Financial Accounting: Double-Entry Book Keeping, Journal, Ledger - Indian Online Seller
Accounting
Accounting is the system a company uses to measure its financial performance by noting
and classifying all the transactions like sales, purchases, assets, and liabilities in a manner that
adheres to certain accepted standard formats. It helps to evaluate a Company’s past performance,
present condition, and future prospects.
Definition
A more formal definition of accounting is the art of recording, classifying, and
summarizing 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.The Need for Accounting
Every organization needs to maintain good records to track how much money they have,
where it came from, and how they spend it. These records are maintained by using an accounting
system.
These records are essential because they can answer such important questions as:
• Am I making or losing money from my business
• How much am I worth?
• Should I put more money in my business or sell it and go into another business?
• How much is owed to me, and how much do I owe?
• How can I change the way I operate to make more profit
Even if you do not own or run a business, as an accountant you will be asked to provide
the valuable information needed to assist management in the decision making process. In addition,
these records are invaluable for filing your organization’s tax returns.
The modern method of accounting is based on the system created by an Italian monk Fra
Luca Pacioli. He developed this system over 500 years ago. This great and scientific system was
so well designed that even modern accounting principles are based on it.
In the past, many businesses maintained their records manually in books – hence the term
“bookkeeping” came about. This method of keeping manual records was cumbersome, slow, and
prone to human errors of translation.
A faster, more organized, and easier method of maintaining books is using Computerized
Accounting Programs. With the decrease in the price of computers and accounting programs, this
method of keeping books has become very popular.
What Accountants Do
We have said that accounting consists of these functions:
• Recording
• Classifying
• Summarizing
• Reporting and evaluating the financial activities of a business
Before any recording can take place, there must be something to record. In accounting,
the something consists of a transaction or event that has affected the business. Evidence of the
transaction is called a document.
For example:
• A sale is made, evidenced by a sales slip.
• A purchase is made, as evidenced by a check and other documents such as an invoice and a
purchase order.
• Wages are paid to employees with the checks and payroll records as support.
• Accountants do not record a conversation or an idea. They must first have a document.
Types of Accounting
The two methods of tracking your accounting records are:
• Cash Based Accounting
• Accrual Method of Accounting
Cash Based Accounting:
Most of us use the cash method to keep track of our personal financial activities. The
cash method recognizes revenue when payment is received, and recognizes expenses when cash is
paid out. For example, your personal checkbook record is based on the cash method. Expenses are
recorded when cash is paid out and revenue is recorded when cash or check deposits are received.
Accrual Accounting:
The accrual method of accounting requires that revenue be recognized and assigned to the
accounting period in which it is earned. Similarly, expenses must be recognized and assigned to
the accounting period in which they are incurred.
A Company tracks the summary of the accounting activity in time intervals called
Accounting periods. These periods are usually a month long. It is also common for a company to create an annual statement of records. This annual period is also called a Fiscal or an Accounting
Year.
The accrual method relies on the principle of matching revenues and expenses. This
principle says that the expenses for a period, which are the costs of doing business to earn income,
should be compared to the revenues for the period, which are the income earned as the result of
those expenses. In other words, the expenses for the period should accurately match up with the
costs of producing revenue for the period.
In general, there are two types of adjustments that need to be made at the end of the
accounting period. The first type of adjustment arises when more expense or revenue has been
recorded than was actually incurred or earned during the accounting period.
An example of this might be the pre-payment of a 2-year insurance premium, say, for
$2000. The actual insurance expense for the year would be only $1000. Therefore, an adjusting
entry at the end of the accounting period is necessary to show the correct amount of insurance
expense for that period.
Similarly, there may be revenue that was received but not actually earned during the
accounting period. For example, the business may have been paid for services that will not
actually be provided or earned until the next year. In this case, an adjusting entry at the end of the
accounting period is made to defer, that is, to postpone, the recognition of revenue to the period it
is actually earned.
Although many companies use the accrual method of accounting, some small businesses
prefer the cash basis. The accrual method generates tax obligations before the cash has been
collected. This benefits the Government because the IRS gets its tax money sooner.
Cash versus Accrual Accounting
Accounts Receivable is an asset that is owed to you but you do not have money in the
bank or property to show you own something -it is intangible, on paper. It grows or accumulates
as you issue invoices; therefore, Accounts Receivable is part of an accrual accounting system.
Double-entry accounting is the most accurate and best way to keep your financial
records. With a computer, you don’t have to fully understand all the accounting details. Basically,
in double entry accounting each transaction affects two or more categories or accounts, so
everything stays in balance. Therefore, if you change an asset balance by issuing an invoice some
other category balance changes as well. In this case, when you issue an invoice, the category that
balances the asset called Accounts Receivable is an income or a sales account.
When you bill your client, there is an increase in income (on paper) and hence an
increase in Accounts Receivable. When you are paid, the paper asset turns into money you put in the bank – a tangible asset. Through a process of recording the payment and the deposit, Accounts
Receivable decreases and the bank balance increases. This accounting program takes care of all
the accounting details.
This paper income can be confusing if you don’t understand that it is the total of all
invoiced work, both paid and unpaid. If you have invoiced clients for a total of $10,000 but only
$2,000 has been paid, your income will be $10,000 and your Accounts Receivable balance will be
$8,000, and your bank account has increased by the $2,000 you received. An accountant would
call this an accrual accounting method.
A cash accounting method only counts income when money is received, and it does not
keep track of Accounts Receivable. However, in real life, small businesses tend to use both
methods without realizing the difference until income tax time.
This program can handle both accrual and cash based accounting. You can use the G/L
Setup option in the G/L module to select either Cash or Accrual based accounting. We
recommended that you consult with your accountant to determine which system will work best for
you.
Classification of Accounting
In order to satisfy needs of different people interested in the accounting information,
different branches of accounting have developed.
Accounting is generally classified into three different disciplines as shown in Figure.
Financial Accounting: Accounting involves recording, classifying and summarizing of past
events and thus is historical in nature. It is Historical accounting which is better known as
financial accounting whose primary intention is to prepare the Statements revealing the Income / Loss and financial position of the business on the basis of events, which have happened in the
period being reckoned.
But this information, though of immense vitality does not adequately aid the
management in planning, controlling, organizing and efficiently conducting the
course of the business as a result of which Cost Accounting and Management
Accounting are in place.
Cost Accounting: It shows classification and analysis of costs on the basis of functions,
processes, products, centers etc. It also deals with cost computation, cost saving, cost reduction,
etc.
Management Accounting:
Management Accounting begins where Financial accounting and Cost
Accounting ends. It deals with the processing of data generated in financial accounting and cost
accounting for managerial decision-making. It also deals with application of managerial
economics concepts for decision-making.
The Accounting Equation
Now let us discuss the accounting equation, which keeps all the business accounts in
balance. We will create this equation in steps to clarify your understanding of this concept. In
order to start a business, the owner usually has to put some money down to finance the business
operations. Since the owner provides this money, it is called Owner’s equity. In addition, this
money is an Asset for the company. This can be represented by the equation:
ASSETS = OWNER’S EQUITY
If the owner of the business were to close down this business, he would receive all its
assets. Let’s say that owner decides to accept a loan from the bank. When the business decides to
accept the loan, their Assets would increase by the amount of the loan. In addition, this loan is also
a Liability for the company. This can be represented by the equation:
Assets = Liabilities + Owner’s Equity
Now the Assets of the company consist of the money invested by the owner, (i.e.
Owner’s Equity), and the loan taken from the bank, (i.e. a Liability). The company’s liabilities
are placed before the owners’ equity because creditors have first claim on assets.
If the business were to close down, after the liabilities are paid off, anything left over
(assets) would belong to the owner
Accounting Principle:
Meaning of Accounting Principles
Accounting principles refer to the rules and actions adopted by the accountants globally for
recording accounting transactions.
These are classified into two categories:
1. Accounting concepts
2. Accounting conventions
Accounting Concepts:
Accounting concepts include the assumptions and conditions on which the science of
accounting is based. These are also known as accounting standards. Important accounting concepts
are:
1. Separate entity concept
2. Going concern concept
3. Money measurement concept
4. Cost concept
5. Dual aspect concept
6. Accounting period concept
7. Realization concept
Business Entity Concept or Separate entity concept:
The concept of business entity assumes that business has a distinct and separate entity
from its owners. It means that for the purposes of accounting, the business and its owners are to be
treated as two separate entities. Keeping this in view, when a person brings in some money as
capital into his business, in accounting records, it is treated as liability of the business to the
owner.
Going Concern Concept:
The concept of going concern assumes that a business firm would continue to carry out
its operations indefinitely, i.e. for a fairly long period of time and would not be liquidated in the
foreseeable future.
Money Measurement Concept:
The concept of money measurement states that only those transactions and happenings in
an organisation which can be expressed in terms of money such as sale of goods or payment of expenses or receipt of income, etc. are to be recorded in the book of accounts. All such
transactions or happenings which cannot be expressed in monetary terms,
For example, the appointment of a manager, capabilities of its human resources or creativity of its
research department
Cost Concept:
The cost concept requires that all assets are recorded in the book of accounts at their
purchase price, which includes cost of acquisition, transportation, installation and making the asset
ready to use
Accounting Period Concept:
Accounting period refers to the span of time at the end of which the financial statements
of an enterprise are prepared, to know whether it has earned profits or incurred losses during that
period and what exactly is the position of its assets and liabilities at the end of that period. Such
information is required by different user at regular interval for various purposes, as no firm can
wait for long to know it financial results as various decisions are to be taken at regular intervals on
the basis of such information.
Dual Aspect Concept:
Dual aspect is the foundation or basic principle of accounting. It provides the very basis
for recording business transactions into the book of accounts. This concept states that every
transaction has a dual or two-fold effect and should therefore be recorded at two places.
Revenue Recognition (Realisation) Concept:
The concept of revenue recognition requires that the revenue for a business transaction
should be included in the accounting records only when it is realized.
Matching Concept:
The process of ascertaining the amount of profit earned or the loss incurred during a
particular period involves deduction of related expenses from the revenue earned during that
period. The matching concept emphasizes exactly on this aspect.
It states that expenses incurred in an accounting period should be matched with revenues
during that period.
Objectivity Concept:
The concept of objectivity requires that accounting transaction should be recorded in an
objective manner, free from the bias of accountants and others
This can be possible when each of the transaction is supported by verifiably documents or
vouchers. For example, the transaction for the purchase of materials may be supported by the cash
receipt for the money paid
Accounting Conventions:
Accounting conventions include the customs and traditions that assist the accountants in
preparing accounting statements. Important accounting conventions are:
1. Convention of conservatism
2. Convention of full disclosure
3. Convention of consistency
4. Convention of materiality
Conservatism Concept:
The concept of conservatism (also called ‘prudence’) provides guidance
for recording transactions in the book of accounts and is based on the policy of playing safe
Full Disclosure Concept:
The financial statement makes a full, fair and adequate disclosure of all
information which is relevant for taking financial decisions
The principle of full disclosure requires that all material and relevant facts concerning
financial performance of an enterprise must be fully and completely disclosed in the financial
statements and their accompanying footnotes
Consistency Concept:
The accounting information provided by the financial statements would be
useful in drawing conclusions regarding the working of an enterprise only when it allows
comparisons over a period of time as well as with the working of other enterprises.
Materiality Concept:
The concept of materiality requires that accounting should focus on material
facts. In certain cases, when the amount involved is very small, strict adherence to accounting
principles is not required. For example, stock of erasers, pencils, scales, etc. are not shown as
assets, whatever amount of stationery is bought in an accounting period is treated as the expense
of that period, whether consumed or not.
Accounting process
The sequence of activities beginning with the occurrence of a transaction is known as the
accounting cycle. This process is shown in the following diagram:
Steps in the Accounting Process
The above diagram shows the financial statements as being prepared after the adjusting
entries and adjusted trial balance. The financial statements also can be prepared before the
adjusting entries with the help of a worksheet that calculates the impact of the adjusting entries
before they actually are posted.
The above stages are repeated in accounting process, as previous years closing balances
are taken as opening balances for current year. As this process is repeated, this is also called as
accounting cycle. This can be represented in the following way
The Accounting Cycle
The following stages are in accounting cycle:
1) All the business transactions are systematically entered in journal by way of journal
entries
2) From the journal, they are recorded in various accounts in the book called ledger
3) With the help of the balances in various accounts, trial balance is prepared to know the
arithmetical accuracy
4) Finally, preparing final accounts with the help of the balance. Trading & Profit & Loss
Account is prepared to ascertain the profit or loss made during a particular period,
balance sheet is prepared to know the exact financial position
Systems of Book-Keeping
Two types of systems of book-keeping are:
1. Single entry system:
It is used to record only cash and personal accounts.
2. Double entry system:
It is used to record each transaction under two different accounts. It is more reliable and efficient than the single entry system.
Difference between Double Entry and Single Entry Systems
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Features
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Double Entry System
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Single Entry System
|
|
Recording of transactions
|
Dual aspect is followed for all
transactions
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Dual aspects is not followed
for all transactions
|
|
Maintenance of books
|
Subsidiary books such as cash, sales, purchases are
maintained
|
Only cash book is maintained
|
|
Maintenance of books of
accounts
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All real, personal, nominal
accounts are maintained
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Only personal account is
maintained
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Preparation of trail balance &
final statements
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Trail balance & Final
statements can be accurately
maintained
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Trail balance cannot be
prepared & Final statements
does not provide accurate
results
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DOUBLE ACCOUNTING SYSTEM
test of four hundred years continuous use. It may be claimed that it is the only system worthy of adoption by the practical businessman. To understand the system of double entry system of bookkeeping all that we need to remember is the fundamental rule:
“Debit – the account which receives the benefit.”
“Credit – the account which gives the benefit”
Types of account
1) Personal Account
2) Real Account
3) Nominal Account
RULES FOR DEBIT & CREDIT.
1) Personal Account: -
This account deals with the individuals of the organization these includes
accounts of natural persons in varied capacities likes suppliers and buyers of goods, lenders and
borrowers of loans etc.
“Debit – the receiver”
“Credit – the giver”
2) Real Account: -
This account deals with the group of individuals of the organization these
include combinations of the properties or assets are known as real account.
“Debit – what comes in”
“Credit – what goes out”
3) Nominal Account: -
Nominal accounts relate to such items which exist in name only. These
items pertain to expenses and gains like interest, rent, commission, discount, salary etc,
“Debit – all expenses and losses”
“Credit – all incomes and gains”
Journal Entries
A journal entry is an entry into an accounting journal. An accounting journal recordsaccounting transactions as they occur. A journal entry converts accounting transactions into the
language of accounting by using debits and credits.
Requirements for journal entries:
All journal entries should satisfy the following requirements:
(1) At least one entry on the debit side
(2) At least one entry on the credit side
(3) Sum of debit side amounts = sum of credit side amounts
Journals (Preparation of Journal Entries):
The word 'Journal' is derived from the French word "jour" meaning 'a day'. Journal,
therefore, means a 'daily record'. Transactions are first entered in a book called 'Journal' to show which accounts should be debited and which credited along with an explanation of the entry (called 'narration'). Journal entry is any transaction that is recorded in the journal. The process of recording the transactions in the journal is termed as journalizing the entries.
All transactions are first recorded in the journal as they occur in a chronological order. This is the first step in the accounting process. The journal is called 'Book of original entry' as all transactions that occur are first recorded here.
The form of the journal is given below:
JOURNAL
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Date
|
Particulars
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L.F
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Debit amount
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Credit amount
|
|
|
|
|
|
|
Date:
is the date of the transaction
Particulars:
Here the names of the account involved are written. First the account to be debited is written and on the next line the account to be credited is written preceded by the word "To". Then
in the next line the explanation for the entry together with necessary details is given (called
'narration')
"L.F" indicates "Ledger Folio" where in the page number in the ledger on which the account is
written up is recorded.
Preparation of journal entries:
All the accounting transactions must be first recorded in Journal. The recording of
transactions in the journal is called journal entry. Preparation of journal entries involves certain
steps that are explained below:
Analyze the transactions and identify the accounts that are affected by the transaction
Ascertain the nature of the accounts involved as real, personal or nominal.
Determine the rule of debit or credit applicable to each of the accounts involved.
Ascertain the account to be debited and the account to be credited.
Now, write the date of transaction in the 'Date' column
Write the name of the account to be debited and the amount to be debited in debit amount
column against the name of the account.
Write the name of the account to be credited in the next line preceded by the word "To"
at a few spaces towards the right in particular column, and the amount to be credited in
the credit amount column against the name of the account.
Write narration (brief description of the transaction) within brackets in the next line in
particular column.
Example:
Let us consider the following transactions and prepare journal entries in the format shown above.
i. Purchased goods on credit from Mr. X for $200,000 on 4 Jan 2009
ii. Sold goods to Mr. Y for cash $100,000 on 12 Jan 2009
iii. Purchased furniture for office purpose $ 20,000 on 25 Jan 2009
iv. Paid $100,000 to Mr. X in full settlement of his dues on 30 Jan 2009
Illustration: I
Journalize the following transactions and prepare a cash ledger.
1. Ram invests Rs. 10, 000 in cash.
2. He bought goods worth Rs. 2000 from shyam.
3. He bought a machine for Rs. 5000 from Lakshman on account.
4. He paid to Lakshman Rs. 2000
5. He sold goods for cash Rs.3000
6. He sold goods to A on account Rs. 4000
7. He paid to Shyam Rs. 1000
8. He received amount from A Rs. 2000
Illustration II
Journalize the following transactions and post them into Ledgers
Jan 1. Commenced business with a capital of Rs. 10000
,, 2. Bought Furniture for cash Rs. 3000
,, 3. Bought goods for cash from ‘B’ Rs. 500
,, 4. Sold goods for cash to A Rs. 1000
,, 5. Purchased goods from C on credit Rs.2000
,, 6. Goods sold to D on credit Rs. 1500
,, 8. Bought machinery for Rs. 3000 paying Cash
,, 12. Paid trade expenses Rs. 50
,, 18. Paid for Advertising to Apple Advertising Ltd. Rs. 1000
,, 19. Cash deposited into bank Rs. 500
,, 20. Received interest Rs. 500
,, 24. Paid insurance premium Rs. 200
,, 30. Paid rent Rs. 500
,, 30. Paid salary to P Rs.1000
LEDGER
Ledger is the secondary book of accounts all business transactions are recorded in the
first instance in the journal, but they must find their place ultimately in the accounts in the ledger in a duly classified form. This ledger are also called final entry book. OR Transferring of all journals in to accounts by using accounting principles is called ledger.
Format of ledger
INTRODUCTION TO FINAL ACCOUNT
All business transactions are first recorded in Journal or Subsidiary Books. They are
transferred to Ledger and balanced it. The main object of keeping the books of accounts is to
ascertain the profit or loss of business and to assess the financial position of the business at the end of the year. The object is better served if the businessman first satisfies himself that the accounts written up during the year are correct or at least arithmetically accurate.
When the transactions are recorded under double entry system, there is a credit for every debit,
when on a/c is debited; another a/c is credited with equal amount. If a Statement is prepared with debit balances on one side and credit balances on the other side, the totals of the two sides will be equal. Such a Statement is called Trial Balance.
Trail Balance
DEFINITION
Trial Balance can be defined as “a list of all balances standing in the Ledger Accounts
and Cash Book of a concern at any given time”.
Advantages:
1. It is the shortest method of verifying the arithmetical accuracy of entries made in the Ledger. If the Trial balances agree, it is an indication that the Accounts are correctly written up; but it is not a conclusive proof.
2. It helps to prepare the Trading A/c, Profit & Loss a/c and Balance Sheet.
3. It presents to the businessman consolidated lists of all Ledger Balances.
Preparation:
There are two methods for preparing the Trial Balance
First Method:
In this method, Ledger Accounts are not balanced. They are totaled. The debit side totals
and the credit side totals are entered in a separate sheet. The grand total of Debit Column will be equal to the grand total of the Credit Column.
Second Method:
This method is more widely used. In this method, ledger accounts are balanced. The brought down balances are then brought to a sheet as given below.
Format of the Trail balance
SUNDRY DEBTORS
When a trader sells on credit basis, The Buyer’s Account in the Ledger is debited. For each buyer, there is one Ledger a/c. Some of the buyer accounts may be automatically balanced. But it is quite natural that many of these Customer’s Accounts have a debit balances. When we bring these balances to the Trial Balance, if we are going to write all individual names of customers, then the Trial balance will be too lengthy. Therefore, first a list of Debtors with their individual debit balances are prepared and totaled. Instead of writing the individual names of Debtors, the total is written under the heading “Sundry Debtors” which appears in the Trial Balance.
SUNDRY CREDITORS
There are a number of parties from whom the Trader buys goods on credit basis. For each one of them, an Account is opened in the Ledger. As in the case of Debtors, a List of Creditors with the balances due to them is prepared. In the Trial Balance, instead of writing the individual names of Creditors,, the total of the balances of the creditors is written under the heading “Sundry Creditors”
If the Trial Balance agrees, it is an indication that the accounts are correctly written up; but it is
not a conclusive proof. If the trial balance disagrees, then the difference amount is generally
placed in ‘Suspense Account’
Illustration:
The balances extracted from the books of Sankar are given below. From the prepare Trial Balance on 31st March 3007.
Sankar’s Capital 30,000, Sundry Creditors 4,000, Sales 30,000, Cash in hand 1,800, Purchases
20,000, Cash in Bank 6,000, Interest (Dr) 400, Bills Receivables 11,000, Sales returns 1,000, Bills Payable 7,000, Purchases Returns 800, Discount earned 800, Sundry Debtors 15,000, Wages
7,000, Commission (Dr) 1,000, Rent 800, Plant and Machinery 8,000, Telephone charges 1,000,
Misc. Income 400
FINAL ACCOUNTS
So far, we have discussed that how the business transactions are recorded in Journal,
ledger, how to detect, rectify the errors and how to prepare trial Balance. It is quite natural that the businessman is interested in knowing whether his business is running on Profit or Loss and also the true financial position of his business. The main aim of Bookkeeping is to inform the
Proprietor, about the business progress and the financial position at the right time and in the right way. Preparation of Final accounts is highly possible only after the preparation of Trial Balance.
Final accounts are done in three steps
1. Trading A/c
2. Profit and Loss A/c
3. Balance sheet
1. Trading and Profit and Loss A/c is prepared to find out Profit or Loss.
2. Balance Sheet is prepared to find out financial position of Company.
Trading and P&L A/c and Balance sheet are prepared at the end of the year or at end of the part.
So it is called Final Account.
Revenue account of trading concern is divided into two-part i.e.
1. Trading Account and
2. Profit and Loss Account.
TRADING ACCOUNT
selling of goods. This account is prepared to find out the difference between the Selling prices and Cost price. If the selling price exceeds the cost price, it will bring Gross Profit.
For example, if the cost price of Rs. 50,000 worth of goods are sold for Rs. 60,000 that
will bring in Gross Profit of Rs. 10,000. If the cost price exceeds the selling price, the result will
be Gross Loss.
For example, if the cost price Rs. 60,000 worth of goods are sold for Rs. 50,000 that will
result in Gross Loss of Rs.10, 000. Thus the Gross Profit or Gross Loss is indicated in Trading
Account.
Items appearing in the Debit side of Trading Account:
1. Opening Stock: Stock on hand at the commencement of the year or period is termed as the
Opening Stock.
2. Purchases: It indicates total purchases both cash and credit made during the year.
3. Purchases Returns or Returns out words: Purchases Returns must be subtracted from the total
purchases to get the net purchases. Net purchases will be shown in the trading account.
4. Direct Expenses on Purchases: Some of the Direct Expenses are.
I. Wages: It is also known as productive wages or Manufacturing wages.
II. Carriage or Carriage Inwards:
III. Octroi Duty: Duty paid on goods for bringing them within municipal limits.
IV. Customs duty, dock dues, clearing charges, Import duty etc.
V. Fuel, Power, Lighting charges related to production.
VI. Oil, Grease and Waste.
VII. Packing charges: Such expenses are incurred with a view to put the goods in
the Saleable Condition.
Items appearing on the credit side of Trading Account:
1. Sales: Total Sales (Including both cash and credit) made during the year.
2. Sales Returns or Return Inwards: Sales Returns must be subtracted from the Total Sales to get Net sales. Net Sales will be shown.
3. Closing stock: Generally, Closing stock does not appear in the Trial Balance. It appears outside the Trial balance. It represents the value of goods at the end of the trading period.
Specimen Form of a trading A/c
BALANCING OF TRADING ACCOUNT
The difference between the two sides of the Trading Account indicates either Gross Profit
or Gross Loss. If the total on the credit side is more, the difference represents Gross Profit. On the other hand, if the total of the debit side is high, the difference represents Gross Loss. The Gross Profit or Gross Loss is transferred to Profit and Loss A/c.
Closing Entries of Trading A/c
Trading A/c is a ledger account. Hence, no direct entries should be made in the trading account.
Several items such as Purchases, Sales are first recorded in the journal and then posted to the
ledger. The Same accounts are closed by the transferring them to the trading account. Hence it is called as closing entries.
Advantages of Trading Account
1. The result of Purchases and Sales can be clearly ascertained
2. Gross Profit ratio to Sales could also be easily ascertained. It helps to determine Price.
3. Gross Profit ratio to direct Expenses could also be easily ascertained. And so, unnecessary
expenses could be eliminated.
4. Comparison of trading account details with previous years details help to draw better
administrative policies.
PROFIT AND LOSS ACCOUNT
Trading account reveals Gross Profit or Gross Loss. Gross Profit is transferred to credit
side of Profit and Loss A/c. Gross Loss is transferred to debit side of the Profit Loss Account.
Thus Profit and Loss A/c is commenced. This Profit & Loss A/c reveals Net Profit or Net loss at a
given time of accounting year.
Items appearing on Debit side of the Profit & Loss A/c
The Expenses incurred in a business is divided in two parts. i.e. one is Direct expenses
are recorded in trading A/c., and another one is Indirect expenses, which are recorded on the debit side of Profit & Loss A/c. Indirect Expenses are grouped under four heads:
1. Selling Expenses: All expenses relating to sales such as Carriage outwards, Travelling
Expenses, Advertising etc.,
2. Office Expenses: Expenses incurred on running an office such as Office Salaries, Rent, Tax,
Postage, Stationery etc.,
3. Maintenance Expenses: Maintenance expenses of assets. It includes Repairs and Renewals,
Depreciation etc.
4. Financial Expenses: Interest Paid on loan, Discount allowed etc., are few examples for Financial Expenses.
Item appearing on Credit side of Profit and Loss A/c.
1. Gross Profit is appeared on the credit side of P & L. A/c.
2. Also other gains and incomes of the business are shown on the credit side.
3. Typical of such gains are items such as
a. Interest received,
b. Rent received,
c. Discounts earned,
d. Commission earned.
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