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Preparatory steps for final accounts

Study Note - 3
Preparatory steps for final accounts

This Study Note includes

● Introduction
● Closing Stock
● Depreciation
● Accrued Expenses
● Prepaid Expenses
● Accrued Income
● Income Received in Advance
● Bad and Doubtful Debtors
● Opening Entries
● Closing Entries
● Rectification Entries
● Depreciation Methods
● Bank Reconciliation
● Conclusion

3.0 Introduction
At the end of the last study note, it was said that Trial Balance forms the basis for preparing
financial statements. However, there are certain other tasks that have to be completed before
these final accounts are prepared. You know that accounting entries are made on the basis of
actual transactions carried out during an accounting period. These are all included in the trial
balance. However, there could be certain other business realities which are to be recognized as
either asset, liability, income, gain, expense, loss or a combination thereof. As we know the
matching concept necessitates the consideration of all aspects which may affect the financial
result of the business. Technically these are called as adjustments for which entries need to be
passed, without which the financial statements will not give a true and fair view of business
activity. We discuss some of these entries and adjustments in the following sections.
Before discussing these, let us understand the meaning of income statement and balance sheet.

Trial Balance based on ledger balances

Income statement shows in- Balance Sheet shows assets and


come & gains and expenses & Liabilities & owner’s equity.
losses for an accounting period. Profit or loss from income state-
The net result is profit or loss. ment is added or deducted
from owner’s capital or equity.

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Depending on the nature of business, the income statement is prepared in different forms like:
a) In case of manufacturing concern, a manufacturing, trading and P & L a/c is prepared
b) In case of a trading or service organization, a trading and P & L a/c is prepared
The manufacturing or trading accounts show Gross margins (or gross losses) and the P & L a/
c shows Net Profit or net loss. This is explained in depth at a later stage in the next chapter.
The balance sheet exhibits the list of assets (which indicate resources owned) and the liabili-
ties & owners’ capital and equity (which shows how the resources are funded).
For company type of organizations, standard formats for P & L and Balance sheet are given in
the Companies Act that is to be adhered to. The accounting should be as per the accounting
standards prescribed by the ICAI.

3.1 Closing Stock


We know when goods are purchased for resale we include them in Purchases a/c, while goods
sold are shown in sales a/c. At the end of accounting period, some of these goods may remain
unsold. If we show the entire cost of purchases in income statement, it will not be as per the
matching concept. We should only show the cost of those goods that are sold during the
period. The balance cost should be carried forward to the next accounting period through the
balance sheet. How should the closing stock be valued? According to the conservative prin-
ciple, the stock is valued at lower of cost or market price. If cost of stock is Rs 125000 and its
realizable market price is only Rs 115000, then the value considered is Rs 115000 only. What it
means is the difference of Rs 10000 is charged off to the current periods profits.
Students are advised to refer to Accounting Standard 2 issued by ICAI to get thorough knowledge on
valuation of inventories.
Please remember the closing stock figure does not appear in the trial balance, but is valued
and directly taken to the P & L a/c. The entry passed for this is:
Closing Stock a/c Dr
To Trading and P & L a/c
In solving the examination problem, this entry is not actually passed, but the effect of its outcome is
given. Here, one effect is “show closing stock as asset in balance sheet” and second effect is “show it on
the credit side of trading a/c”.

3.2 Depreciation
When the business uses its assets to earn income, there is wear and tear of the asset life. Assets
will have limited life and as we go on using it, the value diminishes. Again the question to be
asked is – at what value should the asset be shown in the balance sheet? Consider a machine
was bought on 1st April 2005 for Rs 200000. It’s used for production activity throughout the
year. When the final accounts are being prepared, at what value should it be shown in balance
sheet as on 31st March 2006?

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Preparatory steps for final accounts

Well, according to cost principle initial entry for purchase of machine is shown at cost paid for it
e.g. Rs 200000 in this case. But the fact that the machine is used must be recognized in financials.
Hence the value in the balance sheet must be brought down to the extent of its use. This is
called as Depreciation. How is it calculated? While there are different methods of calculating
depreciation (explained in subsequently), the simple idea is to spread it over the useful life of
the asset, so that at the end of its life the value is zero! In our example, if useful life of the
machine is taken as 10 years, the depreciation will be simply Rs 200000 ÷ 10 i.e. Rs 20000 every
year. So a depreciation of Rs 20000 will be charged to the profit of every year and value of asset
will be brought down by the same value.
Students are advised to refer to Accounting Standard 6 issued by ICAI to get thorough knowledge on
Depreciation accounting.
The entry passed for this is:
Depreciation a/c Dr
To Fixed Asset
The effect given is one – include in the P & L a/c as expense for the period and two – reduce from asset
value in the balance sheet.
Please see section 3.10 describing various methods of depreciation included later in this chapter which
may please be studied.

3.3 Accrued Expenses or Outstanding Expenses


There may be expenses incurred for the current accounting period, but not actually paid for.
The matching concept, however, necessitates that this expense must be recognized as expense
for the current year and should not be deferred till its actual payment. Typically, we know
salary for the month is normally paid in the 1st week of the next month. Imagine the accounting
period close is on 31st March. The salary for the month of March is not paid till 31st March. But
is it is related to this month, it must be booked as expense for the current month and also as a
liability payable in the next month (which is in next accounting period). This can be shown as
follows:

M a rc h sa lar y p a id in A p ril

M a r 2 00 6 A p r 2006

The entry for this is:


Expense a/c Dr
To outstanding Expense a/c or Expense payable a/c
The two effects when preparing the final accounts are:
One – add in respective expense in P & L a/c and two – show as a liability in the balance sheet.

A 64 ACCOUNTING
3.4 Prepaid Expenses
At times we may pay for certain expenses which are period related. For example, the business
has taken an insurance policy against fire on which the annual premium payable is Rs 75000.
The policy is taken on 1st January 2006 valid till 31st December 2006. But the company’s ac-
counting period ends on 31st March 2006. When considering the insurance expense for the
accounting year, what amount should be considered? See the following.

31st Mar
2006 9 months
3 months

1st Jan 31st Dec 2006


2006 12 months

As can be seen, out of the total premium period of 12 months, only 3 months are related to the
current accounting period and the remaining 9 months’ premium is related to the next ac-
counting period. Hence only 3 months’ premium is to be considered as expense for the current
year i.e. Rs 18750 (75000 ÷ 4).
The entry for this is:

Prepaid Insurance a/c Dr

To Insurance a/c
The two effects while preparing final accounts are:
One – Reduce from respective expense in P & L a/c and two – show as an asset in the balance sheet

3.5 Accrued Incomes


Just as expenses accrue, there are instances of income getting accrued at the end of accounting
period. The extent to which it accrues, it must be booked as income for the current accounting
period. Consider, the business has put a One year fixed deposit of Rs 100000 with Citi Bank at
a fixed interest of 9 % p.a. on 1st February 2006 and the interest is credited by the bank on a
semi-annual basis. Also, consider that the accounting period ends on 31st March 2006. The Citi
bank will credit the 1st semi-annual interest on 31st July 2006 and the next on 31st January 2007.
Now, consider the following:

ACCOUNTING A 65
Preparatory steps for final accounts

31st Mar
2006
10 months
2 months

1st Feb 2006 31st Jan 2007


12 months

It can be noticed that interest for the 2 months will be considered as accrued as on 31st of March
2006 and must be taken as income for the current accounting year.

The entry for this is:

Accrued Interest a/c Dr


To Interest a/c

The two effects while preparing final accounts are:


One – Show as income in the P & L a/c and two – show as an asset in the balance sheet

3.6 Income received in advance


If an income is received which is not related to the current accounting period, it cannot be
included in the current year’s P & L a/c. So, if it’s already included as income it must be re-
duced. The entry for this is:

Respective Income a/c Dr


To Income received in advance a/c

The effects while preparing final account are:


One – Reduce from respective income and two – show it as liability in balance sheet

3.7 Bad and doubtful debtors


When goods are sold on credit, the money is generally received after some days. Customers
from whom money is not received till balance sheet date are called as Debtors or Receivables.
The question is what is likelihood of the recoverability of this money? The management has to
analyse all the outstanding cases and form its opinion regarding the recoverability. In case,
management feels that some money is not recoverable at all or if it has doubt over some cases,
it must factor this while making financial statements.
When it is clear that the debtors are not going to pay at all (may be the party has vanished & not

A 66 ACCOUNTING
traceable!), it is considered as ‘Bad Debt’. In case there is only a doubt about likelihood of
getting payment, it is considered as ‘Doubtful Debt’.
In case of Bad Debt, the balance due from customer has to be written off from the books. The
entry for this is:
Bad Debts a/c Dr
To Debtors a/c (in sub-ledger the specific customer a/c is credited)
The effects while preparing the final accounts are:
One – Show as expense in P & L a/c and two – reduce from debtors in the balance sheet
In case of a Doubtful Debt, no write off is done, but a provision is created to recognise the
expense. The entry for this is:
P and L account Dr
To Provision for Doubtful debts A/c
The effects while preparing the final accounts are:
One – Show as expense in P & L a/c and two – reduce from debtors in the balance sheet
It may happen that the business has made a provision for a doubtful debt last year, and during
the current year, it becomes certain that the customer is never going to pay. Then during cur-
rent year, the entry for complete write off of this debt has to be passed. The entry for this is:
Provision for doubtful debts Dr
To BAD debts a/c
The effects while preparing the final accounts are:
One –Reduce from the provision amount in the balance sheet and two – reduce from debtors.

Illustration 1
Indicate what effects for the following adjustments when preparing the final accounts for the
year ended 31st March 2006. Show journal entries as well.
1) The value of unsold goods lying as on 31-3-2006 was Rs 35000. The market price of
these goods was Rs 50000.
2) Depreciation is to be provided as 10 % on Furniture (original cost Rs 50000) and ma-
chinery at 33 % (original cost Rs 90000).
3) The expenses for the month of March 2006 not yet paid are – Telephone Rs 1500, and
travel bills Rs 12000.
4) Prepaid Insurance was Rs 12500
5) Included in sales were Rs 25000 received as advance, but the goods are not yet sup-
plied. The cost of these goods was included in closing stock.
6) Write off Rs 3000 as bad debts and make a provision of 2% on debtors of Rs 100000.
7) The salesmen were entitled to commission of 2% on total sales. During the year the
sales were Rs 525000 before considering the item number (5) above.

ACCOUNTING A 67
Preparatory steps for final accounts

Answer to Illustration 1
The journal entries and the effects in final accounts are shown in the following table:

Sl. Journal Entry Effect in final accounts


No.

1. Closing Stock a/c Dr 35000 Show in trading a/c on credit side


To trading a/c 35000 and show as asset in balance sheet.
The value should be taken as Rs
35000 & not Rs 50000.

2. Depreciation of Furniture a/c Dr 5000 Show both debits as expense in P &


Depreciation on Machinery a/c Dr 30000 L a/c and reduce from values of
To Furniture a/c 5000 respective asset in the balance sheet
To Machinery a/c 30000

3. Telephone expenses a/c Dr 1500 Telephone and travel expenses will


Travel a/c Dr 12000 be shown in P & L and outstanding
To outstanding expenses a/c 13500 expenses will be shown as liability
in balance sheet.

4. Prepaid Insurance a/c Dr 12500 Reduce from the Insurance in P & L


To Insurance a/c 12500 a/c and prepaid insurance will be
shown as asset in balance sheet.

5. Sales a/c Dr 25000 Reduce from sales in trading a/c


To sales in advance a/c 25000 and show the sales in advance as a
liability in the balance sheet.

6. Bad Debts a/c Dr 3000 Show both debits as expenses in P


Doubtful debts provision a/c Dr 1940 & L a/c and reduce from Debtors
To Debtors a/c 4940 in the balance sheet.

7. Salesmen commission a/c Dr 10000 Show as expense in the P & L a/c


To commission payable a/c 10000 and as a liability in the balance
Calculation: ( 525000-25000) * 2% sheet.

Please note that the students must practice this in order to improve understanding. Actually,
there are two ways in which these adjusting entries can be treated:
1) After making trial balance based on transactions captured, these entries are treated
outside books and adjusted directly in P & L a/c or balance sheet and then passed in
journal proper.
2) In practical life however, these entries are passed and then final trial balance is pre-
pared based on which final accounts are made.

A 68 ACCOUNTING
In examination problems, trial balance is given and adjustments are given separately. Students
are expected to pass the adjustments directly in the final accounts. See the illustrations for clear
understanding.

3.8 Opening Entries


At the end of each accounting period, the books of accounts need to be closed for preparation
of final accounts. Also, in the beginning of the new accounting period, new books of accounts
are to be opened. For this purpose, opening and closing entries need to be passed. These entries
are passed in journal proper.
The opening entries are passed only for those ledger a/c balances which are carried forward
from earlier period to the current accounting period. In other words, the balances of assets,
liabilities and owners’ capital and equity accounts are only considered for such opening en-
tries. The opening entry is passed with the closing balances of assets and liabilities & capital
accounts in the last year’s balance sheet.
The entry can be given as:
All Asset a/cs Dr
To all liabilities a/c
To Owners’ capital a/cs
Illustration 2
Consider the following balances in the balance sheet as on 31st March 2006. Pass the opening
entry on 1st April 2007.
Subodh’s Capital a/c 275000
Loan from HDFC bank 425000
Plant and machinery 330000
Cash in hand 20000
Balance at Citi bank 175000
Trade Debtors 355000
Closing stock 135000
Trade Payables 295000
Outstanding Expenses 40000
Prepaid Insurance 20000

ACCOUNTING A 69
Preparatory steps for final accounts

Answer
Plant and machinery Dr 330000
Cash in hand Dr 20000
Balance at Citi bank Dr 175000
Trade Debtors Dr 355000
Closing stock Dr 135000
Prepaid Insurance Dr 20000
To Subodh’s Capital a/c 275000
To Loan from HDFC bank 425000
To Trade Payables 295000
To Outstanding Expenses 40000

3.9 Closing Entries

The Closing Entries are passed on the basis of trial balance for transferring the balances to
Trading and profit and loss a/c. These entries are mainly for:
a) For transferring purchases and direct expenses (goods related) to trading a/c
Trading a/c Dr
To Opening stock a/c
To Purchases a/c
To factory expenses a/c
To freight & carriage inward a/c
b) For transferring sales and closing stocks
Sales a/c Dr
Closing Stock a/c Dr
To Trading a/c

A 70 ACCOUNTING
c) For transferring gross profit or gross loss to P & L a/c
For gross Profit
Trading a/c Dr
To P & L a/c
For Gross Loss
P & L a/c Dr
To Trading a/c
d) For transferring expenses
P & L a/c Dr
To Respective expense a/cs
e) For transferring Incomes
Respective income a/cs Dr
To P & L a/c
f) For transferring Net profit or Net loss
For Net Profit
P & L a/c Dr
To Capital a/c
For Net Loss
Capital a/c Dr
To P & L a/c

3.10 Rectification Entries


In the section 2.5 of the study note two, you were introduced to the reasons why errors could
occur and to the fact that while some errors affect trial balance and some errors do not affect it.
In this section, we will see in depth how the corrections are made to the wrong entries.
When the errors affecting the TB are made, the normal practice is to put the difference to an a/
c called as ‘suspense a/c’ till the time errors are located. On identification of errors, the one effect
goes to the correct a/c and the other effect to the suspense a/c. This is done for one sided errors
e.g. if sales book total is wrongly taken, but individual customers are correctly debited. Such
error will cause difference in trial balance as only sales a/c is wrongly credited. In such cases
the rectification entry will be passed through suspense a/c. In all other cases the rectification is
done by debiting or crediting the correct a/c head and by crediting or debiting the wrong a/c
head.
Let us recapitulate the types of errors and the ways to rectify them in the following table.

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Preparatory steps for final accounts

Type of error Rectification


a) Error of principle – entering A journal entry is passed to give
revenue expense as capital correct effect.
expense or vice versa or
entering revenue receipt as
capital receipt or vice versa.

b) Error of Omission – Simply, the correct entry is passed.


transaction forgotten to be
entered in books of accounts.

c) Errors of commission – Debit or credit wrong a/c head


entering to wrong head of and post it to correct head.
account.

d) Compensating errors – more Pass correcting entry


than one error that could
compensate effect of each
other.

e) Wrong totaling of subsidiary As it affects TB, pass through


books suspense a/c

f) Posting on wrong side of an Pass an entry with double effect –


a/c one to cancel wrong side and other
to give effect on correct side

g) Posting of wrong amount Pass entry with differential


amount
Let us see some illustrations on rectification of entries.
Illustration 3
A merchant, while balancing his books of accounts notices that the TB did not tally. It showed
excess credit of Rs 1700. He placed the difference to Suspense a/c. Subsequently he noticed the
following errors:
a) Goods brought from Narayan for Rs 5000 were posted to the credit of Narayan’s a/c as
Rs 5500
b) An item of Rs 750 entered in Sales returns book was posted to the debit of Pandey who
had returned the goods.

A 72 ACCOUNTING
c) Sundry items of furniture sold for Rs 26000 were entered in the sales book.
d) Discount of Rs 300 from creditors had been duly entered in creditor’s a/c but was not
posted to discount a/c.
Pass necessary journal entries to rectify these errors. Also show the Suspense a/c.
Answer:
1) Goods bought from Narayan are posted to credit of his a/c as Rs 5500 instead of Rs
5000. Here, it is correct to credit Narayan’s a/c. But the mistake is extra credit of Rs 500.
This is one sided error, as posting to purchases a/c is correctly made. So the rectifica-
tion entry will affect the suspense a/c .This needs to be reversed by the rectification
entry:
Narayan’s a/c DR 500
To Suspense a/c 500
2) Goods supplied by business to Pandey were returned back by him. It should have ap-
peared on the credit side of his a/c. For rectifying we will need to credit his a/c with
double the amount i.e. Rs 1500 (Rs 750 to cancel the wrong debit and another Rs 750 to
give effect for correct credit) and the second effect will go to suspense a/c. The correc-
tion entry is:
Suspense a/c Dr 1500
To Pandey a/c 1500
3) Sale of furniture was recorded in sales book. What’s wrong here? Remember that sales
book records sale of goods only and nothing else. Sale of furniture will appear in either
cash book (if sold for cash) or journal proper (if sold on credit). Hence, wrong credit to
sales a/c must be removed and credit should be given to Furniture a/c. It’s important
to note that this rectification entry will not affect the suspense a/c. The correction entry
is:
Sales a/c Dr 26000
To Furniture a/c 26000
4) The discount received from creditor is not entered in discount a/c but was correctly
recorded in creditors’ a/c. This is one sided error and will therefore be routed through
suspense for correction. A discount is received; it must be credited being an income.
Suspense a/c Dr 300
To Discount received a/c 300
Let us now see how suspense a/c will look like. Excess credit of Rs 1700 in Trial Balance will be
shown on the debit side of suspense a/c. This will bring in total debit equal to total credit.

ACCOUNTING A 73
Preparatory steps for final accounts

Let us see some illustrations on rectification of entries.

Dr Suspense a/c Cr
J. Amount J. Amount
Date Particulars F. Rs Date Particulars F. Rs
To balance b/d 1700 By Narayan 500
To discount
received 300 By Pandey 1500

2000 2000
Please observe that after correcting passing all rectification entries, the suspense a/c tallies
automatically.
Illustration 4
Pass necessary journal entries to rectify the following errors:
a) An amount of Rs 200 withdrawn by owner for personal use was debited to trade ex-
penses.
b) Purchase of goods of Rs 300 from Nathan was wrongly entered in sales book.
c) A credit sale of Rs 100 to Santhanam was wrongly passed through purchase book.
d) Rs. 150 received from Malhotra was credited to Mehrotra.
e) Rs 375 paid as salary to cashier Dhawan was debited to his personal a/c.
f) A bill of Rs 2750 for extension of building was debited to building repairs a/c
g) Goods of Rs 500 returned by Akashdeep were taken into stock, but returns were not
posted.
h) Old furniture sold for Rs 200 to Sethi was recorded in sales book.
i) The period end total of sales book was under cast by Rs 100
j) Amount of Rs 80 received as interest was credited to commission.

A 74 ACCOUNTING
Sr Rs Rs
no Particulars Debit Credit

a) Wrong Entry Trade Expenses Dr 200


To Cash 200
Correct entry Drawings Dr 200
To cash 200
Rectification
entry Drawings Dr 200
To Trade expenses 200

b) Wrong Entry Nathan Dr 300


To Sales 300
Correct entry Purchases Dr 300
To Nathan 300
Rectification
entry Purchases Dr 300
Sales Dr 300
To Nathan 600

c) Wrong Entry Purchases Dr 100


To Santhanam 100
Correct entry Santhanam Dr 100
To Sales 100
Rectification
entry Santhanam Dr 200
To Sales 100
To Purchases 100

d) Wrong Entry Cash Dr 150


To Mehrotra 150
Correct entry Cash Dr 150
To Malhotra 150
Rectification
entry Mehrotra Dr 150
To Malhotra 150

e) Wrong Entry Dhawan Dr 375


To cash 375
Correct entry Salary Dr 375
To cash 375
Rectification
entry Salary Dr 375
To Dhawan 375

ACCOUNTING A 75
Preparatory steps for final accounts

f) Wrong Entry Building Repairs Dr 2750


To Cash 2750
Correct entry Buildings Dr 2750
To Cash 2750
Rectification
entry Buildings Dr 2750
ToBuilding Repairs 2750

g) Wrong Entry No entry passed

Correct entry Sales Returns Dr 500


To Akashdeep 500
Rectification
entry Sales Returns Dr 500
To Akashdeep 500

h) Wrong Entry Sethi Dr 200


To Sales 200
Correct entry Sethi Dr 200
To Furniture 200
Rectification
entry Sales Dr 200
To Furniture 200

i) Wrong Entry No entry passed

Correct entry Suspense Dr 100


To Sales 100
Rectification
entry Suspense Dr 100
To Sales 100

j) Wrong Entry Cash Dr 80


To commission 80
Correct entry Cash Dr 80
To Interest 80
Rectification
entry Commission Dr 80
To Interest 80

A 76 ACCOUNTING
3.10.1 Effect of errors on Profit or loss
Some errors may affect the profit or loss for the period while other won’t. How to find it out?
Remember, the P & L a/c reflects items of incomes, gains, expenses and losses. All these ac-
counts are nominal accounts. When an error occurs which affects a nominal account, it will
affect profit or loss otherwise not. So, errors that affect real and personal accounts will not
affect profit or loss.

3.10.2 Correction of errors in subsequent accounting period:


At times when the errors are not located, the difference in the TB is transferred to suspense a/
c and the books are closed. If errors are located in subsequent accounting period, corrections
should be done in such way that the subsequent year’s profit is not affected. Therefore a sepa-
rate a/c by the name of P & l Adjustment a/c is opened and all errors which affect profit or loss
are adjusted through this a/c. The balance in the profit and loss a/c is transferred to the owner’s
capital a/c.
Illustration 5
The books of M/s Shakti trading for the year ended 31st march 2006 were closed with a
difference that was posted to suspense a/c. The following errors were found subsequently:
a) Goods of Rs 12500 returned to Thick & Fast Corporation were recorded in Return In-
ward book as Rs 21500 and from there it was posted to the debit of Thick & fast Corpo-
ration.
b) A credit sale of Rs 7600 was wrongly posted as Rs 6700 to customer’s a/c in sales ledger.
c) Closing stock was overstated by Rs 5000 being totaling error in the schedule of inven-
tory.
d) Rs 8900 paid to Bala was posted to the debit of Sethu as Rs 9800
e) Goods purchased from Evan traders for Rs 3250 was entered in sales book as Rs 3520
f) Rs 1500, being the total of discount column on the payment side of the cash book was
not posted.
Rectify the errors and pass necessary entries giving effects to suspense a/c and P & L
adjustment a/c.
Answer
a) There are 2 errors: one – return outward is wrongly recorded as return inward and two
– amount is also recorded wrongly. First, we need to remove extra debit to Thick & Fast
corporation i.e. Rs 9000 (21500-12500) by crediting it. Also we need to remove wrong
credit of Rs 21500 in sales return by debiting it and credit Rs 12500 to Purchase returns
a/c.
The rectification entry will be:
Suspense a/c Dr 21500
To Thick & Fast Corp 9000
To P & L Adjustment a/c 12500

ACCOUNTING A 77
Preparatory steps for final accounts

b) In this case, error has occurred only in customer’s a/c. hence, profit or loss won’t be
affected and the P & L Adjustment a/c will not be in picture. As customer’s a/c is
debited for Rs 6700 instead of Rs 7600, it needs to be corrected.
The rectification entry will be:
Sundry Debtors a/c Dr 900
To Suspense a/c 900
c) Over casting of closing stock had affected profit which must be reduced through P & L
Adjustment a/c. The rectification entry is:
P & L adjustment a/c Dr 5000
To Suspense a/c 5000
d) As only personal accounts are affected, there won’t be an effect on Profits. So rectifica-
tion will be done through suspense a/c only. The rectification entry is:
Bala a/c Dr 8900
Suspense a/c Dr 900
To Sethu a/c 9800
e) This transaction involves correction of purchase as well as sales, and hence will affect
profit. As the purchases were booked as sales, we will need to cancel sales by debiting
and freshly debit purchase. So overall effect on profit will be 3250 + 3520 i.e. 6770. The
rectification enry will be:
P & L Adjustment a/c Dr 6770
To Evan Traders 6770
f) If discount is appearing on payment side of cash book, it indicates discount received
while making payment and is an item of income. Hence, it will affect profit. The ac-
counting entry will be:
Suspense a/c Dr 1500
To P & L Adjustment a/c 1500

Illustration 6
The trial balance of M/s G & Co did not match as on 31st March 2006.The balance was trans-
ferred to suspense a/c and carried forward the same to the next accounting period. The follow-
ing errors were detected in the next year:
Answer:

a) Vehicle purchase should not have gone through purchase book. Purchases were overstated
thereby reducing profit, which needs to be corrected. Vehicle a/c should be debited.

Vehicle a/c Dr 250000


To P & L Adjustment a/c 250000

A 78 ACCOUNTING
b) The error has occurred in personal a/c only. It will not affect the profit.

Customer’s a/c Dr 17600


To Suspense a/c 17600

c) Discount allowed is expense. Non-recording of the same would affect profit.

P & L Adjustment a/c Dr 500


To Suspense a/c 500

d) As error has occurred in purchase a/c, it will affect profit. The personal a/c of supplier also
needs to be corrected.

P & L Adjustment a/c Dr 10000


Suspense a/c Dr 8800
To Supplier’s a/c 18800

e) As error occurred in sales, it would affect Profit.

P & L adjustment a/c Dr 10000


To Suspense a/c 10000

Dr Suspense a/c Cr
J. Amount J. Amount
Date Particulars F. Rs Date Particulars F. Rs
To balance b/d
(Balancing
figure) 19300 By Customer 17600
To supplier 8800 By P & L Adj 500
By P & L Adj 10000
28100 28100

Dr P & L Adjustment a/c Cr


J. Amount J. Amount
Date Particulars F. Rs Date Particulars F. Rs
To suspense 500 By Vehicle 250000
To supplier 10000
To suspense 10000
To Owner's
capital 229500

250000 250000
In suspense a/c, please note the carried forward balance as the balancing figure. This was not
given in the problem. It is a derived figure.

ACCOUNTING A 79
Preparatory steps for final accounts

3.11 Depreciation Methods


In section 3.2 we discussed briefly the concept of depreciation and accounting entry thereof.
Depreciation is defined as diminution in the value of asset due to use, wear and tear and pas-
sage of time. This diminution is the asset value must be charged to the profits earned over the
useful life of the asset. This is a non-cash expense. Consider a machine acquired for Rs 200000
on 1st April 2005. The useful life of the machine is taken as 5 years. See the following:
Years 0 1 2 3 4 5

Charge to profit 40000 40000 40000 40000 40000


Value of asset 200000 160000 120000 80000 40000 Nil
In its simplest form depreciation charge will be done on equal basis over the useful life of the
asset. In above example, see the charge to P & L and the value of asset as will be shown in the
balance sheet.
Is it always correct to charge depreciation on an equal basis? Is it possible that the asset is used
in the same way and extent every year? In practice, the method of charging depreciation will
depend on the nature of asset, technological obsolescence, nature of business, number of shifts
the asset is used etc. There are dimensions of time, use, time & use, time & maintenance, time
& interest. In India, generally the stipulations of the Companies’ Act are followed for provid-
ing depreciation.
Let us discuss some of the methods of depreciation generally followed:
3.11.1 Straight line method
This method goes with the time dimension. It assumes the charge should be related to time. As
such, the value of asset is reduced by periodic charges over its useful life. The formula applied
is:

Original cost of asset – estimated salvage value


Estimated useful life

For example, if value of asset is Rs 100000, estimated salvage value is Rs 10000 and estimated
useful life is 5 years, the depreciation charge for every year will be
(100000 – 10000)/5 i.e. Rs 18000.
This would mean that depreciation will be charged @ 18% every year on the original cost.
When the asset has an estimated salvage value at the end of its life, the depreciation over its life
will reduce the value of the asset to the level of its salvage value.
Here the schedule of depreciation and the asset value at the end of each year will be
Year Opening Asset Depreciation Closing Asset
Balance @18% balance
1 100000 18000 82000
2 82000 18000 64000
3 64000 18000 46000
4 46000 18000 28000
5 28000 18000 10000

A 80 ACCOUNTING
This simple method is used in case of assets that have definite life like patents, leasehold
assets. However, it does not take into account other dimensions discussed above.

3.11.2 Reducing Balance or Written Down value method


In this method, the periodic charge is calculated on the reduced value of the asset. Here, the
rate of depreciation is applied to the reduced value of the asset every year. The calculation is:
This simple method is used in case of assets that have definite life like patents, leasehold
assets. However, it does not take into account other dimensions discussed above.
n R
D = 1- C

Where D is depreciation %, R = Residual value or salvage value, C is cost of asset and n is life
of asset in years. In above example, D = 100000, R is 10000 and n is 5. Hence,
5 10000
D = 1- 100000
= 1 – 0.630957 = 0.369043 i.e. 36.90%

This % is applied on balance asset value as reduced year by year. The schedule of depreciation
is given below:

Opening Depreciation Closing


Year balance @ 36.9% balance

1 100,000 36,904 63,096

2 63,096 23,285 39,811

3 39,811 14,692 25,119

4 25,119 9,270 15,849

5 15,849 5,849 10,000

It can be observed that the depreciation amount is higher in the initial years and goes on reduc-
ing as time progresses. We know maintenance costs are lower when the machine is new and it
increases with usage of asset. This is exactly what this method recognises. This method is stipu-
lated for taxation purposes.

3.11.3 Production unit method

This method recognises the fact that certain machines have their useful life mentioned in terms
of number of units produced by the machine over its useful life. This method cannot be used
for assets that are non-production assets e.g. building, vehicles, office equipments etc.

The depreciation rate is expressed in terms of ‘Rs per unit produced’ and is computed as:

ACCOUNTING A 81
Preparatory steps for final accounts

C-R
D= N

In above example we have C = 100000, R = 10000. Assume the machine can produce 45000 units
over its estimated life.

The depreciation will be (100000-10000)/45000 i.e. Rs 2 per unit

This method ignores time factor totally. The amount of depreciation charged will vary with the
production volumes and will not be spread evenly over its life. Further, if machine is capable of
producing non-standard units, it’s difficult to adopt this method.

3.11.4 Production hour method

Here all considerations in the production unit method apply except for the fact that the pro-
duction hours are taken in place of production units. If in above example, the machine can
work for 30000 hours over its life, the depreciation amount will be (100000-10000)/30000 i.e. Rs
3 per hour. The limitations of this method are more or less same as the unit method. However,
in this case it can be applied even if machine produces different types of products.

There are other methods as well like annuity method, revaluation method, and sum of digits methods.
However, these are very rarely used and hence not discussed at this level.

Students must be aware that the rates of depreciation for company form of organization are
given in the Companies Act 1956 under schedule XIV. It says that the straight line or written
down method could be used. Whichever method is selected must be applied consistently. Un-
less there is a valid reason, the method should not be changed. If in case of computer systems,
the technology changes, the rate of depreciation may be tuned to reflect that fact. The financial
statements should disclose this fact and also disclose the effect of such change on the profitabil-
ity of the period.

Illustration 7

A company purchased furniture of Rs 40000 on 1st April 2003. It charges depreciation @ 10% on
reducing balance method every year. On 1st July 2005, a part of furniture was sold for Rs 4000,
the original cost of which was Rs 8000 purchased on 1st April ‘03. The accounting years of the
company ends on 31st march every year. Show Furniture a/c from 1st April 2003 to 31st March
2006. Also, calculate profit or loss on sale of furniture.

A 82 ACCOUNTING
Answer:
In books of company
Dr. Furniture a/c Cr.

Amount
Date Particulars Rs Date Particulars Amount Rs
By
1-Apr-03 To Bank 40000 31-Mar-04 Depreciation 4000
By Balance
31-Mar-04 c/d 36000
40000 40000
To Balance By
1-Apr-04 b/d 36000 31-Mar-05 Depreciation 3600
By Balance
31-Mar-05 c/d 32400
36000 36000
To Balance
1-Apr-05 b/d 32400 1-Jul-05 By bank 4000
By
Depreciation
on sold
1-Jul-05 machine 162
P & L (loss
1-Jul-05 on sale) 2318
By
31-Mar-06 depreciation 2592
By Balance
31-Mar-06 c/d 23328
32400 32400
1-Apr-06 23328

Notes :

Calculation of Profit or loss on sale of furniture

ACCOUNTING A 83
Preparatory steps for final accounts

Original cost on 1st April 03 8000


Less: depreciation 10% for 2003-04 on 8000 -800
W. D. V. as on 31-3-2004 7200
Less: depreciation 10% for 2004-05 on 7200 -720
W. D. V. as on 31-3-2005 6480
depreciation 10% till 30-06-2005 on 6480 for 3 months
Less: -162
W. D. V. as on 1-7-2005 6318
Sale price 4000
Loss on sale 2318

Depreciation on 31-03-2005 for remaining furniture

Original cost of the balance furniture 32000


Less: Depreciation @ 10% for 2003-04 on 32000 -3200
W. D. V. as on 31-3-2004 28800
Less: depreciation 10% for 2004-05 on 28800 -2880
W. D. V. as on 31-3-2005 25920
Less: depreciation 10% for 2005-06 on 25920 -2592
W. D. V. as on 31-3-2006 23328

Illustration 8

A fabrication shop has been charging depreciation @ 10% on reducing balance method on
opening balance of the asset for the years 1998 to 2001. The balance in the Machinery a/c
showed a balance of Rs 54000. Machines worth 16800 were added in Sept 1998 and worth Rs
11400 were added in December 2000. The management decided to charge depreciation @ 20%
on the same method but calculated on closing balance of each year with retrospective effect
from 1998.
Prepare machinery a/c for the years 1998 to 2001. Also show the effect on the profit due to
change in the method of calculation.
Answer:

In this case, the depreciation is calculated on reducing balance. The summary of changes made
by management is:

Rate of Depreciation Calculated on


Old method 10% on reducing balance Opening balance of the year
New method 20% on reducing balance Closing balance of the year

Please note here, the balance as on 1st Jan 1998 is not given. It will have to be calculated by
working back as shown in following table. The balance on 31-12-01 is given as Rs 54000 which
is closing, but as depreciation is calculated on the opening @ 10%, it will be 1/9th on closing
balance.

A 84 ACCOUNTING
Depreciation as per current practice of 10% on Opening balance

Dep @ 10%
Date Purchase Clo Balance on op bal Op balance

31-Dec-01 54,000 6,000 60,000

31-Dec-00 Total 60,000

31-Dec-00 New 11,400

31-Dec-00 Old 48,600 5,400 54,000

31-Dec-99 54,000 6,000 60,000

31-Dec-98 Total 60,000

30-Sep-98 New 16,800

31-Dec-98 Old 43,200 4,800 48,000


Total Depreciation till
2001 22,200

Now that we have arrived at the balance as on 1st Jan 1998, it will be easy for us to prepare a
schedule of depreciation as per the new method. The retrospective effect is shown below.

Depreciation as per new method of 20% on Closing balance


Dep @ 20%
Date Purchase Op Balance on cl bal Cl balance
31-Dec-98 Old 48,000
30-Sep-98 New 16,800
31-Dec-98 Total 64,800 12,960 51,840
31-Dec-99 51,840 10,368 41,472
31-Dec-00 Old 41,472
31-Dec-00 New 11,400
31-Dec-00 Total 52,872 10,574 42,298
31-Dec-01 42,298 8,460 33,838

Total Depreciation till 2001 42,362


Extra cumulative charge due to change in
method 20,162

ACCOUNTING A 85
Preparatory steps for final accounts

The machinery a/c will be prepared as per the old method only till 2001 as this was the actual
method in vogue. But at the end of 2001, an adjustment will to be passed for the extra deprecia-
tion due to change in method. This is shown below.
In books of company
Dr. Machinery a/c Cr

Date Particulars Amount Rs Date Particulars Amount Rs


1-Jan-98 To balance b/d 48000 31-Dec-98 By depreciation 4800
30-Sep-98 To Bank 16800 31-Dec-98 By balance c/d 60000
64800 64800
1-Jan-99 To balance b/d 60000 31-Dec-99 By depreciation 6000
31-Dec-99 By balance c/d 54000
60000 60000
1-Jan-00 To balance b/d 54000 31-Dec-00 By depreciation 5400
31-Dec-00 To Bank 11400 31-Dec-00 By balance c/d 60000
65400 65400
1-Jan-01 To balance b/d 60000 31-Dec-01 By depreciation
(old method) 6000
31-Dec-01 By depreciation
(extra as revised) 20162
31-Dec-01 By balance c/d 33838
60000 60000
1-Jan-02 To balance b/d 33838

Illustration 9
Suvin runs an engineering machine shop. He procured a second hand lathe machine on 1st
April 2000 for Rs 80000. He spent Rs 10000 for carriage & installation. He further spent Rs 10000
on overhauling it to put in proper working condition. On 1st October 2002, the old machine
was sold for Rs 45000 and on the same day he procured another new versatile machine for Rs
150000. He used to provide for depreciation @ 10 % on original cost. In 2005, it was decided that
the method should be changed to 15% on diminishing value. Show Machinery a/c in the books
of Mr. Suvin till 31st March 2005.

Answer:
Here the cost of the first machine that will be capitalized is:
Basic cost of machine 80000
Freight & Installation 10000
Overhauling 10000
Total 100000

A 86 ACCOUNTING
Please note that overhauling charges have been capitalized i.e. considered as cost of machine
and not as repairs & maintenance cost. This is because the cost incurred is to put the machine in
working condition initially. Please remember, routine expenses on repairs like servicing and
oiling will be considered as revenue expenses for a period and charged to the profit immedi-
ately on incurring. But expenses like enhancement to capacity of an asset, initial installation
and overhauling will be treated as capital expenditure and will be included in the cost of asset.
Depreciation will be calculated thereon. In this case, therefore, the depreciation will be calcu-
lated on Rs 100000.

Secondly, the change in method of depreciation is made in 2005. Still, the effect of such change
in method has to be calculated with retrospective effect even if it is not stated so in the problem.
This is as per Accounting Standard 6 issued by ICAI. The shortfall or excess resulting out of
change in method will be accounted in P & L a/c of the year of change.
The schedule of depreciation is shown below:

Depreciation as per 10% and 15% on Diminishing balance


sale Profit / Dep @ Dep @
Date Cost price loss 10% WDV 15% WDV
2000-
2001 Purchase 100,000 10,000 90,000
2001-
2002 Depreciation 9,000 81,000
2002-
2003 Sold on 1st Oct 2002 45,000
Depreciation till 30-
09-02 (31,950) 4,050 76,950
2002- new purchased 1st
2003 Oct 150,000 7,500 142,500 11,250 138,750
2003-
2004 Depreciation 14,250 128,250 20813 117937

21,750 32063
Extra depreciation to
be charged in 04-05 10313
2004-
2005 Depreciation 17691

Total depreciation 28004 100246

ACCOUNTING A 87
Preparatory steps for final accounts

In books of Mr. Suvin


Dr. Machinery A/c Cr.
Amount
Date Particulars Rs Date Particulars Amount Rs
1-Apr-00 To Bank 100000 31-Mar-01 By depreciation 10000
31-Mar-01 By balance c/d 90000
100000 100000
1-Apr-01 To Balance b/d 90000 31-Mar-02 By depreciation 9000
31-Mar-02 By balance c/d 81000
90000 90000
1-Apr-02 To Balance b/d 81000 30-Sep-02 By depreciation 4050
1-Oct-02 To Bank 150000 1-Oct-02 By Bank 45000
1-Oct-02 By P & L 31950
31-Mar-03 By depreciation 7500
31-Mar-03 By balance c/d 142500
231000 231000
1-Apr-03 To Balance b/d 142500 31-Mar-04 By depreciation 14250
31-Mar-04 By balance c/d 128250
142500 142500
1-Apr-04 To Balance b/d 128250 31-Mar-05 By depreciation* 28004
31-Mar-05 By balance c/d 100246
128250 128250
1-Apr-05 To Balance b/d 100246

* Depreciation includes the difference between change in method (10313) and depreciation
for the Year

3.12 Bank Reconciliation


We have studied the cash book which has two columns viz. cash and bank. The majority of
transactions get settled through cash or bank. For cash received or paid, the effect in the cash
box is instant. The transactions settled through the medium of bank (i.e. by way of cheque, pay
order, draft etc) take a little longer time. If customer pays by cheque, it is deposited in the bank
who will sent it for clearance and then only it will be credited by the bank into the a/c of
business entity. This may take about a week. Similarly, when a cheque is issued to supplier, he
will deposit in his bank which in turn will clear it. Because of such time lag, there would be
difference in the records.
The records here would mean Cash book (in books of business entity) and Pass book (main-
tained by the bank). The contents of bank passbook (or bank statement) are exactly the same as
that of cash book with a mirror image effect. When cheques is received the entry in books of
accounts of business is

A 88 ACCOUNTING
Bank a/c Dr
To customer a/c
For the bank, this amount is collected through the clearing system and payable to the business
entity’s a/c. The entry in their books will be
Clearing a/c Dr
To business Entity’s a/c
Hence they will show it as payable i.e. as a credit. Thus all debits in the bank column of the cash
book will correspond to the credit entries in the bank passbook and all credits in the bank
column of the cash book will correspond to the debit entries in the bank passbook. Due to the
time differences, these entries may not exactly match at a given point of time. This necessitates
that these two statements are reconciled regularly:
1) To identify differences
2) To know reasons for differences
3) To ensure the required entries are made in the books of accounts
4) To ensure that entries are made by the bank in time.
It may be noted that before the final accounts are prepared, bank reconciliation is a must. It is a
very important preparatory step. If an entity has a/c with more than one bank, all such a/cs
must be reconciled regularly i.e. weekly or monthly. In these days of internet banking where
the bank statements are available online, the reconciliation also can be an online activity. In
fact, modern accounting packages are equipped with automatic reconciliations. A bank state-
ment is entered in the computer system (or a soft copy is uploaded) and then a programme is
run which will throw up the transactions leading to the differences. It is necessary for a begin-
ner to understand the mechanism of how to prepare the bank reconciliation statement. The
first milestone on this journey is to understand the various reasons for differences between the
two records.
3.12.1 Reasons for differences between cash book and pass book
The differences are basically of two types:
a) Items appear in cash book but not appearing in passbook and
b) Items appear in passbook but not appearing the cash book
Let us understand these reasons:
A) Items not appearing in bank passbook
1) Cheques issued by business entity not debited by the bank – This may be because
they might not have been banked by the payee or it may still be under clearance. The
entry in cash book will be made immediately when the cheque is issued thereby reduc-
ing the bank balance in the books of entity’s books of a/cs. Here, bank balance as per
cash book will be less, but as per bank passbook it will be more. This is also termed as
unpresented cheques.

ACCOUNTING A 89
Preparatory steps for final accounts

2) Cheques deposited but not credited by the bank – The business entity may receive
cheques or draft which is deposited into the bank for collecting the payment. Again
entry in cash book will be instant thereby increasing the balance. Here, bank balance as
per cash book will be more that the balance as per bank passbook. This is also called as
outstanding cheques.
3) Errors – The bank may by mistake miss out entering the debit or credit which results in
the difference.
4) Standing Instructions – The entity may give standing instruction to the bank for cer-
tain regular payments like loan repayment installment, transfer of funds etc. This may
get entered in the cash book immediately, but passbook entry may be delayed.
B) Items not appearing in the cash book
1) Bank Interest, bank charges etc. - The bank will charge interest on overdraft or also
charges for services, issue of demand draft, pay orders etc. Here, being the source of
transaction, the bank will record in the passbook immediately and send the debit ad-
vice slips to the business entity. The entry in the cash book may be delayed. Similarly
the bank could credit interest on fixed deposits, which may get entered in business
books at a later date.
2) Direct deposits in bank account – Sometimes customers or others may directly deposit
an amount in the bank for goods or services rendered. The bank will enter it immedi-
ately, but entry in cash book will appear later.
3) Bills for collection – The business entity may send bills of exchange for collection. The
bank will collect the payment and credit the same in the passbook. The entry in cash
book will be made only after receipt of information from the bank.
4) Errors – The records may be missed out by the bookkeeper of the business entity.

3.12.2 Steps in preparing Bank Reconciliation statement


One has to have a systematic approach towards preparation of the reconciliation. To avoid
a lengthy reconciliation, one must ensure that the entries in the cash book are absolutely
online. One also must obtain the bank statements at regular intervals. Once this checking
is done, bank reconciliation could be done by following these steps:
a) Identify the balances and the character thereof. Remember, a debit balance in cash book
means asset where as a credit balance means a bank overdraft. In bank passbook, it’s
reverse. A debit balance in passbook means overdraft and a credit balance is a favourable
balance. This must be carefully understood.
b) Based on the above, start with the balance (or overdraft) as per one book and arrive at
the balance (or overdraft) as per the other book. The items of differences will be added
to or deducted from the balance (or overdraft) with which the reconciliation is started.
c) The end result should be the balance (or overdraft) as per the other book e. g. if you start
with balance as per cash book, then after adding or deducting items of differences, you
should arrive at the balance (or overdraft) as per the passbook.

A 90 ACCOUNTING
d) One has to make sure that all the items of differences from cash book as well as bank
book are taken into account in the reconciliation statement.
e) Whether the items of differences should be added or deducted will depend on the se-
quence you follow. This is shown in following table:
When reconciliation is started with Bal. as per O/D as Bal as OD as per
CB per CB per PB PB
Cheques deposited in bank, but not Less Add Add Less
cleared
Cheques issued, but not presented in Add Less Less Add
bank
Bank charges debited in PB only Less Add Add Less
Interest credited in PB only Add Less Less Add
Interest debited in PB only Less Add Add Less
Payments by bank debited in PB only Less Add Add Less
Direct payment by customer in PB Add Less Less Add
only
Bills discounted & dishonoured in PB Less Add Add Less
only
Cheques deposited, dishonoured in Less Add Add Less
PB only

Please note the abbreviations CB – cash book, PB – pass book, OD – overdraft


Illustration 10
The bank column of the cash book showed an overdraft of Rs 5000 on 31-03-2005, whereas as
per bank statement the overdraft is Rs 4200. The following differences were noticed between
the two records:
1) Cheques of Rs 2400 issued but not encashed by customers
2) Cheques deposited but not cleared Rs 1200
3) Collection charges debited by bank not recorded in CB Rs 100
4) Bank interest charged by the bank not recorded in CB Rs 300
5) Cheques dishonoured debited by bank not in CB Rs 400
6) Interest directly received by bank not entered in CB Rs 400
Prepare bank reconciliation statement after amending the CB.

ACCOUNTING A 91
Preparatory steps for final accounts

Answer:
Here, please note that amended CB is asked. What it actually means is to record all revenue
(expense or income) items of differences and those items that are recorded in PB only must first
be recorded in the CB and then the reconciliation statement should be prepared by taking the
revised balance as per CB. Here is the amended CB.

Dr. Cash Book (bank column only) Cr.


Particulars Amount Rs Particulars Amount Rs
To Interest
received 400 By balance b/d (OD) 5000
By collection charges 100
By bank interest 300
To Balance c/d By customer (chq
(OD) 5400 dishonoured) 400
5800 5800

Bank reconciliation statement as on 31-03-2005


Bank OD as per CB 5400
Add: Cheques deposited, but not cleared 1200
Less: cheques issued but not encashed 2400
Bank OD as per PB 4200

Illustration 11
Mr. Narayan has given extract of his HDFC Bank statement for the month of December
2006 as follows:

Details Withdrawal Deposit Balance


Balance as on 1-12-2005 12500 Cr
Deposits realized:
Cash 60000 72500 Cr
Customers’ cheques deposited in Nov 05 5000 77500 Cr
deposited in Dec 05 170000 247500 Cr
Bank charges 400 247100 Cr
Cash paid 10000 237100 Cr
Cheques honoured issued before Dec 05 68100 169000 Cr
issued in Dec 05 156000 13000 Cr

His cash book showed cash balance of Rs 3000 and bank OD of Rs 53450 as on 1st Decem-
ber 2005. His transactions during December 2005 were as follows:
a) Cash collected on sales Rs 60000 which was banked on a daily basis. Credit sales were
Rs 190000.

A 92 ACCOUNTING
b) Cheques received from customers for Rs 150000 in full settlement of the invoices of Rs
153000.
c) Credit purchases were Rs 155000
d) Cheques of Rs 132000 were issued against the November purchases of Rs 134000
e) Advances received from customers Rs 30000 & advances paid to suppliers Rs 25000
f) Amount withdrawn from bank Rs 10000 of which Rs 4000 was for personal use of Mr.
Narayan and balance was for business expenses.
g) Expenses Rs 9000 of which Rs 5000 was by cheque and the rest by cash
h) Cash paid on behalf of customer Rs 4500
i) Bank charges Rs 150 debited by bank in November were recorded in cash book in De-
cember on receipt of bank statement.
It was noticed that cheques Rs 2500 deposited and cheques Rs 5500 issued before 1st December
were not cleared by 31st December. Prepare Cash book for December 2005 with discount, cash
and bank columns. Also prepare bank reconciliation statement as on 30th November and as of
31st December 2005.

Dr. Cash Book of Mr. Narayan for the month of December 2005 Cr.
Particulars Dis HDFC Cash Particulars Dis HDFC Cash
Balance b/d 3000
balance b/d (OD) 53450
Cash deposited in bank
Cash sales 60000 (contra) 60000
Cash deposited in Cheques issued to
bank (contra) 60000 suppliers 2000 132000
Customers cheques Advances to suppliers
deposited 3000 150000 by cheque 25000
Advance cheques Cash withdrawn
from Customers 30000 (contra) 6000
Cash withdrawn
(contra) 6000 Drawings 4000
Expenses paid 5000 4000
Cash paid on behalf of
Customer 4500
Bank charges 150
To Balance c/d (OD) Balance c/d 14400 500
3000 240000 69000 2000 240000 69000

ACCOUNTING A 93
Preparatory steps for final accounts

Please note here, the reconciliation statements are asked for 2 different dates. We must find out
items of differences between cash book and bank statement as on both dates and then should
prepare the reconciliation statements. Transactions of credit sales and credit purchases for the
month will have no relevance of posting in cash book.

HDFC Bank reconciliation as on 30th November 2005


Particulars Amount Amount
Rs. Rs.
Balance as per bank statement (credit) 12500

Add: cheques deposited but not cleared 7500


(5000+ 2500) 150 7650
Add: Bank charges not recorded in CB

Less: Cheques issued not presented 73600


( 68100 + 5500)

Balance as per Cash Book (Overdraft) 53450

Particulars Amount Amount


Rs Rs
Balance as per Cash Book 14400

Add: Cheques issued but not presented


Issued in November 5500
Issued in December (162000 – 156000) 6000 11500

Less: Cheques deposited but not cleared


Deposited in November 2500
Deposited in December ( 180000 – 170000) 10000 12500
Less: Bank charges for December not entered in 400
CB

13000
Balance as per pass Book

A 94 ACCOUNTING
Illustration 12

The following is a summary from cash book of M/s Adarsh Trading for the month of Sept 2006

Balance b/d 1407 Payments 15520


Receipts 15073 Balance c/d 960
16480 16480

On investigation it was found that


1) Bank charges of Rs 35 were not entered in the cash book
2) A cheques of Rs 47 issued to supplier was entered by mistake as a receipt in the cash
book.
3) A cheques of Rs 18 was returned by the bank marked as ‘refer to drawer’ but it’s not
entered in cash book
4) The balance brought forward in Sept 2005 should have been 1470
5) Cheques paid to suppliers Rs 214, Rs 370 and Rs 30 have not been presented for pay-
ment.
6) Deposits of Rs 1542 on 30th Sept were cleared by the bank on 2nd October.
7) The bank charged a cheque wrongly to Adarsh trading Rs 72
8) Bank statement shows overdraft as on 30th Sept 2006.
Show what adjustments will you make in the cash book and prepare a bank reconciliation
statement as on 30-09-2006.

Answer:
As we know, the errors in the cash book must first be corrected and entries that have been
missed out in the CB should be recorded.

Cash Book for Sept 2006

Original balance b/d 960 Bank charges not recorded earlier 35


Error in balance carried 63 Cheques issued recorded as receipt 94
Now corrected (2*47)
Cheque returned 18
Revised balance c/d 876

ACCOUNTING A 95
Preparatory steps for final accounts

Now we can prepare the bank reconciliation statement.


Particulars Amount Amount
Rs Rs
Balance as per Cash Book 876

Less: Deposits not cleared 1542


Less: Cheques charged by mistake 72 1614

Add: Cheques issued but not presented 614


(214 + 370 + 30)

Overdraft as per pass book 124


Illustration 13
From the following particulars of M/s Suresh enterprises, prepare a bank reconciliation
statement:
1) Bank overdraft as per pass book as on 31st March 2006 was Rs 8800
2) Cheques deposited in bank for Rs 5800 but only Rs 2000 were cleared till 31st March
3) Cheques issued were Rs. 2500, Rs 3800 and Rs 2000 during the month. The cheque of Rs
5800 is still with supplier.
4) Dividend collected by bank Rs 1250 was wrongly entered as Rs 1520 in cash book.
5) Amount transferred from fixed deposit a/c into the current a/c Rs 2000 appeared only
in pass book
6) Interest on overdraft Rs 930 was debited by bank in pass book and the information was
received only on 3rd April 2006.
7) Direct deposit by M/s Rajesh Traders Rs 400 not entered in cash book.
8) Corporation tax Rs 1200 paid by bank as per standing instruction appears in PB only.
Answer:
Particulars Amount Amount
Rs. Rs.
Overdraft as per Pass Book 8800

Add: Cheques issued but not presented till 31st March 5800
Add: Transfer from fixed deposit 2000
Add: Direct deposit by Rajesh traders 400 8200

Less: Cheques deposited but not cleared 3800


Less: Dividend collected excess recorded in CB 270
Less: Interest on overdraft debited in PB only 930
Less: Corporation tax paid appeared in PB only 1200 6200

Overdraft as per Cash Book 10800

A 96 ACCOUNTING
Illustration 14
Following are the extracts of cash book and pass book of Mr. Sunil. Prepare a bank reconcilia-
tion statement.

Dr. Cash Book (bank column only) Cr.


Amount
Date Particulars Rs Date Particulars Amount Rs
1-Jan-06 To Balance b/d 1080 2-Jan-06 By wages 850
2-Jan-06 To interest 52 6-Jan-06 By investments 1000
5-Jan-06 To Kamdar 900 8-Jan-06 By purchases 306
8-Jan-06 To sales 609 9-Jan-06 Be self 160
10-Jan-06 To rent 56 10-Jan-06 By Bapat 210
12-Jan-06 To Ganpat 1252 10-Jan-06 By drawings 80
13-Jan-06 To Ram 888 14-Jan-06 By Fakir 1822
15-Jan-06 By Mustafa 810
To Balance c/d
15-Jan-06 (OD) 401
5238 5238

Dr. Pass Book Cr.


Amount
Date Particulars Rs Date Particulars Amount Rs
2-Jan-06 To wages 850 1-Jan-06 By balance b/d 1132
6-Jan-06 To investments 1000 6-Jan-06 By kamdar 900
7-Jan-06 To purchases 306 8-Jan-06 By sales 609
9-Jan-06 To self 160 10-Jan-06 By rent 56
10-Jan-06 To self 80 10-Jan-06 By Jamdar 200
13-Jan-06 To Bills payable 100

15-Jan-06 To balance c/d 401


2897 2897

Answer:

The reconciliation period is 1st Jan to 15th Jan 2006. From comparison of both the extracts it can
be found that:

a) Cheques issued to Bapat, Fakir and Mustafa are not encashed till 15th Jan 06 and will
appear in reconciliation.
b) Direct deposit by Jamdar is not appearing in cash book is also a reconciliation item
c) Interest received of Rs 52 is appearing in Cash book only. This has to be dealt with
carefully. Interest is normally credited by bank first and then on the basis of credit
advice an entry is made in cash book. Hence, it’s probable that the interest must have

ACCOUNTING A 97
Preparatory steps for final accounts

been credited by bank before 1st Jan and it would have appeared in the reconciliation
statement of December. This item is thus not considered.
d) Cheques received from Ganpat and Ram not cleared till 15th Jan and hence will appear
in the reconciliation statement.
e) Bills payable cleared by bank not recorded in cash book will appear as item of reconcili-
ation.

Particulars Amount Amount


Rs. Rs.
Overdraft as per Cash Book 401

Less: Cheques issued not presented till 15th Jan


(210+1822+810) 2842
Less: Direct deposit by Jamdar 200 3042

Add: Cheques deposited but not cleared (1252+888) 2140


Add: Bills payable not recorded in CB 100 2240

Overdraft as per Pass Book 401

Please note that even if the final balances as per cash book and pass book given in this problem
are matching, it’s not necessary that all items of transactions are matching. There could be
compensating items due to which reconciliation becomes necessary. It is absolutely essential
that all items in both books are offset against each other.

A 98 ACCOUNTING
3.13 Conclusion
Now that you have learnt the entire accounting process, you have reached a stage where you
can prepare the financial statements viz. Profit and Loss a/c and Balance sheet. These financial
statements portray the financial position of the business. It must be ensured that the account-
ing principles are strictly adhered to. This will ensure that the financial statements exhibit a
true and fair view of the affairs of the business. Remember, there are quite a few stakeholders
having different stakes in business. Each stakeholder uses these financial statements and check
whether their interests are protected. Also, they want to know whether the business is growing
and profitable or not.
The process can be summarised in pictorial form as under:

Jou rnal &


Source
subsid iary books
docum ents L e d g e rs

C losing en tries &


Final A d justm ents Trial
A ccounts - P Balance
& L and B.S.

ACCOUNTING A 99

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