ACCOUNTING

Accountancy is the process of communicating financial information about a business entity to users such
as shareholders and managers. The communication is generally in the form of financial statements that
show in money terms the economic resources under the control of management; the art lies in selecting
the information that is relevant to the user and is reliable. The principles of accountancy are applied to
business entities in three divisions of practical art, named accounting, bookkeeping, and auditing.

Meaning of Financial Accounting

Financial accountancy (or financial accounting) is the field of accountancy concerned with the
preparation of financial statements for decision makers, such as stockholders, suppliers, banks,
employees, government agencies, owners and other stakeholders.

The American Accounting Association defines Accounting as the process of identifying, measuring and
communicating economic information to permit informed judgments and decision by users of the
information. This definition stresses three aspects viz., identifying, measuring and communicating
economic information.

In the words of the Committee on Terminology appointed by the American Institute of Certified
Public Accountants:

Accounting is the art of recording, classifying and summarising in a significant manner and in terms
of money, transactions and events which are, in part at least, of a financial character and interpreting
the results thereof.

Financial accountancy is used to prepare accountancy data for people outside the organisation or for
those, who are not involved in the mundane administration of the company. In short, financial accounting
is the process of summarising financial data, which is taken from an organisation's accounting records and
publishing it in the form of annual or quarterly reports, for the benefit of people outside the organisation.
Financial accountancy is governed not only by local standards but also by international accounting
standard.

Definition and Explanation of Transaction:

The main function of an accountant is to record properly the financial transactions of a business concern
in the books of accounts and to ascertain its true result at the year end. Thus transaction is the foundation
of accounting - the first and formest element of accounting. In a word, it is the life and blood of
Accounting. Hence the accountant must have a fair idea about the term "transaction."

In ordinary language "transaction" means exchange of something. But in Accounting it is used in a

special sense. If the financial position of a business concern changes on the happening of an event which
is measurable in terms of money, that event is regarded as a "transaction" in Accounting.

Or
A business event which can be measured in terms of money and which must be recorded in the books of
accounts is called a "transaction".

Event:

In ordinary language "Event" means anything that happens. Human life is full of events. So many events
take place in the family and social life of a person. The events may be classified into two types:

1. Monetary Events:

Events which are related with money, i.e. which change the financial position of a person are known as
"monetary events". For example, daily shopping, marriage ceremony, birthday anniversary, marriage
anniversary etc.

2. Non-Monetary Events:

Events which are not related with money i.e. which do not change the financial position of a person are
known as "non-monetary events". For example, winning a game, delivering a lecture in a meeting etc.

In business accounting only those events which change the financial position of the business and
which call for accounting are recognized as "Events". In other words, all monetary events are
regarded as "business transactions."

1. .

OBJECTIVES OF FINANCIAL ACCOUNTING

The objectives of financial accounting can be stated as follows:

i) To keep systematic records: Accounting is done ro keep a systematic record of financial transactions,
like purchase of goods, sale of goods, cash receipts and cash payments. Systematic record of various
assets and liabilities of the business is also to be maintained.

ii) To ascertain the net effect of the business operations i.e., profit or loss of business: We know that
the primary objective of business is to make profit and the businessman is very much interested in
knowing the same. A proper record of income and expenses facilitates the preparation of the profit and
loss account (income statement). The profit and loss account reveals the profit earned or loss incurred by
the business firm during a particular period.

iii) To ascertain the financial position of the business: The businessman is not only interested in
knowing the operating result, but also interested in knowing the financial position of his business i.e.,
where it stands. In other words, he wants to know what the business owes others and what it owns, and
what happened to his capital-whether the capital has increased or decreased or remained constant. A
systematic record of various assets and liabilities helps in the preparation of a statement known as
balance sheet (position statement) which answers these questions.
iv) To provide accounting information to interested parties: Apart from the owners, there are various
other parties who are interested in knowing about the business firm, such as the management, the bank,
the creditors, the tax authorities, etc. For this purpose, the accounting system has to supply the required
information.

NATURE OF FINANCIAL ACCOUNTING

i. Science as well as Art: Financial accounting is a science because it is based on facts and is systematic
in approach. But its application in different situations requires skill and this makes it an art. Hence we can
say that it is a science as well as art.
ii. Monetary in nature: Financial accounting involves recording, classifying and summarising financial
transactions and events in terms of money, and interpreting the results thereof. Hence it is basically
monetary in nature. Non- monetary transactions if any are to be converted into their estimated money
value for recording them into financial statements.
iii. Systematic in nature: Financial accounting is the art of recording and presenting financial
transactions in a systematic manner which makes the information easy to understand and meaningful
for taking informed decisions.

iv. Positive as well as normative: There are two main types of financially accounting theory that impact
the practice of accounting. Normative theory concerns how things should be done. It answers the
question “what ought to be”. For example, ideas about the meaning of economic income can influence the
way in which regulators decide that accounting systems should measure profit. In contrast, positive
accounting theory tries to explain why things are the way they are. It answers the question “what is”. For
example, why managers choose a particular accounting method over another, or choose not to invest in
advertising activities.
v. Periodic: Financial accounts are prepared on a periodic basis. Most of the companies publish their
financial statements only once a year, in their annual report though they may be preparing it on monthly
or quarterly basis.

vi. Historic in nature: Financial accounting is based on past events and historic data. It records the
transactions and events which have taken place at their historic values i.e. the value at the time of
transaction and it is not revised with time even if the transaction is of a long term nature.

vii. Governed by rules and regulations: Financial accounting is governed by the rules and regulations
prescribed by the competent authorities in the form of accounting standards and transparency norms.

SCOPE OF FINANCIAL ACCOUNTING

Scope of financial accounting can be outlined as follows:

i. Identification of Position Altering Financial Transactions and Events: Accounting is concerned

with financial transactions and events which bring about a change in the resources (or wealth) position of
the business firm. Such transactions have to be identified first, as and when they occur. It is not difficult
because there will be proof in the form of a bill or receipt (called vouchers). With the help of these bills
and receipts identification of a transaction is easy.

ii. Measurement of Financial Transactions: The financial transactions are to be measured or expressed
in terms of money, if not done already. Generally, this problem will not arise, because the statement of
proof expresses the transaction in terms of money. For example, if ten machines are purchased at the rate
of Rs. 20,000 each, then the bill is prepared for Rs. 2 lacs. But, if an event cannot be expressed in
monetary terms, it will not come under the scope of accounting.
iii. Recording of Transactions: The transactions which are identified and measured are to be recorded
in a book called journal or in one of its sub-divisions.

iv. Classification of Recorded Transactions: The recorded transactions are to be classified with a view
to group transactions of similar nature at one place. The work of classification is done in a separate book
called ledger. In the ledger, a separate account is opened for each item so that all transactions relating to it
can be brought to one place. For example, all payments of salaries are brought to salaries account.

v. Summarising the Data: The recording and classification of many transactions will result in a mass of
financial data. It is, therefore, necessary to summarise such data periodically (at least once a year), in a
significant and meaningful form. The summarisation is done in the form of profit and loss account which
reveals the profit made or loss incurred, and the balance sheet which reveals the financial position.

vi. Analysis and Interpretation: The summary results will have to be analysed and interpreted (critically
explained). The interpretation forms the basis of financial and management decisions.

vii. Communication: Financial data needs to be communicated to interested parties. Accounting

information is generally communicated in the form of a 'report'. Big organisations generally present
printed reports, called published accounts.

ROLE/ SIGNIFICANCE OF FINANCIAL ACCOUNTING

The following points bring out the role and significance of financial accounting:

i. Maintaining systematic records: It is a primary function of accounting to keep a proper and

chronological record of transactions and events, which provides a base for further processing and proof
for checking and verification purposes. It embraces writing in the original/subsidiary books of entry,
posting to ledger, preparation of trial balance and final accounts. Financial accounting generates some key
documents, which includes profit and loss account, patterning the method of business traded for a specific
period and the balance sheet that provides a statement, showing mode of trade in business for a specific
period. It records financial transactions showing both the inflows and outflows of money from
sales, wages etc.

ii. Meeting legal requirements: Accounting helps to comply with the various legal requirements. It is
mandatory for joint stock companies to prepare and present their accounts in a prescribed form. Various
returns such as income tax, sales tax are prepared with the help of the financial accounts.

iii. Managing Business Assets: Accounting provides information regarding balance of cash in hand and
at bank. the stock of goods on hand, the amount receivable from various parties, the amount invested in
various other assets, etc. Information about these matters help owner(s) and management to make use of
the assets in the best possible way. Records serve a dual purpose as evidence in the event of any dispute
regarding ownership title of any property or assets of the business. It also helps prevent unwarranted and
unjustified use. This role is of paramount importance, for it makes the best use of available resources.

iv. Facilitates Rational Managerial Decisions: Through financial accounting it is possible to identify
reasons for the profit earned or loss suffered. The identification of reasons helps in taking necessary steps
to increase profits further, or to avoid losses. Accounting information will also help in planning and
controlling the activities of the business. Accounting is the key to success for any decision making
process. Managerial decisions based on facts and figures take the organisation to heights of success. An
effective price policy, satisfied wage structure, collective bargaining decisions, competing with rivals,
advertisement and sales promotion policy etc all owe it to well set accounting structure. Accounting
provides the necessary database on which a range of alternatives can be considered to make managerial
decision-making process a rational one. Financial accounting empowers the managers and aids them in
managing more efficiently by preparing standard financial information, which includes monthly
management report tracing the costs and profits against budgets, sales and investigations of the cost.

v. Meets the information requirements: With the help of information contained in the accounting
records, financial statements viz., Profit and Loss Account and Balance Sheet can be easily prepared.
These statements enable the businessman to know the net result of the business during an accounting
period and its financial position. Various interested parties such as owners, management, lenders,
creditors, etc. get the necessary information at frequent intervals which help them in their decision-
making.

vi. Facilitates a comparative study: The financial statements prepared will enable the enterprise to
compare its present position with that of its past, and with that of similar organisations. This helps them to
draw useful conclusions and improve its performance.

viii. Corporate Governance: Financial accounting helps in building transparency and leads to good
corporate governance. It is difficult to conceal fraud, theft, etc. as there is an automatic check in the form
of periodic balancing of books of account. Further, in big organisations the record keeping work is
divided among many persons so the chances of committing fraud are minimised.

ix. Tax Management: The Government levies various taxes such as customs duty, excise duty, sales
tax, and income tax. Properly maintained accounting records will help in the settlement of tax matters
with the tax authorities.

x. Ascertaining value of business: In the event of sale of a business firm, the accounting records will
help in ascertaining the value of business.

LIMITATIONS OF FINANCIAL ACCOUNTING

One of the major limitations of financial accounting is that it does not take into account the non-monetary
facts of the business like the competition in the market, change in the value for money etc. The following
limitations of financial accounting have led to the development of cost accounting:

1. No clear idea of operating efficiency: You will agree that, at times, profits may be more or less, not
because of efficiency or inefficiency but because of inflation or trade depression. Financial accounting
will not give you a clear picture of operating efficiency when prices are rising or decreasing because of
inflation or trade depression.

2. Weakness not spotted out by collective results: Financial accounting discloses only the net result of
the collective activities of a business as a whole. It does not indicate profit or loss of each department, job,
process or contract. It does not disclose the exact cause of inefficiency i.e. it does not tell where the
weakness is because it discloses the net profit of all the activities of a business as a whole. Similarly, loss
or less profit disclosed by the profit and loss account is a signal of bad performance of the business in
whole, but the exact cause of such performance is not identified.

3. Not helpful in price fixation: In financial accounting, costs are not available as an aid in determining
prices of the products, services, production order and lines of products.

4. No classification of expenses and accounts: In financial accounting, there is no such system by which
accounts are classified so as to give relevant data regarding costs by departments, processes, products in
the manufacturing divisions, by units of product lines and sales territories, by departments, services and
functions in the administrative division. Further expenses are not attributed as to direct and indirect items.
They are not assigned to the products at each stage of production to show the controllable and
uncontrollable items of overhead costs.

5. No control on cost: It does not provide for a proper control of materials and supplies, wages, labour
and overheads.

6. No standards to assess the efficiency: In financial accounting, there is no such well developed system
of standards, which would enable you to appraise the efficiency of the organisation in using materials,
labour and overhead costs. Again, it does not provide you any such information, which would help you to
assess the performance of various persons and departments in order that costs do not exceed a reasonable
limit for a given quantum of work of the requisite quality.

7. Provides only historical information: Financial accounting is mainly historical and tells you about the
cost already incurred. As financial data is summarised at the end of the accounting period it does not
provide day-to-day cost information for making effective plans for the coming year and the period after
that.

8. Inadequate information for reports: It does not provide adequate information for reports to
outside agencies such as banks, government, insurance companies and trade associations

PROCESS OF ACCOUNTING
Process step Explanation of the steps
Identify The transaction “identified” was the purchase of a printer.
Measure The cost of the printer was “measured” as 5000.
The transaction was “recorded” in books systematically as
Record
5000.
The transaction was then moved to the
Classify
ledger and “classified” with similar transactions.
Here the ledger balance was “summarized” and converted
Summarize
into trial balance and financial statements accordingly.
Purchase manager “analyzed” the financial statements at
Analyze
year-end.
The analysis lead to the “interpretation” that the printer was
Interpret
costly and cheaper alternatives were available.
This was “communicated” to the owners as a recommendation
Communicate
for future purchases of this kind.

Debits and Credits

These are the backbone of any accounting system. Understand how debits and credits work and you'll
understand the whole system. Every accounting entry in the general ledger contains both a debit and a
credit. Further, all debits must equal all credits. If they don't, the entry is out of balance. That's not good.
Out-of-balance entries throw your balance sheet out of balance.

Therefore, the accounting system must have a mechanism to ensure that all entries balance. Indeed, most
automated accounting systems won't let you enter an out-of-balance entry-they'll just beep at you until
you fix your error.

Assets and Liabilities

Balance sheet accounts are the assets and liabilities. When we set up your chart of accounts, there will be
separate sections and numbering schemes for the assets and liabilities that make up the balance sheet.

A quick reminder: Increase assets with a debit and decrease them with a credit. Increase liabilities with a
credit and decrease them with a debit.

Identifying assets

Simply stated, assets are those things of value that your company owns. The cash in your bank account is
an asset. So is the company car you drive. Assets are the objects, rights and claims owned by and having
value for the firm.

Since your company has a right to the future collection of money, accounts receivable are an asset-
probably a major asset, at that. The machinery on your production floor is also an asset. If your firm owns
real estate or other tangible property, those are considered assets as well. If you were a bank, the loans
you make would be considered assets since they represent a right of future collection.

There may also be intangible assets owned by your company. Patents, the exclusive right to use a
trademark, and goodwill from the acquisition of another company are such intangible assets. Their value
can be somewhat hazy.

Generally, the value of intangible assets is whatever both parties agree to when the assets are created. In
the case of a patent, the value is often linked to its development costs. Goodwill is often the difference
between the purchase price of a company and the value of the assets acquired (net of accumulated
depreciation).

Identifying liabilities

Think of liabilities as the opposite of assets. These are the obligations of one company to another.
Accounts payable are liabilities, since they represent your company's future duty to pay a vendor. So is
the loan you took from your bank. If you were a bank, your customer's deposits would be a liability, since
they represent future claims against the bank.

We segregate liabilities into short-term and long-term categories on the balance sheet. This division is
nothing more than separating those liabilities scheduled for payment within the next accounting period
(usually the next twelve months) from those not to be paid until later. We often separate debt like this. It
gives readers a clearer picture of how much the company owes and when.

Income and Expenses

Further down in the chart of accounts (usually after the owners' equity section) come the income and
expense accounts. Most companies want to keep track of just where they get income and where it goes,
and these accounts tell you.

A final reminder: For income accounts, use credits to increase them and debits to decrease them. For
expense accounts, use debits to increase them and credits to decrease them.

Income accounts

If you have several lines of business, you'll probably want to establish an income account for each. In that
way, you can identify exactly where your income is coming from. Adding them together yields total
revenue.

Typical income accounts would be

• Sales revenue from product A
• Sales revenue from product B (and so on for each product you want to track)
• Interest income
• Income from sale of assets
• Consulting income

Most companies have only a few income accounts. That's really the way you want it. Too many accounts
are a burden for the accounting department and probably don't tell management what it wants to know.
Nevertheless, if there's a source of income you want to track, create an account for it in the chart of
accounts and use it.

Expense accounts

Most companies have a separate account for each type of expense they incur. Your company probably
incurs pretty much the same expenses month after month, so once they are established, the expense
accounts won't vary much from month to month. Typical expense accounts include
• Salaries and wages
• Telephone
• Electric utilities
• Repairs
• Maintenance
• Depreciation
• Amortization
• Interest
• Rent
 Capital and Revenue Items in Accounting

Meaning and Definition of Capital Expenditures

An expenditure which results in the acquisition of permanent asset which is intended lo be permanently
used in the business for the purpose of earning revenue, is known as capital expenditure. These
expenditures are 'non-recurring' by nature. Assets acquired by incurring these expenditures are utilized by
the business for a long time and thereby they earn revenue. For example, money spent on the purchase of
building, machinery, furniture etc. Take the case of machinery-machinery is permanently used for,
producing goods and profit is earned by selling those goods. This is not expenditure for one accounting
period, machinery has long life and its benefit will be enjoyed over a long period of time. By long period
of time we mean a period exceeding one accounting period.

Moreover, any expenditure which is incurred for the purpose of increasing profit earning capacity or
reducing cost of production is a capital expenditure. Sometimes the expenditure even not resulting in the
increase of profit earning capacity but acquires an asset comparatively permanent in nature will also be a
capital expenditure.

Examples:

1. Purchase of furniture, motor vehicles, electric motors, office equipment, loose tools and other
tangible assets.
2. Cost of acquiring intangible assets like goodwill, patents, copy rights, trade marks, patterns and
designs etc.
3. Addition or extension of assets.
4. Money spent on installation and erection of plant and machinery and other fixed assets.
5. Wages paid for the construction of building.
6. Structural improvements or alterations in fixed assets resulting in an increase in their useful life
or profit earning capacity.
7. Cost of issue of shares and debentures (certain expenditures are incurred by the companies when
share and debentures are issued).
8. Legal expenses on raising loans for the purchase of fixed assets.
9. Interest on loan and capital during the construction period.
10. Expenditures incurred for the development of mines and plantations etc.
11. Money spent to bring a second-hand asset into working condition.
12. Cost of replacing factory building from an old place to a new arid better site.
13. Premium given for a lease.

Meaning and Definition of Revenue Expenditure

All the expenditures which are incurred in the day to day conduct and administration of a business and the
effect-of which is completely exhausted within the current accounting year are known as "revenue
expenditures". These expenditures are recurring by nature i.e. which are incurred for meeting day today
requirements of a business and the effect of these expenditures is always short-lived i.e. the benefit
thereof is enjoyed by the business within the current accounting year. These expenditures are also known
as "expenses or expired costs." e.g. Purchase of goods, salaries paid, postages, rent, traveling expenses,
stationery purchased, wages paid on goods purchased etc.
This expenditure is incurred on items or services which are useful to the business but are used up in less
than one year and, therefore, only temporarily increase the profit-making capacity of the business.

Revenue expenditure also includes the expenditure incurred for the purchase of raw material and stores
required for manufacturing saleable goods and the expenditure incurred to maintain the- fixed assets in
proper working conditions i.e. repair of machinery, building, furniture etc.

Examples:

Following are the examples of revenue expenditure.

1. Wages paid to factory workers.

2. Oil to lubricate machines.
3. Power required to run machine or motor.
4. Expenditure incurred in the ordinary conduct and administration of business, i.e. rent, , carriage
on saleable goods, salaries, wages manufacturing expenses, commission, legal expenses,
insurance, advertisement, free samples, postage, printing charges etc.
5. Repair and maintenance expenses incurred on fixed assets.
6. Cost of saleable goods.
7. Depreciation of fixed assets used in the business.
8. Interest on borrowed money.
9. Freight, cartage, octroi duty, transportation, insurance paid on saleable goods.
10. Petrol consumed in motor vehicles.
11. Service charges to motor vehicles.
12. Bad debts.

Recognition of Capital and Revenue Expenditure

We have no hard and fast rule for distinguishing capital expenditure from revenue expenditure because,
the same item of expenditure may be treated as capital, revenue or deferred revenue depending upon the
circumstances.

For example, to a machinery dealer purchase of machinery is a revenue expenditure, while machinery
purchased for manufacturing goods is a capital expenditure. In the same way, wages are generally a
revenue expenditure, but wages paid for the installation and erection of a machinery is a capital
expenditure. However, generally the following principles are followed to make a distinction between
capital expenditure and revenue expenditure.

1. Any expenditure that benefits the business for several accounting years, is regarded as a capital
expenditure; any expenditure that benefits the business only for one accounting year is considered
a revenue expenditure.
2. Any expenditure which is not incurred repeatedly and regularly (non-recurring) is a capital
expenditure, while any expenditure which is incurred again and again (recurring) is a revenue
expenditure e.g., motor car is not bought again and again, but petrol required to drive it is to be
bought at regular intervals.
3. Expenditure incurred after buying second-hand asset to bring it into proper working order is a
capital expenditure.
 4. Expenditure incurred on the purchase and installation of a new asset is regarded as capital
expenditure.
5. Any expenditure incurred on the extension or addition to an existing asset is considered as a
capital expenditure.

Bookkeeping
Bookkeeping is the recording of financial transactions, and is part of the process
of accounting in business.[1] Transactions include purchases, sales, receipts, and payments by an individual
person or an organization/corporation. There are several standard methods of bookkeeping, including
the single-entry and double-entry bookkeeping systems. While these may be viewed as "real" bookkeeping,
any process for recording financial transactions is a bookkeeping process.
Bookkeeping is the work of a bookkeeper (or book-keeper), who records the day-to-day financial transactions
of a business. They usually write the daybooks (which contain records of sales, purchases, receipts, and
payments), and document each financial transaction, whether cash or credit, into the correct daybook—that is,
petty cash book, suppliers ledger, customer ledger, etc.—and the general ledger. Thereafter, an accountant can
create financial reports from the information recorded by the bookkeeper.
Bookkeeping refers mainly to the record-keeping aspects of financial accounting, and involves preparing
source documents for all transactions, operations, and other events of a business.

Definition and Explanation of Double Entry System:

Every business transaction causes at least two changes in the financial position of a business concern at
the same time - hence, both the changes must be recorded in the books of accounts. This concept is
explained on Analysis of Business Transaction page. Otherwise, the books of accounts will remain
incomplete and the result ascertained therefore will be inaccurate. For example, we buy machinery for Rs.
100,000. Obviously, it is a business transaction. It has brought two changes machinery increases by Rs.
100,000 and cash decreases by an equal amount. While recording this transaction in the books of
accounts, both the changes must be recorded. In accounting language these two changes are termed as "a
debit change" and "a credit change" The detail about these terms is given under the topic account. Thus
we see that for every transaction there will be two entries one debit entry and another credit entry. For
each debit there will be a corresponding credit entry of an equal amount. Conversely, for every credit
entry there will be a corresponding debit entry of an equal amount. So, the system under which both the
changes in a transaction are recorded together - one change is debited, while the other change is credited
with an equal amount - is known as double entry system.

Locus Pacioli, an Italian wrote a first book on double entry system in 1494. It is regarded as the best and
the only scientific method of accounting system universally accepted throughout the world. It has been
built on well defined rules and principles which is the foundation of modern accountancy.

The fundamental principle of double entry system lies in analyzing the two changes (parties) involved in
business transactions and properly recording of both the changes in the books of accounts. There is no
exception to this principle. If a complete picture of the transactions is to be reflected through books of
accounts, the double entry system must be duly observed. Otherwise the books of accounts will fail to
provided complete information and the very objective of accounting will be defeated.
Advantages of Double Entry System

Double entry system is acknowledged as the best method of accounting in the modern world. Following
are the main advantages of double entry system:

1. Under this method both the aspects of each and every transaction are recorded. So it is possible to
keep complete account.
2. Since both the aspects of a transaction are recorded, for each debit there must be a corresponding
credit of an equal amount. Therefore, total debits must be equal to total credits. In fact, it is
possible to verify the arithmetical accuracy of the books of accounts by ascertaining whether the
two sides become equal or not through a process known as trial balance.
3. Under this system profit and loss account can be prepared easily by taking together all the
accounts relating to income or revenue and expenses or losses and thereby the result of the
business can be ascertained.
4. A balance sheet can be prepared by taking together all the accounts relating to assets and
liabilities and thereby the financial position of the business can be assessed.
5. Under this system mistakes and deflections can be detected - this exerts a moral pressure on the
accountant and his staff.
6. Under this system necessary statistics are easily available so that the management can take
appropriate decision and run the business efficiently.
7. All the necessary details about a transaction can be obtained quickly and easily.
8. The total amount owed by debtors and the total amount owed to creditors can be ascertained
easily.

Accounting Principles:
It ensures that common practices and conventions are followed, and that the common rules and
procedures are complied with. This observance of accounting principles has helped developed a
widely understood grammar and vocabulary for recording financial statements.
For example, two accountants may choose two equally correct methods for recording a particular
transaction based on their own professional judgment and knowledge.
Accounting principles involve both accounting concepts and accounting conventions. Here are
brief explanations.

Accounting Concepts
1. Business entity concept: A business and its owner should be treated separately as far as
their financial transactions are concerned.
2. Money measurement concept: Only business transactions that can be expressed in terms of
money are recorded in accounting, though records of other types of transactions may be kept
separately.
3. Dual aspect concept: For every credit, a corresponding debit is made. The recording of a
transaction is complete only with this dual aspect.
4. Going concern concept: In accounting, a business is expected to continue for a fairly long
time and carry out its commitments and obligations. This assumes that the business will not
be forced to stop functioning and liquidate its assets at “fire-sale” prices.
5. Cost concept: The fixed assets of a business are recorded on the basis of their original cost
in the first year of accounting. Subsequently, these assets are recorded minus depreciation.
No rise or fall in market price is taken into account. The concept applies only to fixed assets.
6. Accounting year concept: Each business chooses a specific time period to complete a cycle
of the accounting process—for example, monthly, quarterly, or annually—as per a fiscal or
a calendar year.
7. Matching concept: This principle dictates that for every entry of revenue recorded in a
given accounting period, an equal expense entry has to be recorded for correctly calculating
profit or loss in a given period.
8. Realisation concept: According to this concept, profit is recognised only when it is earned.
An advance or fee paid is not considered a profit until the goods or services have been
delivered to the buyer.

Accounting Conventions
There are four main conventions in practice in accounting: conservatism; consistency; full
disclosure; and materiality.
Conservatism is the convention by which, when two values of a transaction are available, the
lower-value transaction is recorded. By this convention, profit should never be overestimated,
and there should always be a provision for losses.
Consistency prescribes the use of the same accounting principles from one period of an
accounting cycle to the next, so that the same standards are applied to calculate profit and loss.
Materiality means that all material facts should be recorded in accounting. Accountants should
record important data and leave out insignificant information.
Full disclosure entails the revelation of all information, both favorable and detrimental to a
business enterprise, and which are of material value to creditors and debtors.

Fundamental and Subsidiary Books:

Subsidiary Books are those books of original entry in which transactions of similar nature are
recorded at one place and in chronological order. In a big concern, recording of all transactions
in one Journal and posting them into various ledger accounts will be very difficult and involve a
lot of clerical work.
This is avoided by sub-dividing the journal into various subsidiary journals or books. The
subdivisions of journal into various subsidiary journals for recording transactions of similar
nature are called as ‘Subsidiary Books.’

The different subsidiary books and their purpose are shown below:
1. Purchases Day Book – for recording credit purchase of goods only. Cash purchase or assets
purchased on credit are not entered in this book.
2. Sales Day Book – for recording credit sales of goods only. Assets sold or cash sales are not
recorded in this book.
3. Purchases Returns Book – for recording the goods returned to the suppliers when purchased
on credit.
4. Sales Returns Books – for recording goods returned by the customers when sold on credit.
5. Bills Receivable Book – for recording the bills received [Bills Receivables] from customers
for credit sales.
6. Bills Payables Book – for recording the acceptances [Bills Payables] given to the suppliers for
credit purchases.
7. Cash Book – for all receipts and payments of cash.
8. Journal Proper – for recording any transaction which could not be recorded in the above-
mentioned subsidiary books. For example, assets purchased or sold on credit and opening entry
etc., are entered in this book.

Advantages of Subsidiary Books:

The following are the advantages of Subsidiary books or Special journal:

1. Saving of Clerical Labour:

Subsidiary books effect considerable saving of clerical labour in postings and narration.
Transactions of any one class such as credit purchases, credit sales, cash transactions etc., are
recorded through separate subsidiary journals and there is no need for giving narration.
For example, by recording the transactions in the Purchase Day book 50% of the labour in
postings is saved. The periodical total of this book is to be debited to the Purchases a/c. Only the
personal accounts of the suppliers are to be credited.

2. Division of Clerical Work:

As separate journals are used for recording the transactions of each particular type, the division
of clerical labour amongst several office clerks becomes possible. This makes speedy record of
day-to-day transactions practicable.

3. Minimizes Frauds:
These books make possible the introduction of internal check system under which the system of
rotation of writing up books can be adopted. This helps minimizing errors and detecting frauds.

4. Facilitates Further Reference:

As transactions of similar nature are grouped together in a separate book, the further reference to
any particular item is considerably facilitated.

Classification of Accounts
1. Personal Accounts
Accounts which are related with accounts of individuals, firms, companies are known as personal
accounts. The personal accounts may further be classified into three categories:

(i) Natural Personal Accounts: Accounts of individuals relating to natural persons such as Akhil’s
A/c, Rajesh’s A/c, Sohan’s A/c are natural personal accounts.

(ii) Artificial Personal Accounts: Accounts of companies, institutions such as Reliance Industries
Ltd; Lions Club, M/s Sham & Sons, National College account are artificial personal accounts. These
exist only in the eyes of law.

(iii) Representative Personal Accounts: The accounts which represent some person such as wage
outstanding account, prepaid insurance account, accrued interest account are considered as
representative personal accounts.

2. Real Accounts
Real accounts are the accounts related to assets/properties. These may be classified into tangible real
account and intangible real account. The accounts relating to tangible assets such as building, plant,
machinery, cash, furniture etc. are classified as tangible real accounts. Intangible real accounts are
the accounts related to intangible assets such as goodwill, trademarks, copyrights, franchisees,
Patents etc.
3. Nominal Accounts
The accounts relating to income, expenses, losses and gains are classified as nominal accounts. For
example Wages Account, Rent Account, Interest Account, Salary Account, Bad Debts Accounts.

RULES FOR DEBIT AND CREDIT Golden rules:

Type of Accounts Rules for Debit Rules for Credit

(a) Personal Account
Debit the receiver Credit the giver
(b) Real Account
Debit what comes in Credit what goes out
(c) Nominal Account
Debit all expenses and losses
Credit all incomes and gains

USERS OF ACCOUNTING INFORMATION:

Accounting information is widely used by various types of parties for several different reasons.
Few of them are:
Type of
Who uses it Main Purpose
User
For trends, budgeting and detecting performance
Business Managers Internal
bottlenecks
Owners Internal To interpret the profit and loss associated with the business
To check the financial health and keep a check on recent
Employees Internal
developments of the business
They provide risk capital, to keep a track of ROI and
Investors External
associated risk
Banks, NBFCs etc. they are mainly concerned with the
Lenders External financial stability of a business to provide loans, overdraft,
etc.
Legal purposes of tax calculations, collect state and a
Government External
country level data
To analyze financial health and accordingly provide ratings
Research Agencies External
to the business
To analyze the liquidity of a business and deciding a credit
Creditors External
limit
 Journal:
First of all, transactions are recorded in a book known as journal.
According to double entry system of bookkeeping, transactions are recorded in the books of accounts in two
stages:

• First stage - Journal

• Second stage - Ledger

The flow of accounting information from the time a transaction takes place to its recording in the ledger may be
illustrated as follows:
Business Transaction

↓
Business Document Prepared

↓
Entry Recorded in Journal

↓
Entry Posted to Ledger

The initial record of each transaction is evidenced by a business document such as invoice, cash, voucher etc.
Transactions are first recorded in journal and there after posted to two or three concerned accounts in the ledger.

Journal:
The word journal has been derived from the French word "Jour" Jour means day. So, journal means daily.
Transactions are recorded daily in journal and hence it has named so. As soon as a transaction takes place its
debit and credit aspects are analyzed and first of all recorded chronologically (in the order of their occurrence)
in a book together with its short description. This book is known as journal. Thus we see that the most important
function of journal is to show the relationship between the two accounts connected with a transaction. This
facilitates writing of ledger. Since transactions are first of all recorded in journal, so it is calledbook of original
entry or prime entry or primary entry or preliminary entry, or first entry.

Entry:
Recording a transaction in the appropriate place of the concerned book of account is called entry. Entry may be
of the following two types:

Journal Entry:
Recording a transaction in a journal is called journal entry or journalizing.

Ledger Entry:

Recording a transaction from journal to the concerned account in the ledger is called ledger entry. It is also
known as ledger posting.

Narration:
A short explanation of each transaction is written under each entry which is called narration. The subject matter
of the transaction can be ascertained through narration. Besides this, if there be any mistake in determining debit
or credit aspect of a transaction, it can be easily detected from narration. "A journal entry is not complete
without narration".

Characteristics:
Journal has the following features:

1. Journal is the first successful step of the double entry system. A transaction is recorded first of all in
the journal. So, journal is called the book of original entry.
2. A transaction is recorded on the same day it takes place. So, journal is also called a day book.
3. Transactions are recorded chronologically. So, journal is called chronological book.
4. For each transaction the names of the two concerned accounts indicating which is debited and which is
credited, are clearly written into consecutive lines. This makes ledger - posting easy. That is why
journal is called "assistant to ledger" or "subsidiary book".
5. Narration is written below each entry.
6. The amount is written in the last two columns - debit amount in debit column and credit amount in
credit column.

Advantages of Journal:
The following are the advantages of journal:

1. Each transaction is recorded as soon as it takes place. So there is no possibility of any transaction being
omitted from the books of account.
2. Since the transactions are kept recorded in journal chronologically with narration, it can be easily
ascertained when and why a transaction has taken place.
3. For each and every transaction which of the two concerned accounts will be debited and which account
credited, are clearly written in journal. So, there is no possibility of committing any mistake in writing
the ledger.
4. Since all the details of transactions are recorded in journal, it is not necessary to repeat them in ledger.
As a result ledger is kept tidy and brief.
5. Journal shows the complete story of a transaction in one entry.
6. Any mistake in ledger can be easily detected with the help of journal.

Format of Journal:
Date Particulars L.F Amount Amount
Account to be debited .............................Dr. XXX
Account to be credited XXX
(Narration)
Rules for Journalizing:
How a transaction is recorded in journal, is discussed below:

Suppose the transaction is:

Purchased furniture from M. A on 10.01.05 for $16,000.

Here furniture accounting is debited and M A account is credited.

Date Particulars L.F Amount Amount
10.01.05 Furniture A/C .............................Dr. 16,000
M. A A/C 16,000
(Being cost of furniture purchased)

The various columns of journal are explained in details below:

Date:

This column is used to write the date of the business transaction. Different date formats are used in different
countries. Different formats of date are: 15.03.1981, 03.15.1981, 15 March 1981 etc.

Particulars or Details Column:

In this column the names of the two connected accounts are written in two consecutive lines - in the first line the
name of account debited and in the second line the name of account credited. While the name of account debited
always placed close the the left hand margin line, the name of account credited is commenced a short distance
away from the margin line. This arrangement will show clearly which account is debited and which credited.
This also shows that credit amount is placed on the right side of debit amount. The world "Dr" is used at the end
of the name of account debited. It is not necessary to place the word "Cr." after the name of the credited
account, because if one account is Dr. it follows that the other account must be Cr. Below the names of the two
accounts, i.e. in the third line narration is written usually within a bracket. According to tradition, narration is
written starting with a word "being". But modern practice is not to use this word. In most of countries even in
Great Britain using the word "To" at the beginning of the name of account credited has become out-dated. So,
here it has not been used too. But it is optional for the students.

Ledger Folio (L.F):

The page numbers of the ledger where the two concerned accounts have been posted, are written in this column
against the name of each account. This will help locating easily the two concerned accounts from the ledger. On
the other hand, when a transaction is posted to ledger, the concerned folio number of the ledger is written in this
column. Thus if a folio number stands written in this column, it will mean that the transaction has already been
posted to ledger.

Amount:

The debit amount is written in the first "amount" column against the name of account debited and the credit
amount in the second "amount" column against the name of account credited.

Note: Although the above form of journal is used in examination answer book. It is not fully correct. Because in
large concerns journal is divided into eight subdivisions for the sake of convenience. Out of them only in one
subdivision (i.e. journal proper) the above form is used. In the remaining seven subdivisions the form of journal
is different.

Simple Entry and Compound Entry:

Every transaction effects two accounts - one is debited and another is account is credited. Thus in recording a
transaction in a journal one account is debited and another account is credited. This type of entry is
called simple entry.

The entry in which more than one account is debited or more than one account is credited, is known as
compound entry. Three or more accounts are connected with a compound entry.

Example of Simple Entry:

For example, on 10.04.05 we bought furniture from S. The entry is:

Date Particulars L.F Amount Amount
10.04.05 Furniture A/C .............................Dr. 10,000
S A/C 10,000
(Being furniture purchased on credit)

Example Compound Entry:

For example on 16.05.05 we paid $ 1,000 on account of salaries and $600 on account of rent. For this the entry
will be:
Date Particulars L.F Amount Amount
16.05.05 Salary A/C .............................Dr. 1,000
Rent A/C 600
Cash A/C 10,000
(Being salaries and rent)

Here tow accounts have been debited and the entry involves three accounts. Hence, it is a compound entry.

Personal Books and Business Books:

It should be noted here that no private transactions of the proprietor can be recorded in the books of business.
On the other hand, no transactions of the business can be recorded in the books of its proprietor. But the
transactions in between proprietor and business must be recorded in the books of both the proprietor and
business. If these rules are not strictly followed, the books of account will fail to disclose the true result of
business.

We are concerned with the books of business, not with the private books of proprietor. Transactions between the
business and its proprietor are recorded in the following two accounts:

1. Capital Account: The money with which proprietor starts his business is called capital. When
proprietor brings capital in the business, it is recorded in capital A/C. Capital account is in fact the
personal account of the proprietor. So, it is a personal account. The proprietor has given the benefit to
the business through introduction of capital. So proprietor's account A/C, i.e. capital account will be
credited. From the view point of bookkeeping the introduction of capital to the business by proprietor
means that the proprietor lends the money to his business and the business becomes indebted to him.
 The proprietor is regarded as a special or internal creditor to the business.

Example: Mr. R started a business with $20,000

Date Particulars L.F Amount Amount

16.05.05 Cash A/C .............................Dr. 20,000
Capital A/C 20,000
(Being capital brought in)

2. Drawings: If the proprietor draws any money or takes goods from his business for his personal use, it
will be recorded in drawings A/C. Drawings A/C is the personal account of the proprietor, so it is
classified as the personal account. Proprietor receives benefit, when he withdraws money or goods
from business. So the proprietor's account i.e. drawing is debited.

Example:

Date Particulars L.F Amount Amount

16.05.05 Drawings A/C .............................Dr. 2,000
Cash A/C 2,000
(Being amount withdrawn by proprietor)

Cash Discount:
The manufacturers and whole sellers frequently grant cash discount to their debtors who will pay their debts
before due date for goods purchased by them on credit. The seller regards it a "cash discount" or "sale discount"
or "discount allowed". The buyer calls the discount as "purchase discount" or "discount received". The use of
sales discount not only stimulate prompt collection but also tend to the possibilities of losses resulting from "bad
debts

Example of Journal:
Journalise the following transactions:
2005
Feb. 3 X commenced business with a capital of $15,000
05 Purchased good $6,000
07 Purchased goods on credit from S & Co. $3,000
10 Purchased furniture $2,400
11 Sold goods $3,900
15 Sold goods on credit to D $2,250
20 Paid salaries $960
25 Received commission $75
26 Returned goods to S & Co. $600.
27 Returned goods by D $450
28 Received from D $1,500
Paid to S & Co. $1,800
X withdrew from business $900
 Charged depreciation on $240
Borrowed from K $1,500

Solution:

Journal
Date Particular L.F Amount Amount
2005
Feb. 3 Cash A/C ......................................................Dr. 15,000
Capital 15,000
(Being capital brought in)
5 Purchases A/C...............................................Dr. 6,000
Cash A/C 6,000
(Being goods purchased for cash)
7 Purchases A/C...............................................Dr. 3,000
S & Co. A/C 3,000
(Being goods purchased form S & Co on credit)
10 Furniture A/C.................................................Dr. 2,400
Cash A/C 2,400
(Being furniture purchased for cash)
11 Cash A/C......................................................Dr. 3,900
Sales A/C 3,900
(Being goods sold for cash)
15 D Bros. A/C..................................................Dr. 2,250
Sales A/C 2,250
(Being goods sold on credit to D)
20 Salaries A/C.................................................Dr. 960
Cash A/C 960
(Being salaries paid)
25 Cash A/C......................................................Dr. 75
Commission A/C 75
(Being commission received)
26 S & Co. A/C..................................................Dr. 600
Purchases A/C Return 600
(Being goods returned to S & co.)
27 Sales Returns A/C........................................Dr. 450
D Bros. A/C 450
(Being goods returned by D Bros.)
28 Cash A/C......................................................Dr. 1,500
D Bros. A/C 1,500
(Being amount received from D Bros.)
" S & Co. A/C..................................................Dr. 1,800
Cash A/C 1,800
(Being amount paid to S & Co.)
" Drawings A/C................................................Dr. 900
Cash A/C 900
(Being amount paid to S & Co.)
" Depreciation A/C...........................................Dr. 240
 Furniture A/C 240
(Being depreciation charged on furniture)
" Cash A/C......................................................Dr. 1,500
K A/C 1,500
(Being amount borrowed from K)

Ledger
In the second process, the transactions are classified in a suitable manner and recorded in another book
known as ledger.

The journal provides a complete listing of the daily transactions of a business. But it does not provide information
about a specific account in one place. For example, to know how much cash balance we have, the accounting clerk
would have to check all the journal entries in which cash is involved, and this is very laborious job; because there
are hundreds or even thousands of cash transactions recorded on different pages of journal. To avoid this difficulty,
the debit and credit of journalized transactions are transferred to ledger accounts. Thus all the changes for a single
account are located in one place - in a ledger account. This makes it easy to determine the current balance of any
account.

Definition and Explanation of Ledger:

The book in which accounts are maintained is called ledger. Generally, one account is opened on each page of this
book, but if transactions relating to a particular account are numerous, it may extend to more than one page. All
transactions relating to that account are recorded chronologically. From journal each transaction is posted to at least
two concerned accounts - debit side of one account and credit side of another account. Remember that, if there are
two accounts involved in a journal entry, it will be posted to two accounts in the ledger and if the journal entry
consists of three accounts (compound entry) it will be posted to three different accounts in the ledger. The process of
transferring information from journal to ledger accounts is known as posting. The goal of all transactions is ledger.
Ledger is known as the destination of entries in journal but it must be remembered that transactions cannot be
recorded directly in the ledger - they must be routed through journal. This concept is illustrated below:
 Transaction

↓
Journal

↓
Ledger

So, the books in which all the transactions of a business concern are finally recorded in the concerned accounts in a
summarized form is called ledger.

Characteristics of Ledger Account:

The ledger has the following main characteristics:

1. It has two identical sides - left hand side (debit side) and right hand side (credit side).
2. Debit aspect of all the transactions are recorded on the debit side and credit aspects of all the transactions
are recorded on credit side according to date.
3. The difference of the totals of the two sides represents balance. The excess of debit side over credit side
indicates debit balance, while excess of credit side over debit side indicates the credit balance. If the two
sides are equal, there will be no balance.
4. Generally the balance is drawn at the year end and recorded on the lesser side to make the two sides equal.
This balance is know as closing balance.
5. The closing balance of the current year becomes the opening balance of the next year.

Types or Forms of Ledger Accounts:

There are two forms of ledger accounts. These are:

1. Standard form
2. Self-balancing form

Standard Form of Ledger Account:

To understand clearly as to how to write the accounts in ledger, the standard form of an account is given below with
two separate transactions:
Date Particulars J.R Amount Date Particulars J.R Amount
2005 2005
Dec. 17 Cash A/C 1,200 Dec. 17 Purchases A/C 2,000

It appears that each account in the ledger has two similar sides - left hand side is called debit side (briefly Dr.) and
right hand side (briefly Cr.) side. Now a days these two words are not used, because it is obvious that the left hand
side is debit side and right hand side is credit side.

Posting Procedure:

Transferring information i.e. entries from journal to ledger accounts is called posting. The procedure of posting from
journal to ledger is as follows:
 1. Locate the ledger account from the first debit in the journal entry.
2. Record the date in the date column on the debit side of the account. The date is the date of transaction
rather than the date of the posting.
3. Record the name of the opposite account (account credited in entry) in the particular (also know as
reference column, description column etc) column.
4. Record the page number of the journal in the journal reference (J.R) column from where the entry is being
posted.
5. Record the amount of the debit in the "amount column"
6. Locate the ledger account for the first credit in the journal and follow the same procedure.

Balancing An Account:

The difference between the two sides of an account is its balance. The balance is written on the lesser side to make
the two sides equal. The process of equalizing the two sides of an account is known as balancing.

The rules for balancing an account are stated as below:

1. Add up the amount columns of both the sides of an account and write the totals in a separate slip of paper.
2. Find out the difference of the two totals.
3. Write down the difference on the lesser side of the account.
4. Now total up both the sides and write the totals and draw double lines under them.
5. Again write the difference on the opposite side below the double line.

If the debit side of an account is heavier, its balance is known as debit balance. and if the credit side of an account is
heavier its balance is know as credit balance. If the two sides are equal, that account will show zero balance. The
rules for determining the balance is as follows:
Total debit = More than total credit = Debit balance
Total credit = More than total debit = Credit balance
Total debit = Total credit = Nil balance

It may be noted that at the time of balancing an account debit balance is placed on the credit side and credit balance
on debit site. This balance is known as closing balance. What is closing balance in this year, is the opening balance
of the next year.

Example:

Enter the following transactions in journal and post them into ledger:
2005
Jan. 1 Mr. Javed started business with cash $100,000
2 He purchased furniture for $20,000
3 He purchased goods for $60,000
5 He sold goods for cash $80,000
6 He paid salaries $10,000

Solution:

Journal
Date Particular L.F Amount Amount
2005
Jan. 1 Cash A/C .....................................................Dr. 9 100,000
Capital 11 100,000
(Being capital brought in)
2 Furniture A/C.................................................Dr. 13 20,000
Cash A/C 9 20,000
(Being furniture purchased for cash)
3 Purchases A/C...............................................Dr. 15 60,000
Cash A/C 9 60,000
(Goods purchased for cash)
5 Cash A/C......................................................Dr. 9 80,000
Sales A/C 17 80,000
(Sold goods for cash)
6 Salaries A/C..................................................Dr. 19 10,000
Cash A/C Return 9 10,000
(Salaries paid)

Ledger

Cash Account (No.9)

Date Particular J.R Amount Date Particulars J.R Amount
2005 2005
Jan.1 Capital A/C 1 100,000 Jan.2 Furniture A/C 1 20,000
Jan.5 Sales A/C 1 80,000 Jan.3 Purchases A/C 1 60,000
Jan.6 Salaries A/C 1 10,000
Balance c/d 90,000
Total 180,000 Total 180,000

Capital Account (No.11)

Date Particular J.R Amount Date Particulars J.R Amount
2005 2005
Jan.6 Balance c/d 100,000 Jan.1 Cash A/C 1 100,000
Total 100,000 Total 100,000

Furniture Account (No.13)

Date Particular J.R Amount Date Particulars J.R Amount
2005 2005
Jan.2 Cash A/C 1 20,000 Jan.6 Balance c/d 20,000
Total 20,000 Total 20,000

Purchases Account (No.15)

Date Particular J.R Amount Date Particulars J.R Amount
2005 2005
Jan.3 Cash A/C 1 60,000 Jan.6 Balance c/d 60,000
 Total 60,000 Total 60,000

Sales Account (17)

Date Particular J.R Amount Date Particulars J.R Amount
2005 2005
Jan.6 Balance c/d 80,000 Jan.5 Cash A/C 1 80,000
Total 80,000 Total 80,000

Salaries Account (19)

Date Particular J.R Amount Date Particulars J.R Amount
2005 2005
Jan.6 Cash A/C 1 10,000 Jan.6 Balance c/d 10,000
Total 10,000 Total 10,000

Self Balancing Form of Ledger Accounts:

In practice the standard form of the ledger account is not used. But it is usually used for examination purposes.

In practice, the self balancing form of ledger accounts is used. The advantage of this type of ledger account is that
the balance of the account after each transaction is available at a glance from the last column. So, much time and
labor is saved. In the following example self balancing ledger accounts have been used.

Example:

Enter the following transactions in journal and post them into the ledger and also prepare a trial balance.
2005
Jan. 1 Mr. X started business with cash $80,000 and furniture $20,000.
Jan. 2 Purchased goods on credit worth $30,000 from Y.
Jan. 3 Sold goods for cash $16,000.
Jan. 4 Sold goods on credit to S for $10,000
Jan. 8 Cash received from S $9,800 in full settlement of his account.

Solution:

Journal
Date Particulars L.F DR. Cr.
2005 Amount ($) Amount ($)
Jan. 1 Cash A/C 5 80,000
Furniture A/C 7 20,000
Capital A/C 9 1,00,000
(Owner invested cash and furniture)

Jan. 2 Purchases Account 11 30,000

Y 13 30,000
(Bought goods on credit)
Jan. 3 Cash A/C 5 16,000
Sales A/C 15 16,000
(Sold goods for cash)

Jan. 4 S A/C 17 10,000

Sales A/C 15 10,000
(Sold goods on credit)

Jan. 8 Cash A/C 5 9,800

Discount A/C 19 200
S A/C 17 10,000
(Cash received and discount allowed)

Ledger

Cash Account (No.5)

Date references J.R Debit Credit Balance
2005 Dr. Cr.
Jan. 1 Capital A/C 5 80,000 80,000
Jan. 3 Sales A/C 5 16,000 96,000
Jan. 8 S A/C 5 9,800 105,800

Furniture Account (No.7)

Date references J.R Debit Credit Balance
2005 Dr. Cr.
Jan. 1 Capital A/C 5 20,000 20,000

Capital Account (No.9)

Date references J.R Debit Credit Balance
2005 Dr. Cr.
Jan. 1 Cash A/C 5 80,000 80,000
Jan. 1 Furniture A/C 5 20,000 1,00,000

Purchases Account (No.11)

Date references J.R Debit Credit Balance
2005 Dr. Cr.
Jan. 2 Y A/C 5 30,000 30,000

Y Account (No.13)
Date references J.R Debit Credit Balance
2005 Dr. Cr.
Jan. 2 Purchases A/C 5 30,000 30,000
 Sales Account (No.15)
Date references J.R Debit Credit Balance
2005 Dr. Cr.
Jan. 3 Cash A/C 5 16,000 16,000
Jan. 4 S A/C 5 10,000 26,000

S Account (No.17)
Date references J.R Debit Credit Balance
2005 Dr. Cr.
Jan. 4 Sales A/C 5 10,000 10,000
Jan. 8 Cash A/C 5 9,800
Jan. 8 Discount A/C 5 200 Nil

Discount Account (No.19)

Date references J.R Debit Credit Balance
2005 Dr. Cr.
Jan. 8 S A/C 5 200 200

Cash book

The cash book is used to record receipts and payments of cash. It works as a book of original
entry as well as a ledger account. The entries related to receipt and payment of cash are first
recorded in the cash book and then posted to the relevant ledger accounts. Moreover, a cash book
is a substitute for cash account in the ledger. A company that properly maintains a cash book
does not need to open a cash account in its ledger.

Types of cash book

There are four major types of cash book that companies usually maintain to account for their
cash flows. These are given below:
1. A single column cash book to record only cash transactions.
2. A double/two column cash book to record cash as well as bank transactions.
3. A triple/three column cash book to record cash, bank and purchase discount and sales
discount.
4. A petty cash book to record small day to day cash expenditures.

1. The single column cash book (also known as simple cash book) is a cash book that is used
to record only cash transactions of a business. It is very identical to a traditional cash account
in which all cash receipts are recorded on left hand (debit) side and all cash payments are
recorded on right hand (credit) side in a chronological order.
 The single column cash book has only one money column on both debit and credit sides titled as
“amount” which is periodically totaled and balanced like a T-account. As stated earlier, a single
column cash book records only cash related transactions. The entries relating to checks issued,
checks received, purchases discount, and sales discount are not recorded in single column cash
book.

Format:
The specimen/format of a single column cash book is given below:

Example
The Harper Company uses a single column cash book to record all cash transactions. It engaged in
the following cash transactions during the month of September 2016.
• Sep.01: Cash in hand at start of the month $4,654.
• Sep.02: Paid salaries to employees for the last month $3,000.
• Sep.05: Cash received from S & Co. for a previous credit sale $2,720.
• Sep.06: Merchandise purchased for cash $1,400.
• Sep.07: Merchandise sold for cash $4,700.
• Sep.10: Office furniture purchased for cash $3,080.
• Sep.12: Stationary purchased for cash $170.
• Sep.15: Merchandise sold for cash $9,000.
• Sep.17: Cash paid to A & Co. for a previous credit purchase $1,780.
• Sep.20: Merchandise purchased for cash $2,460.
• Sep.21: Merchandise sold for cash $4,680.
• Sep.24: Cash received from S & Co. for a previous credit sale $2,400.
• Sep.28: Cash paid for office rent $1,600.
• Sep.30: Merchandise sold for cash $7,200

Required: Record the above transactions in a single column cash book (simple cash book) and post
entries from the cash book to the relevant ledger accounts in general and subsidiary ledgers.

Solution
Single column cash book of Harper Company:

The double column cash book (also known as two column cash book) has two money columns on
both debit and credit sides – one to record cash transactions and one to record bank transactions. In
other words, we can say that if we add a bank column to both sides of a single column cash book, it
would become a double column cash book. The cash column is used to record all cash transactions
and works as a cash account whereas bank column is used to record all receipts and payments made
by checks and works as a bank account. Both the columns are totaled and balanced like a traditional
T-account at the end of an appropriate period which is usually one month.

Since a double column cash book provides cash as well as bank balance at the end of a period, some
organizations prefer to maintain a double column cash book rather than maintaining two separate
ledger accounts for recording cash and bank transactions.

Format

The format/specimen of a double column cash book is given below:

The above format of double column cash book has six columns on both debit and credit sides. The
purpose of cash and bank columns has been explained at the start of this article and the purpose of
date, description, voucher number (VN) and posting reference (PR) columns has been explained
in single column cash book article.

Important points to remember while making entries in a double column cash book

Recording cash transactions:

1. All cash receipts are recorded in cash column on the debit side and all cash payments are
recorded in cash column on credit side of the double column cash book.
2. If cash is received from a debtor or customer and is deposited into the bank account on the
same date, the entry will be made in the bank column on the debit side, not in the cash
column.

Recording bank transactions:

1. When a check is received and the same is deposited into the bank account on the same date,
the amount of the check is entered in the bank column on the debit side.
2. When a check is received and the same is not deposited into the bank on the same date, the
amount of the check is entered in the cash column, not in the bank column.
3. When a check received from a receivable on a date subsequent to its receipt is deposited into
the bank account, the entry is made in the bank column on the debit side and in the cash
column on credit side. It is called a contra entry.
4. When a check is issued, the amount of the check is entered in the bank column on the credit
side.

The triple column cash book (also referred to as three column cash book) is the most
exhaustive form of cash book which has three money columns on both receipt (Dr) and
payment (Cr) sides to record transactions involving cash, bank and discounts. A triple
column cash book is usually maintained by large firms which make and receive payments in
cash as well as by bank and which frequently receive and allow cash discounts.
 The procedure of recording transactions in a triple/three column cash book is similar to that
of a double column cash book. The only difference between two types of cash book is that a
double column cash book has two money columns (i.e., cash and bank) whereas a triple
column cash book has three money columns (i.e., cash, bank and discount).

The cash and bank columns of triple column cash book are used as accounts and are
periodically totaled and balanced just like in case of a double column cash book. The
discount column is only totaled. It is not balanced because it does not work as an account.

In general ledger, two separate accounts are maintained for discount allowed and discount
received. The total of discount column on debit side of cash book represents the total cash
discount allowed to customers during the period and is posted to the discount allowed
account maintained in the ledger. The total of discount column on credit side represents the
total cash discount received from suppliers during the period and is posted to the discount
received account maintained in the ledger.

Discount allowed is an expense and discount received is an income of the business.

Format

The format of a triple/three column cash book is given below:

Example

The P&G LLC records its cash and bank transactions in a triple column cash book. The following
transactions were performed by the company during the month of June 2018.
• Jun 01: Cash in hand $800 (debit balance), Cash at bank $3,365 (debit balance).
• Jun 03: Paid James & Co. by check $1,175, discount received from him $25.
• Jun 05: Received from David & Co. a check amounting to $990, discount allowed to him
$10.
• Jun 07: Deposited into bank the check received from David & Co.
• Jun 10: Purchased stationary for cash, $170.
• Jun 15: Purchased merchandise for cash, $1,280.
• Jun 15: Cash sales for the first half of the month, $2,450.
• Jun 16: Deposited into bank $1,250.
• Jun 18: Withdrawn from bank for personal expenses $100.
• Jun 19: Issued a check amounting to $1,630 to James & Co. and discount received from him
$20.
• Jun 21: Drew from bank for office use, $420.
 • Jun 24: Received a check amounting to $1,435 from Henry & Co. and allowed him a
discount of $15. The Henry’s check was deposited into bank immediately.
• Jun 25: Paid a check to Jacob Inc. amounting to $385 and received a discount of $15.
• Jun 27: Bought furniture for cash for office use, $380.
• Jun 29: Paid office rent by check, $350.
• Jun 30: Cash sales for the second half of the month $4,550.
• Jun 30: Paid salaries by check $760.
• Jun 30: Withdrew from bank for office use $470.

Required:
1. Record the above transactions in a triple/three column cash book of P & G LLC and balance
the cash and bank columns of the cash book.
2. Post entries from triple/three column cash book to appropriate accounts in general ledger,
accounts receivable subsidiary ledger and accounts payable subsidiary ledger.

Solution:
1. Triple/three column cash book

1. Check received from David & Co. on June 05 has been recorded in the cash column because it was not
deposited into bank on the same date.
2. 450 is the number of discount allowed account in the general ledger. The discount allowed account is an
expense account.
3. 455 is the number of discount received account in the ledger. Discount received account is an
income/revenue account.

Besides maintaining a main or general cash book, many companies also maintain a small cash book
known as petty cash book to record small day to day expenditures of the business.

Petty cash book is a type of cash book that is used to record minor regular expenditures such as office
teas, bus fares, fuel, newspapers, cleaning, pins, and causal labor etc. These small expenditures are
usually paid using coins and currency notes rather than checks. The person responsible for spending
petty cash and recording it in a petty cash book is known as petty cashier.