capital expenditure already incurred.

Do it Yourself

Look at your surroundings and identify at least five depreciable assets in your home,
school, hospital, printing press and in a bakery.

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230 Accountancy

7.2 Depreciation and other Similar Terms

There are some terms like ‘depletion’ and ‘amortisation’, which are also used in
connection with depreciation. This has been due to the similar treatment given
to them in accounting on the basis of similarity of their outcome, as they represent
the expiry of the usefulness of different assets.

7.2.1 Depletion
The term depletion is used in the context of extraction of natural resources like
mines, quarries, etc. that reduces the availability of the quantity of the material
or asset. For example, if a business enterprise is into mining business and
purchases a coal mine for ` 10,00,000. Then the value of coal mine declines
with the extraction of coal out of the mine. This decline in the value of mine is
termed as depletion. The main difference between depletion and depreciation is
that the former is concerned with the exhaution of economic resources, but the
latter relates to the usage of an asset. In spite of this, the result is erosion in the
volume of natural resources and expiry of the service potential. Therefore,
depletion and depreciation are given similar accounting treatment.

7.2.2 Amortisation
Amortisation refers to writing-off the cost of intangible assets like patents,
copyright, trade marks, franchises, goodwill which have utility for a specified
period of time. The procedure for amortisation or periodic write-off of a portion
of the cost of intangible assets is the same as that for the depreciation of fixed
assets. For example, if a business firm buys a patent for ` 10,00,000 and
estimates that its useful life will be 10 years then the business firm must write-
off ` 10,00,000 over 10 years. The amount so written- off is technically referred
to as amortisation.

7.3 Causes of Depreciation

These have been very clearly spelt out as part of the definition of depreciation in
the Accounting Standard 6 and are being elaborated here.

7.3.1 Wear and Tear due to Use or Passage of Time

Wear and tear means deterioration, and the consequent diminution in an assets
value, arising from its use in business operations for earning revenue. It reduces
the asset’s technical capacities to serve the purpose for, which it has been meant.
Another aspect of wear and tear is the physical deterioration. An asset
deteriorates simply with the passage of time, even though they are not being put
to any use. This happens especially when the assets are exposed to the rigours
of nature like weather, winds, rains, etc.

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Depreciation, Provisions and Reserves 231

7.3.2 Expiration of Legal Rights

Certain categories of assets lose their value after the agreement governing their
use in business comes to an end after the expiry of pre-determined period.
Examples of such assets are patents, copyrights, leases, etc. whose utility to
business is extinguished immediately upon the removal of legal backing to them.

7.3.3 Obsolescence
Obsolescence is another factor leading to depreciation of fixed assets. In ordinary
language, obsolescence means the fact of being “out-of-date”. Obsolescence
implies to an existing asset becoming out-of-date on account of the availability
of better type of asset. It arises from such factors as:
• Technological changes;
• Improvements in production methods;
• Change in market demand for the product or service output of the asset;
• Legal or other description.

7.3.4 Abnormal Factors

Decline in the usefulness of the asset may be caused by abnormal factors such as
accidents due to fire, earthquake, floods, etc. Accidental loss is permanent but
not continuing or gradual. For example, a car which has been repaired after an
accident will not fetch the same price in the market even if it has not been used.

7.4 Need for Depreciation

The need for providing depreciation in accounting records arises from conceptual,
legal, and practical business consideration. These considerations provide
depreciation a particular significance as a business expense.
7.4.1 Matching of Costs and Revenue
The rationale of the acquisition of fixed assets in business operations is that these
are used in the earning of revenue. Every asset is bound to undergo some wear
and tear, and hence lose value, once it is put to use in business. Therefore,
depreciation is as much the cost as any other expense incurred in the normal
course of business like salary, carriage, postage and stationary, etc. It is a charge
against the revenue of the corresponding period and must be deducted before
arriving at net profit according to ‘Generally Accepted Accounting Principles’.

7.4.2 Consideration of Tax

Depreciation is a deductible cost for tax purposes. However, tax rules for the
calculation of depreciation amount need not necessarily be similar to current
business practices,

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7.4.3 True and Fair Financial Position

If depreciation on assets is not provided for, then the assets will be over valued
and the balance sheet will not depict the correct financial position of the business.
Also, this is not permitted either by established accounting practices or by specific
provisions of law.

7.4.4 Compliance with Law

Apart from tax regulations, there are certain specific legislations that indirectly
compel some business organisations like corporate enterprises to provide
depreciation on fixed assets.

Test Your Understanding - I

State whether the following statements are true or false:
1. Depreciation is a non-cash expense.
2. Depreciation is also charged on current assets.
3. Depreciation is decline in the market value of tangible fixed assets.
4. The main cause of depreciation is wear and tear caused by its usage.
5. Depreciation must be charged so as to ascertain true profit or loss of the business.
6. Depletion term is used in case of intangible assets.
7. Depreciation provides fund for replacement.
8. When market value of an asset is higher than book value, depreciation is not
charged.
9. Depreciation is charged to reduce the value of asset to its market value.
10. If adequate maintenance expenditure is incurred, depreciation need not be
charged.

7.5 Factors Affecting the Amount of Depreciation

The determination of depreciation depends on three parameters, viz. cost,
estimated useful life and probable salvage value.

7.5.1 Cost of Asset

Cost (also known as original cost or historical cost) of an asset includes invoice
price and other costs, which are necessary to put the asset in use or working
condition. Besides the purchase price, it includes freight and transportation
cost, transit insurance, installation cost, registration cost, commission paid on
purchase of asset add items such as software, etc. In case of purchase of a
second hand asset it includes initial repair cost to put the asset in workable

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Depreciation, Provisions and Reserves 233

condition. According to Accounting Standand-6 of ICAI, cost of a fixed asset is

“the total cost spent in connection with its acquisition, installation and
commissioning as well as for addition or improvement of the depreciable asset”.
For example, a photocopy machine is purchased for ` 50,000 and ` 5,000 is
spent on its transportation and installation. In this case the original cost of the
machine is ` 55,000 (i.e. ` 50,000 + `5,000 ) which will be written-off as
depreciation over the useful life of the machine.

7.5.2 Estimated Net Residual Value

Net Residual value (also known as scrap value or salvage value for accounting
purpose) is the estimated net realisable value (or sale value) of the asset at the
end of its useful life. The net residual value is calculated after deducting the
expenses necessary for the disposal of the asset. For example, a machine is
purchased for ` 50,000 and is expected to have a useful life of 10 years. At the
end of 10th year it is expected to have a sale value of ` 6,000 but expenses
related to its disposal are estimated at ` 1,000. Then its net residual value shall
be ` 5,000 (i.e. ` 6,000 – ` 1,000).

7.5.3 Depreciable Cost

Depreciable cost of an asset is equal to its cost (as calculated in point 7.5.1
above) less net residual value (as calculated in point 7.5.2,) Hence, in the above
example, the depreciable cost of machine is ` 45,000 (i.e., ` 50,000 –
` 5,000.) It is the depreciable cost, which is distributed and charged as
depreciation expense over the estimated useful life of the asset. In the above
example, ` 45,000 shall be charged as depreciation over a period of 10 years. It
is important to mention here that total amount of depreciation charged over the
useful life of the asset must be equal to the depreciable cost. If total amount of
depreciation charged is less than the depreciable cost then the capital expenditure is
under recovered. It violates the principle of proper matching of revenue and expense.

7.5.4 Estimated Useful Life

Useful life of an asset is the estimated economic or commercial life of the asset.
Physical life is not important for this purpose because an asset may still exist
physically but may not be capable of commercially viable production. For
example, a machine is purchased and it is estimated that it can be used in
production process for 5 years. After 5 years the machine may still be in good
physical condition but can’t be used for production profitably, i.e., if it is still
used the cost of production may be very high. Therefore, the useful life of the
machine is considered as 5 years irrespective of its physical life. Estimation of
useful life of an asset is difficult as it depends upon several factors such as

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usage level of asset, maintenance of the asset, technological changes, market

changes, etc. As per Accounting Standard – 6 useful life of an asset is normally
the “period over which it is expected to be used by the enterprise”. Normally,
useful life is shorter than the physical life. The useful life of an asset is expressed
in number of years but it can also be expressed in other units, e.g., number of
units of output (as in case of mines) or number of working hours. Useful life
depends upon the following factors :
• Pre-determined by legal or contractual limits, e.g., in case of leasehold asset,
the useful life is the period of lease.
• The number of shifts for which asset is to be used.
• Repair and maintenance policy of the business organisation.
• Technological obsolescence.
• Innovation/improvement in production method.
• Legal or other restrictions.

7.6 Methods of Calculating Depreciation Amount

The depreciation amount to be charged for during an accounting year depends
upon depreciable amount and the method of allocation. For this, two methods
are mandated by law and enforced by professional accounting practice in India.
These methods are straight line method and written down value method. Besides
these two main methods there are other methods such as – annuity method,
depreciation fund method, insurance policy method, sum of years digit method,
double declining method, etc. which may be used for determining the amount of
depreciation. The selection of an appropriate method depends upon the following :
• Type of the asset;
• Nature of the use of such asset;
• Circumstances prevailing in the business;
As per Accounting Standard-6, the selected depreciation method should be
applied consistently from period to period. Change in depreciation method may
be allowed only under specific circumstances.

7.6.1 Straight Line Method

This is the earliest and one of the widely used methods of providing depreciation.
This method is based on the assumption of equal usage of the asset over its
entire useful life. It is called straight line for a reason that if the amount of
depreciation and corresponding time period is plotted on a graph, it will result
in a straight line (figure 7.1).

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Depreciation, Provisions and Reserves 235

It is also called fixed installment method because the amount of depreciation

remains constant from year to year over the useful life of the asset. According to
this method, a fixed and an equal amount is charged as depreciation in every
accounting period during the lifetime of an asset. The amount annually charged
as depreciation is such that it reduces the original cost of the asset to its scrap
value, at the end of its useful life. This method is also known as fixed percentage
on original cost method because same percentage of the original cost (infact
depreciable cost) is written off as depreciation from year to year.
The depreciation amount to be provided under this method is computed
by using the following formula:

Cost of asset - Estimated net residential value

Depreciation =
Estimated useful life of the asset

Rate of depreciation under straight line method is the percentage of the total
cost of the asset to be charged as deprecation during the useful lifetime of the
asset. Rate of depreciation is calculated as follows:

Annual depreciation amount

Rate of Depreciation = × 100
Acquisition cost

Consider the following example, the original cost of the asset is ` 2,50,000.
The useful life of the asset is 10 years and net residual value is estimated to
be ` 50,000. Now, the amount of depreciation to be charged every year will be
computed as given below:
Annual Depreciation Amount
Acqusition cost of asset − Estimated net residential value
=
Estimated life of asset

` 2, 50 , 00 0 − ` 50 , 00 0
i.e. = = ` 2 0, 00 0
10

Fig. 7.1 : Depreciation amount under straight line method

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236 Accountancy

The rate of depreciation will be calculated as :

Annual depreciation amount
(i) Rate of Depreciation = × 100
Acquisition cost
From point (i), the annual depreciation amounts to ` 20,000.
` 20, 000
Thus, the rate of depreciation will be = × 100 = 8%
` 2, 50, 000

7.6.1.1 Advantages of Straight Line Method

Straight Line method has certain advantages which are stated below:
• It is very simple, easy to understand and apply. Simplicity makes it a popular
method in practice;
• Asset can be depreciated upto the net scrap value or zero value. Therefore,
this method makes it possible to distribute full depreciable cost over useful
life of the asset;
• Every year, same amount is charged as depreciation in profit and loss account.
This makes comparison of profits for different years easy;
• This method is suitable for those assets whose useful life can be estimated
accurately and where the use of the asset is consistent from year to year
such as leasehold buildings.

7.6.1.2 Limitations of Straight Line Method

Although straight line method is simple and easy to apply it suffers from
certain limitations which are given below.
• This method is based on the faulty assumption of same amount of the utility
of an asset in different accounting years;
• With the passage of time, work efficiency of the asset decreases and repair
and maintenance expense increases. Hence, under this method, the total
amount charged against profit on account of depreciation and repair taken
together, will not be uniform throughout the life of the asset, rather it will
keep on increasing from year to year.

7.6.2 Written Down Value Method

Under this method, depreciation is charged on the book value of the asset. Since
book value keeps on reducing by the annual charge of depreciation, it is also
known as ‘reducing balance method’. This method involves the application of a
pre-determined proportion/percentage of the book value of the asset at the
beginning of every accounting period, so as to calculate the amount of
depreciation. The amount of depreciation reduces year after year.

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Depreciation, Provisions and Reserves 237

For example, the original cost of the asset is ` 2,00,000 and depreciation is
charged @ 10% p.a. at written down value, then the amount of depreciation will
be computed as follows:
10
(i) Depreciation (I year) = ` 20, 00, 00 0 × = ` 2 0, 000
100
(ii) Written down value = ` 2,00,000 – 20,000 = `1,80,000
(at the end of the I year)
10
(iii) Depreciation (II year) = ` 1, 8 0, 0 00 × = ` 1 8 , 0 00
1 00
(iv) Written down value = ` 1,80,000 – `18,000 = 1,62,000
(at the end of the II year)
10
(v) Depreciation (III year) = ` 1, 6 2, 0 00 × = ` 1 6 , 2 00
1 00
(vi) Written down value = ` 1,62,000 – ` 16,200 = ` 1,45,800
(at the end of III year)
As evident from the example, the amount of depreciation goes on reducing
year after year. For this reason, it is also known ‘reducing installment’ or
‘diminishing value’ method. This method is based upon the assumption that
the benefit accruing to business from assets keeps on diminishing as the
asset becomes old (refer figure 7.2). This is due to the reason that a pre-
determined percentage is applied to a gradually shrinking balance on the
asset account every year. Thus, large amount is recovered depreciation charge
in the earlier years than in later years.

Fig. 7.2 : Depreciation amount using written down value method

Under written down value method, the rate of depreciation is computed by using
the following formula:
 s 
R = 1 − n ×100
 c
 

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Where, r = Rate of depreciation

n = Expected useful life
s = Scrap value
c = Cost of an asset
For example, the original cost of a truck is ` 9,00,000 and its net salvage
value after 16 years of useful life is ` 50,000 then the appropriate rate of
depreciation will be computed as under:
 50,000 
R = 1 −16 ×100 = (1 − 0.834) ×100 = 16.6%
 9,00,000 
 

7.6.2.1 Advantages of Written Down Value Method

Written down value method has the following advantages:
• This method is based on a more realistic assumption that the benefits from
asset go on diminishing (reducing) with the passage of time. Hence, it calls
for proper allocation of cost because higher depreciation is charged in earlier
years when asset’s utility is higher as compared to later years when it becomes
less effective.
• It results into almost equal burden of depreciation and repair expenses taken
together every year on profit and loss account;
• Income Tax Act accept this method for tax purposes;
• As a large portion of cost is written-off in earlier years, loss due to obsolescence
gets reduced;
• This method is suitable for fixed assets which last for long and which require
increased repair and maintenance expenses with passage of time. It can also
be used where obsolescence rate is high.
7.6.2.2 Limitations of Written Down Value Method
Although this method is based upon a more realistic assumption it suffers from
the following limitations.
• As depreciation is calculated at fixed percentage of written down value,
depreciable cost of the asset cannot be fully written-off. The value of the
asset can never be zero;
• It is difficult to ascertain a suitable rate of depreciation.

7.7 Straight Line Method and Written Down Method: A Comparative Analysis
Straight line and written down value methods are generally used for calculating
depreciation amount in practice. Following are the points of differences between
these two methods.

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Depreciation, Provisions and Reserves 239

7.7.1 Basis of Charging Depreciation

In straight line method, depreciation is charged on the basis of original cost or
(historical cost). Whereas in written down value method, the basis of charging
depreciation is net book value (i.e., original cost less depreciation till date) of the
asset, in the beginning of the year.

7.7.2 Annual Charge of Depreciation

The annual amount of depreciation charged every year remains fixed or constant
under straight line method. Whereas in written down value method the annual
amount of depreciation is highest in the first year and subsequently declines in
later years. The reason for this difference, is the difference in the basis of charging
depreciation under both methods. Under straight line method depreciation is
calculated on original cost while under written down value method it is calculated
on written down value.

7.7.3 Total Charge Against Profit and Loss Account on Account of

Depreciation and Repair Expenses
It is a well-accepted phenomenon that repair and maintenance expenses
increase in later years of the useful life of the asset. Hence, total charge against
profit and loss account in respect of depreciation and repair expenses increases
in later years under straight line method. This happens because annual
depreciation charge remains fixed while repair expenses increase. On the other
hand, under written down value method, depreciation charge declines in later
years, therefore total of depreciation and repair charge remains similar or equal
year after year.

7.7.4 Recognition by Income Tax Law

Straight line method is not recognised by Income Tax Law while written down
value method is recognised by the Income Tax Law.

7.7.5 Suitability
Straight line method is suitable for assets in which repair charges are low the
possibility of obsolescence is low and scrap value depends upon the time period
involved, such as freehold land and buildings, patents, trade marks, etc. Written
down value method is suitable for assets which are affected by technological
changes and require more repair expenses with passage of time such as plant
and machinery, vehicles, etc.

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Basis of Difference Straight Line Method Written Down Value

Method

1. Basis of charging depre- Original cost Book Value (i.e. original

ciation cost less depreciation
charged till date)
2. Annual depreciation charge Fixed (Constant) year Declines year after year

3. Total charge against Unequal year after year. Almost equal every year.
profit and loss account in It increases in later years.
respect of depreciation
and repairs
4. Recognition by income Not recognised Recognised
tax law
5. Suitablity It is suitable for assets in It is suitable for assets,
which repair charges are which are affected by
less, the possibility of technological changes
and obsolescence is low and require more repair
scrap value depends upon expenses with passage of
the time period involved. time.

Fig. 7.3 : Comparison of straight line and written down value method

7.8 Methods of Recording Depreciation

In the books of account, there are two types of arrangements for recording
depreciation on fixed assets:
• Charging depreciation to asset account or
• Creating Provision for depreciation/Accumulated depreciation account.

7.8.1 Charging Depreciation to Asset account

According to this arrangement, depreciation is deducted from the depreciable
cost of the asset (credited to the asset account) and charged (or debited) to profit
and loss account. Journal entries under this recording method are as follows:
1. For recording purchase of asset (only in the year of purchase)
Asset A/c Dr. (with the cost of asset including
installation, freight, etc.)
To Bank/Vendor A/c
2. Following two entries are recorded at the end of every year
(a) For deducting depreciation amount from the cost of the asset.
Depreciation A/c Dr. (with the amount of depreciation)
To Asset A/c
(b) For charging depreciation to profit and loss account.
Profit & Loss A/c Dr. (with the amount of depreciation)
To Depreciation A/c

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3. Balance Sheet Treatment

When this method is used, the fixed asset appears at its net book value (i.e. cost
less depreciation charged till date) on the asset side of the balance sheet and not at
its original cost (also known as historical cost).

7.8.2 Creating Provision for Depreciation Account/Accumulated

Depreciation Account
This method is designed to accumulate the depreciation provided on an asset in
a separate account generally called ‘Provision for Depreciation’ or ‘Accumulated
Depreciation’ account. By such accumulation of depreciation the asset account
need not be disturbed in any way and it continues to be shown at its original
cost over the successive years of its useful life. There are some basic characteristic
of this method of recording depreciation. These are given below:
• Asset account continues to appear at its original cost year after year over its
entire life;
• Depreciation is accumulated on a separate account instead of being adjusted
in the asset account at the end of each accounting period.
The following journal entries are recorded under this method:
1. For recording purchase of asset (only in the year of purchase)
Asset A/c Dr. (with the cost of asset including
installation, expenses etc.)
To Bank/Vendor A/c (cash/credit purchase)
2. Following two journal entries are recorded at the end of each year:
(a) For crediting depreciation amount to provision for depreciation account
Depreciation A/c Dr. (with the amount of depreciation)
To Provision for depreciation A/c
(b) For charging depreciation to profit and loss account
Profit & Loss A/c Dr. (with the amount of depreciation)
To Depreciation A/c
3. Balance sheet treatment
In the balance sheet, the fixed asset continues to appear at its original cost on the asset
side. The depreciation charged till that date appears in the provision for depreciation account,
which is shown either on the “liabilities side” of the balance sheet or by way of deduction
from the original cost of the asset concerned on the asset side of the balance sheet.

Illustration 1
M/s Singhania and Bros. purchased a plant for ` 5,00,000 on April 01, 2017, and spent
` 50,000 for its installation. The salvage value of the plant after its useful life of 10 years
is estimated to be ` 10,000. Record journal entries for the year 2016-17 and draw up Plant
Account and Depreciation Account for first three years given that the depreciation is
charged using straight line method if :
(i) The books of account close on March 31 every year; and
(ii) The firm charges depreciation to the asset account.

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242 Accountancy

Solution
Books of Singhania and Bros.
Journal

Date Particulars L.F. Debit Credit

Amount Amount
` `
2016
Apr. 01 Plant A/c Dr. 5,00,000
To Bank A/c 5,00,000
(Purchased plant for ` 5,00,000)
Apr. 01 Plant A/c Dr. 50,000
To Bank A/c 50,000
(Expenses incurred on installation)
2017
Mar. 31 Depreciation A/c Dr. 54,000
To Plant A/c 54,000
(Depreciation charged on asset)
Mar. 31 Profit and Loss A/c Dr. 54,000
To Depreciation A/c 54,000
(Depreciation debited to profit and
loss account)

Plant Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2016 2017
Apr. 01 Bank 5,00,000 Mar. 31 Depreciation 54,000
Balance c/d 4,96,000
Bank 50,000
(Installation
expenses)
5,50,000 5,50,000

2017 2018
Apr. 01 Balance b/d 4,96,000 Mar. 31 Depreciation 54,000
Balance c/d 4,42,000
4,96,000 4,96,000

2018 2019
Apr. 01 Balance b/d 4,42,000 Mar. 31 Depreciation 54,000
Balance c/d 3,88,000
4,42,000 4,42,000
2019
Apr. 01 Balance b/d 3,88,000

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Depreciation Account
Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amounts

` `
2017 2017
Mar. 31 Plant 54,000 Mar. 31 Profit and Loss 54,000
2018 2018
Mar. 31 Plant 54,000 Mar. 31 Profit and Loss 54,000
2019 2019

Mar. 31 Plant 54,000 Mar. 31 Profit & Loss 54,000

Workings Notes
(1) Calculation of original cost
(`)
Purchase cost 5,00,000
Add: Installation cost 50,000
Original cost 5,50,000
Salvage value 10,000
Useful life 10 years
` 5, 50, 000 − ` 10, 000
(2) Depreciation amount = = ` 5 4 , 0 0 0 p .a .
10

Illustration 2
M/s Mehra and Sons acquired a machine for ` 1,80,000 on October 01, 2016, and spent
` 20,000 for its installation. The firm writes-off depreciation at the rate of 10% on original
cost every year. Record necessary journal entries for the year 2017 and draw up Machine
Account and Depreciation Account for first three years given that:
(i) The book of accounts closes on March 31 every year; and
(ii) The firm charges depreciation to asset account.

Solution
Books of Mehra and Sons
Journal
Debit Credit
Date Particulars L.F. Amount Amount
` `
2016
Oct. 01 Machine A/c Dr. 1,80,000
To Bank A/c 1,80,000
(Purchased machine for `1,80,000)
Oct. 01 Machine A/c Dr. 20,000
To Bank A/c 20,000
(Expenses incurred on installation)

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244 Accountancy

2017
Mar. 31 Depreciation A/c Dr. 10,000
To Machine A/c 10,000
Depreciation charged on machine)
Mar. 31 Profit and Loss A/c Dr. 10,000
To Depreciation A/c 10,000
(Depreciation debited to profit and loss
account)
2018
Mar. 31 Depreciation A/c Dr. 20,000
To Machine A/c 20,000
(Depreciation charged on machine)
Mar. 31 Profit and Loss A/c Dr. 20,000
To Depreciation A/c 20,000
(Depreciation debited to profit and loss
account)
2019
Mar. 31 Depreciation A/c Dr. 20,000
To Machine A/c 20,000
(Depreciation charged on machine)
Mar. 31 Profit and Loss A/c Dr. 20,000
To Depreciation A/c 20,000
(Depreciation debited to profit and
loss account)

Books of M/s Mehra and Sons

Machine Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2016 2017
Oct. 01 Bank 1,80,000 Mar. 31 Depreciation 10,000
Oct. 01 Bank 20,000 (for 6 months)
(Installation Balance c/d 1,90,000
expenses) Mar. 31
2,00,000 2,00,000
2017 2018
Apr. 01 Balance b/d 1,90,000 Mar. 31 Depreciation 20,000
1,70,000
Balance c/d
1,90,000 1,90,000
2018 2019
Apr. 01 Balance b/d 1,70,000 Mar. 31 Depreciation 20,000
Balance c/d 1,50,000
1,70,000 1,70,000

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Depreciation, Provisions and Reserves 245

Depreciation Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017 2017
Mar. 31 Machine 10,000 Mar. 31 Profit & Loss 10,000
10,000 10,000
2018 2018
Mar. 31 Machine 20,000 Mar. 31 Profit & Loss 20,000
20,000 20,000
2019 2019
Dec. 31 Machine 20,000 Dec. 31 Profit & Loss 20,000
20,000 20,000

Working Notes
(1) Calculation of original cost of the machine
`
Purchase cost 1,80,000
Add Installation cost 20,000
Original cost 2,00,000
(2) Depreciation expense = 10% of ` 2,00,000 every year
= ` 20,000 p.a.
(3) During the year 2016, depreciation shall be charged only for 6 months, as
acquisition date is October 01, 2016, i.e., the asset is used only for 6 months
during the year 2016-17.
6
(4) Depreciation (2016-17) = ` 20,000 x = `10,000
12
Illustration 3
Based on data given in question number 2 record journal entries and prepare Machine
account, Depreciation account and Provision for Depreciation account for the first 3 years
if provision for depreciation account is maintained by the firm.
Solution
Books of Mehra and Sons
Machine Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amounts
` `
2016 2017
Oct. 1 Bank 1,80,000 Mar. 31 Balance c/d 2,00,000
Oct. 1 Bank
(Installation 20,000
expenses)
2,00,000 2,00,000

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246 Accountancy

2017 2018
Apr. 01 Balance b/d 2,00,000 Mar. 31 Balance c/d 2,00,000
2,00,000 2,00,000

Provision for Depreciation Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amounts
` `
2016 2016
Mar. 31 Balance c/d 10,000 Mar. 31 Depreciation 10,000
10,000 10,000
2017 2017
Mar. 31 Balance c/d 30,000 Apr. 01 Balance b/d 10,000
Mar. 31 Depreciation 20,000
30,000 30,000
2018 2018
Mar. 31 Balance c/d 50,000 Apr. 1 Balance b/d 30,000
2017
Mar. 31 Depreciation 20,000
50,000 50,000

Depreciation Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2017 2017
Mar. 31 Provision for 10,000 Mar.31 Profit & Loss 10,000
Deprection
10,000 10,000
2018 2018
Mar. 31 Provision for 20,000 Mar.31 Profit & Loss 20,000
Depreciation
20,000 20,000
2019 2019
Mar. 31 Provision for 20,000 Mar.31 Profit & Loss 20,000
Depreciation
20,000 20,000

Illustration 4
M/s. Dalmia Textile Mills purchased machinery on April 01, 2016 for ` 2,00,000 on credit
from M/s Ahuja and sons and spent ` 10,000 for its installation. Depreciation is

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Depreciation, Provisions and Reserves 247

provided @10% p.a. on written down value basis. Prepare Machinery Account for the first
three years. Books are closed on March 31, every year.

Solution
Books of Dalmia Textiles mills
Machinery Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2016 2017
Apr. 01 Bank 2,00,000 Mar. 31 Depreciation 21,0001
Bank 10,000 Balance c/d 1,89,000
2,10,000 2,10,000
2017 2018
Apr. 01 Balance b/d 1,89,000 Mar. 31 Depreciation 18,9002
Balance c/d 1,70,100
1,89,000 1,89,000
2018 2019
Apr. 01 Balance b/d 1,70,100 Mar. 31 Depreciation 17,0103
Balance c/d 1,53,090
1,70,100 1,70,100
2020 Balance b/d 1,53,090

Working Notes
1. Calculation of the amount of depreciation (`)
Original cost on 01.04.2016 2,10,000 (i.e. 2,00,000 + 10,000)
Less: Depreciation for 2016-17 (21,000)
WDV on 01.04.2017 1,89,000
Less: Depreciation for 2017-18 (18,900)
WDV on 01.04.2018 1,70,100
Less: Depreciation for 2018-19 (17,010)
WDV on 01.04.2017 1,53,090

Illustration 5
M/s Sahani Enterprises acquired a printing machine for ` 40,000 on July 01, 2014 and
spent ` 5,000 on its transport and installation. Another machine for ` 35,000 was purchased
on January 01, 2016. Depreciation is charged at the rate of 20% on written down value.
Prepare Printing Machine account.

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Solution
Books of Sahani Enterprises
Printing Machine Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2014 2015
Jul. 01 Bank 40,000 Mar. 31 Depreciation 6,7501
Bank 5,000 Balance c/d 38,250
45,000 45,000
2015 2016

Apr. 01 Balance b/d 38,250 Mar. 31 Depreciation 9,4002

Jan. 01 Bank 35,000 Balance c/d 63,850
73,250 73,250
2016 2017
Apr. 01 Balance b/d 63,850 Mar.31 Depreciation 12,7703
Balance c/d 51,080
63,850 63,850
2017
Apr. 01 Balance b/d 51,080

Working Notes
(`)
Orignal cost machine purchased on July 01, 2014 45,000
(–) Depreciation till Mar. 31, 2015 (for 9 months @ 20%) (6,750)1
38,250
+ Cost of new machine purchased on Jan. 01, 2016 35,000
73,250
(–) Depreciation for the year 2015-2016
(20% of 38,250 + 20% of ` 35,000 for 3 month) (9,400)2
WDV on Mar. 31, 2016 63,850
(–) Depreciation for the year 2016 – 17 (20% of ` 63,850) (12,770)3
WDV on Mar. 31, 2017 51,080

Test Your Understanding - II

Basaria Confectioner bought a cold storage plant on July 01, 2014 for `1,00,000.
Compare the amount of depreciation charged for first three years using:
1. Rate of depreciation @ 10% on original cost basis;
2. Rate of depreciation @ on written down value basis;
3. Also, plot the computed amount of depreciation on a graph.

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Depreciation, Provisions and Reserves 249

7.9 Disposal of Asset

Disposal of asset can take place either (a) at the end of its useful life or (b) during
its useful life (due to obsolescence or any other abnormal factor).
If it is sold at the end of its useful life, the amount realised on account of the sale
of asset as scrap should be credited to the asset account and the balance is
transferred to profit and loss account. In this regard the following journal entries
are recorded.
1. For sale of asset as scrap
Bank A/c Dr.
To Asset A/c
2. For transfer of balance in asset account
(a) In case of profit
Asset A/c Dr.
To Profit and Loss A/c
(b) In case of loss
Profit and Loss A/c Dr.
To Asset A/c
In case, however, the provision for depreciation account has been in use
for recording the depreciation, then before passing the above entries transfer
the balance of the provision for depreciation account to the asset account by
recording the following journal entry:
Provision for depreciation A/c Dr.
To Asset A/c
For example, R.S. Limited purchased a vehicle for ` 4,00,000. After
4 years its salvage value is estimated at ` 40,000. To find out the amount of
depreciation to be charged every year based on straight line basis, and show
as to how the vehicle account would appear for four years assuming it is sold
for ` 50,000 at the end when
(a) depreciation is charged to asset account; and
(b) provision for depreciation account is maintained.
Consider the following entries in the book of account of R.S. Limited
(a) When depreciation is charged to assets account

Books of R.S. Limited

Vehicle Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
I Bank 4,00,000 End of Depreciation 90,000
year the year Balance c/d 3,10,000

4,00,000 4,00,000

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250 Accountancy

II Balance b/d 3,10,000 End of Depreciation 90,000

year the year Balance c/d 2,20.000
3,10,000 3,10,000
III Balance b/d 2,20,000 End of Depreciation 90,000
year the year Balance c/d 1,30,000
2,20,000 2,20,000
IV Balance b/d 1,30,000 Depreciaton 99,000
year Profit and 10,000 Bank 50,000
loss (Profit on
sale of vehicle)
1,40,000 1,40,000

(b) When Provision for depreciation account is maintained.

Books of R.S. Limited
Vehicle Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
I Bank 4,00,000 End of Balance c/d 4,00,000
year the year

4,00,000 4,00,000

II Balance b/d 4,00,000 End of Balance c/d 4,00,000

year the year

4,00,000 4,00,000

III Balance b/d 4,00,000 End of Balance c/d 4,00,000

year the year
4,00,000 4,00,000
IV Balance b/d 4,00,000 Provison for 3,60,000
year Profit and loss 10,000 depreciation
(Profit on Sale Bank 50,000
of Vehicle)

4,10,000 4,10,000

Provision for Depreciation

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
Ist Balance b/d 90,000 End of Depreciation 90,000
year year
90,000 90,000

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Depreciation, Provisions and Reserves 251

II Balance b/d 1,80,000 End of Balance c/d 90,000

year the year Depreciation 90,000
1,80,000 1,80,000
III Balance b/d 2,70,000 End of Balance c/d 1,80,000
year the year Depreciation 90,000
2,70,000 2,70,000
IV Machinery 3,60,000 End of Balance c/d 2,70,000
year the year Provison for 90,000
Depreciation
3,60,000 3,60,000

7.9.1 Use of Asset Disposal Account

Asset disposal account is designed to provide a complete and clear view of all
the transactions involved in the sale of an asset under one account head. The
concerned variables are the original cost of the asset, depreciation accumulated
on the asset upto date, sale price of the asset, value of the parts of the asset
retained for use, if any and the resultant profit or loss on disposal. The balance
of this amount is transferred to the profit and loss account.
This method is generally used when a part of the asset is sold and provision
for depreciation account exists.
Under this method, a new account titled Asset Disposal Account is opened.
The original cost of the asset being sold is debited to the asset disposal account
and accumulated depreciation amount appearing in provision for depreciation
account relating to that asset till the date of disposal is credited to the asset
disposal account. The net amount realised from the sale of the asset is also
credited to this account. The balance of asset disposal account shows profit
or loss which is transferred to profit and loss account. The advantage of this
method is that it gives a full picture of all the transactions related to asset
disposal at one place. The journal entries required for the preparation of asset
disposal account is as follows:
1. Asset Disposal A/c Dr. (with the original cost of asset,
To Asset A/c being sold)
2. Provision for Depreciation A/c Dr. (with the accumulated balance in
To Asset Disposal A/c provision for depreciation account)
3. Bank A/c Dr. (with the net sales proceeds)
To Asset Disposal A/c
Asset Disposal Account may ultimately show a debit or credit balance. The
debit balance on the account indicate loss on disposal and would be dealt with
as follows:

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252 Accountancy

Profit and Loss A/c Dr. (with the amount of loss on sale)
To Asset Disposal A/c
The credit balance of the account, profit on disposal and would be closed
by the following journal entry:
Asset Disposal A/c Dr. (with the amount of profit on sale)
To Profit and Loss A/c
For example, Karan Enterprises has the following balances in its books
as on March 31, 2017
Machinery (gross value): ` 6,00,000
Provision for depreciation: ` 2,50,000
A machine purchased for ` 1,00,000 on November 01, 2013, having accumulated
depreciation amounting to ` 60,000 was sold on April 1, 2017 for ` 35,000. The
Asset Disposal account will be prepared in the following manner:

Books of Karan Enterprises

Machinery Disposal Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars L.F. Amount
` `
2017 2017
Apr. 01 Machinery 1,00,000 Apr. 01 Provision for 60,000
depreciation
Apr. 01 Bank 35,000
2018
Mar. 31 Profit & Loss
(Loss on sale) 5,0001
1,00,000 1,00,000

Machinery Account
Dr. Cr.
Date Particulars Amount Date Particulars Amount
` `
2017 2017
April 01 Balance b/d 6,00,000 Apr. 01 Machine
Disposal 1,00,000
2018
Mar. 31 Balance c/d 5,00,000
6,00,000 6,00,000

Working Notes
(1) Computation of loss on sale of machinery `
Original cost of the asset being sold 1,00,000
Less: accumulated depreciation (60,000)
40,000

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Depreciation, Provisions and Reserves 253

(2) Sales value realised (35,000)

Loss on sale (i.e. ` 40,000 – ` 35,000) 5,0001

Illustration 6
On January 01, 2015, Khosla Transport Co. purchased five trucks for ` 20,000 each.
Depreciation has been provided at the rate of 10% p.a. using straight line method and
accumulated in provision for depreciation acount. On January 01, 2016, one truck was
sold for ` 15,000. On July 01, 2017, another truck (purchased for ` 20,000 on Jan, 01,
2014) was sold for ` 18,000. A new truck costing ` 30,000 was purchased on October 01,
2016. You are required to prepare trucks account, Provision for depreciation account and
Truck disposal account for the years ended on December 2015, 2016 and 2017 assuming
that the firm closes its accounts in December every year.

Solution
Book of Khosla Transport Co.
Trucks Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2015 2015

Jan. 01 Bank 1,00,000 Dec. 31 Balance c/d 1,00,000

(Purchase of
truck) 1,00,000 1,00,000
2016 2016
Jan. 01 Balance b/d 1,00,000 Jan. 01 Truck disposal 20,000
Dec 31 Balance c/d 80,000
1,00,000 1,00,000
2017 2017
Jan. 01 Balance b/d 80,000 Jul. 01 Truck disposal 20,000
Oct. 01 Bank 30,000 Dec. 31 Balance c/d 90,000
(Purchase of
new truck) 1,10,000 1,10,000

Truck Disposal Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2016 2016
Jan. 01 Machinery 20,000 Jan. 01 Provision for 2,000
Depreciation
Jan. 01 Bank (Sale) 15,000
Jan. 01 Profit & Loss 3,0004
(Loss on sale)
20,000 20,000

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254 Accountancy

2017 2017
Jul. 01 Machinery 20,000 Jul. 01 Provision for
Jul. 01 Profit & Loss 3,000 Depreciation
(Profit on sale)5 (` 2,000 +
2,000 +1,000) 5,000
Jul. 01 Bank (Sale) 18,000
23,000 23,000

Provision for Depreciation Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2015 2015
Dec. 31 Balance c/d 10,000 Dec. 31 Depreciation 10,0001
10,000 10,000
2016 2016
Jan. 01 Truck Disposal 2,000 Jan. 01 Balance b/d 10,000
Dec. 31 Balance c/d 16,000 Dec. 31 Depreciation 8,0002
18,000 18,000
2017 2017
Jan. 01 Truck Disposal 5,000 Jan. 01 Balance b/d 16,000
Dec. 31 Balance c/d 18,750 Dec. 31 Depreciation
(` 6000+
1000+750) 7,7503
23,750 23,750

Working Notes
1. Calculation of amount of depreciation `
Year - 2015
10% on ` 1,00,000 for one year 10,0001
Year - 2016
10% on ` 80,000 for one year 80002
Year – 2017
10% on ` 60,000 for 1 year 6,000
10% on ` 20,000 for six months 1,000
10% on ` 30,000 for three months 7,50
7,7503
2. Loss on sale of first truck
Original cost on January 01, 2015 20,000
Less depreciation at 10% (2,000)
Book value on January 1, 2016 18,000
Sales price realised on 01.01.2016 (15,000)
Loss on sale of first machine 3,0004

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Depreciation, Provisions and Reserves 255

3. Profit on sale of second truck `

Original Cost of second truck 20,000
(Less) depreciation charged
2015 2,000
2016 2,000
2017 (upto June, 2016) 1,000 5,000
Book value of second truck 15,000
Sale price of second truck 18,000
Profit on sale 3,000

Illustration 7
On April 01, 2015, following balances appeared in the books of M/s Kanishka Traders:
Furniture account ` 50,000, Provision for depreciation on furniture ` 22,000. On October
01, 2015 a part of furniture purchased for Rupees 20,000 in April 01, 2011 was sold for
` 5,000. On the same date a new furniture costing ` 25,000 was purchased. The depreciation
was provided @ 10% p.a. on original cost of the asset and no depreciation was charged on
the asset in the year of sale. Prepare furniture account and provision for depreciation
account for the year ending March 31, 2016.

Solution
Books of Kanishka Traders
Furniture Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2015 2015
Apr. 01 Balance b/d 50,000 Oct.01 Bank 5,000
Oct. 01 Bank 25,000 2016 Provision for 8,000
March 31 depreciation 7,0001
Profit and Loss
(Loss on sale)
Balance c/d 55,000
75,000 75,000

Provision for Depreciation on Furniture Account

Dr. Cr.
Date Particulars J.F. Amount Date Particular J.F. Amount
` `
2015 2015
Oct. 01 Furniture 8,000 Apr. 01 Balance b/d 22,000
(Accumulated
depreciation on
furniture sold)
2016 2016
Mar. 31 Balance c/d 18,250 Mar. 31 Depreciation
(` 3,000 + 4,250
26,250 1,250) 26,250

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256 Accountancy

Working Notes
1. Calculation of amount of depreciation
Calculation of loss on sale `
Original cost of furniture on 01.10.2015 20,000
Less: Depreciation for 4 year from 01.04.2011 to
31.04.2015 (no depreciation for the year of sale
@10% p.a. on original cost 8,000
Value as on 01.10.2015 12,000
Sale price 5,000
2. Loss on sale 7,0001
Depreciation for the year 2015-16
10% of ` 30,000 (` 50,000 – ` 20,000) for full year 3,000
10% of ` 25,000 for 6 month 1,250
4,250

Illustration 8
Solve illustration 07, if the firm maintains furniture disposal account prepared along with
furniture account and provision for depreciation on furniture account.

Books of Anil Traders

Furniture Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2015 2015
Apr. 01 Balance b/d 50,000 Apr. 01 Furniture 20,000
disposal
Oct.01 Bank 25,000 2016
Mar. 31 Balance c/d 55,000
75,000 75,000

Provision for Depreciation on Furniture Account

Dr. Cr.
Date Particulars J.F. Amount Date Particular J.F. Amount
` `
2015 2015
Oct.01 Furniture 8,000 Apr.01 Balance b/d 22,000
disposal
2016 2016
Mar. 31 Balance c/d 18,250 Mar.31 Depreciation 4,250
26,250 26,250

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Depreciation, Provisions and Reserves 257

Furniture Disposal Account

Dr. Cr.
Date Particulars J.F. Amount Date Particular J.F. Amount
` `
2015 2015
Oct.01 Furniture 20,000 Oct.01 Provision for
Depreciation 8,000
Bank 5,000
Profit & Loss
(Loss on sale) 7,000
20,000 20, 000

Illustration 9
On Jan 01, 2012 Jain & Sons purchased a second hand plant costing ` 2,00,000 and spent
` 10,000 on its overhauling. It also spent ` 5,000 on transportation and installation of
the plant. It was decided to provide for depreciation @ of 20% on written down value. The
plant was destroyed by fire on July 31, 2015 and an insurance claim of ` 50,000 was
admitted by the insurance company. Prepare plant account, accumulated depreciation
account and plant disposal account assuming that the company closes its books on
December 31, every year.

Solution

Books of Jain & Sons.

Plant Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2012 2012
Jan. 01 Bank 2,15,000 Dec. 31 Balance c/d 2,15,000
2,15,000 2,15,000
2013 2013
Jan. 01 Balance b/d 2,15,000 Dec. 31 Balance c/d 2,15,000
2,15,000 2,15,000
2014 2014
Jan. 01 Balance b/d 2,15,000 Dec. 31 Balance c/d 2,15,000
2,15,000 2,15,000
2015 2015
Jan. 01 Balance b/d 2,15,000 Jul. 31 Plant disposal 2,15,000
2,15,000 2,15,000

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258 Accountancy

Accumulated Depreciation Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2012 2012
Dec. 31 Balance c/d 43,000 Dec. 31 Depreciation 43,0001
43,000 43,000
2013 2013
Jan. 01 Balance c/d 77,400 Jan. 01 Balance b/d 43,000
Depreciation 34,4002
77,400 77,400
2014 2014
Dec. 31 Balance c/d 1,04,920 Jan. 01 Balance b/d 77,400
Dec. 31 Depreciation 27,5203
1,04,920 1,04,920
2015
2015 Jan. 01 Balance b/d 1,04,920
Jul. 31 Plant disposal 1,17,763 July 31 Depreciation 12,8434
1,17,763 1,17,763

Plant Disposal Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2015 2015
Jul. 31 Plant 2,15,000 Jul. 31 Accumulated 1,17,763
depreciation
Insurance Co. 50,000
Profit & Loss 47,2375
(Loss on sale)
2,15,000 2,15,000

Working Notes:
1. Calculation of Depreciation Amount (`)
Original cost on 01.01.2012 2,15,000
(2,00,000 + 10,000+ 5,000)
Depreciation for the year 2012
(@20% of ` 2,15,000) (43,0001)
1,72,000

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Depreciation, Provisions and Reserves 259

Depreciation for the year 2013

(@20% of ` 1,72,000) (34,4002)
1,37,600
Depreciation for the year 2014
(@20% of ` 1,37,600) 27,5203
1,10,080
Depreciation till 31.07.15 (12,8434)
(@20% of ` 1,10,080) 97,237
Insurance claim (50,000)
Loss on disposal 47,2375

7.10 Effect of any Addition or Extension to the Existing Asset

An existing asset may require some additions or extensions for being suitable
for operations. Such additions/extensions may or may not become an integral
part of the asset. The amount incurred on such additions/extensions is
capitalised and written off as depreciation over the life of the asset. It is
important to mention here that the amount so incurred is in addition to usual
repair and maintenance expenses. AS-6 (Revised) mentions that
• Any addition or extension, which becomes an integral part of the existing
asset should be depreciated over the useful life of that asset;
• The depreciation on such addition or extension may also be provided
at the rate applied to the existing asset;
• Where an addition or extension retains a separate identity and is capable
of being used after the existing asset is disposed off, depreciation, should
be provided independently on the basis of its own useful life.

Illustration 10
M/s Digital Studio bought a machine for ` 8,00,000 on April 01, 2013. Depreciation was
provided on straight-line basis at the rate of 20% on original cost. On April 01, 2015
a substantial modification was made in the machine to make it more efficient at a cost of
` 80,000. This amount is to be depreciated @ 20% on straight line basis. Routine
maintenance expenses during the year 2013-14 were ` 2,000.
Draw up the Machine account, Provision for depreciation account and charge to profit
and loss account in respect of the accounting year ended on March 31, 2016.

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260 Accountancy

Solution
Books of Digital Studio
Machine Account
Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2015 2016
Apr 01 Balance b/d 800,000 Mar 31 Balance c/d 8,80,000
Bank 80,000
8,80,000 8,80,000

Provision for Depreciation Account

Dr. Cr.
Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2014 2015
Mar 31 Balance c/d 4,96,000 April 01 Balance b/d 3,20,0001
2016
Mar 31 Depreciation 1,76,0002
4,96,000 4,96,000

Working Notes
1. Cost of modification is capitalised but routine repair expenses are treated as
revenue expenditure.
2. Calculation of balance of provision for depreciation account on 01.04.2014.
Original Cost on 01.04.2013 = ` 8,00,000
Depreciation for the years 2013-14 and 2014-15 = ` 3,20,0001
(@ 20% of ` 8,00,000 )
3. Depreciation for the year 2015-16 is calculated as under:
20% of 8,00,000 = ` 1,60,000
20% of ` 80,000 = ` 16,000
Total Depreciation for 2015-16 = ` 1,76,0002
4. Amount to be charged to profit and loss account
Depreciation ` 1,76,000
Repair and maintenance ` 2,000

Illustration 11
M/s Nishit printing press bought a printing machine for ` 6, 80,000 on April 01, 2015.
Depreciation was provided on straight line basis at the rate of 20% on original cost. On
April 01, 2017 a modification was made in the machine to increase its technical reliability
for ` 70,000. On the same date, an important component of the machine was replaced for

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Depreciation, Provisions and Reserves 261

` 20,000 due to excessive wear and tear. Routine maintenance expenses during the year
are ` 5,000
Prepare machinery account, provision for depreciation account. Show the working notes
accordingly for the year ending March 31, 2018.

Machinery Account

Date Particular J.F. Account Date Particular J.F. Account

` `
2017 2018
Apr. 01 Balance b/d 6,80,000 Mar. 31 Balance c/d 7,70,000
Bank 70,000
Bank 20,000

7,70,000 7,70,000

Provision for Depreciation Account

Date Particulars J.F. Amount Date Particulars J.F. Amount
` `
2018 2017
Mar.31 Balance c/d 4,26,000 Apr.01 Balance b/d 2,72,000
2018
Mar.31 Depreciation 1,54,000
4,26,000 4,26,000

Working Notes `

1. Cost of Machine for the year 2015 = 6,80,000

Depreciation Charged for the

 20 
2
Years 2015-16 and 2016-17 = 100 × 6,80,000

= 2,72,000

2. Depreciation for the year 2017-18 = ` 6,80,000

20% of 6,80,000 = 1,36,000
20% of 90,000 = 18,000
(i.e., ` 70,000 + ` 20,000)
Depreciation for the year 2017-18 = 1,54,000

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SECTION – II
Provisions and Reserve
7.11 Provisions
There are certain expenses/losses which are related to the current accounting
period but amount of which is not known with certainty because they are not
yet incurred. It is necessary to make provision for such items for ascertaining
true net profit. For example, a trader who sells on credit basis knows that
some of the debtors of the current period would default and would not pay or
would pay only partially. It is necessary to take into account such an expected
loss while calculating true and fair profit/loss according to the principle of
Prudence or Conservatism. Therefore, the trader creates a Provision for Doubtful
Debts to take care of expected loss at the time of realisation from debtors. In
a similar way, Provision for repairs and renewals may also be created to provide
for expected repair and renewal of the fixed assets. Examples of provisions are :
• Provision for depreciation;
• Provision for bad and doubtful debts;
• Provision for taxation;
• Provision for discount on debtors; and
• Provision for repairs and renewals.
It must be noted that the amount of provision for expense and loss is a
charge against the revenue of the current period. Creation of provision ensures
proper matching of revenue and expenses and hence the calculation of true
profits. Provisions are created by debiting the profit and loss account. In the
balance sheet, the amount of provision may be shown either:
• By way of deduction from the concerned asset on the assets side. For example,
provision for doubtful debts is shown as deduction from the amount of
sundry debtors and provision for depreciation as a deduction from the
concerned fixed assets;
• On the liabilities side of the balance sheet alongwith current liabilities, for
example provision for taxes and provision for repairs and renewals.

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Depreciation, Provisions and Reserves 263

7.11.1 Accounting Treatment for Provisions

The accounting treatment of all types of provisions is almost similar. Therefore,
the accounting treatment is explained here taking up the case of provision for
doubtful debts.
As already stated that when business transaction takes place on credit basis,
debtors account is created and its balance is shown on the asset-side of the
balance sheet. These debtors may be of three types:
• Good Debtors are those from where collection of debt is certain.
• Bad Debts are those debtors from where collection of money is not
possible and the amount of credit given is a certain loss.
• Doubtful Debts are those debtors who may pay but business firm is not
sure about the collection of full amount from them. In fact, as a matter
of business experience, some percentage of such debtors are not likely
to pay, hence treated as doubtful debts. To consider this possible loss
on account of non-payment by some debtors, it is a common practice
(and necessary also) to make a suitable provision for doubtful debts at
the time of ascertaining true profit or loss. The provision for doubtful
debts is usually calculated as a certain percentage of the total amount
due from sundry debtors after deducting/writing-off all known bad
debts. Provision for doubtful debts is also called ‘Provision for bad and
doubtful debts’. It is created by debiting the amount of required provision
to the profit and loss account and crediting it to provision for doubtful
debts account.
For creating a provision for doubtful debts the following journal entry
is recorded:
Profit and Loss A/c Dr. (with the amount of provision)
To Provision for doubtful debts A/c
This is explained with the help of the following example
Observe an extract of the trial balance from the books of Trehan Traders
on March 31, 2014 is given below:

Date Account title L.F. Debit Credit

Amount Amount
` `
Sundry Debtors 68,000

Additional Information
• Bad debts proved bad but not recorded amounted to ` 8,000
• Provision is to be maintained at 10% of debtors.

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In order to create the provision for doubtful debts, the following journal
entries will be recorded:
Journal
Date Particulars L.F. Amount Amount
` `
2014
Mar. 31 Bad debts A/c Dr. 8,000
To Sundry debtors A/c 8,000
(Bad debts written off)
Mar. 31 Profit & Loss A/c Dr. 8,000
To Bad debts A/c 8,000
(Bad debts debited to profit and
loss account)
Mar. 31 Profit and Loss A/c Dr. 6,0001
To Provision for doubtful debts a/c 6,0001
(For creating provision for doubtful debts)

Working Notes
Provision for doubtful debts @10% of sundry debtors i.e.
` 68,000 – ` 8000 = ` 60,000
10
` 6000 × = ` 60001
100

7.12 Reserves
A part of the profit may be set aside and retained in the business to provide for
certain future needs like growth and expansion or to meet future contingencies
such as workmen compensation. Unlike provisions, reserves are the
appropriations of profit to strengthen the financial position of the business.
Reserve is not a charge against profit as it is not meant to cover any known
liability or expected loss in future. However, retention of profits in the form of
reserves reduces the amount of profits available for distribution among the
owners of the business. It is shown under the head Reserves and Surpluses on
the liabilities side of the balance sheet after capital.Examples of reserves are:
• General reserve;
• Workmen compensation fund;
• Investment fluctuation fund;
• Capital reserve;
• Dividend equalisation reserve;
• Reserve for redemption of debenture.

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7.12.1 Difference between Reserve and Provision

The points of difference between reserve and provision are explained below:
1. Basic nature : A provision is a charge against profit whereas reserve is an
appropriation of profit. Hence, net profit cannot be calculated unless all
provisions have been debited to profit and loss account, while a reserve is
created after the calculation of net profit.
2. Purpose : Provision is made for a known liability or expense pertaining to
current accounting period, the amount of which is not certain. On the
other hand reserve is created for strengthening the financial position of
the business. Some reserves are also mandatory under the law.
3. Presentation in balance sheet: Provision is shown either (i) by way of deduction
from the item on the asset side for which it is created, or (ii) on the liabilities
side along with current liabilities. On the other hand, reserve is shown on
the liabilities side after capital.
4. Effect on taxable profits : Provision is deducted before calculating taxable
profits. Hence, it reduces taxable profits. A reserve is created from profit
after tax and therefore it has no effect on taxable profit.
5. Element of compulsion : Creation of provision is necessary to ascertain true
and fair profit or loss in compliance with ‘Prudence’ or ‘Conservatism’ concept.
It has to be made even if there are no profits. Whereas creation of a reserve is
generally at the discretion of the management. However, in certain cases law
has stipulated for the creation of specific reserves such as Debenture
Redemption Reserve. Reserve cannot be created unless there are profits.
6. Use for the payment of dividend : Provision cannot be used for distribution
as dividends while general reserve can be used for dividend distribution.

Basis of Difference Provision Reserve

1. Basic nature Charge against profit. Appropriation of profit.
2. Purpose It is created for a known It is made for strengthening
liability or expense pertaining the financial position of
to current accounting period, the business.Some reserves
the amount of which is not are also mandatory under law.
certain.
3. Effect on taxable It reduces taxable profits. It has no effect on taxable
profits. profit.
4. Presentations in It is shown either (i) by way It is shown on the liabilities.
Balance sheet of deduction from the item on side after capital amount.
the asset side for which it is
created, or (ii) In the liabilities
side along with current
liabilities.

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5. Element of Creation of provision is Generally, creation of a Reserve

compulsion necessary to ascertain true is at the discretion of the mana-
and fair profit or loss in gement. Reserve cannot be
compliance ‘Prudence’ or created unless there are profits.
‘Conservatism’ concept. However, in certain cases law
It must be made even has stipulated for the creation
if there are no profits. of specific reserves such as
‘Debenture’ ‘Redemption ’
reserve.
6. Use for the payment It can not be used for It can be used for divided
of dividend dividend distribution. distribution.

Fig. 7.4 : Showing comparison between provisions and reserves

7.12.2 Types of Reserves

A reserve is created by retention of profit of the business can be for either a
general or a specific purpose.
1. General reserve : When the purpose for which reserve is created is not
specified, it is called General Reserve. It is also termed as free reserve because
the management can freely utilise it for any purpose. General reserve
strengthens the financial position of the business.
2. Specific reserve : Specific reserve is the reserve, which is created for some
specific purpose and can be utilised only for that purpose. Examples of
specific reserves are given below :
(i) Dividend equalisation reserve: This reserve is created to stabilise or
maintain dividend rate. In the year of high profit, amount is transferred
to Dividend Equalisation reserve. In the year of low profit, this reserve
amount is used to maintain the rate of dividend.
(ii) Workmen compensation fund: It is created to provide for claims of the
workers due to accident, etc.
(iii) Investment fluctuation fund: It is created to make for decline in the
value of investment due to market fluctuations.
(iv) Debenture redemption reserve: It is created to provide funds for
redemption of debentures.
Reserves are also classified as revenue and capital reserves according to the
nature of the profit out of which they are created.
(a) Revenue reserves : Revenue reserves are created from revenue profits which
arise out of the normal operating activities of the business and are otherwise
freely available for distribution as dividend. Examples of revenue
reserves are:
• General reserve;
• Workmen compensation fund;

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• Investment fluctuation fund;

• Dividend equalisation reserve;
• Debenture redemption reserve;
(b) Capital reserves: Capital reserves are created out of capital profits which do
not arise from the normal operating activities. Such reserves are not available
for distribution as dividend. These reserves can be used for writing off capital
losses or issue of bonus shares in case of a company. Examples of capital
profits, which are treated as capital reserves, whether transferred as such
or not, are :
• Premium on issue of shares or debenture.
• Profit on sale of fixed assets.
• Profit on redemption of debentures.
• Profit on revaluation of fixed asset & liabilities.
• Profits prior to incorporation.
• Profit on reissue of forfeited shares

7.12.3 Difference between Revenue and Capital Reserve

Revenue reserves and capital reserves are differentiated on the following grounds:
1. Source of creation : Revenue reserve is created out of revenue profits, which
arise out of the normal operating activities of the business and are otherwise
available for dividend distribution. On the other hand capital reserve is created
primarily out of capital profit, which do not arise from the normal operating
activities of the business and are not available for distribution as dividend.
But revenue profits may also be used for creation of capital reserves.
2. Purpose : Revenue reserve is created to strengthen the financial position, to
meet unforeseen contingencies or for some specific purposes. Whereas capital
reserve is created for compliance of legal requirements or accounting practices.
3. Usage : A specific revenue reserve can be utilised only for the earmarked
purpose while a general reserve can be utilised for any purpose including
distribution of dividend. Whereas a capital reserve can be utilised for specific
purposes as provided in the law in force, e.g., to write off capital losses or
issue of bonus shares.

Basis of Difference Revenue Reserve Capital Reserve

1. Source of creation It is created out of revenue It is created primarily out of
profits which arise out of capital profit which do not arise
normal operating activities out of the normal operating
of the business and are activities of the business and not
otherwise available for available for dividend distribution.
dividend distribution. But revenue profits may also be
used for this purpose.

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2. Purpose It is created to strengthen It is created for compliance of

the financial position, to legal requirements or accounting
meet unforeseen practices.
contingencies or for some
specific purposes.
3. Usage A specific revenue reserve It can be utilised for specific
can be utilised only for the purposes as provided in the law
earmarked purpose while a in force e.g., to write off capital
general reserve can be losses or issue of bonus shares.
utilised for any purpose
including distribution of
dividend.

Fig. 7.5 : Difference between capital reserve and revenue reserve

7.12.4 Importance of Reserves

A business firm may consider it proper to set up some mechanism to protect
itself from the consequences of unknown expenses and losses, it may be required
to bear in future. It may also regard it as more appropriate in certain cases to
reduce the amount that can be drawn by the proprietors as profit in order to
conserve business resource to meet certain significant demands in future. An
example of such a demand is the much needed expansion in the scale of business
operations. This is presented as the justification for reserves in business activities
and in accounting. The amount so set aside may be meant for the purpose of :
• Meeting a future contingency
• Strengthening the general financial position of the business;
• Redeeming a long-term liability like debentures, etc.

7.13 Secret Reserve

Secret reserve is a reserve which does not appear in the balance sheet. It may
also help to reduce the disclosed profits and also the tax liability. The secret
reserve can be merged with the profits during the lean periods to show improved
profits. Management may resort to creation of secret reserve by charging higher
depreciation than required. It is termed as ‘Secret Reserve’, as it is not known to
outside stakeholders. Secret reserve can also be created by way of :
• Undervaluation of inventories/stock
• Charging capital expenditure to profit and loss account
• Making excessive provision for doubtful debts
• Showing contingent liabilities as actual liabilities
Creation of secret reserves within reasonable limits is justifiable on grounds of
expediency, prudence and preventing competition from other firms.

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Test Your Understanding - III

I State with reasons whether the following statements are True or False ;
(i) Making excessive provision for doubtful debits builds up the secret reserve in
the business.
(ii) Capital reserves are normally created out of free or distributable profits.
(iii) Dividend equalisation reserve is an example of general reserve.
(iv) General reserve can be used only for some specific purposes.
(v) ‘Provision’ is a charge against profit.
(vi) Reserves are created to meet future expenses or losses the amount of which is
not certain.
(vii) Creation of reserve reduces taxable profits of the business.
II Fill in the correct words :
(i) Depreciation is decline in the value of ...........
(ii) Installation, freight and transport expenses are a part of ...........
(iii) Provision is a ........... against profit.
(iv) Reserve created for maintaining a stable rate of dividend is termed as...........

Key Terms Introduced in the Chapter

• Depreciation, Depreciable cost, original cost, useful life;
• Depletion, Obsolescence, Amortisation;
• Salvage value/Residual value/Scrap value;
• Written down value/Reducing balance value/Diminishing value;
• Straight Line/Fixed Installment Method;
• Asset Disposal Account;
• Accumulated Depreciation/Provision for Depreciation Account, Reserve,
Provision, Capital Reserve, Revenue Reserve, General Reserve, Specific
Reserve, Secret Reserve, Provision for Doubtful Debts.

Summary With Reference to Learning Objectives

1. Meaning of depreciation : Depreciation is decline in the value of a tangible
fixed asset. In accounting, depreciation is the process of allocating depreciable
cost over useful life of a fixed asset.
2. Depreciation and similar terms : Depreciation term is used in the context of
tangible fixed assts. Depletion (in the context of extractive industries), and
amortisation (in the context of intangible assets) are other related terms.
Factors Affecting Depreciation :
• Wear and Tear due to use and/or passage of time
• Expiration of Legal Rights
• Obsolescence
3. Importance of depreciation :
• Depreciation must be charged to ascertain true and fair profit or loss.
• Depreciation is a non-cash operating expense.
4. Methods of charging depreciation : Depreciation amount can be calculated using :
• Straight line method, or
• Written down value method

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5. Factors affecting the amount of depreciation :

Depreciation amount is determined by —
• Original cost
• Salvage value, and
• Useful life of the asset
6. Provisions and Reserves : A provision is a charge against profit. It is created
for a known current liability the amount of which is uncertain. Reserve on
the other hand, is an appropriation of profit. It is created to strengthen the
financial position of the business.
7. Types of Reserves : Reserves may be —
• General reserve and specific reserve;
• Revenue reserve and capital reserve.
8. Secret Reserve : When total depreciation charged is higher than the total
depreciable cost, Secret reserve’ is created. Secret reserve is not explicitly
shown in the balance sheet.

Questions for Practice

Short Answers
1.
What is ‘Depreciation’?
2.
State briefly the need for providing depreciation.
3.
What are the causes of depreciation?
4.
Explain basic factors affecting the amount of depreciation.
5.
Distinguish between straight line method and written down value method
of calculating depreciation.
6. “In case of a long term asset, repair and maintenance expenses are expected
to rise in later years than in earlier year”. Which method is suitable for
charging depreciation if the management does not want to increase burden
on profits and loss account on account of depreciation and repair.
7. What are the effects of depreciation on profit and loss account and balance
sheet?
8. Distinguish between ‘provision’ and ‘reserve’ .
9. Give four examples each of ‘provision’ and ‘reserves’.
10. Distinguish between ‘revenue reserve’ and ‘capital reserve’.
11. Give four examples each of ‘revenue reserve’ and ‘capital reserves’.
12. Distinguish between ‘general reserve’ and ‘specific reserve’.
13. Explain the concept of ‘secret reserve’.

Long Answers
1. Explain the concept of depreciation. What is the need for charging
depreciation and what are the causes of depreciation?
2. Discuss in detail the straight line method and written down value method
of depreciation. Distinguish between the two and also give situations where
they are useful.
3. Describe in detail two methods of recording depreciation. Also give the
necessary journal entries.

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Depreciation, Provisions and Reserves 271

4. Explain determinants of the amount of depreciation.

5. Name and explain different types of reserves in details.
6. What are ‘provisions’. How are they created? Give accounting treatment in
case of provision for doubtful Debts.

Numerical Problems
1. On April 01, 2010, Bajrang Marbles purchased a Machine for ` 1,80,000 and spent
` 10,000 on its carriage and ` 10,000 on its installation. It is estimated that its
working life is 10 years and after 10 years its scrap value will be ` 20,000.
(a) Prepare Machine account and Depreciation account for the first four
years by providing depreciation on straight line method. Accounts are
closed on March 31st every year.
(b) Prepare Machine account, Depreciation account and Provision for
depreciation account (or accumulated depreciation account) for the first
four years by providing depreciation using straight line method accounts
are closed on March 31 every year.
(Ans:[a] Balance of Machine account on April 1, 2014 `1,28,000.
[b] Balance of Provision for depreciation account as on 1.04.2014
`72,000.)
2. On July 01, 2010, Ashok Ltd. Purchased a Machine for ` 1,08,000 and spent
` 12,000 on its installation. At the time of purchase it was estimated that
the effective commercial life of the machine will be 12 years and after 12
years its salvage value will be ` 12,000.
Prepare machine account and depreciation Account in the books of Ashok
Ltd. For first three years, if depreciation is written off according to straight
line method. The account are closed on December 31st, every year.
(Ans: Balance of Machine account as on 1.01.2013 `97,500).
3. Reliance Ltd. Purchased a second hand machine for ` 56,000 on October 01,
2011 and spent ` 28,000 on its overhaul and installation before putting it to
operation. It is expected that the machine can be sold for ` 6,000 at the end
of its useful life of 15 years. Moreover an estimated cost of ` 1,000 is expected
to be incurred to recover the salvage value of ` 6,000. Prepare machine account
and Provision for depreciation account for the first three years charging
depreciation by fixed installment Method. Accounts are closed on March 31,
every year.
(Ans: Balance of provision for depreciation account as on 31.03.15 `18,200).
4. Berlia Ltd. Purchased a second hand machine for ` 56,000 on July 01, 2015
and spent ` 24,000 on its repair and installation and ` 5,000 for its carriage.
On September 01, 2016, it purchased another machine for
` 2,50,000 and spent ` 10,000 on its installation.
(a) Depreciation is provided on machinery @10% p.a on original cost method
annually on December 31. Prepare machinery account and depreciation
account from the year 2015 to 2018.
(b) Prepare machinery account and depreciation account from the year 2011
to 2018, if depreciation is provided on machinery @10% p.a. on written
down value method annually on December 31.
(Ans: [a] Balance of Machine account as on 1.01.19 `2,54,583.
[b] Balance of Machine account as on 1.01.19 `2,62,448).

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272 Accountancy

5. Ganga Ltd. purchased a machinery on January 01, 2014 for ` 5,50,000 and
spent ` 50,000 on its installation. On September 01, 2014 it purchased another
machine for ` 3,70,000. On May 01, 2015 it purchased another machine for
` 8,40,000 (including installation expenses).
Depreciation was provided on machinery @10% p.a. on original cost method
annually on December 31. Prepare:
(a) Machinery account and depreciation account for the years 2014, 2015,
2016 and 2017.
(b) If depreciation is accumulated in provision for Depreciation account
then prepare machine account and provision for depreciation account
for the years 2014, 2015, 2016 and 2017.
(Ans: [a] Balance of machine account as on 01.01.15 ` 12,22,666.
[b] Balance of provision for dep. account as on 01.01.15 ` 5,87,334).
6. Azad Ltd. purchased furniture on October 01, 2014 for ` 4,50,000. On March
01, 2015 it purchased another furniture for ` 3,00,000. On July 01, 2016 it
sold off the first furniture purchased in 2014 for ` 2,25,000. Depreciation is
provided at 15% p.a. on written down value method each year. Accounts are
closed each year on March 31. Prepare furniture account, and accumulated
depreciation account for the years ended on March 31, 2015, March 31, 2016
and March 31, 2017. Also give the above two accounts if furniture disposal
account is opened.
(Ans. Loss on sale of furniture `1,15,546,
Balance of provision for depreciation account as on 31.03.15 ` 85,959.)
7. M/s Lokesh Fabrics purchased a Textile Machine on April 01, 2011 for
` 1,00,000. On July 01, 2012 another machine costing ` 2,50,000 was
purchased . The machine purchased on April 01, 2011 was sold for ` 25,000
on October 01, 2015. The company charges depreciation @15% p.a. on straight
line method. Prepare machinery account and machinery disposal account for
the year ended March 31, 2016.
(Ans. Loss on sale of Machine account `7,500.
Balance of machine account as on 1.04.15 `1,09,375).
8. The following balances appear in the books of Crystal Ltd, on Jan 01, 2015
`
Machinery account on 15,00,000
Provision for depreciation account 5,50,000
On April 01, 2015 a machinery which was purchased on January 01, 2012 for
` 2,00,000 was sold for ` 75,000. A new machine was purchased on July 01,
2015 for ` 6,00,000. Depreciation is provided on machinery at 20% p.a. on
Straight line method and books are closed on December 31 every year. Prepare
the machinery account and provision for depreciation account for the year
ending December 31, 2015.
(Ans. Profit on sale of Machine ` 5,000.
Balance of machine account as on 31.12.15 ` 19,00,000.
Balance of Provision for depreciation account as on 31.12.15 ` 4,90,000).
9. M/s. Excel Computers has a debit balance of ` 50,000 (original cost
` 1,20,000) in computers account on April 01, 2010. On July 01, 2010 it
purchased another computer costing ` 2,50,000. One more computer was

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purchased on January 01, 2011 for ` 30,000. On April 01, 2014 the computer
which has purchased on July 01, 2010 became obselete and was sold for
` 20,000. A new version of the IBM computer was purchased on August 01,
2014 for ` 80,000. Show Computers account in the books of Excel Computers
for the years ended on March 31, 2011, 2012, 2013, 2014 and 2015. The
computer is depreciated @10 p.a. on straight line method basis.
(Ans: Loss on sale of computer ` 1,36,250.
Balance of computers account as on 31.03.15 ` 83,917).
10. Carriage Transport Company purchased 5 trucks at the cost of ` 2,00,000 each
on April 01, 2011. The company writes off depreciation @ 20% p.a. on original
cost and closes its books on December 31, every year. On October 01, 2013,
one of the trucks is involved in an accident and is completely destroyed.
Insurance company has agreed to pay ` 70,000 in full settlement of the claim.
On the same date the company purchased a second hand truck for ` 1,00,000
and spent ` 20,000 on its overhauling. Prepare truck account and provision for
depreciation account for the three years ended on December 31, 2013. Also
give truck account if truck disposal account is prepared.
(Ans: Loss of settlement of Truck Insurance `30,000.
Balance of Provision for depreciation A/c as on 31.12.13 `4,46,000.
Balance of Trucks account as on 31.12.13 `9,20,000).
11. Saraswati Ltd. purchased a machinery costing ` 10,00,000 on January 01, 2011.
A new machinery was purchased on 01 May, 2012 for ` 15,00,000 and another
on July 01, 2014 for ` 12,00,000. A part of the machinery which originally cost
` 2,00,000 in 2011 was sold for ` 75,000 on April 30, 2014. Show the machinery
account, provision for depreciation account and machinery disposal account
from 2011 to 2015 if depreciation is provided at 10% p.a. on original cost and
account are closed on December 31, every year.
(Ans: Loss on sale of Machine `58,333.
Balance of Provision for dep. A/c as on 31.12.15 ` 11,30,000.
Balance of Machine A/c as on 31.12.15 ` 35,00,000).
12. On July 01, 2011 Ashwani purchased a machine for ` 2,00,000 on credit.
Installation expenses ` 25,000 are paid by cheque. The estimated life is 5
years and its scrap value after 5 years will be ` 20,000. Depreciation is to be
charged on straight line basis. Show the journal entry for the year 2011 and
prepare necessary ledger accounts for first three years.
(Ans: Balance of Machine A/c as on 31.12.13 `1,22,500).
13. On October 01, 2010, a Truck was purchased for ` 8,00,000 by Laxmi Transport
Ltd. Depreciation was provided at 15% p.a. on the diminishing balance basis
on this truck. On December 31, 2013 this Truck was sold for ` 5,00,000.
Accounts are closed on 31st March every year. Prepare a Truck Account for
the four years.
(Ans: Profit on Sale of Truck `58,237).
14. Kapil Ltd. purchased a machinery on July 01, 2011 for ` 3,50,000. It purchased
two additional machines, on April 01, 2012 costing ` 1,50,000 and on October
01, 2012 costing ` 1,00,000. Depreciation is provided @10% p.a. on straight
line basis. On January 01, 2013, first machinery become useless due to
technical changes. This machinery was sold for ` 1,00,000. prepare machinery
account for 4 years on the basis of calendar year.
(Ans: Loss on sale of machine ` 1,97,500.
Balance of Machine account as on 31.12.14 ` 1,86,250).

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15. On January 01, 2011, Satkar Transport Ltd., purchased 3 buses for
` 10,00,000 each. On July 01, 2013, one bus was involved in an accident and
was completely destroyed and ` 7,00,000 were received from the Insurance
Company in full settlement. Depreciation is written off @15% p.a. on
diminishing balance method. Prepare bus account from 2011 to 2014. Books
are closed on December 31 every year.
(Ans: Profit on insurance claim ` 31,687.
Balance of Bus account as on 1.01.15 ` 10,44,013).
16. On October 01, 2011 Juneja Transport Company purchased 2 Trucks for
` 10,00,000 each. On July 01, 2013, One Truck was involved in an accident
and was completely destroyed and ` 6,00,000 were received from the insurance
company in full settlement. On December 31, 2013 another truck was involved
in an accident and destroyed partially, which was not insured. It was sold off
for ` 1,50,000. On January 31, 2014 company purchased a fresh truck for
` 12,00,000. Depreciation is to be provided at 10% p.a. on the written down
value every year. The books are closed every year on March 31. Give the truck
account from 2011 to 2014.
(Ans: Loss on Ist Truck Insurance claim ` 3,26,250.
Loss on IInd Truck ` 7,05,000.
Balance of Truck account as on 31.03.14 ` 11,80,000).
17. A Noida based Construction Company owns 5 cranes and the value of this
asset in its books on April 01, 2017 is ` 40,00,000. On October 01, 2017 it
sold one of its cranes whose value was ` 5,00,000 on April 01, 2017 at a 10%
profit. On the same day it purchased 2 cranes for ` 4,50,000 each.
Prepare cranes account. It closes the books on December 31 and provides for
depreciation on 10% written down value.
(Ans: Profit on sale of crane ` 47,500.
Balance of Cranes account as on 31.12.17 ` 41,15000).
18. Shri Krishan Manufacturing Company purchased 10 machines for ` 75,000
each on July 01, 2014. On October 01, 2016, one of the machines got destroyed
by fire and an insurance claim of ` 45,000 was admitted by the company. On
the same date another machine is purchased by the company for ` 1,25,000.
The company writes off 15% p.a. depreciation on written down value basis.
The company maintains the calendar year as its financial year. Prepare the
machinery account from 2014 to 2017.
(Ans: Loss on settle of insurance claim ` 7,735.
Balance of Machine account as on 31.12.17 ` 4,85,709).
19. On January 01, 2014, a Limited Company purchased machinery for
` 20,00,000. Depreciation is provided @15% p.a. on diminishing balance method.
On March 01, 2016, one fourth of machinery was damaged by fire and ` 40,000
were received from the insurance company in full settlement. On September 01,
2016 another machinery was purchased by the company for `15,00,000.
Write up the machinery account from 2010 to 2013. Books are closed on
December 31, every year.
(Ans: Loss on settle of insurance claim ` 3,12,219.
Balance of Machine account as on 31.12.17 ` 19,94,260).

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Depreciation, Provisions and Reserves 275

20. A Plant was purchased on 1st July, 2015 at a cost of ` 3,00,000 and
` 50,000 were spent on its installation. The depreciation is written off at 15%
p.a. on the straight line method. The plant was sold for ` 1,50,000 on October
01, 2017 and on the same date a new Plant was installed at the cost of
` 4,00,000 including purchasing value. The accounts are closed on December
31 every year.
Show the machinery account and provision for depreciation account for 3 years.
(Ans: Loss on sale of Plant ` 81,875.
Balance of Machine account as on 31.12.17 ` 4,00,000.
Balance of Provision for Depreciation account as on 31.12.17 ` 15,000.).
21. An extract of Trial balance from the books of Tahiliani and Sons Enterprises
on March 31, 2017 is given below:
Name of the Account Debit Amount Credit Amount
` `
Sundry debtors. 50,000
Bad debts 6,000
Provision for doubtful debts 4,000
Additional Information:
• Bad Debts proved bad but not recorded amounted to ` 2,000.
• Provision is to be maintained at 8% of Debtors.
Give necessary accounting entries for writing off the bad debts and creating
the provision for doubtful debts account. Also show the necessary accounts.
(Ans: New provision for Bad debts ` 3,840, profit and loss account [Dr.]
` 7,840.)
22. The following information are extract from the Trial Balance of M/s Nisha
traders on 31 March 2017.
Sundry Debtors 80,500
Bad debts 1,000
Provision for bad debts 5,000
Additional Information
Bad Debts ` 500
Provision is to be maintained at 2% of Debtors.
Prepare bad debts accound, Provision for bad debts account and profit and
loss account.
(Ans: New provision ` 1,600 Profit and loss account [Cr.] ` 1,900).

Checklist to Test Your Understanding

Test Your Understanding - I

1. T, 2. F, 3. F, 4. T, 5. T, 6. F, 7. T, 8. F, 9. F, 10. F,
Test Your Understanding - II

Depreciation for 1 year (2014-15) = ` 7500 (Charged for 9 months)

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276 Accountancy

Depreciation for 2 year (2015-16) = ` 1,00,000 – ` 7500 = ` 92,500

10
= ` 92500 × = ` 9250
100

Depreciation for 3 year (2016-17) = ` 92500 – 9250 = ` 83050

10
= ` 83050 × = ` 8305
100

Test Your Understanding - III

1. (i) True (ii) False (iii) False (iv) False
(v) True (vi) False (vii) False

2. (i) Assets (ii) Acquisition cost

(iii) Charge (iv) Dividend equilisation fund.

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