Accounting for Managers/Management Accounting (Unit-1) by Dr. Abhay Singh Chauhan

Accounting for Management
By
Dr. Abhay Singh Chauhan

Chapter Objectives
 Describe the need for accounting
 Perceive the development of accounting
 Explain the meaning of accounting
 Name the persons interested in accounting disclosures
 Identify the objectives of accounting
 Describe the role of accountant in the society
3/27/2020 Dr. Abhay Singh Chauhan 2

Need for Accounting Records and communicates the financial result of
operations of an organization to various concerned parties
such as stakeholders, government agencies etc.
 Provides information that helps the management of the
organization to plan the future course of action and other
funds related issues.

Definition of Accounting
 Definition of accounting by American Accounting
Association (AAA):
“Accounting is the process of identifying, measuring
and communicating economic information to permit
informed judgments and decisions by users of the
information”

Functions of Accounting
 Recording: Accounting helps record all the business
transactions of financial character in an orderly
manner. Recording is done on various Journals.
 Classifying: After the systematic analysis of the
recorded data, the entries of similar nature are
grouped at one place. Transactions are classified on
Journals.
 Summarizing: The classified data is displayed in
understandable and easy to use statements such as
balance sheet, trial balance etc.

Functions of Accounting (Cont..)
 Financial Dealing: Accounting records only
monetary transactions that are of financial nature.
 Analyzing: A methodical classification of recorded
data and presenting in financial statements such as
current liabilities etc.
 Interpreting: Accounting helps in explaining the
meaning and significance of the data in simplified
form.
 Communicating: Accounting helps in
communicating the analyzed and interpreted
information in the form of graphs, ratios etc.

Book Keeping and Accounting
 Accounting refers to designing the system for recording
the financial data and then presenting it in logical
manner to the end users.
 Book-keeping is concerned with recording financial data
in an orderly manner.

End Users of Accounting Information
 Proprietors: Profitability and financial health of an
enterprise needs to be communicated to the proprietors.
 Managers: Financial disclosures communicate the
financial health and help the managers to plan and
manage the enterprise better.
 Creditors: Entities that have extended credit look into
financial statements to ascertain security of their credit.

End Users of Accounting Information
(Cont..)
 Prospective Investors: Financial statements
communicate profitability and financial health to attract
investment into an enterprise.
 Government: Financial statements serve as the basis of
meeting government liabilities pertaining to taxation,
labour and corporate laws.
 Employees: Bonus or profit sharing or Employees Stock
Options Plan is prepared using financial statements.

Role of an Accountant
 Role of the accountant in public service:
 Provides services such as financial audit, cost audit etc.
 Is the member of professional bodies, Institute of
Chartered Accountants of India and Institute of Cost and
Work Accountants of India.
 Trained in a prescribed manner and observe accounting
principles enunciated by the professional body.
 Observe the code of ethics laid down by the professional
body.

Role of an Accountant (Cont..)
 Role of the accountant in employment:
 Is employed in business or non business
entities.
 Maintains accounting records for the entity
 Provides information for tax returns,
financial performance etc.

Accounts Services
 Maintenance of the books of accounts:
 Keeps a systematic record of business transactions
 Provides information on financial performance of the
entity
 Helps the management of an organization in taking
important decisions on the basis of vital accounts
information
 Reduces the risk of losing information due to loss of
memory because the information is recorded

Accounts Services (Cont..)
 Helps perform the comparative study on performance
after fixed interval of time
 Maintains the accounting records systematically that are
acceptable to tax authorities and can be taken as evidence
in court of law
 Serves as the basis for proper evaluation of business entity

Summary
 In this unit, you have:
 Described the need for accounting
 Perceived the development of accounting
 Explained the meaning of accounting
 Named the persons interested in accounting disclosures
 Identified the objectives of accounting
 Described the role of accountant in the society

Chapter Objectives
 Explain the meaning of accounting principles
 Differentiate between accounting concepts and
conventions
 Name the accounting standards issued by the Institute
of Chartered Accountants of India
 Describe the different systems of accounting

Meaning of Accounting Principles
 Accounting principles refer to the rules and
actions adopted by the accountants globally for
recording accounting transactions.
 These are classified into two categories:
 Accounting concepts
 Accounting conventions

Accounting Concepts
 Accounting concepts include the assumptions
and conditions on which the science of
accounting is based.
 These are also known as accounting standards.
 Important accounting concepts are:
 Separate entity concept
 Going concern concept
 Money measurement concept
 Cost concept
 Dual aspect concept
 Accounting period concept
 Realization concept

Accounting Conventions
 Accounting conventions include the customs and
traditions that assists the accountants in preparing
accounting statements.
 Important accounting conventions are:
 Convention of conservatism
 Convention of full disclosure
 Convention of consistency
 Convention of materiality

Institute of Chartered Accountants of
India
 Council of Institute of Chartered Accountants
issues from time-to-time preface to the
statements of accounting standards that defines
the various aspects of accounting standards.
 It established an Accounting Standards Board
(ASB) on 22nd April, 1977.
 The function of ASB is to formulate accounting
standards, which are then established by the
Council of Institute of Chartered Accountants.

Preface to the Statements of
Accounting Standards
 It defines standards related to following features:
 Formation of accounting standards board
 Objectives and functions of the Accounting Standards
Board
 General purpose financial statements
 Scope of accounting standards
 Procedure for issuing an accounting standard
 Compliance with the accounting standards

Systems of Book-Keeping
 Two types of systems of book-keeping are:
 Single entry system: It is used to record only cash
and personal accounts.
 Double entry system: It is used to record each
transaction under two different accounts. It is more
reliable and efficient than the single entry system.

Difference Between Double Entry and
Single Entry Systems
Features Double Entry System Single Entry System
Recording of
transactions
Dual aspect concept is
completely followed for all
transactions
Dual aspect concept is not
followed for all transactions
Maintenance of
books
Subsidiary books such as Cash,
Sales and Purchase books are
maintained
Only Cash book is
maintained
Maintenance of
books of accounts
All real, nominal and personal
accounts are maintained
Only personal accounts are
maintained
Preparation of
trial balance and
financial
statements
Trial balance and financial
statements can be accurately
prepared
Trial balance cannot be
prepared and financial
statements does not provide
accurate results

Accounting Equation
 It is defined as:
Assets = Equities
Or, Assets = Liabilities + Capital
 Assets refers to the properties owned by a
business
 Equities refers to the rights to the properties.
 Liabilities refers to the equity of creditors that
represent debts of the business.
 Capital refers to the equity of owners of the
business.

Systems of Accounting
 Two basic systems of accounting are:
 Cash system of accounting: In this system, entries
are made only when cash is received or paid. It is
followed by the Government of various countries.
 Mercantile system of accounting: In this system,
entries are made for amount that is due for payment or
receipt. It is followed by the industrial and
commercial firms.
 Mercantile system is preferred over cash system
because it considers the effect of transactions
and reflects the financial position of the
company.

Summary
 In this chapter, you have:
 Explained the meaning of accounting principles
 Defined accounting concepts and conventions
 Named the accounting standards issued by the
Institute of Chartered Accountants of India
 Explained the difference between double entry and
single entry systems
 Described the different systems of accounting

Chapter Objectives
 Identify the stages of accounting cycle
 Appreciate the role of journal in recording business
transactions
 Understand the rules of debit and credit applicable to
different type of business transactions
 Describe the various categories of accounts
 Pass appropriate entries for recording transactions in
the journal

Accounting Cycle
 The stages involved in accounting cycle are:
 Creating Journal for recording transactions
 Creating Ledger for classifying the transactions recorded
in Journal
 Preparing Trial Balance, Trading Account, Profit and
Loss Account and Balance Sheet for summarising the
results of transactions
 Computing accounting ratios for determining the
liquidity, solvency and profitability of business

Journal
 Journal is a book that records all daily transactions in
the chronological order of date.
 It is also known as book of original entry.
 The process of recording a transaction in Journal is
known as Journalising.
Date Particulars L.F.
Debit
Rs.
Credit
Rs.

Types of Transactions
 All the business transactions are categorized into three
types:
 Transactions related to persons
 Transactions related to properties and assets
 Transactions related to income and expenses
 Depending upon the types of transactions, the
accounts under which the transactions are recorded
are classified into personal, real and nominal accounts.

Personal Accounts
 Personal account includes accounts of persons and
organizations with whom the business deals.
 Types of personal accounts:
 Natural personal accounts: It includes accounts of
persons such as John’s Account.
 Artificial personal accounts: It includes accounts of
organizations such as accounts of company, club and
Government.
 Representative personal accounts: It includes
accounts that represent a group of persons such as
outstanding salaries account for employees.
 Rule of debit and credit
 Debit the receiver
 Credit the giver

Real Accounts
 Real accounts represent accounts of properties and
assets.
 Types of real accounts:
 Tangible real accounts: It represents accounts of things
that can be touched or measured, such as cash account,
furniture account and stock account.
 Intangible real accounts: It represents accounts of things
that cannot be touched, such as patent account and
goodwill account.
 Rule of debit and credit:
 Debit what comes in
 Credit what goes out

Nominal Account
 Nominal accounts represent accounts for incomes,
gains, expenses and losses.
 Example: rent account, rates account , insurance
account, loss by fire account.
 Rule of debit and credit:
 Debit all expenses and losses
 Credit all incomes and gains

Classification of Goods Account
 Goods are the objects purchased by the business
for resale.
 Accounts related to goods are classified into:
 Purchases account: It records all purchases of goods
and the account is debited on purchasing the goods.
 Sales account: It records the sales of goods and the
account is credited on selling the goods.
 Purchases returns account: It records the return of
goods purchased and the account is credited on
returning the purchased goods.
 Sales returns account: It records the return of goods
sold and the account is debited on receiving the sold
goods.

Passing Entries to Journal
 Illustration: John starts a business with capital of Rs.
20,000 on Jan 1, 2000. He purchased furniture for cash of
Rs. 5,000 on Jan 5, 2000. He paid rent for business premises
of Rs. 2,000 on Jan 10, 2000.
Debit
Rs.
Credit
Rs.
2000
Jan 1 Cash Account Dr.
To Capital Account
(Being commencement of business)
20,000
20,000
Jan 5 Furniture Account Dr.
To Cash Account
(Being purchase of furniture)
5,000
5,000
Jan 10 Rent Account Dr.
To Cash Account
(Being payment of rent )
2,000
2,000

Summary
 Identified the stages of accounting cycle
 Understood the role of journal in recording business
transactions
 Described the rules of debit and credit applicable to
different types of business transactions
 Described the different types of goods accounts
 Learned the passing of entries to Journal

Ledger Posting and
Trial Balance

Chapter Objectives
 Explain the role of Ledger in recording business
transactions
 Understand the meaning and rules of posting
 Understand the meaning and objective of preparing a
Trail Balance
 Understand how to make posting and preparing a Trial
balance
 Explain the importance of Voucher system

Ledger
 Ledger is a book that contains a set of accounts.
 It organizes the transactions recorded in Journal under
their respective account heads.
 Two forms of Ledger are:
 Bound Ledger
 Loose Leaf Ledger
Amount
Rs
Amount
Rs
Dr. Cr.CASH ACCOUNT

Posting
 Posting is the process of transferring the
Journal entries to their corresponding accounts
in Ledger.
 During posting, the names of accounts in
Journal should match with the names of
accounts in Ledger.
 Posting should be completed before the
financial statements are prepared.
 Active accounts such as Cash Account and
Personal Accounts of various parties should be
posted on a daily basis.

Methods of Posting
 Methods of posting are:
 Consider a particular side, say debit and make complete
posting of all debit entries from journal to Ledger. Then
make complete posting of all the credit entries.
 Consider a particular account and post all the debit and
credit entries related to that account appearing on a
particular page of the Journal. Then consider another
account and perform the method repeatedly.
 Consider a Journal entry and complete its posting. Then
proceed with the next Journal entry.

Relationship between Journal and Ledger
 Transactions are first recorded in Journal and then in
Ledger.
 Journal records transactions in chronological order of
date, whereas Ledger records transactions in an
analytical order.
 Journal is more reliable than Ledger because the
transactions are recorded in Journal, from where the
Ledgers are made.

Rules of Posting
 Open separate accounts in Ledger for posting transactions
related to different accounts in the Journal.
 For a particular entry in the Journal, the account
corresponding to the debit entry should be debited in
Ledger under the account that corresponds to the credit
entry.
 For a particular entry in the Journal, the account
corresponding to the credit entry should be credited in
Ledger under the account that corresponds to the debit
entry.
 Write ‘To’ before the account that appears on the debit side
of a Ledger and ‘By’ before the account that appears on the
credit side of a Ledger.

Example of Posting
Debit
Rs.
Credit
Rs.
2007
Jan 5 Cash Account Dr.
To Capital Account
10,000
10,000
Jan 7 Furniture Account Dr.
To Cash Account
4,000
4,000
Journal

Example of Posting (Contd..)
CASH ACCOUNT
Date Particulars L.F. Amount Date Particulars L.F. Amount
2007
Jan 5 To Capital A/c 10,000
2007
Jan 7 By Furniture A/c 4,000
CAPITALACCOUNT
2007
Jan 5 By Cash A/c 10,000
FURNITURE ACCOUNT
2007
Jan 7 To Cash A/c 4,000
Ledger

Trial Balance
 Trial balance is a statement that consists of all the
debit and credit balances of various accounts in Ledger
on a particular date.
Particulars Debit
Rs
Credit
Rs
TRIAL BALANCE
As on 31st January

Objective of Preparing Trial Balance
 Trial Balance is used for checking the arithmetic
accuracy of accounting entries.
 It forms the basis for preparing financial statements
such as Trading Account, Profit and Loss Account and
Balance Sheet.
 It presents the entire Ledger in a summarized form.

Methods of Preparing Trial Balance
 Two methods of preparing Trial Balance are:
 Totals method: The totals of debit and credit of the
accounts in Ledger are transferred to the debit and
credit sides of the Trial Balance.
 Balance method: The debit and credit balances of the
accounts in Ledger are transferred to the debit and
credit sides of the Trial Balance
 In both the methods, the total of debit and credit
columns in the Trial Balance must be same.

Example of Trial Balance
Particulars Debit
Rs
Credit
Rs
Cash Account 12,000
Capital Account 10,000
Purchase Account 4,000
John 2,000
Sales Account 4,000
Total 16,000 16,000
TRIAL BALANCE
(as on 31st January,
2007)

Voucher System
 Voucher system is defined as a method for verifying,
recording and making payment of all items that
require the disbursement of cash.
 The basic activities involved in Voucher system are:
 Preparing voucher for each item of expenditure
 Making payment after properly verifying an authorized
voucher
 Developing an efficient system for determining the
amount to be paid at the end of each day

Voucher System (Contd..)
 Documents used in Voucher system are:
 Vouchers
 Voucher Register
 Unpaid Voucher File
 Cheque Register
 Paid Voucher File
 Vouchers Payable Account

Advantages of Voucher System
 Safeguards cash disbursements
 Reduces book-keeping work
 Records all current liabilities
 Strengthens the internal check system
 Provides ways for planning future cash requirements

Limitations of Voucher System
 Is unsuitable for small business enterprises
 Requires proper personnel and finances
 Fails to provide overall account position of a creditor
 Is difficult to maintain in case of partial payment
returns

Summary
 Explained the role of Ledger in recording business
transactions
 Understood the meaning and rules related to posting
 Understood the meaning and the objective of preparing
a Trail Balance
 Understood how to make posting and preparing a Trial
balance
 Explained the usage of Voucher System

Chapter Objectives
 Explain the importance of subdivision of Journal
 Name the different types of Journals
 Record Transactions in different Journals

Importance of Subdivision of Journal
 Subdivision of Journal means dividing the Journal into
various subsidiary books.
 It reduces the size of Journal and thus handling of
Journal becomes easier.
 It helps in division of labour by allowing different
persons to write different Journals.
 It helps in classifying information by associating a
Journal with a particular aspect of the business.

Types of Journals
 Journals can be broadly categorized into two
types:
 Special Journal: Helps record transactions of
specific type. It is further divided into the following
types:
 Cash Journal
 Goods Journal
 Bills Journal
 General Journal: It is also known as Journal
Proper. It records all such transactions that do not
occur frequently in business. Examples of such
transactions are opening entries, closing entries,
adjustment entries, transfer entries and purchases
of fixed assets.

Cash Journal
 Cash Journal is used for recording all cash
transactions.
 It is also known as Cash Book.
 Types of Cash Journal:
 Simple Cash Book
 Two Columnar Cash Book
 Three Columnar Cash Book
 Multi Columnar Cash Book
 Cash Receipts Book
 Cash Payment Book

Simple Cash Book
 Simple Cash Book is just like an ordinary Cash
account.
 It is also known as Single Column Cash Book.
 It functions both as a book and as a Ledger account.
Amount
Rs
Amount
Rs
Dr. Cr.SIMPLE CASH BOOK

Two Columnar Cash Book
 Two Columnar Cash Book consists of two columns for
recording cash details:
 Cash column: It records cash receipts and payments.
 Discount column: It records discount received and
discount given.
Dis-
count
Rs
Cash
Rs
Dat
e
Particulars L.F.
Dis-
Count
Rs
Cash
Rs
Dr. Cr.TWO COLUMNAR CASH BOOK

Three Columnar Cash Book
 Three Columnar Cash Book consists of three columns
for recording cash details.
 The first two columns are same as the Two Columnar
Cash Book.
 Bank column is the additional column in Three
Columnar Cash Book.
 Bank column records money deposited and money
withdrawn from the bank.

Three Columnar Cash Book (Cont…)
 Format of Three Column Cash Book:
DateParticularsL.F.
Dis-
count
Rs
Cash
Rs
Bank
Rs
DateParticularsL.F.
Dis-
Count
Rs
Cash
Rs
Bank
Rs
Dr. Cr.CASH BOOK

Multi Columnar Cash Book
 Multi Columnar Cash Book consists of more than
three columns for recording cash details.
DateParticularsTotal
Rs
DateParticularsVoucher
No.
Col1
Rs
Col2
Rs
Col3
Rs
Col4
Rs
Col5
Rs
Total
Rs
Dr. Cr.CASH BOOK

Cash Receipts and Cash Payments Books
 Cash Receipts Book: It records all cash receipts
transactions. Posting from Cash Receipts Book to
Ledger is done daily and the entries are recorded in
the credit side of the Ledger. At the end of a week,
the Cash account is debited with the total cash
received.
 Cash Payments Book: It records all cash
payments transactions. Posting from Cash
Payment Book to Ledger is done on a daily basis
and the entries are recorded in the debit side of the
Ledger. At the end of a week, the Cash account is
credited with the total cash paid.

Goods Journal
 Goods Journal is used for recording all transactions
related to goods.
 Types of Goods Journal are:
 Purchases Journal: It records all credit purchases of
goods.
 Sales Journal: It records all credit sales of goods.
 Purchases Returns Journal: It records all returns of
goods purchased on credit.
 Sales Returns Journal: It records all returns of goods
sold on credit.

Bills Journal
 Bills Journal is used to record all bills of exchange and
promissory notes received or issued by the business.
 Types of Bills Journal are:
 Bills Receivable Journal: It records all bills of exchange
and promissory notes received by the business from its
debtors.
 Bills Payable Journal: It records all bills of exchange
and promissory notes issued by the business in favour of
its creditors.

Summary
 Explained the importance of subdivision of Journal
 Named the different types of Journals
 Recorded Transactions in different Journals

Chapter Objectives
 Understand the concepts of a negotiable instrument
 Explain the different types of negotiable instruments
 Record transactions related to negotiable instruments

Concepts of Negotiable Instruments
 Negotiable instruments are the documents having
certain cash value.
 They are used in commercial transactions that
involve monetary dealings.
 Examples of negotiable instruments are
promissory notes, bills of exchange and cheques.
 A negotiable instrument can be of two forms:
 Order instrument: It is used to make payment to the
person named in the instrument.
 Bearer instrument: It is used to make payment to the
person who has the instrument.

Promissory Note
 It is a document, which acts as a written promise to pay
a certain sum of money to a particular person.
 It represents an unconditional order duly signed by the
maker of the document.

Features of Promissory Note
 It involves two parties:
 Promissor: It refers to the maker of the promissory
note. The promissor is also called debtor.
 Promissee: It refers to the payee to whom the amount
should be paid. The promissee is also called creditor.
 It is used only to pay certain money to a person.
 It should specify the amount to be paid along with
interest, if any.
 It should specify the name and designation, if
required, of the payee.

Features of Promissory Note (cont…)
 A special type of promissory note can be made to make
payment to the bearer. Such promissory note can only
be drawn by the Reserve Bank of India (RBI).
 It is different from bank note, which is issued by an
authorized bank for making payment to the bearer on
demand. A promissory note is issued by private
individuals, whereas in India, a bank note is only
issued by RBI.

Bill of Exchange
 It is a document, which directs a certain person in
written, to pay the specified sum of money to the
bearer or the payee as specified in the document.
 Like promissory notes, it also unconditionally
promises to pay the amount to the payee on demand
and is duly signed by the maker.

Features of Bill of Exchange
 It includes three parties:
 Drawer: It refers to the person who prepares the bill of
exchange.
 Drawee: It refers to the person, who should pay the
money specified in the bill of exchange.
 Payee: It refers to the person to whom the specified
money should be paid. In some cases, drawer and payee
can be same.
 The drawer is the creditor and orders the drawee to
pay the specified amount to payee.
 A special type of bill of exchange, known as time
bill of exchange, can be made to make payment to
the bearer after a particular period of time.

Types of Bills of Exchange
 Main types of bills of exchange are:
 Time bills: They refer to the bills of exchange that are
used to make payment after a particular period of time.
Such bills should be duly accepted by the drawee.
 Demand bills: They refer to the bills of exchange that
are used to make payment on demand. The acceptance
of drawee is not necessary for demand bills.
 Trade bills: They refer to the bills of exchange that are
used in the context of a genuine trade transaction. Here,
the drawer issues the bill of exchange and the drawee
should duly accept the same.

Types of Bills of Exchange (cont…)
 Accommodation bills: They refer to the trade bills that
are used for providing funds to a particular person.
 Inland bills: They refer to the bill of exchange that are
used for both drawing and making payment in a
particular country.
 Foreign bills: They refer to the bill of exchange that are
drawn in one country and made payable in some other
country.

Cheque
 It is a document, which directs a bank to pay a
particular sum of money to the payee.
 The bank pays the specified amount from the account
specified by the cheque.
 It becomes obsolete after a particular time period from
the date specified in the cheque.
 Like other negotiable instruments, cheque is also duly
signed by the maker and promises to pay the payee
unconditionally.

Features of Cheque
 It is drawn on a specified banker.
 It is payable only on demand.
 Its electronic form can be generated by the bank to
make electronic payment.
 Its electronic truncated image is generated by the
clearing house during the course of clearing cycle.

Important Terms
 Holder: It refers to the person, who is entitled to
possess the negotiable instrument and has the
right to recover the amount due on negotiable
instrument.
 Holder in due course: It refers to the holder, who
obtains a negotiable instrument for valuable
consideration and before maturity.
 Acceptance of bill: It refers to the process of
accepting the order of making payment by the
drawee of a bill of exchange.
 Endorsement: It refers to the process of
transferring the ownership of a negotiable
instrument by the payee in favour of some other
person.

Important Terms (cont…)
 Drawee in case of need: It refers to the second
party, to whom the drawer of a bill of exchange
instructs the holder to present the bill, in case the
drawee dishonours the bill.
 Maturity of bill: It refers to the date on which a
negotiable instrument matures. That is the date on
which the payee can use the instrument to get its
payment.
 Dishonour: It refers to the non-payment of the
amount mentioned in the negotiable instrument
on the date of maturity.
 Noting: It refers to the authentic and official proof
of presentment and dishonour of a negotiable
instrument.

Important Terms (cont…)
 Protesting: It refers to the formal certificate of
dishonour, which is issued by the notary public to
the holder of the negotiable instrument on his
demand.
 Retiring of a bill: It refers to the withdrawal of the
negotiable instrument before its maturity, if all the
parties associated with the negotiable instrument
are agreed.
 Renewal of a bill: It refers to the issue of a new
bill after the original bill has been either
dishonoured or retired.

Accounting Entries For Promissory Note/Bill
of Exchange
 The accounting entries for promissory note and bill of
exchange are same.
 The terms promissee and maker are used in case of
promissory note.
 The terms drawer and drawee are used in case of bill of
exchange.

of Exchange (cont…)
 Accounting entries when a bill of exchange is kept till
the maturity date:
 In the book of drawer:
 On selling goods on credit:
Drawee A/c Dr.
To Sales A/c
 On receipt of the bill duly accepted by drawee:
Bills Receivable A/c Dr.
To Drawee A/c
 On receiving payment on maturity of the bill:
Cash A/c Dr.
To Bills Receivable A/c

of Exchange (cont…)
 In the books of drawee:
 On purchasing goods on credit from drawer:
Purchase A/c Dr.
To Drawer A/c
 On acceptance of bill in favour of drawer:
Drawer A/c Dr.
To Bills Payable A/c
 On payment of the bill on maturity:
Bills Payable A/c Dr.
To Cash A/c

Accounting Entries For Cheque
 Cheque of Rs. 10,000 is received on 10th Jan from BC Co.
and is sent to the bank on 14th Jan. Entry for this
cheque is made in Cash Book as shown below:
Date ParticularsL.F.
Cash
Rs
Bank
Rs
Cash
Rs
Bank
Rs
Jan 10 To BC Co. 10,000 Jan 14 By Bank C 10,000
Jan 14 To Cash C 10,000
Dr. Cr.CASH BOOK

Summary
 Understood the concept of a negotiable instrument
 Explained the different types of negotiable instruments
 Recorded transactions related to negotiable instruments

Chapter Objectives
 Identify the objectives of preparing various final
accounts
 Understand the treatment of different items in the
preparation of the final accounts
 Explain the importance of final accounts
 Describe the role of worksheet in preparing final
accounts

Objectives of Final Accounts
 Final accounts refer to the various accounts and
statements that provide information related to the
progress of the business.
 These are prepared from the Trial Balance.
 They provide the following information:
 Profit earned or loss suffered by the business during a
particular accounting period
 Financial position of the business

Accounts and Statements Comprising Final
Accounts
 Final accounts with respect to a particular business
are:
 Trading account
 Profit and Loss account
 Balance Sheet
 Trading account and Profit and Loss account are
together known as income statements.
 Income statements are the final summary of the
accounts that affect the profit and loss position of the
business.

Trading Account
 It shows the overall results of purchasing and selling of
goods.
 It includes all the direct expenses incurred in the
business.
 It provides gross profit earned by the business, if total
sales is greater than total purchases.
 It provides gross loss suffered by the business, if total
sales is less than total purchases.

Format of Trading AccountTrading Account
Dr. (For the period ended . . . . . . . . ) Cr.
Particulars Amount Particulars Amount
To Opening stock By Sales
To Purchases Less: Sales returns
Less: Purchases returns By Closing stock
To Wages
To Customs and import duty
To Carriage expenses
To Royalty
To Manufacturing expenses
To Packing expenses
Total Total
To gross profit transferred to
profit and loss account
By gross loss transferred
to profit and loss account

Items on Debit Side of Trading Account
 Opening stock: It refers to the total cost of goods
left unsold at the beginning of the current
accounting period.
 Purchases: It refers to the total cost of goods
purchased, both in cash and credit. In case of
purchases returns, first net purchases is computed
by deducting purchases returns from purchases
and the result is then debited to the Trading
account.
 Wages: It refers to the amount paid to the workers
for manufacturing, loading and unloading of
goods.
 Customs and import duty: It refers to the
amount paid as customs and import duty when the
goods are purchased from outside the country.

Items on Debit Side of Trading Account
(cont…)
 Carriage expenses: It refers to the direct expenses
that are incurred while transferring the purchased
goods from vendor to the factory. These expenses
are also known as freight in, carriage in or cartage.
 Royalty: It refers to the amount paid to the owner
for using his rights.
 Manufacturing expenses: It refers to the
expenses spent on gas, electricity, water and fuel,
which are required to run the factory.
 Packing expenses: It refers to the amount spent
in packing the purchased goods to bring them to
factory.

Items on Credit Side of Trading Account
 Closing stock: It refers to the total cost of the
goods that are left unsold at the end of the
accounting period.
 Sales: It refers to the total cost of goods sold, both
in cash and credit. In case of sales returns, first the
net sales is computed by deducting the sales
returns from total sales and the result is then
credited to the Trading account.

Importance of Trading Account
 It provides information related to gross profit and
loss and helps in defining the upper limits for the
operating expenses of the business.
 It helps in the computation of gross profit ratio. A
decrease in the gross profit ratio indicates increase
in the purchased cost or decrease in the selling
price.
 It allows the comparison of opening and closing
stocks of two accounting periods. This helps in
preventing unnecessary investment of funds for
the purchase of inventories.

Profit and Loss Account
 Profit and Loss account shows all incomes and indirect
expenses related to business.
 Indirect expenses include those expenses such as
administrative, selling and distribution expenses that
are required for the operation of business.
 Profit and Loss account provides net profit earned or
net loss suffered by the business.

Format of Profit and Loss Account
Profit and Loss Account
Particulars Amount Particulars Amount
To Gross loss b/d By Gross profit b/d
To Salaries By Interest received
To Rent By Commission received
To Commission By Discount received
To Advertisements
To Bad debts
To Discount
To Net profit transferred to
Capital Account
To Net loss transferred to
Capital Account
Total Total

Items on Debit Side of Profit and Loss
Account
 Gross loss: It is transferred from the Trading
account.
 Salaries: It refers to the amount paid to the
employees as their salaries.
 Interest paid: It refers to the amount paid as
interest on loans.
 Commission paid: It refers to the amount paid as
commission to the agents.
 Trade expenses: It refers to the amount spent on
various number of small but important expenses
related to business.

Items on Debit Side of Profit and Loss
Account (cont…)
 Printing and stationary: It refers to the amount
spent on printing of bills, invoices, registers, files
and letter heads.
 Advertisements: It refers to the amount spent for
attracting customers to buy the products.
 Bad debts: It refers to the amount, which is not
paid by the debtors to whom the goods were sold
on credit.
 Discount: It refers to the amount, which is
reduced from the list price of goods.

Items on Credit Side of Profit and Loss
Account
 Gross profit: It is transferred from the Trading
account.
 Interest received: It refers to the amount received
as interest on investments.
 Commission received: It refers to the
commission earned by the business for giving
business to others.

Importance of Profit and Loss Account
 It provides information about net profit earned or
net loss suffered by the business.
 It helps in determining whether the business is
being run efficiently or not by comparing the
Profit and Loss account of two accounting periods.
 It helps in taking effective control steps by
analyzing the various expenses listed in the Profit
and Loss account of the current year with that of
the previous years.
 It allows in the estimation of profits for the coming
years by comparing the profits of previous years.

Manufacturing Account
 It is a special account, which is prepared only when the
business is engaged in manufacturing of goods.
 It provides the cost of goods manufactured during a
given accounting period.
 In case of manufacturer, the manufacturing account
should be prepared prior to the preparation of Trading
account and Profit and Loss account.

Format of Manufacturing Account
Manufacturing Account
Particulars AmountParticulars Amount
To Work-in progress (Opening) By Work-in progress (Closing)
To Raw materials consumed: By Sale of scrap
Opening stock By Cost of production of
finished goods
Add: Purchase of raw materials
Less: Closing stock of raw
materials
To direct wages
To factory overheads

Balance Sheet
 It is a financial statement that states the financial
position of the business.
 It lists the assets and liabilities of a business on a
particular date.
 The assets and liabilities on a Balance Sheet are listed
in either of the following two orders:
 Liquidity order
 Permanency order

Format of Balance SheetBalance Sheet
(As on . . . . . . . . . . . )
Liabilities Amoun
t
Assets Amount
Bank overdraft Cash in Hand
Outstanding expenses Cash at bank
Bills payable Prepaid expenses
Sundry creditors Bills receivables
Long-terms loans Sundry debtors
Capital Closing stock
Raw materials
Work-in-progress
Finished goods
Plant and machinery
Total Total

Items on Balance Sheet
 The left side of Balance Sheet represents the liabilities
of the business.
 Liabilities are the claims of the creditors against the
assets of a firm.
 The two categories of liabilities are:
 Current liabilities: The liabilities that are payable
within a year.
 Fixed liabilities: The liabilities that are to be paid
atleast after a year.

Items on Balance Sheet (cont…)
 The right side of Balance Sheet represents the assets of
the business.
 Assets represents the resources acquired by the
business.
 The categories of assets are:
 Current assets: The assets that can be easily convertible
into cash.
 Liquid assets: The assets that can be immediately
convertible into cash without any loss.

Items on Balance Sheet (cont…)
 Fixed assets: The assets that are acquired for carrying
out the business and are not meant for resale.
 Intangible assets: The assets like Goodwill and patents
that cannot be seen or touch.
 Fictitious assets: The assets that are neither tangible
nor possess a property.

Adjustment Entries
 These are the entries that are made at the end of
an accounting period after closing the books of
accounts and preparing Trail Balance.
 Some of the adjustment entries that are required
for the preparation of final accounts are:
 Closing stock
 Outstanding expenses
 Outstanding income
 Income received in advance
 Depreciation
 Bad debts
 Interest on capital
 Interest on drawings

Worksheet
 It is a preliminary draft prepared to prevent the errors
that might occur in the Trial Balance due to the
adjustment entries.
 It consists of following information:
 The original Trial Balance
 The adjustment required in the Trial Balance due to the
adjustment entries
 The new Trial Balance, known as Adjusted Trial Balance

Format of Worksheet
S.no Name of
Account
L.F. Trial
Balance
Adjustme
nts
Adjusted
Trial
Balance
Income
Statement
Balance
Sheet
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.

Advantages of Worksheet
 It reduces the possibility of error and helps in
identifying the location of errors occurred due to
adjustment entries.
 It helps in classifying and summarizing the details
represented in the Trial Balance and the adjusting
data.
 It also helps in the preparation of final accounts
and passing of closing entries.
 It allows to determine the net result of business
operation prior to the preparation of final
accounts.

Summary
 Identified the objectives of preparing various final
accounts
 Understood the treatment of different items in the
preparation of the various final accounts
 Explained the importance of various final accounts
 Described the role of worksheet in preparing final
accounts

Chapter Objectives
 Understand the concept of different types of errors
 Identify the procedure for locating errors
 Describe the meaning and importance of suspense
account
 Rectify accounting errors by means of appropriate
journal entries
 Understand the effect of different errors on
computation of business profits

Identification of Errors
 Errors occur when some transactions are incorrectly
entered in the account books.
 Identification and rectification of the errors is
necessary to ensure the correctness of final accounts.
 Errors are classified into four categories:
 Omission error: This error occurs when a transaction is
not recorded in the Journal. This type of error is difficult
to locate because it is not reflected in the Trial Balance
as both debit and credit entries related to a transaction
are missing.

Identification of Errors (contd.)
 Commission error: This error occurs while posting and
balancing of accounts in Ledger. This type of error can
be easily located by analyzing the Trial Balance.
 Principle error: This error occurs when the accountant
fails to distinguish between revenue and capital items.
This type of error is difficult to locate because it is not
reflected in the Trial Balance.

Identification of Errors (contd.)
 Compensating error: This error occurs when the
entries corresponding to two transactions, which are
incorrectly entered in the account books, compensate
each other. It is difficult to locate this type of error
because it does not affect the overall debit and credit
balances of an account.

Location of Error
 The omission, commission and compensating errors
cannot be located from the Trial Balance. Location of
such errors can only be determined when:
 Statements of accounts are received from the suppliers,
customers and other business associates
 Statements of accounts are sent to the customers
 Internal and external audits are performed

Location of Error (contd.)
 Errors like principle errors are easily located when
there is a mismatch between the debit and credit
totals of the Trial Balance. To locate such errors, an
accountant performs any of the following tasks:
 Computes the difference between debit and credit totals
in Trial Balance and performs various operations on it to
determine the error entry
 Checks the schedules of sundry creditors and debtors
 Checks the total of all the subsidiary books such as Sales
Book and Purchase Book
 Checks all the entries in Journal and their posting in
Ledger

Suspense Account
 It is a temporary account to which the difference in the
Trial Balance is transferred.
 It should be opened only when the accountant fails to
determine the location of errors.
 It is closed when the accounting entries are passed to
rectify the errors that resulted in the difference in the
Trial Balance.

Rectifying Accounting Entries
 To rectify the errors in the books of accounts, special
entries known as rectifying entries are passed in the
books of accounts.
Illustration: Sales Book overcast by Rs. 100.

Rectifying Accounting Entries (contd.)
 The following are the rectifying entries for the given
situation:
 Case 1: Accountant has identified the location of error
before transferring the difference in Trial Balance to
Suspense account.
Date Particulars Dr. Cr.
Sales Account Dr.
(Being excess credit to Sales account,
now rectified)
100

Rectifying Accounting Entries (contd.)
 Case 2: Accountant has identified the location of error
after transferring the difference in Trial Balance to
Suspense account.
Date Particulars Dr. Cr.
Sales account Dr.
To Suspense account
100
100

Effect of Errors on Profit
 Errors in the books of accounts, which are
associated with Trading account and Profit and
Loss account, may affect the profit calculation of
business for a particular period.
 Example of accounts that affects the profit
calculation of business are Purchase, Sales,
Expense and Income accounts.
 Accounts that should be debited are if
unnecessarily credited will result in increase in the
net profit.
 Accounts that should be credited are if
unnecessarily debited will result in decrease in the
net profit.

Summary
 Understood the concept of different types of errors
 Identified the procedure for locating errors
 Described the meaning and importance of Suspense
account
 Rectified accounting errors by means of appropriate
journal entries
 Understood the effect of different errors on computation
of business profits

Depreciation, Provisions
and Reserves

Chapter Objectives
 Understand the concept of depreciation
 Identify the causes of depreciation
 Explain the meaning of depreciation accounting
 Compute depreciation according to different methods
of providing depreciation
 Explain the role of depreciation policy

Depreciation
 Depreciation is defined as the gradual decrease in the
value of an asset.
 Causes of depreciation are:
 Wear and tear
 Exhaustion
 Obsolescence
 Efflux of time
 Accidents

Features of Depreciation
 It is applicable to all fixed assets except some assets
like land and antique.
 It is a charge against profits and true profit of a
business can only be computed after charging
depreciation.
 It differs from maintenance expenses, which are
incurred for keeping the machines in a workable state.

Depreciation Accounting
 Depreciation accounting is concerned with
distributing the cost of a tangible asset over its
estimated useful life.
 Objectives of depreciation accounting are:
 To determine true profit of business
 To provide true financial position of business
 To provide funds for the purchase of new assets

Fixation of Depreciation Amount
 Depreciation amount of a particular asset is computed
and is charged to the profit and loss account.
 Depreciation amount in respect to a particular asset
depends upon the following factors:
 Cost of asset
 Estimated scrap value
 Estimated useful life

Methods of Recording Depreciation
 To record the depreciation in the books of account,
two methods are used:
 Using Provision for Depreciation account
 Without using Provision for Depreciation account

(contd.)
 Using Provision for Depreciation account:
 The Provision for Depreciation account is credited with
the depreciation amount chargeable in a year.
 The Asset account provides the original cost of asset.
 The Provision for Depreciation account is transferred to
the Asset account, when the asset is sold.
 Without using Provision for Depreciation
account:
 The Depreciation account is debited with the
depreciation amount chargeable in a year and the same
amount is credited to the Asset account.
 The Depreciation account is transferred to the Profit
and Loss account.

(contd.)
 In both the methods, when the asset is sold:
 On profit, the balance of Asset account is transferred to
the Profit and Loss account.
 On loss, the amount realized on account of sale is
transferred to the Asset account.

Methods for Providing Depreciation
 The methods used for computing depreciation are
classified into three categories:
 Uniform charge methods
 Declining charge or accelerated depreciation methods
 Other methods

Uniform Charge Methods
 In these methods a uniform depreciation amount is
charged every year.
 The various uniform charge methods are:
 Fixed installment method: It is also known as Straight
Line Method (SLM). It provides a fixed amount of
depreciation every year. In this, depreciation is
computed by dividing the difference of original cost of
asset and estimated scrap value by the estimated life of
the asset in years.

Uniform Charge Methods (contd.)
 Depletion method: It is also known as productive
output method. In this, depreciation depends upon the
actual cost of the asset and actual and estimated
quantities of output to be produced using the asset.
 Machine hour rate method: It is also known as service
hours method. In this, depreciation depends upon the
running time of the asset. Depreciation is computed by
dividing the difference of asset and scrap value by the
life of the asset in hours.

Declining Charge Depreciation Methods
 In these methods, the depreciation amount to be
charged decreases with the expected life of the asset.
 The various declining charge depreciation methods
are:
 Diminishing balance method: Depreciation is
computed on the book value of the asset. Depreciation
rate is obtained using the formula:
1 – n ((net residual value/acquisition cost)

Declining Charge Depreciation Methods
(contd.)
 Sum of years digits method: It is similar to the
diminishing balance method. Depreciation is computed
as the product of remaining life of asset divided by the
sum of n digits, where n is the estimated life of asset in
year, and original cost.
 Double declining balance method: It is also similar to
the diminishing balance method, but the depreciation
rate is double the rate computed using the straight line
method.

Other Methods
 Group depreciation method: In this, the
homogeneous assets having similar average life are
grouped together under a common summary
account. The depreciation rate is computed from
the expected average life and the scrap values of
assets of a group.
 Inventory system depreciation: In this,
depreciation is computed for the assets whose
expected life cannot be determined. Depreciation
amount is computed by subtracting the cost of
asset at the end of the accounting period from the
total cost of the asset available at the beginning
and purchased during the accounting period.

Other Methods (contd.)
 Annuity method: In this, depreciation is
computed by considering the cost of asset and the
interest on the actual cost of the asset that the
business would have earned if the amount have
been invested in some investment.
 Depreciation fund method: In this, the
depreciation amount is invested in some securities.
This helps in the business to gather funds for the
purchase of new assets.

Other Methods (contd.)
 Insurance policy method: In this, the business
takes an insurance policy for a particular amount
and pays a fixed amount of premium every year. At
the end of the duration of insurance policy, the
insurance company pays the insured amount, which
is used by the business to buy new assets.

Depreciation Policy
 Objectives of depreciation policy:
 To recover the amount invested in purchasing an asset
before the expiry of the economic life of the asset.
 To ensure that a uniform rate of return on investment is
achieved.
 To generate funds for purchasing of new asset after the
expiry of an old asset.
 To determine correct profit and loss information of the
business.

Depreciation Policy (contd.)
 Aspects that should be considered while developing
the depreciation policy:
 An appropriate method for computing depreciation
should be selected depending upon the nature of assets
and objectives of the management.
 The provisions for depreciation should be periodically
reviewed.
 The depreciation policy should be evaluated in the
context of tax, price level changes and Government
regulations.

Provision
 Provision is the amount that is set aside from
the profits of the business for providing:
 Depreciation, renewals and decrease in the value of
assets.
 An known liability, which cannot be determined.
 It is a charge against profits and is created by
debiting the Profit and Loss account.
 It cannot be distributed as profits.
 Examples: Provision for bad debts, provision for
repairs and renewals and provision for discount.

Reserve
 Reserve is the portion of earnings and receipts of a
business that is kept aside for a specific purpose other
than a provision for depreciation.
 It is an appropriation of profits that ultimately results to
an increase in the funds of the proprietor.
 It can be distributed as profits, if required.
 It is shown on the liability side of the Balance Sheet
under the heading Reserves and Surplus.

Reserve Funds
 Reverse funds are the reserves that are kept for
investment outside the business.
 Types of reserve funds:
 Revenue reserves: They are created out of revenue
profits of the business.
 Capital reserves: They are created out of capital profits
of the business.
 Secret reserves: They are the reserves that are not shown
on the Balance Sheet.

Summary
 Understood the concept of depreciation
 Identified the causes of depreciation
 Explained the meaning of depreciation accounting
 Computed depreciation according to different methods
of providing depreciation
 Explained the role of depreciation policy

Accounting for Managers/Management Accounting (Unit-1) by Dr. Abhay Singh Chauhan

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