CASH BOOK

2.2 DOUBLE- COLUMN CASH BOOK

If along with columns for amounts to record cash receipts and cash payments another column
is added on each side to record the cash discount allowed or the discount received, or a column
on the debit side showing bank receipts and another column on the credit side showing
payments through bank. It is a double column cash book.
Cash discount is an allowance which often accompanies cash payments. For example, if a
customer owes Rs. 500 but is promised that 2% will be deducted if payment is made within a
certain period, the customer can clear his account by paying promptly Rs. 490. Cash received
will be Rs. 490 and Rs. 10 will be the discount for the firm receiving the payment discount is a
loss; for the person making the payment it is a gain. Since cash discount is allowed only if cash
is paid, it is convenient to add a column for discount allowed on the receipt side of the cash
book and a column for discount received on the payment side of the cash book.
In the cash column on the debit side, actual cash received is entered; the amount of the discount
allowed, if any, to the customer concerned is entered in the discount column. Similarly, actual
cash paid is entered in the cash column on the payments side and discount received in the
discount column. Also the bank column on the debit side records all receipts through bank and
the same column on the credit side shows payment through bank.
Balancing: It should be noted that the discount columns are not balanced. They are merely
totalled. The total of the discount column on the receipts side shows total discount allowed to
customers and is debited to the Discount Account. The total of the column on the payments
side shows total discount received and is credited to the Discount Account. The Cash columns
are balanced, as already shown. The bank columns are also balanced and the balancing figure
is called bank balance. Thus a double column cash book should have two columns on each side
comprising of either cash and discount transaction or cash and bank transactions.
Illustration 2
Ganesh commenced business on 1st April, 2009 with Rs. 2,000 as capital. He had the following
cash transactions in the month of April 2009:
Rs. Rs.
April 1 Purchased furniture April 7 Paid for petty expenses 15
and paid cash 250 " 8 Cash purchases 150
"2 Purchased goods 500
"4 Sold goods for cash 950
13 Paid for Typewriter 1,000
"5 Paid cash to Ram Mohan 560
"6 He allowed discount 10 "" Paid Ali & Sons 400
"6 Received cash from
Krishna & Co. 600 "" They allowed discount 8
Allowed discount 20
Make out the two-column Cash Book (Cash and discount column) for the month of April,
2006.

2.70 COMMON PROFICIENCY TEST

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Solution
CASH BOOK
Dr. Cr.
Date Receipts L.F. Discount Amount Date Payments L.F. Discount Amount
2009 Rs. Rs. 2009 Rs. Rs.
April1 To Capital A/c 2,000 April1 By Furniture A/c 250
"4 To Sales A/c 950 "2 By Purchases A/c 500
"6 To Krishna A/c 20 600
"5 By Ram Mohan 10 560
"7 By Petty
Expenses A/c 15
"8 By Purchases A/c 150
"13 By Typewriter A/c 1,000
"13 By Ali & Sons 8 400
"30 By Balance c/d 675
20 3,550 18 3,550
May 1 To Balance b/d 675

To summarise :
(i) the discount columns in the cash book are not accounts;
(ii) they are not balanced; and
(iii) their totals are entered in the discount account in the ledger.
Note : The person who pays, is credited by both the cash paid by him and the discount allowed
to him. Similarly, the person to whom payment is made, is debited with both the amount paid
and the discount allowed by him.
2.3 THREE-COLUMN CASH BOOK
A firm normally keeps the bulk of its funds at a bank; money can be deposited and withdrawn
at will if it is current account. Probably payments into and out of the bank are more numerous
than strict cash transactions. There is only a little difference between cash in hand and money
at bank. Therefore, it is very convenient if, on each side in the cash book, another column is
added to record cash deposited at bank (on the receipt side of the cash book) and payments
out of the bank (on the payment side of the cash book).
For writing up the three-column cash book the under mentioned points should be noted:
1. While commencing a new business, the amount is written in the cash column if cash is
introduced and in the bank column if it is directly put into the bank with the description
"To Capital Account". If a new cash book is being started for an existing business, the
opening balances are written as : "To Balance b/d".

FUNDAMENTALS OF ACCOUNTING 2.71

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 CASH BOOK

2. All receipts are written on the receipts side, cash in the cash column and cheques in the
bank column. If any discount is allowed to the party paying the amount, the discount is
entered in the discount column. In the particulars column the name of the account in
respect of which payment has been received is written.
3. All payments are written on the payments side, cash payment in the cash column and
payments by cheques in the bank column. If some discount has been received from the
party receiving the payment, it is entered in the discount column.
4. Contra Entries: Often cash is withdrawn from bank for use in the office. In such a case the
amount is entered in the bank column on the payments side and also in the cash column
on the receipts side. In the reverse case of cash being sent to the bank, the amount is
recorded in the bank column on the receipts side and in cash column on payment side.
Against such entries, the letter "C" should be written in the LF. column, to indicate that
these are contra transaction and no further posting is required for them.
Note : If initially cheques received are entered in the cash column and then sent to the
bank, the entry is as if cash has been sent to the bank.
While recording contra entries, the basic but important rules should be followed -
(a) The Receiver Dr.
The Giver Cr.
(b) All what comes in Dr.
All what goes out Cr.
e.g. where a Cash Book with separate columns for Bank Account is maintained.
(a) If cash is deposited in Bank Account, the Bank will be the Receiver, hence it will be
Debited and as the cash is going out, cash will be credited.
(b) If cash is withdrawn from the Bank Account, the Bank will be the Giver, hence it will
be Credited and, as the cash is coming in, cash will be Debited.
5. If some cheque sent to the bank is dishonoured, i.e., the bank is not able to collect the
amount, it is entered in the bank column on the credit side with the name of the related
party in the particulars column.
6. If some cheque issued by the firm is not paid on presentation, it is entered in the Bank
column on the debit side with the name of the party to whom the cheque was given.
7. In a rare case, a cheque received may be given to some other party, i.e., endorsed. On
receipt, it must have been entered in the bank column on the debit side;on endorsement
the amount will be written in the bank column on the credit side.
The advantages of such type of Cash Book are that -
(a) the Cash Account and the Bank Account are prepared simultaneously, therefore the
double entry is completed in the Cash Book itself. Thus the contra entries can be
easily cross-checked in Cash column in one side and the Bank column in the other
side of the Cash Book. Also the chances of error are reduced.

2.72 COMMON PROFICIENCY TEST

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 (b) the information regarding Cash in Hand and the Bank Balance can be obtained very
easily and quickly as there is no need to prepare Ledger of the Bank Account.
In case of maintaining more than one Bank Account, separate column can be add for each
Bank Account. Transactions between these two or more Bank Accounts can be recorded and
tallied with a much less effort.
Suppose, there are two Bank Accounts namely PNB Current Account and SBI-Cash Credit
Account. Now, if a cheque is deposited from PNB cheque Book to SBI Account, the receiver -
i.e., PNB Account will be debited and the giver i.e. the SBI Account shall be credited.
Balancing: The discount columns are totalled but not balanced. The cash columns are balanced
exactly in the same manner as indicated for the simple cash book. The process is similar for
balancing the bank columns also. It is possible, however, that the bank may allow the firm to
withdraw more than the amount deposited i.e., to have an overdraft, In such a case, the total
of the bank column on the credit side is bigger than the one on the debit side. The difference is
written on the debit side as "To Balance c/d." Then the totals are written on the two sides
opposite one another, the balance is then entered on the credit side as "By Balance b/d."
However, the usual case is that payments into the bank will exceed the withdrawals or payments
out of the bank. Then the bank columns are balanced just like the cash columns.
Illustration 3
Enter the following transactions in Cash Book with Discount and Bank Columns. Cheques are
first treated as cash receipt.
2009 Rs.
Jan.1 Chandrika commences business with Cash 20,000
"3 He paid into Current A/c 19,000
"4 He received cheque from Kirti & Co. on account 600
"7 He pays in bank Kirty & Co's cheque 600
"10 He pays Rattan & Co. by cheque and is allowed discount Rs. 20 330
"12 Tripathi & Co pays into his Bank A/c 475
"15 He receives cheque from Warshi and allows him discount Rs. 35 450
"20 He receives cash Rs. 75 and cheque Rs. 100 for cash sale
"25 He pays into Bank, including cheques received on 15th and 20th 1,000
"27 He pays by cheque for cash purchase 275
"30 He pays sundry expenses in cash 50

FUNDAMENTALS OF ACCOUNTING 2.73

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 Solution

2.74
CASH BOOK
Dr. Cr.
CASH BOOK

Date Receipts L.F. Discount Cash Bank Date Payments L.F. Discount Cash Bank
Rs. Rs. Rs. Rs. Rs. Rs.
2009 2009
Jan. 1 To Capital A/c 20,000 Jan. 3 By Bank A/c C 19,000
3 To Cash C 19,000 7 By Bank A/c C 600
4 To Kirti & Co. 600 10 By Ratan & Co. 20 330
7 To Cash C 600 25 By Bank A/c C 1,000
12 To Tripathi & Co. 475 27 By Purchases A/c 275
15 To Warsh 35 450 30 By S. Exp. A/c 50
20 To Sales A/c 175
25 To Cash C 1,000

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31 By Balance c/d 300 20,745
35 21,225 21,075 20 21,225 21,075
Feb. 1 To Balance b/d 300 20,745

COMMON PROFICIENCY TEST

 3. POSTING THE CASH BOOK ENTRIES
Students would have seen that the cash columns in the cash book is actually the cash account
and the bank column is actually bank account. Also, the discount columns are memorandum
columns, meant only to provide information about the total discount allowed and total discount
received.
The debit side columns for cash and bank indicate receipts. Therefore, the amounts debited in
the cash book should be put to the credit of the account in respect of which cash or cheque has
been received. For instance, in the cash book given above we see that Rs. 175 have been received
for sale of goods. For posting, the amount is credited to the Sales Account as "By Cash Rs. 175."
We also see M/s. Warsi have paid Rs. 450 and also they have been allowed Rs. 35 as discount;
thus they have discharged a debt of Rs. 485. In the account of M/s. Warsi, the posting is on the
credit side as
"By Cash Rs. 450
By Discount Rs. 35"
or as :
By Sundries Rs. 485"
All payments are recorded on the credit side. The particulars columns show on what account
payments have been made. In the ledger accounts concerned the amount in put on the debit
side. For example, the cash book shows that a cheque for Rs. 330 has been issued to
M/s. Ratan & Co. and also that they have allowed a discount of Rs. 20; thus an obligation of
Rs. 350 has been met. In the account of M/s. Ratan & Co. the posting is :
"To Bank Rs. 330
"To Discount Rs. 20"
Or
"To Sundries Rs. 350"
The rule thus develops: From the debit side of the cash book credit the various accounts with
their respective amounts (including any discount that may have been allowed); from the credit
side of cash book the posting will be to the debit of the accounts mentioned in the particular
column with their respective amounts (including the discount which may have been received).
As has been shown already, the total of the discount columns on the debit side is debited to the
discount account ;the total of the column on the credit side is credited to the discount account.
From the cash book given on the previous page Rs. 35 is debited and Rs. 20 be credited to the
discount account.

4. PETTY CASH BOOK

In a business house a number of small payments, such as for telegrams, taxi fare, cartage, etc.,
have to be made. If all these payments are recorded in the cash book, it will become unnecessarily
heavy. Also, the main cashier will be overburdened with work. Therefore, it is usual for firms

FUNDAMENTALS OF ACCOUNTING 2.75

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 CASH BOOK

to appoint a person as 'Petty Cashier' and to entrust the task of making small payments say
below Rs. 25, to him. Of course he will be reimbursed for the payments made. Later, on an
analysis, the respective account may be debited.
4.1 IMPREST SYSTEM OF PETTY CASH
It is convenient to entrust a definite sum of money to the petty cashier in the beginning of a
period and to reimburse him for payments made at the end of the period. Thus, he will have
again the fixed amount in the beginning of the new period. Such a system is known as the
imprest system of petty cash.
The system is very useful specially if an analytical Petty Cash Book is used. The book has one
column to record receipt of cash (which is only from the main cashier) and other columns to
record payments of various types. The total of the various columns show why payments have
been made and then the relevant accounts can be debited.
(i) The amount fixed for petty cash should be sufficient for the likely small payments for a
relatively short period, say for a week or a fortnight.
(ii) The reimbursement should be made only when petty cashier prepares a statement showing
total payments supported by vouchers, i.e., documentary evidence and should be limited
to the amount of actual disbursements.
(iii) The vouchers should be filed in order.
(iv) No payment should be made without proper authorization. Also, payments above a certain
specified limit should be made only by the main cashier
(v) The petty cashier should not be allowed to receive any cash except for reimbursement.
In the petty cash book the extreme left-hand column records receipts of cash. The money
column towards the right hand shows total payments for various purposes; a column is usually
provided for sundries to record infrequent payments. The sundries column is analysed. At the
end of the week or the fortnight the petty cash book is balanced. The method of balancing is
the same as for the simple cash book.
Illustration 4
Shri Ramaswamy maintains a Columnar Petty Cash Book on the Imprest System. The imprest
amount is Rs. 500. From the following information, show how his Petty Cash Book would
appear for the week ended 12th September, 2009:
7-9-2009 Balance in hand 134.90
Received Cash reimbursement to make up the imprest 365.10
Stationery 49.80
8-9-2009 Miscellaneous Expenses 20.90
9-9-2009 Repairs 156.70
10-9-2009 Travelling 68.50
11-9-2009 Stationery 71.40
12-9-2009 Miscellaneous Expenses 6.30
Repairs 48.30

2.76 COMMON PROFICIENCY TEST

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 Solution
PETTY CASH BOOK
Date Receipts Amount Date Payments Total Stationery Travelling Misc. Exps. Repairs
Amount
2009 Rs. 2009 Rs. Rs. Rs. Rs. Rs.

Sept. 7 To Balance b/d 134.90 7 By Stationery 49.80 49.80

To Reimbursement 365.10 8 By Misc. Expenses 20.90 20.90
9 By Repairs 156.70 156.70
10 By Travelling 68.50 68.50

FUNDAMENTALS OF ACCOUNTING
11 By Stationery 71.40 71.40
12 By Misc. Expenses 6.30 6.30
By Repairs 48.30 48.30
421.90 121.20 68.50 27.20 205.00
By Balance c/d 78.10
500.00 500.00

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13 To Balance b/d 78.10

2.77
 CASH BOOK

Illustration 5
Prepare a Petty Cash Book on the imprest System from the following:
2009 Rs.
Jan.1 Received Rs. 100 for petty cash
" 2 Paid bus fare .50
" 2 Paid cartage 2.50
" 3 Paid for Postage & Telegrams 5.00
" 3 Paid wages for casual labourers 6.00
" 4 Paid for stationery 4.00
" 4 Paid tonga charges 2.00
" 5 Paid for the repairs to chairs 15.00
" 5 Bus fare 1.00
" 5 Cartage 4.00
" 6 Postage and Telegrams 7.00
" 6 Tonga charges 3.00
" 6 Cartage 3.00
" 6 Stationery 2.00
" 6 Refreshments to customers 5.00

2.78 COMMON PROFICIENCY TEST

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 Solution
PETTY CASH BOOK
Receipts Date V. No. Particulars Total Con- Cartage Statio- Postage & Wages Sundries
veyance nery Telegrams
Rs. 2009 Rs. Rs. Rs. Rs. Rs. Rs. Rs.
100 Jan.1 To Cash
2 1 By Conveyance .50 .50
2 By Cartage 2.50 2.50
3 3 By Postage and Telegrams 5.00 5.00
4 By Wages 6.00 6.00

FUNDAMENTALS OF ACCOUNTING
4 5 By Stationery 4.00 4.00
6 By Conveyance 2.00 2.00
5 7 By Repairs to Furniture 15.00 15.00
8 By Conveyance 1.00 1.00
9 By Cartage 4.00 4.00
6 10 By Postage and Telegrams 7.00 7.00
" 11 By Conveyance 3.00 3.00

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" 12 By Cartage 3.00 3.00
" 13 By Stationery 2.00 2.00
" 14 By General Expenses 5.00 5.00
60.00 6.50 9.50 6.00 12.00 6.00 20.00
By Balance c/d 40.00
100.00
40.00 To Balance b/d
60.00 8 To Cash

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 CASH BOOK

4.2 ADVANTAGES OF PETTY CASH BOOK

There are mainly three advantages:
(i) Saving of time of the chief cashier;
(ii) Saving in labour in writing up the cash book and posting into the ledger; and
(iii) Control over small payments.
4.3 POSTING THE PETTY CASH BOOK
In the ledger, a petty cash account is maintained; when an amount is given to the petty cashier,
the petty cash account is debited. Each week or forthnight, the total of the payments made is
credited to this account. The petty cash account will then show the balance in the hand of the
cashier; on demand he should be able to produce it for counting. At the end of the year, the
balance is shown in the balance sheet as part of cash balance.
Of course, the payments must be debited to their respective amounts as shown by the petty
cash book. For this two methods may be used:
(i) From the petty cash book the total of the various columns may be directly debited to the
concerned accounts; or
(ii) A journal entry may first be prepared on the basis of the petty cash book, debiting the
accounts shown by the various analysis columns, and crediting the total of the payment
of the petty cash accounts.
For Illustration 5 the journal entry and relevant accounts are as follows:
2009 Rs. Rs.
Jan. 6 Conveyance Account Dr. 6.50
Cartage account Dr. 9.50
Stationery account Dr. 6.00
Postage and Telegrams account Dr. 12.00
Wages Account Dr. 6.00
Repairs Account Dr. 15.00
General Expenses Account Dr. 5.00
To Petty Cash Account 60.00
(Being the analysis of the Petty Cash Book for
the week ending Jan. 6)
Entry for cash handed over to the Petty Cashier
Petty Cash Account Dr. Rs. 100
To Cash Account Rs. 100
(Being Cash received)

2.80 COMMON PROFICIENCY TEST

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 Petty Cash Account
Date Particulars Folio Amount Date Particulars Folio Amount
2009 Rs. 2009
Jan.1 To Cash 100.00 Jan.6 By Sundries:
"8 To Cash 60.00 Conveyance 6.50
Cartage 9.50
Stationery 6.00
Postage and Telegrams 12.00
Wages 6.00
Repairs 15.00
General
Expenses 5.00

5. ENTRIES FOR SALE THROUGH CREDIT/DEBIT CARDS

Now-a-days sales through Credit/Debit Cards are issued by almost every Bank in India either
directly or with collaboration of some other agencies. HSBC Card, SBI Card, BOB Card, ICICI
Bank Card, HDFC Card and Andhra Bank Card are some of the popular Cards.
The procedure for issuing Credit/Debit Cards are as follows -
1. A small Plastic Card, called Credit Card is issued by bank to a prospective customer, after
verifying his credibility, which is generally measured by his income sources. Debit Card is
issued by bank to a customer who has an account with the bank, maintaining a minimum
balance. Now a days ATM Card issued by the bank can also be used as Debit Card. This
card would contain an embossed 16 digit number and also the name of the cardholder.
2. Generally Bank charges annual subscription fees from the credit card holder. No fee is
charged in case of Debit Card, though some banks charge a nominal fee on Debit Card.
3. When the Card holder intends to buy some goods or services through Credit or Debit
Card, the seller fills in a form, generally in triplicate, the details of the goods a with the
amount of sales and uses the embossed card with the help of the Credit Card machine to
print the data on that form. Also the customer has to countersign the form. One carbon
copy of the form is given to the customer for the record.
4. The seller sums up the different amounts sold like this and submits, generally everyday, to
his bank all the forms. The amount is credited by the bank to the seller's account and
debited to the account of the Bank or the company issuing the Credit/Debit Card.
5. The bank issuing the Card, charges commission for each such transaction, which varies
between 1% to 4% and is immediately debited to seller's bank account.
6. The bank sends a monthly statement to the card holder. In case of Debit Card the account
is immediately debited to the card holder's account, whereas in case of Credit Card, card

FUNDAMENTALS OF ACCOUNTING 2.81

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 CASH BOOK

holder has to pay the amount in full or part. However, if not paid in full, the interest is
charged.
5.1 ACCOUNTING FOR CREDIT/DEBIT CARD SALE
From the seller's point of view, this type of sale is equivalent to a cash sale. Commission charged
by the bank will be treated as selling expenses. The following general entries will be made in
the seller's books of accounts
1. Bank A/c Dr.
To Sales Account
(Sales made through Credit/Debit Card)
2. Commission Account Dr.
To Bank Account
(Commission charged by bank)
Illustration 7
Enter the following transaction in Cash Bank with Discount and Bank columns. Cheques are
first treated as cash receipts -
2009 Rs.
March1 Cash in Hand 15,000
Overdraft in Bank 6,000
2 Cash Sales 3,000
3 Paid to Sushil Bros. by cheque 3,400
Discount received 100
5 Sales through credit card 2,800
6 Received cheque from Srijan 6,200
7 Endorsed Srijan's cheque in favour of Adit
9 Deposit into Bank 6,800
10 Received cheque from Aviral
and deposited the same into Bank
by allowing discount of Rs. 50 3,600
11 Adit informed that Srijan's cheque is dishonoured
15 Sales through Debit Card 3,200
24 Withdrawn from Bank 1,800
28 Paid to Sanchit by cheque 3,000
30 Bank charged 1% commission on sales through
Debit/Credit Cards

2.82 COMMON PROFICIENCY TEST

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 Solution
CASH BOOK
Dr. Cr.
Date Particulars L.F. Discount Cash Bank Date Particulars L.F. Discount Cash Bank
Rs. Rs. Rs. Rs. Rs. Rs.

2009 2009
March 1 To Balance c/d 15,000 March 1 By Balance b/d 6,000
2 To Sales 3,000 3 By Sushil Bros. 100 3,400
5 To Sales 2,800 7 By Adit 6,200

FUNDAMENTALS OF ACCOUNTING
6 To Srijan 6,200 9 By Bank C 6,800
9 To Cash A/c C 6,800 12 By Shijan 6,200
10 To Aviral 50 3,600 24 By Cash A/c C 1,800
12 Adit 6,200 28 By Sanchit 3,000
15 To Sales A/c 3,200 30 By Commisson 60

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24 To Bank A/c C 1,800 31 By Balance c/d 13,000 2,140
50 32,200 16,400 100 32,200 16,400

2.83
 CASH BOOK

SELF EXAMINATION QUESTIONS

Pick up the correct answer from the given choices:
1. (i) The total of discounts column on the debit side of the cash book, recording cash
discount deducted by customers when paying their accounts, is posted to the
(a) credit of the discount allowed account.
(b) debit of the discount received account.
(c) credit of the discount received account.
(d) debit of the discount allowed account.
(ii) Which of the following is the kind of a cash book ?
(a) Simple column cash book
(b) Double-column cash book
(c) Three-column cash book
(d) All of the above
(iii) Cash book is a type of __________ but treated as a ____________ of accounts.
(a) Subsidiary book, principal book
(b) Principal book, subsidiary book
(c) Subsidiary book, subsidiary book
(d) Principal book, principal book
(iv) Which of the following is not a column of a three-column cash book?
(a) Cash column
(b) Bank column
(c) Petty cash column
(d) Discount column
(v) Salaries due for the month of March will appear
(a) on the receipt side of the cash book
(b) on the payment side of the cash book
(c) as a contra entry
(d) nowhere in the cash book
(vi) Contra entries are passed only when
(a) double-column cash book is prepared
(b) three-column cash book is prepared
(c) simple cash book is prepared
(d) None of the above

2.84 COMMON PROFICIENCY TEST

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2. Choose the most appropriate answer from the given choices.
(i) The Cash Book records
(a) all cash receipts
(b) all cash payments
(c) all cash receipts and payments
(d) cash and credit sale of goods.
(ii) The balance in the petty cash book is
(a) an expense
(b) a profit
(c) an asset
(d) a liability.
(iii) If Ram has sold goods for cash, the entry will be recorded
(a) in the Cash Book
(b) in the Sales Book
(c) in the Journal
(d) in the Stock Book.

ANSWERS

1
(i) (d) (ii) (d) (iii) (a) (iv) (c) (v) (d) (vi) (b)

2
(i) (c) (ii) (c) (iii) (a)

FUNDAMENTALS OF ACCOUNTING 2.85

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 CHAPTER - 2

ACCOUNTING
PROCESS

Unit 6

Capital and Revenue

Expenditures
and Receipts

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Learning Objectives
After studying this unit you will be able to :

 Learn the criteria for identifying Revenue Expenditure and distinguishing from Capital
Expenditure.
 Be familiar with the term Deferred Revenue Expenditure.
 Learn the distinction between capital and revenue receipts.
 Understand the linkage of such distinction with the preparation of final accounts.

1. INTRODUCTION
Accounting aims in ascertaining and presenting the results of the business for an accounting
period. For ascertaining the periodical business results, the nature of transactions should be
analysed whether they are of capital or revenue nature. The Revenue Expense relates to the
operations of the business of an accounting period or to the revenue earned during the period
or the items of expenditure, benefits of which do not extend beyond that period. Capital
Expenditure, on the other hand, generates enduring benefits and helps in revenue generation
over more than one accounting period. Revenue Expenses must be associated with a physical
activity of the entity. Therefore, whereas production and sales generate revenue in the earning
process, use of goods and services in support of those functions causes expenses to occur.
Expenses are recognised in the Profit & Loss Account through matching principal which tells
us when and how much of the expenses to be charged against revenue. A part of the
expenditure can be capitalised only when these can be traced directly to definable streams of
future benefits.
The distinction of transaction into revenue and capital is done for the purpose of placing them
in Profit and Loss account or in the Balance Sheet. For example: revenue expenditures are
shown in the profit and loss account as their benefits are for one accounting period i.e. in
which they are incurred while capital expenditures are placed on the asset side of the balance
sheet as they will generate benefits for more than one accounting period and will be transferred
to profit and loss account of the year on the basis of utilisation of that benefit in particular
accounting year. Hence, both capital and revenue expenditures are ultimately transferred to
profit and loss account.
Revenue expenditures are transferred to profit and loss account in the year of spending while
capital expenditures are transferred to profit and loss account of the year in which their benefits
are utilised. Therefore we can conclude that it is the time factor, which is the main determinant
for transferring the expenditure to profit and loss account. Also expenses are recognized in
profit and loss account through matching concept which tells us when and how much of the
expenses to be charged against revenue. However, distinction between capital and revenue
creates a considerable difficulty. In many cases borderline between the two is very thin.

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 CAPITAL AND REVENUE EXPENDITURES AND RECEIPTS

2. CONSIDERATIONS IN DETERMINING CAPITAL AND

REVENUE EXPENDITURES
The basic considerations in distinction between capital and revenue expenditures are:
(a) Nature of business: For a trader dealing in furniture, purchase of furniture is revenue
expenditure but for any other trade, the purchase of furniture should be treated as capital
expenditure and shown in the balance sheet as asset. Therefore, the nature of business is a very
important criteria in separating an expenditure between capital and revenue.
(b) Recurring nature of expenditure: If the frequency of an expense is quite often in an
accounting year then it is said to be an expenditure of revenue nature while non-recurring
expenditure is infrequent in nature and do not occur often in an accounting year. Monthly
salary or rent is the example of revenue expenditure as they are incurred every month while
purchase of assets is not the transaction done regularly therefore, classified as capital expenditure
unless materiality criteria defines it as revenue expenditure.
(c) Purpose of expenses: Expenses for repairs of machine may be incurred in course of normal
maintenance of the asset. Such expenses are revenue in nature. On the other hand, expenditure
incurred for major repair of the asset so as to increase its productive capacity is capital in
nature. However, determination of the cost of maintenance and ordinary repairs which should
be expensed, as opposed to a cost which ought to be capitalised, is not always simple.
(d) Effect on revenue generating capacity of business: The expenses which help to generate
income/revenue in the current period are revenue in nature and should be matched against
the revenue earned in the current period. On the other hand, if expenditure helps to generate
revenue over more than one accounting period, it is generally called capital expenditure.
When expenditure on improvements and repair of a fixed asset is done, it has to be charged to
Profit and Loss Account if the expected future benefits from fixed assets do not change, and it
will be included in book value of fixed asset, where the expected future benefits from assets
increase.
(e) Materiality of the amount involved: Relative proportion of the amount involved is another
important consideration in distinction between revenue and capital. Even, if expenditure does
not increase the productive capacity of an asset, it may be capitalised because the amount is
material or expenditure may increase the asset value and yet to be expensed because the amount
is immaterial.

3. CAPITAL EXPENDITURES AND REVENUE EXPENDITURES

As we have already discussed, capital expenditure contributes to the revenue earning capacity
of a business over more than one accounting period whereas revenue expense is incurred to
generate revenue for a particular accounting period. The revenue expenses either occur in
direct relation with the revenue or in relation with accounting periods, for example cost of
goods sold, salaries, rent, etc. Cost of goods sold is directly related to sales revenue whereas
rent is related to the particular accounting period. Capital expenditure may represent acquisition
of any tangible or intangible fixed assets for enduring future benefits. Therefore, the benefits
arising out of capital expenditure last for more than one accounting period whereas those
arising out of revenue expenses expire in the same accounting period.

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 4. DEFERRED REVENUE EXPENDITURES
Deferred revenue expenditure is that expenditure for which payment has been made or a
liability incurred but which is carried forward on the presumption that it will be of benefit over
a subsequent period or periods. In short, it refers to that expenditure that is, for the time being,
deferred from being charged against income. Such suspension of 'charging of' operation may
be due to the nature of expenses and the benefits expected there from. So, long as deferred
revenue expenditure is not written off, this is shown on the assets side of the balance sheet
under the head "Miscellaneous Expenditure."
Deferred revenue expenditure should be revenue expenditure by nature in the first instance,
for example, advertisement. But its matching with revenue may be deferred considering the
benefits to be accrued in future.
A thin line of difference exists between deferred revenue expenses and prepaid expenses. The
benefits available from prepaid expenses can be precisely estimated but that is not so in case of
deferred revenue expenses. Heavy advertising to launch a new product is a deferred expenditure
since the benefit from it will be available over the next three to five years but one cannot say
precisely how long the benefit would be available and the exact amount of benefit. On the
other hand, insurance premium paid say, for the year ending 30th June, 2006 when the
accounting year ends on 31st March, 2006 will be an example of prepaid expense to the extent
of premium relating to three months' period i.e. from 1st April, 2006 to 30th June, 2006. Thus
the insurance protection will be available precisely for three months after the close of the Year
and the amount of the premium to be carried forward can be calculated exactly.
Illustration 1
State with reasons whether the following statements are 'True' or 'False'.
(1) Overhaul expenses of second-hand machinery purchased are Revenue Expenditure.
(2) Money spent to reduce working expenses is Revenue Expenditure.
(3) Legal fees to acquire property is Capital Expenditure.
(4) Amount spent as lawyer's fee to defend a suit claiming that the firm's factory site belonged
to the plaintiff's land is Capital Expenditure.
(5) Amount spent for replacement of worn out part of machine is Capital Expenditure.
(6) Expense incurred on the repairs and white washing for the first time on purchase of an
old building are Revenue Expenses.
(7) Expenses in connection with obtaining a license for running the cinema is Capital
Expenditure.
(8) Amount spent for the construction of temporary huts, which were necessary for
construction of the Cinema House and were demolished when the cinema house was
ready, is Capital Expenditure.
(9) Heavy advertising to introduce a new product or to explore a new market is Capital
Expenditure.

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 CAPITAL AND REVENUE EXPENDITURES AND RECEIPTS

Solution
(1) False: Overhaul expenses are incurred to put second-hand machinery in working condition
to derive endurable long-term advantage. So it should be capitalised.
(2) False: It may be reasonably presumed that money spent for reducing revenue expenditure
would have generated long-term benefits to the entity. It becomes part of intangible fixed
assets if it is in the form of technical know-how and tangible fixed assets if it is in the form
of additional replacement of any of the existing tangible fixed assets. So this is capital
expenditure.
(3) True: Legal fee paid to acquire any property is part of the cost of that property. It is
incurred to possess the ownership right of the property and hence a capital expenditure.
(4) False: Legal expenses incurred to defend a suit claiming that the firm's factory site belongs
to the plaintiff is maintenance expenditure of the asset. By this expense, neither any
endurable benefit can be obtained in future in addition to that what is presently available
nor the capacity of the asset will be increased. Maintenance expenditure in relation to an
asset is revenue expenditure.
(5) False: Amount spent for replacement of any worn out part of a machine is revenue expense
since it is part of its maintenance cost.
(6) False: Repairing and white washing expenses for the first time of an old building are
incurred to put the building in usable condition. These are the part of the cost of building.
Accordingly, these are capital expenditure.
(7) True: The Cinema Hall could not be started without license. Expenditure incurred to
obtain the license is pre-operative expense which is capitalised. Such expenses are amortised
over a period of time.
(8) True: Cost of temporary huts constructed which were necessary for the construction of
the cinema house is part of the construction cost of the cinema house. Therefore such costs
are to be capitalised.
(9) False: The effect of heavy advertising with regard to the launching of a new product or to
explore a new market will last generally for more than one accounting period. But it does
not create any property of tangible or intangible nature and so the expenditure is spread
over the period for which its effect would remain. This type of expenditure items are
termed as deferred revenue expenditure.
Illustration 2
State with reasons whether the following are Capital or Revenue Expenditure:
(1) Expenses incurred in connection with obtaining a license for starting the factory for
Rs. 10,000.
(2) Rs. 1,000 paid for removal of stock to a new site.
(3) Rings and Pistons of an engine were changed at a cost of Rs. 5,000 to get fuel efficiency.
(4) Money paid to Mahanagar Telephone Nigam Ltd. (MTNL) Rs. 8,000 for installing telephone
in the office.
(5) A factory shed was constructed at a cost of Rs. 1,00,000. A sum of Rs. 5,000 had been
incurred in the construction of temporary huts for storing building material.

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Solution
(1) Money paid Rs. 10,000 for obtaining license to start a factory is a capital expenditure. This
is an item of expenditure incurred to acquire the right to carry on business.
(2) Rs. 1,000 paid for removal of stock to a new site is revenue expenditure. This is neither
bringing enduring benefit nor enhancing the value of the asset.
(3) Rs. 5,000 spent in changing Rings and Pistons of an engine to get fuel efficiency is capital
expenditure. This is an expenditure on improvement of a fixed asset. It results in increasing
profit-earning capacity of the business by cost reduction.
(4) Money deposited with MTNL for installation of telephone in office is not expenditure.
This is treated as an asset and the same is adjusted over a period of time against actual
telephone bills.
(5) Cost of construction of building including cost of temporary huts is capital expenditure.
Building is fixed asset which will generate enduring benefit to the business over more than
one accounting period. Construction of temporary huts is incidental to the main
construction. Such cost is also capitalised with the cost of building.

5. CAPITAL RECEIPTS AND REVENUE RECEIPTS

Just as a clear distinction between Capital and Revenue expenditure is necessary, in the same
manner capital receipts must be distinguished from revenue receipts.
Receipts which are obtained in course of normal business activities are revenue receipts (e.g.
receipts from sale of goods or services, interest income etc.). On the other hand, receipts which
are not revenue in nature are capital receipts (e.g. receipts from sale of fixed assets or investments,
secured or unsecured loans, owners contributions etc.). Revenue and capital receipts are
recognised on accrual basis as soon as the right of receipt is established. Revenue receipts
should not be equated with the actual cash receipts. Revenue receipts are credited to the Profit
and Loss Account.
On the other hand, Capital receipts are not directly credited to Profit and Loss Account. For
example, when a fixed asset is sold for Rs. 92,000 (cost Rs. 90,000), the capital receipts
Rs. 92,000 is not credited to Profit and Loss Account. Profit/Loss on sale of fixed assets is
calculated and credited to Profit and Loss Account as follows:
Sale Proceeds Rs. 92,000
Cost (Rs. 90,000)
Profit Rs. 2,000
Illustration 3
Good Pictures Ltd., construct a cinema house and incur the following expenditure during the
first year ending 30th June, 2009.
(i) Second-hand furniture worth Rs. 9,000 was purchased; repainting of the furniture costs
Rs. 1,000. The furniture was installed by own workmen, wages for this being Rs. 200.

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 CAPITAL AND REVENUE EXPENDITURES AND RECEIPTS

(ii) Expenses in connection with obtaining a license for running the cinema worth Rs. 20,000.
During the course of the year the cinema company was fined Rs. 1,000, for contravening
rules. Renewal fee Rs. 2,000 for next year also paid.
(iii) Fire insurance, Rs. 1,000 was paid on 1st January, 2009 for one year.
(iv) Temporary huts were constructed costing Rs. 1,200. They were necessary for the
construction of the cinema. They were demolished when the cinema was ready.
Point out how you would classify the above items.
Solution
1 The total cost of the furniture should be treated as Rs. 10,200 i.e., all the amounts mentioned
should be capitalised since without such expenditure the furniture would not be available
for use. If Rs. 1,000 and Rs. 200 have been respectively debited to the Repairs Account and
the Wages Account, these accounts will be credited to the Furniture Account.
2. License for running the cinema house is necessary, hence its cost should be capitalised.
But the fine of Rs. 1,000 is revenue expenditure. The renewal fee for the next year is also
revenue expenditure but pertains to the next year; hence, it is a prepaid expense.
3. Half of the insurance premium pertains to the year beginning on 1st July, 2009. Hence
such amount should be treated as prepaid expense. The remaining amount is revenue
expense for the current year.
4. Since the temporary huts were necessary for the construction, their cost should be added
to the cost of the cinema hall and thus capitalised.
Illustration 4
State with reasons, how you would classify the following items of expenditure:
1. Overhauling expenses of Rs. 25,000 for the engine of a motor car to get better fuel efficiency.
2. Inauguration expenses of Rs. 25 lacs incurred on the opening of a new manufacturing
unit in an existing business.
3. Compensation of Rs. 2.5 crores paid to workers, who opted for voluntary retirement.
Solution
1. Overhauling expenses are incurred for the engine of a motor car to derive better fuel
efficiency. These expenses will reduce the running cost in future and thus the benefit is in
form of endurable long-term advantage. So this expenditure should be capitalised.
2. Inauguration expenses incurred on the opening of a new unit may help to explore more
customers. This expenditure is in the nature of revenue expenditure, as the expenditure
may not generate any enduring benefit to the business over more than one accounting
period.
3. The amount paid to workers on voluntary retirement is in the nature of revenue expenditure.
Since the magnitude of the amount of expenditure is very significant, it may be better to
defer it over future years.

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Illustration 5
Classify the following expenditures and receipts as capital or revenue:
(i) Rs. 10,000 spent as travelling expenses of the directors on trips abroad for purchase of
capital assets.
(ii) Amount received from debtors during the year.
(iii) Amount spent on demolition of building to construct a bigger building on the same site.
(iv) Insurance claim received on account of a machinery damaged by fire.
Solution
(i) Capital expenditure.
(ii) Revenue receipt.
(iii) Capital expenditure.
(iv) Capital receipt.
Illustration 6
Are the following expenditures capital in nature?
(i) M/s ABC & Co. run a restaurant. They renovate some of the old cabins. Because of this
renovation some space was made free and number of cabins was increased from 10 to 13.
The total expenditure was Rs. 20,000.
(ii) M/s New Delhi Financing Co. sold certain goods on installment payment basis. Five
customers did not pay installments. To recover such outstanding installments, the firm
spent Rs. 10,000 on account of legal expenses.
(iii) M/s Ballav & Co. of Delhi purchased a machinery from M/s Shah & Co. of Ahmedabad.
M/s Ballav & Co. spent Rs. 40,000 for transportation of such machinery.
(iv) M/s Dogra & Co. spent Rs. 1,00,000 for organising an Inter-school Hockey Tournament
in Delhi. This was for advertising their new school bag and other books and stationery
which they want to market.
(v) M/s Dogra & Co. installed a machinery for Rs. 5,00,000 on 1.1.2003. They were charging
deprecation on straight line basis taking useful life of the machine as 10 years. In December,
2009 they found that the machine became obsolete which could not be used. The machine
can fetch only Rs. 50,000.
Solution:
(i) Renovation of cabins increased the number of cabins. This has an effect on the future
revenue generating capability of the business. Thus the renovation expense is capital
expenditure in nature.
(ii) Expense incurred to recover installments due from customer do not increase the revenue
generating capability in future. It is a normal recurring expense of the business. Thus the
legal expenses incurred in this case is revenue expenditure in nature.
(iii) Expenses incurred on account of transportation of fixed asset is capital expenditure in
nature.

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 CAPITAL AND REVENUE EXPENDITURES AND RECEIPTS

(iv) The purpose of expenses incurred for organising the Inter-school Hockey Tournament is
to advertise for some new products. This advertisement may have some enduring effect so
far as marketability of the new products. This expense may be treated as deferred revenue
expenditure.
(v) Loss arising out of obsolescence of machinery is revenue expenditure. This loss is to be
charged against revenue of the year in which such loss is recognised. In this case, loss due
to obsolescence is:
Rs.
Cost 5,00,000
Less: Depreciation 2003-2009 3,50,000
Written down value at the end of 2009 1,50,000
Less: Estimated scrap value 50,000
1,00,000
This loss is revenue loss in nature.
Illustration 7
Are the following expenses capital in nature?
(i) Wages paid for installation of fixed assets.
(ii) Expenses of trial run of a newly installed machine.
(iii) Money deposited with the wholesaler as security.
(iv) Money paid to Mahanagar Telephone Nigam Ltd. (MTNL) Rs. 8,000 for installing
Telephone in the office.
(v) Amount spent for inauguration of new selling centre.
(vi) Free gift to customers of a new product.
(vii) Diwali advance to employees.
(viii) Money advanced to suppliers for booking of goods.
Solution:
(i) Expenses incurred including wages for installation of any fixed asset is capital expenditure
in nature.
(ii) Expenses incurred for trial run of a newly installed machinery is capital expenditure in
nature.
(iii) Money deposited as security is not an expenditure item.
(iv) Money deposited with MTNL for installation of telephone is not expenditure item. This is
treated as an asset.
(v) Expenses incurred for inauguration of branch is treated as revenue expenditure. Sometime
heavy expenditures incurred at the inaugural are meant for advertisement purposes,
which have enduring effect on the future revenue generating capability of the business.
Such expenses may be treated as deferred revenue expenditure.

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(vi) Free gift to customers is an advertisement expense. This is normally treated as a revenue
expenditure. In case the amount involved in such free gift is heavy in relation to the
volume of sales of the business and in case such free gift has an enduring effect on the
future revenue generating capability of the business, it is treated as deferred revenue
expenditure.
(vii) Diwali advance to employees is not an expense item.
(viii) Money advanced to supplies for booking goods is not an expense item.

SELF EXAMINATION QUESTIONS

Pick up the correct answer from the given choices:
1. Classify the following expenditures and receipts as capital or revenue:
(i) Money spent Rs. 10,000 as traveling expenses of the directors on trips abroad for
purchase of capital assets is
(a) Capital expenditures (b) Revenue expenditures
(c) Deferred revenue expenditures (d) None of the above
(ii) Amount of Rs. 5,000 spent as lawyers fee to defend a suit claiming that the firms
factory site belonged to the plaintiffs land is
(a) Capital expenditures (b) Revenue expenditures
(c) Deferred revenue expenditures (d) None of the above
(iii) Entrance fee of Rs. 2,000 received by Ram and Shyam Social Club is
(a) Capital receipt (b) Revenue receipt
(c) Capital expenditures (d) Revenue expenditures
(iv) Subsidy of Rs. 40,000 received from the government for working capital by a
manufacturing concern is
(a) Capital receipt (b) Revenue receipt
(c) Capital expenditures (d) Revenue expenditures
(v) Insurance claim received on account of machinery damaged completely by fire is
(a) Capital receipt (b) Revenue receipt
(c) Capital expenditures (d) Revenue expenditures
(vi) Interest on investments received from UTI is
(a) Capital receipt (b) Revenue receipt
(c) Capital expenditures (d) Revenue expenditures
(vii) Amount received from IDBI as a medium term loan for augmenting working capital is
(a) Capital expenditures (b) Revenue expenditures
(c) Capital receipt (d) Revenue receipt

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 CAPITAL AND REVENUE EXPENDITURES AND RECEIPTS

(viii) A bad debt recovered during the year will be

(a) Capital expenditures (b) Revenue expenditures
(c) Capital receipt (d) Revenue receipt
(ix) A second hand car is purchased for Rs. 10,000, the amount of Rs. 1,000 is spent on its
repairs, Rs. 500 is incurred to get the car registered in owners name and Rs. 1,200 is
paid as dealers commission. The amount debited to car account will be
(a) Rs. 10,000. (b) Rs. 10,500. (c) Rs. 11,500. (d) Rs. 12,700.
(x) Revenue from sale of products, ordinarily, is reported as part of the earning in the
period in which
(a) the sale is made. (b) the cash is collected.
(c) the products are manufactured. (d) the planning takes place.
(xi) If repair cost is Rs. 25,000, whitewash expenses are Rs. 5,000, cost of extension of
building is Rs. 2,50,000 and cost of improvement in electrical wiring system is Rs.
19,000; the amount to be expensed is
(a) Rs. 2,99,000. (b) Rs. 44,000. (c) Rs. 30,000. (d) Rs. 49,000.
[Ans. 1: (i)-(a), (ii)-(b), (iii)-(a), (iv)-(b), (v)-(a), (vi)-(b), (vii)-(c), (viii)-(d), (ix)-(d), (x)-(a), (xi)-(c)]
2. Out of the following which are (1) capital expenditure; (2) revenue expenditure; and (3)
deferred revenue expenditure?
(i) Rs. 1,200 spent on the repairs of machine is
(a) capital expenditure; (b) revenue expenditure;
(c) deferred revenue expenditure; (d) None of the above.
(ii) Rs. 2,500 spent on the overhaul of machines purchased second-hand is
(a) capital expenditure; (b) revenue expenditure;
(c) deferred revenue expenditure; (d) None of the above.
(iii) Whitewashing expenses are
(a) capital expenditure; (b) revenue expenditure;
(c) deferred revenue expenditure; (d) None of the above.
(iv) Paper purchased for use as stationery is
(a) capital expenditure; (b) revenue expenditure;
(c) deferred revenue expenditure; (d) None of the above.
(v) Advertising campaign to launch a new product is
(a) capital expenditure; (b) revenue expenditure;
(c) deferred revenue expenditure; (d) None of the above.
[Ans: 2: (ii) is a capital expenditure and Item no. (v) is deferred revenue expenditure, and
remaining items are revenue expenditures.]

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 CHAPTER - 2

ACCOUNTING
PROCESS

Unit 7

Contingent Assets
and Contingent
Liabilities

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 CONTINGENT ASSETS AND CONTINGENT LIABILITIES

Learning Objectives
After studying this unit you will be able to :

 Understand the meaning of the terms 'Contingent Assets' and 'Contingent Liabilities'.
 Distinguish 'Contingent Liabilities' with 'Liabilities' and 'Provisions'.

1. CONTINGENT ASSETS
A contingent asset may be defined as a possible asset that arises from past events and whose
existence will be confirmed only after occurrence or non-occurrence of one or more uncertain
future events not wholly within the control of the enterprise. It usually arises from unplanned
or unexpected events that give rise to the possibility of an inflow of economic benefits to the
business entity. For example, a claim that an enterprise is pursuing through legal process,
where the outcome is uncertain, is a contingent asset.
As per the concept of prudence as well as the present accounting standards, an enterprise
should not recognise a contingent asset. These assets are uncertain and may arise from a claim
which an enterprise pursues through a legal proceeding. There is uncertainty in realisation of
claim. It is possible that recognition of contingent assets may result in recognition of income
that may never be realised. However, when the realisation of income is virtually certain, then
the related asset no longer remains as contingent asset.
A contingent asset need not be disclosed in the financial statements. A contingent asset is
usually disclosed in the report of the approving authority (Board of Directors in the case of a
company, and the corresponding approving authority in the case of any other enterprise), if
an inflow of economic benefits is probable. Contingent assets are assessed continually and if it
has become virtually certain that an inflow of economic benefits will arise, the asset and the
related income are recognised in the financial statements of the period in which the change
occurs.

2. CONTINGENT LIABILITIES
The term 'Contingent liability' can be defined as
"(a) a possible obligation1 that arises from past events and the existence of which will be
confirmed only by the occurrence or non-occurrence of one or more uncertain future
events not wholly within the control of the enterprise; or
(b) a present obligation2 that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
(ii) a reliable estimate of the amount of the obligation cannot be made."

1
Possible Obligation: An obligation is a possible obligation if, based on the evidence available, its existence at the balance sheet date
is considered not probable.
2
Present Obligation: An obligation is a present obligation if, based on the evidence available, its existence at the balance sheet date
is considered probable, i.e., more likely than not.

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A contingent liability is a possible obligation arising from past events and may arise in future
depending on the occurrence or non-occurrence of one or more uncertain future events [part
(a) of the definition]. A contingent liability may also be a present obligation that arises from
past events [(part (b) of the definition)].
An enterprise should not recognise a contingent liability. A Contingent liability is required to be
disclosed unless possibility of outflow of a resource embodying economic benefits is remote.
These liabilities are assessed continually to determine whether an outflow of resources
embodying economic benefits has become probable. If it becomes probable that an outflow or
future economic benefits will be required for an item previously dealt with as a contingent
liability, a provision is recognised in financial statements of the period in which the change in
probability occurs except in the extremely rare circumstances where no reliable estimate can
be made.

3. DISTINCTION BETWEEN CONTINGENT LIABILITIES AND

LIABILITIES
The distinction between a liability and a contingent liability is generally based on the judgement
of the management. A liability is defined as the present financial obligation of an enterprise,
which arises from past events. The settlement of a liability results in an outflow from the
enterprises of resources embodying economic benefits. On the other hand, in the case of
contingent liability, either outflow of resources to settle the obligation is not probable or the
amount expected to be paid to settle the liability cannot be measured with sufficient reliability.
Examples of contingent liabilities are claims against the enterprise not acknowledged as debts,
guarantees given in respect of third parties, liability in respect of bills discounted and statutory
liabilities under dispute etc. In addition to present obligations that are recognised as liabilities
in the balance sheet, enterprises are required to disclose contingent liability in their balance
sheets by way of notes.

4. DISTINCTION BETWEEN CONTINGENT LIABILITIES AND

PROVISIONS
Provision means "any amount written off or retained by way of providing for depreciation,
renewal or diminution in the value of assets or retained by way of providing for any known
liability of which the amount cannot be determined with substantial accuracy".
It is important to know the difference between provisions and contingent liabilities. The
distinction between both of them can be explained as follows:

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 CONTINGENT ASSETS AND CONTINGENT LIABILITIES

Provision Contingent liability

(1) Provision is a present liability of uncertain A Contingent liability is a possible
amount, which can be measured reliably obligation that may or may not crystallise
by using a substantial degree of estimation. depending on the occurrence or non-
occurrence of one or more uncertain future
events.
(2) A provision meets the recognition criteria. A contingent liability fails to meet the same.

(3) Provision is recognised when (a) an Contingent liability includes present

enterprise has a present obligation arising obligations that do not meet the recognition
from past events; an outflow of resources criteria because either it is not probable that
embodying economic benefits is probable, settlement of those obligations will require
and (b) a reliable estimate can be made of outflow of economic benefits, or the
the amount of the obligation. amount cannot be reliably estimated.

(4) If the management estimates that it is If the management estimates, that it is less
probable that the settlement of an obligation likely that any economic benefit will
will result in outflow of economic benefits, outflow the firm to settle the obligation, it
it recognises a provision in the balance discloses the obligation as a contingent
sheet. liability.

Let us take an example to understand the distinction between provisions and contingent
liabilities. The Central Excise Officer imposes a penalty on Alpha Ltd. for violation of a provision
in the Central Excise Act. The company goes on an appeal. If the management of the company
estimates that it is probable that the company will have to pay the penalty, it recognises a
provision for the liability. On the other hand, if the management anticipates that the judgement
of the appellate authority will be in its favour and it is less likely that the company will have to
pay the penalty, it will disclose the obligation as a contingent liability instead of recognising a
provision for the same.

SELF EXAMINATION QUESTIONS

Pick up the correct answer from the given choices:
1. (i) Contingent asset usually arises from unplanned or unexpected events that give rise to
(a) The possibility of an inflow of economic benefits to the business entity.
(b) The possibility of an outflow of economic benefits to the business entity.
(c) Either (a) or (b)
(d) None of the above.

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 (ii) If an inflow of economic benefits is probable then a contingent asset is disclosed
(a) in the financial statements.
(b) in the report of the approving authority (Board of Directors in the case of a
company, and the corresponding approving authority in the case of any other
enterprise).
(c) In the cash flow statement.
(d) None of the above.
(iii) In the case of ___________, either outflow of resources to settle the obligation is not
probable or the amount expected to be paid to settle the liability cannot be measured
with sufficient reliability.
(a) Liability.
(b) Provision.
(c) Contingent liabilities.
(d) Contingent assets.
(iv) Present liability of uncertain amount, which can be measured reliably by using a
substantial degree of estimation is termed as ________.
(a) Provision.
(b) Liability.
(c) Contingent liability.
(d) None of the above.
(v) In the financial statement, contingent liability is
(a) Recognised
(b) Not recognised.
(c) Adjusted.
(d) None of the above.

ANSWERS
(i) (a) (ii) (b) (iii) (c) (iv) (a) (v) (a)

FUNDAMENTALS OF ACCOUNTING 2.101

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 CHAPTER - 2

ACCOUNTING
PROCESS

Unit 8

Rectification of
Errors

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Learning Objectives
After studying this unit, you will be able to :

 Understand different types of errors which may occur in course of recording transactions
and events.
 Be familiar with the steps involved in locating errors.
 Learn the nature of one-sided errors and two-sided errors.
 Understand why suspense account is opened for rectification of errors.
 Understand the technique of correcting errors of one period in the next accounting period.

1. INTRODUCTION
Unintentional omission or commission of amounts and accounts in the process of recording
the transactions are commonly known as errors. These various unintentional errors can be
committed at the stage of collecting financial information/data on the basis of which financial
statements are drawn or at the stage of recording this information. Also errors may occur as a
result of mathematical mistakes, mistakes in applying accounting policies, misinterpretation of
facts, or oversight. To check the arithmetic accuracy of the journal and ledger accounts, trial
balance is prepared. If the trial balance does not tally, then it can be said that there are errors
in the accounts which requires rectification thereof. Some of these errors may affect the Trial
Balance and some of these do not have any impact on the Trial Balance although such errors
may affect the determination of profit or loss, assets and liabilities of the business.
Illustrative Case of Errors and their Nature
We have seen that after preparing ledger accounts a trial balance is taken out where debit and
credit balances are separately listed and totalled. If the two totals do not agree, it is definite
that there have been some errors. We shall now study the types of errors which may be
committed and how they may be rectified. For this purpose, the working of the following
illustrative cases should be carefully seen.
Illustrative Cases of Errors
(a) Wrong Entry: Let us start from the first phase in the accounting process. Wrong entry of
the value of transactions and events in the subsidiary books, Journal Proper and Cash Book
may occur.
Example 1: Credit purchases Rs. 17,270 are entered in the Purchases Day Book as Rs. 17,720.
Credit sales of Rs. 15,000 gross less 1% trade discount are wrongly entered in Sales Day Book
at Rs. 15,000. Cheque issued Rs. 19,920 are wrongly entered in the credit of bank column in
the Cash Book as Rs. 19,290.
(b) Wrong positing from subsidiary books: Subsidiary books are totalled periodically and
posted to the appropriate ledger accounts. There may arise totalling errors. Totalling errors
may arise due to wrong entry or simply these may be independent errors.
Example 2: For the month of January, 2006 total of credit sales are Rs. 1,75,700, this is wrongly
totalled as Rs. 1,76,700 and posted to sales account as Rs. 1,76,700.

FUNDAMENTALS OF ACCOUNTING 2.103

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 RECTIFICATION OF ERRORS

(c) Wrong casting of subsidiary book: For example, wrong castings of the Cash Book result
in balancing error.
Example 3: The following cash transactions of M/s Tularam & Co. occurred:
2009
Jan. 1 Balance - cash Rs. 1,200 bank Rs. 16,000;

Jan. 2 Cheque issued to M/s Bholaram & Co., a supplier, for Rs. 22,500;

Jan. 6 Cheque collected from M/s Scindia & Bros. Rs. 42,240 and deposited for clearance;

Jan. 7 Cash sales Rs. 27,200 paid wages Rs. 12,400;

Jan. 8 Cash sales Rs. 37,730 cash deposited to bank Rs. 35,000.

The following Cash Book entries are passed:

Cash Book
Dr. Cr.
Date Particulars Cash Bank Date Particulars Cash Bank
Rs. Rs. Rs. Rs.
2009 2006
Jan. 1 To Balance b/d 1,200 16,000 Jan. 2 By M/s Bholaram & Co. A/c 22,500
Jan. 6 To M/s Scindia & Bros A/c 42,420 By Wages A/c 12,200
Jan. 7 To Sales A/c 27,200 By Bank A/c 34,500
Jan. 8 To Sales A/c 37,370 By Balance c/d 19,070 71,420

Jan. 8 To Cash A/c 34,500

65,770 93,920 65,770 93,920

Wrong entries and casting are shown in bold prints. However, errors of cash entries generally
are not carried. Usually cash balances are tallied daily. So errors are identified at an early
stage. But bank balance cannot be checked daily and thus errors may be carried until bank
reconciliation is made. In the above example, there are four wrong entries and one wrong
casting Bank and cash balances are affected by these errors.
(d) Wrong casting of ledger balances: Likewise Cash Book, any ledger account balance may
be cast wrongly. Obviously wrong postings make the balance wrong; but that is not wrong
casting of balances. Whenever there arises independent casting error as in the case of bank
column in the Cash Book of example (4), that is called wrong casting of ledger balances.

2.104 COMMON PROFICIENCY TEST

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Example 4: The following are the credit purchases of M/s Ballav Bros.:
2009
Jan. 1 Purchases from M/s Saurabh & Co.- gross Rs. 1,00,000 less 1% trade discount.
Jan. 3 Purchases from M/s Netai & Co.- gross Rs. 70,000 less 1% trade discount.
Jan. 6 Purchases from M/s Saurabh & Co.- gross Rs. 60,000 less 1% trade discount
Let us cast M/s Saurabh & Co.'s Account:
M/s Saurabh & Co. Account
Dr. Cr.
Date Particulars Amount Date Particulars Amount
Rs. Rs.
2009 2009
Jan. 1 To Balance c/d 1,55,000 Jan. 1 By Purchases A/c 99,000
Jan. 6 By Purchases A/c 59,000
1,55,000 1,55,000

While casting the credit side an error has been committed and so the account is wrongly
balanced.
Example 5: Goods are purchased on credit from M/s Saurabh & Co. for Rs. 27,030 and from
M/s Karnataka Suppliers for Rs. 28,050. The following Day Book is prepared:
Purchases Day Book
Date Particulars Amount
Rs.
M/s Saurabh & Co. 27,050
M/s Karnataka Suppliers 28,030
55,080

In the Day Book both the transactions are entered wrongly but the first error has been
compensated by the second. Even if these errors are not rectified Trial Balance would tally.
Trial Balance
Particulars Dr. Cr.
Rs.
M/s Saurabh & Co. 27,050
M/s Karnataka Suppliers 28,030
Purchases Account 55,080
55,080 55,080

FUNDAMENTALS OF ACCOUNTING 2.105

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 RECTIFICATION OF ERRORS

2. STAGES OF ERRORS
Errors may occur at any of the following stages of the accounting process:
2.1 AT THE STAGE OF RECORDING THE TRANSACTIONS IN JOURNAL
Following types of errors may happen at this stage:
(i) Errors of principle,
(ii) Errors of omission,
(iii) Errors of commission.
2.2 AT THE STAGE OF POSTING THE ENTRIES IN LEDGER
(i) Errors of omission:
(a) Partial omission,
(b) Complete omission.
(ii) Errors of commission:
(a) Posting to wrong account,
(b) Posting on the wrong side,
(c) Posting of wrong amount.
2.3 AT THE STAGE OF BALANCING THE LEDGER ACCOUNTS
(a) Wrong Totalling of accounts,
(b) Wrong Balancing of accounts.
2.4 AT THE STAGE OF PREPARING THE TRIAL BALANCE
(a) Errors of omission,
(b) Errors of commission:
1. Taking wrong account,
2. Taking wrong amount,
3. Taking to the wrong side.
On the above basis, we can classify the errors in four broad categories:
1. Errors of Principle,
2. Errors of Omission,
3. Errors of Commission,
4. Compensating Errors.

2.106 COMMON PROFICIENCY TEST

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 3. TYPES OF ERRORS
Basically errors are of two types:
(a) Errors of principle: When a transaction is recorded in contravention of accounting
principles, like treating the purchase of an asset as an expense, it is an error of principle. In
this case there is no effect on the trial balance since the amounts are placed on the correct
side, though in a wrong account.
(b) Clerical errors: These errors arise because of mistake committed in the ordinary course of
the accounting work. These are of three types:
(i) Errors of Omission: If a transaction is completely or partially omitted from the books of
account, it will be a case of omission. Examples would be: not recording a credit
purchase of furniture or not posting an entry into the ledger.
(ii) Errors of Commission: If an amount is posted in the wrong account or it is written on
the wrong side or the totals are wrong or a wrong balance is struck, it will be a case of
"errors of commission."
(iii) Compensating Errors: If the effect of errors committed cancel out, the errors will be
called compensating errors. The trial balance will agree.
From another point of view, error may be divided into two categories:
(a) Those that affect the trial balance - because of the errors that trial balance does
not agree; and
(i) Wrong casting of the subsidiary books [see (b) above.]
(ii) Wrong balancing of an account [see (a) above.]
(iii) Posting an amount on the wrong side [see (d) above.]
(iv) Wrong posting, ie., writing the wrong amount [see (d) above.]
(v) Omitting to post an amount from a subsidiary book.
(vi) Omitting to post the totals of subsidiary book.
(vii) Omitting to write the cash book balances in the trial balance.
(viii)Omitting to write the balance of an account in the trial balance.
(ix) Writing a balance in wrong column of the trial balance.
(x) Totalling the trial balance wrongly.
(b) The errors that do not affect the trial balance are the following:
(i) Omitting an entry altogether from the subsidiary book [see (i) above.]
(ii) Making an entry in the wrong subsidiary book [see (ii) above.]
(iii) Posting an amount in a wrong account but on the correct side, e.g., an
amount to be debited to A is debited to B, the trial balance will still agree.
(iv) Errors of principle: Suppose on the purchase of a typewriter, the office expenses account
is debited; the trial balance will still agree.
(v) Compensating errors: If the effect of an error is cancelled by the effect of some other
error, the trial balance will naturally agree. Suppose an amount of Rs. 10 received
from A is not credited to his account and the total of the sales book is Rs. 10 in excess.
The omission of credit to A's account will be made up by the increased credit to the
Sales Account; there will not be any effect on the trial balance.

FUNDAMENTALS OF ACCOUNTING 2.107

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 A chart of the types of errors is given below:

2.108
ERRORS

Errors of Principle (Treating a Clerical Errors

revenue expense as capital
expenditure or vice versa or
the sale of a fixed asset as
ordinary sale). Trial Balance
RECTIFICATION OF ERRORS

will agree. Errors of Omission Errors of Compensating

Commission Errors. Trial
Balance will
agree.

Omitting an entry Omitting to post the

completely from the ledger account from
subsidiary books. Trial the subsidiary books.

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Balance will agree. Trial Balance will not agree.

Writing the wrong Wrong casting Posting the Posting an Wrong

amount in the of subsidiary wrong amount amount on balancing
subsidiary books. books. in the ledger. the wrong side. of an account
Trial Balance
will agree.

Trial Balance will not agree.

COMMON PROFICIENCY TEST

 4. STEPS TO LOCATE ERRORS
Even if there is only a very small difference in the trial balance, the errors leading to it must be
located and rectified. A small difference may be the result of a number of errors. The following
steps will be useful in locating errors :
(i) The two columns of the trial balance should be totalled again. If in place of a number of
accounts, only one amount has been written in the trial balance the list of such accounts
should be checked and totalled again. List of debtors is the example from which Sundry
debtors balance is derived.
(ii) It should be seen that the cash and bank balances have been written in the trial balance.
(iii) The exact difference in the trial balance should be established. The ledger should be gone
through; it is possible that a balance equal to the difference has been omitted from the trial
balance. The difference should also be halved; it is possible that balance equal to half the
difference has been written in the wrong column.
(iv) The ledger accounts should be balanced again.
(v) The casting of subsidiary books should be checked again, especially if the difference is
Re. 1, Rs. 100 etc.
(vi) If the difference is very big, the balance in various accounts should be compared with the
corresponding accounts in the previous period. If the figures differ materially the cases
should be seen; it is possible that an error has been committed. Suppose the sales account
for the current year shows a balance of Rs. 32,53,000 whereas it was Rs. 36,45,000 last
year; it is possible that there is an error in the Sales Account.
(vii) Postings of the amounts equal to the difference or half the difference should be checked. It
is possible that an amount has been omitted to be posted or has been posted on the wrong
side.
(viii)If there is still a difference in the trial balance, a complete checking will be necessary. The
posting of all the entries including the opening entry should be checked. It may be better
to begin with the nominal accounts.

5. RECTIFICATION OF ERRORS
Errors should never be corrected by overwriting. If immediately after making an entry it is
clear that an error has been committed, it may be corrected by neatly crossing out the wrong
entry and making the correct entry. If however the errors are located after some time, the
correction should be made by making another suitable entry, called rectification entry. In fact
the rectification of an error depends on at which stage it is detected. An error can be detected
at any one of the following stages:
(a) Before preparation of Trial Balance.
(b) After Trial Balance but before the final accounts are drawn.
(c) After final accounts, i.e., in the next accounting period.

FUNDAMENTALS OF ACCOUNTING 2.109

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 RECTIFICATION OF ERRORS

5.1 BEFORE PREPARATION OF TRIAL BALANCE

There are some errors which affect one side of an account or which affect more than one
account in such a way that it is not possible to pass a complete rectification entry. In other
words, there are some errors which can be corrected, if detected at this stage, by making
rectification statement in the appropriate side(s) of concerned account(s). It is important to
note here that such errors may involve only one account or more than one account. Read the
following illustrations:
(i) The sales book for November is undercast by Rs. 200. The effect of this error is that the
Sales Account has been credited short by Rs. 200. Since the account is posted by the total
of the sales book, there is no error in the accounts of the customers since they are posted
with amounts of individual sales. Hence only the Sales Accounts is to be corrected. This
will be done by making an entry for Rs. 200 on the credit side: "By undercasting of Sales
Book for November Rs. 200".
(ii) While posting the discount column on the debit side of the cash book the discount of
Rs. 10 allowed to Ramesh has not been posted. There is no error in the cash book, the total
of discount column presumably has been posted to the discount account on the debit side.
The error is in not crediting Ramesh by Rs. 10. This should now be done by the entry "By
omission of posting of discount on ----- Rs. 10".
(iii) Rs. 200 received from Ram has been entered by mistake on the debit side of his account.
Since the cash book seems to have been correctly written, the error is only in th account of
Ram - he should have been credited and not debited by Rs. 200. Not only is the wrong
debit to be removed but also a credit of Rs. 200 is to be given.This can be done now by
entering Rs. 400 on the credit side of his account. The entry will be "By Posting on the
wrong side - Rs. 400".
(iv) Rs. 50 was received from Mahesh and entered on the debit side of the cash book but was
not posted to his account. By the error, which affects only the account of Mahesh, Rs. 50
has been omitted from the credit side of his account. The rectification will be by the entry.
"By Omission of posting on the Rs. 50"
(v) Rs. 51 paid to Mohan has been posted as Rs. 15 to the debit of his account. Mohan has
been debited short by Rs. 36. The rectifying entry is "To mistake in posting on Rs. 36".
(vi) Goods sold to Ram for Rs. 1,000 was wrongly posted from sales day book to the debit of
purchase account. Ram has however been correctly debited. Here the error affects two
accounts, viz., purchases account and sales account but we cannot pass a journal entry
for its rectification because both the accounts need to be credited . The rectification will be
by the entry "By wrong posting on Rs. 1,000" in the credit of purchases account and also
"By omission of posting on - Rs. 1,000" in the credit sales account.
(vii) Bills receivable from Mr. A of Rs. 500 was posted to the credit of Bills payable Account
and also credited to A account. Here also although two accounts are involved we cannot
pass a complete journal entry for rectification. The rectification will be by the entry "To
wrong posting on Rs. 500" in debit of Bills payable Account and also "To omission of
posting on Rs. 500" in the debit of Bills Receivable Account.

2.110 COMMON PROFICIENCY TEST

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(viii)Goods purchased from Vinod for Rs. 1,000 was wrongly credited to Vimal account by
Rs. 100. Again we cannot pass a complete journal entry for rectification even though two
accounts are involved. The rectification will be done by the entry "To wrong posting on
Rs. 100" in the debit of Vimal account and "By omission of posting on Rs 1,000" in the
credit of Vinod account.
Thus, from the above illustrations we are convinced that the general rule that errors affecting
two accounts can always be corrected by a journal entry is not always valid.
Such errors will be rectified as follows:
(a) To correct the wrong balancing of the bank column, an entry will be made on the debit
side on first November as follows. "To mistake in balancing Rs. 500".
(b) To correct the excess posting in purchases book the entry will be "By Mistake in totalling
the purchases book for October, 2005 Rs 100".
(c) The discount account will be opened and posted as already shown.
(d) In account of G. Norwood we shall first debit Rs. 640 so that the wrong credit of Rs. 320 is
converted into the debit of Rs. 320.
The entry will be "To Wrong posting on October 5, Rs. 640." Then to remove the wrong debit of
Rs. 312 and give the correct credit of Rs. 320 Rs. 632 will be entered on the credit side by the
entry. "By Wrong posting on October 16, Rs. 632. The account of G.Norwood will appear as
shown below:
G. Norwood
Dr. Cr.
2005 Rs. 2005 Rs.
Oct. 16 To Cash Book 312 Oct. 5 By Sales Book 320
" 11 To Wrong posting " 31 By Wrong posting
on Oct. 5 on Oct. 16
(wrong side) 640 (wrong side, wrong amount)
632
952 952

(e) Rs. 36 has to be debited to the Purchases Account since on the 26th October, Rs. 36 was
credited to this account in excess. The entry will be "To Wrong posting on Oct. 26 Rs. 36".
Illustration 2
How would you rectify the following errors in the book of Rama & Co.?
1. The total to the Purchases Book has been undercast by Rs. 100.
2. The Returns Inward Book has been undercast by Rs. 50.
3. A sum of Rs. 250 written off as depreciation on Machinery has not been debited to
Depreciation Account.

FUNDAMENTALS OF ACCOUNTING 2.111

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 RECTIFICATION OF ERRORS

4. A payment of Rs. 75 for salaries (to Mohan) has been posted twice to Salaries Account.
5. The total of Bills Receivable Book Rs. 1,500 has been posted to the credit of Bills Receivable
Account.
6. An amount of Rs. 151 for a credit sale to Hari, although correctly entered in the Sales
Book, has been posted as Rs. 115.
7. Discount allowed to Satish Rs. 25 has not been entered in the Discount Column of the
Cash Book. It has been posted to his personal account.
Solution
1. The Purchases Account should receive another debit of Rs. 100 since it was debited short
previously :
"To Undercasting of Purchases Book for the month of --- Rs. 100."
2. Due to this error the Returns Inward Account has been posted short by Rs. 50 : the correct
entry will be :
"To Undercasting of Returns Inward Book for the month of --- Rs. 50."
3. The omission of the debit to the Depreciation Account will be rectified by the entry :
"To Omission of posting on Rs. 250".
4. The excess debit will be removed by a credit in the Salaries Account by the entry :
"By double posting on Rs. 75".
5. Rs. 1,500 should have been debited to the Bills Receivable Account and not credited. To
correct the mistake, the Bills Receivable Account should be debited by Rs. 3,000 by the
entry:
"To Wrong posting of B/R received on Rs. 3,000"
6. Hari's personal A/c is debited Rs. 36 short the rectification entry will be :
"To Wrong posting Rs. 36".
7. Due to this error, the discount account has been debited short by Rs. 25. The required
entry is :
"To Omission of discount allowed to Satish on Rs. 25."
So far we have discussed the correction of errors which affected only one Account of more
than one account but for which rectifying entries were not complete journal entries in fact that
rectifying entry is made directly in the account(s) concerned. We shall now take up the correction
of errors which affect more than one account in such a way that complete journal entries are
possible for their rectification. Read the following illustrations :
(i) The purchase of machinery for Rs. 2,000 has been entered in the purchases book. The
effect of the entry is that the account of the supplier has been credited by Rs. 2,000 which
is quite correct. But the debit to the Purchases Account is wrong : the debit should be to
Machinery Account. To rectify the error, the debit in the purchases Account has to be
transferred to the Machinery Account. The correcting entry will be to Credit Purchases
Account and debit the Machinery Account. Please see the three entries made below: the
last entry rectifies the error:
Wrong Entry : Rs. Rs.
Purchases Account Dr. 2,000
To Creditor 2,000

2.112 COMMON PROFICIENCY TEST

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 Correct Entry :
Machinery Account Dr. 2,000
To Creditor 2,000
Rectifying Entry :
Machinery Account Dr. 2,000
To Purchases Account 2,000
(ii) Rs. 100 received from Kamal Kishore has been credited in the account of Krishan Kishore.
The error is that there is a wrong credit in the account of Krishan Kishore and omission of
credit in the account of Kamal Kishore; Krishan Kishore should be debited and Kamal
Kishore be credited. The following three entries make this clear :
Wrong Entry : Rs. Rs.
Cash Account Dr. 100
To Krishan Kishore 100
Correct Entry :
Cash Account Dr. 100
To Kamal Kishore 100
Rectifying Entry :
Krishan Kishore Dr. 100
To Kamal Kishore 100
(iii) The sale of old machinery, Rs. 1,000 has been entered in the sales book. By this entry the
account of the buyer has been correctly debited by Rs. 1,000. But instead of crediting the
Machinery Account. Sales Account has been credited. To rectify the error this account
should be debited and the Machinery Account credited. See the three entries given below:
Wrong Entry : Rs. Rs.
Buyer's Account Dr. 1,000
To Sales Account 1,000
Correct Entry :
Buyer's Account Dr. 1,000
To Machinery Account 1,000
Rectifying Entry :
Sales Account Dr. 1,000
To Machinery Account 1,000
Illustration 3
The following errors were found in the book of Ram Prasad & Sons. Give the necessary entries
to correct them.
(1) Rs. 500 paid for furniture purchased has been charged to ordinary Purchases Account.
(2) Repairs made were debited to Building Account for Rs. 50.

FUNDAMENTALS OF ACCOUNTING 2.113

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 RECTIFICATION OF ERRORS

(3) An amount of Rs. 100 withdrawn by the proprietor for his personal use has been debited
to Trade Expenses Account.
(4) Rs. 100 paid for rent debited to Landlord's Account.
(5) Salary Rs. 125 paid to a clerk due to him has been debited to his personal account.
(6) Rs. 100 received from Shah & Co. has been wrongly entered as from Shaw & Co.
(7) Rs. 700 paid in cash for a typewriter was charged to Office Expenses Account.

Solution
JOURNAL
Particulars L.F. Dr. Cr.
Rs. Rs.
(1) Furniture A/c Dr. 500
To Purchases A/c 500
(Correction of wrong debit to Purchases A/c
for furniture purchased)
(2) Repairs A/c Dr. 50
To Building A/c 50
(Correction of wrong debit to building A/c for
repairs made)
(3) Drawings A/c. Dr. 100
To Trade Expenses A/c 100
(Correction of wrong debit to Trade Expenses
A/c for cash withdrawn by the proprietor for
his personal use)
(4) Rent A/c Dr. 100
To Landlord's Personal A/c 100
(Correction of wrong debit to land-lord's A/c
for rent paid)
(5) Salaries A/c Dr. 125
To Clerk's (Personal) A/c 125
(Correction of wrong debit to Cleark's personal
A/c for salaries paid)
(6) Shaw & Co. Dr. 100
To Shah & Co. 100
(Correction of wrong credit to Shaw & Co.
Instead of Shah & Co.)
(7) Typewriter A/c Dr. 700
To Office Expenses A/c 700
(Correction of wrong debit to Office Expenses
A/c for purchase of typewriter)

2.114 COMMON PROFICIENCY TEST

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Illustration 4
Give journal entries to rectify the following :
(1) A purchase of goods from Ram amounting to Rs. 150 has been wrongly entered through
the Sales Book.
(2) A Credit sale of goods amounting Rs. 120 to Ramesh has been wrongly passed through
the Purchase Book.
(3) On 31st Dec. 2003 goods of the value of Rs. 300 were returned by Hari Saran and were
taken into stock on the same date but no entry was passed in the books.
(4) An amount of Rs. 200 due from Mahesh Chand, which had been written off as a Bad
Debt in a previous year, was unexpectedly recovered, and had been posted to the personal
account of Mahesh Chand.
(5) A Cheque for Rs. 100 received from Man Mohan was dishonoured and had been posted
to the debit of Sales Returns Account.
Solution
JOURNAL
Particulars L.F. Dr. Cr.
Rs. Rs.

(1) Purchases A/c Dr. 150

Sales A/c Dr. Dr. 150
To Ram 300
(Correction of wrong entry in the sales Book
for a purchases of goods from Ram)
(2) Ramesh Dr. 240
To Purchases A/c 120
To Sales A/c 120
(Correction of wrong entry in the Purchases
Book of a credit sale of goods to Ram)
(3) Returns Inwards A/c Dr. 300
To Hari Saran 300
(Entry of goods returned by him and taken in
stock omitted from records)
(4) Mahesh Chand Dr. 200
To Bad Debts Recovered A/c 200
(Correction of wrong credit to Personal A/c in
respect of recovery of previously written off bad debts)
(5) Man Mohan Dr. 100
To Sales Return A/c 100
(Correction of wrong debit to Sales Returns A/c
for dishonour of cheque received from Man Mohan)

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 RECTIFICATION OF ERRORS

Thus it can be said that errors detected before the preparation of trial balance can be rectified
either through rectification statements (not entries) or through rectification entries.
5.2 AFTER TRIAL BALANCE BUT BEFORE FINAL ACCOUNTS
The method of correction of error indicated so far is appropriate when the errors have been
located before the end of the accounting period. After the corrections the trial balance will
agree. Sometimes the trial balance is artificially made to agree inspite of errors by opening a
suspense account and putting the difference in the trial balance to the account - the suspense
account will be debited if the total of the credit column in the trial balance exceeds the total of
the debit column; it will be credited in the other case.
One must note that such agreement of the trial balance will not be real. Effort must be made to
locate the errors.
The rule of rectifying errors detected at this stage is simple. Those errors for which complete
journal entries were not possible in the earlier stage of rectification (i.e., before trial balance)
can now be rectified by way of journal entry(s) with the help of suspense account, for it these
errors which gave rise to the suspense account in the trial balance. The rectification entry for
other type of error i.e. error affecting more than one account in such a way that a complete
journal entry is possible for its rectification, can be rectified in the same way as in the earlier
stage (i.e. before trial balance).
In a nutshell, it can be said that each and every error detected at this stage can only be corrected
by a complete journal entry. Those errors for which journal entries were not possible at the
earlier stage will now be rectified by a journal entry(s), the difference or the unknown side is
being taken care of by suspense account. Those errors for which entries were possible even at
the first stage will now be rectified in the same way.
Suppose, the sales book for November, 2005 is cast Rs. 100 short; as a consequence the trial
balance will not agree. The credit column of the trial balance will be Rs. 100 short and a
Suspense Account will be credited by Rs. 100. To rectify the error the Sales Account will be
credited (to increase the credit to the right figure. Since now one error remains, the Suspense
Account must be closed- it will be debiting the Suspense Account. The entry will be :
Suspense Account Dr. Rs. 100
To Sales Account Rs. 100
(Correction of error of undercasting the sales
Book for Nov. 2005)

Illustration 5
Correct the following errors (i) without opening a Suspense Account and (ii) opening a Suspense
Account :
(a) The Sales Book has been totalled Rs. 100 short.
(b) Goods worth Rs. 150 returned by Green & Co. have not been recorded anywhere.
(c) Goods purchased Rs. 250 have been posted to the debit of the supplier Gupta & Co.

2.116 COMMON PROFICIENCY TEST

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(d) Furniture purchased from Gulab & Bros, Rs. 1,000 has been entered in Purchases Day
Book.
(e) Discount received from Red & Black Rs. 15 has not been entered in the Discount Column
of the Cash Book.
(f) Discount allowed to G. Mohan & Co. Rs. 18 has not been entered in the Discount Column
of the Cash Book. The account of G. Mohan & Co. has, however, been correctly posted.
Solution
If a Suspense Account is not opened.
(a) Since sales book has been cast Rs. 100 short, the Sales Account has been similarly credited
Rs. 100 short. The correcting entry is to credit the Sales Account by Rs. 100 as "By wrong
totalling of the Sales Book Rs. 100".
(b) To rectify the omission, the Returns Inwards Account has to be debited and the account of
Green & Co. credited. The entry :
Returns Inward Account Dr. Rs. 150
To Green & Co. Rs.150
(Goods returned by the firm, previously
omitted from the Returns Inward Book)
(c) Gupta & Co. have been debited Rs. 250 instead of being credited. This account should
now be credited by 500 to remove the wrong debit and to give the correct debit. The entry
will be on the credit side... "By errors in posting Rs. 500".
(d) By this error Purchases Account has to be debited by Rs. 1,000 whereas the debit should
have been to the Furniture Account. The correcting entry will be :
Furniture Account Dr. Rs. 1,000
To Purchases Account Rs. 1,000
(Correction of the mistake by which
purchases Account was debited instead
of the Furniture Account)
(e) The discount of Rs. 15 received from Red & Black should have been entered on the credit
side of the cash book. Had this been done, the Discount Account would have been credited
(through the total of the discount column) and Red & Black would have been debited.
This entry should not be made :
Red & Black Dr. Rs. 15
To Discount Account Rs. 15
(Rectification of the error by which the discount
allowed by the firm was not entered in Cash Book)

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 RECTIFICATION OF ERRORS

(f) In this case the account of the customer has been correctly posted; the Discount Account
has been debited Rs. 18 short since it has been omitted from the discount column on the
debit side of the cash book. The discount account should now be debited by the entry; "To
Omission of entry in the Cash Book Rs. 18."
If a Suspense Account is opened :

Particulars L.F. Dr. Cr.

Rs. Rs.
(a) Suspense Account Dr. 100
To Sales Account 100
(Being the correction arising from under-
casting of Sales Day Book)
(b) Return Inward Account Dr. 150
To Green & Co. 150
(Being the recording of unrecorded returns)
(c) Suspense Account Dr. 500
To Gupta & Co. 500
(Being the correction of the error by
which Gupta & Co. was debited instead
of being credited by Rs. 250).
(d) Furniture Account Dr. 1,000
To Purchases Account 1,000
(Being the correction of recording purchase
of furniture as ordinary purchases)
(e) Red & black Dr. 15
To Discount Account 15
(Being the recording of discount omitted to be recorded)
(f) Discount Account Dr. 18
To Suspense Account 18
(Being the correction of omission of the
discount allowed from Cash Book
customer's account already posted correctly).

2.118 COMMON PROFICIENCY TEST

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 Suspense Account
Dr. Cr.
Date Particulars Amount Date Particulars Amount
Rs. Rs.
To Sales A/c 100 By Difference in
To Gupta & Co. 500 Trial Balance 582
By Discount A/c 18
600 600

Note :
(i) One should note that the opening balance in the Suspense Account will be equal to the
difference in the trial balance.
(ii) If the question is silent as to whether a Suspense Account has been opened, the student
should make his assumption, state it clearly and then proceed.
Illustration 6
Correct the following errors found in the books of Mr. Dutt. The Trial Balance was out by
Rs. 493 excess credit. The difference thus has been posted to a Suspense Account.
(a) An amount of Rs. 100 was received from D. Das on 31st December, 2009 but has been
entered in the Cash Book on 3rd January, 2010.
(b) The total of Returns Inward Book for December has been cast Rs. 100 short.
(c) The purchase of an office table costing Rs. 300 has been passed through the Purchases
Day Book.
(d) Rs. 375 paid for Wages to workmen for making show-cases had been charged to "Wages
Account".
(e) A purchase of Rs. 67 had been posted to the creditors' account as Rs. 60.
(f) A cheque for Rs. 200 received from P. C. Joshi had been dishonoured and was passed to
the debit of "Allowances Account".
(g) Rs. 1000 paid for the purchase of a motor cycle for Mr. Dutt had been charged to
"Miscellaneous Expenses Account".
(h) Goods amounting to Rs. 100 had been returned by customer and were taken in to stock,
but no entry in respect there of, was made into the books.
(i) A sale of Rs. 200 to Singh & Co. was wrongly credited to their account.
Solution
(a) The following entry should be passed on 31st December, 2009:
Particulars L.F. Rs. Rs.
Bank Account Dr. 100
To D. Das 100
(Being the amount received)

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 RECTIFICATION OF ERRORS

The entry already passed in the Cash Book on 3rd January, 2010 will be reversed by
entering on the credit side of the Cash Book : "By D. Das Rs. 100" (to reverse entry wrongly
passed on January 3).
(b) Returns Inward Account Dr. 100
To Suspense Account 100
(Being the mistake in totalling the Returns
Inward Book corrected)
(c) Furniture Account Dr. 300
To Purchases Account 300
(Being the rectification of mistake by which
purchase of furniture was entered in Purchases
book and hence debited to Purchases Account)
(d) Furniture Account Dr. 375
To Wages Account 375
(Being the wages paid to workmen for
making show-cases which should be
capitalised and not to be charged to
Wages Account)
(e) Suspense Account Dr. 7
To Creditor's (personal) Account 7
(Being the mistake in crediting the
Creditors Account less by Rs. 7, now corrected)
(f) P.C. Joshi Dr. 200
To Allowances Account 200
(Being the cheque of P.C. Joshi
dishonoured, previously debited to Alloweances Account)
(g) Drawings Account Dr. 1,000
To Miscellaneous Expenses 1,000
(Being the motor cycle purchased for
Mr. Dutt debited to his Drawings Account
instead of Miscellaneous Expenses Account
as previously done by mistake)
(h) Returns Inward Account Dr. 100
To Customer's (Personal) Account 100
(Correction of the omission to record return
of goods by customers)
(i) Singh & Co. Dr. 400
To Suspense Account 400
(Being the correction of mistake by which
the account of Singh & Co. was credited by
Rs. 200 instead of being debited)

2.120 COMMON PROFICIENCY TEST

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 Suspense Account
Dr. Cr.
Date Particulars Amount Date Particulars Amount
2009 Rs. 2009
Dec.31 To Difference in Dec. 31 By Returns
Trial Balance 493 "" Inwards A/c 100
"" To Creditor's A/c 7 "" By Singh & Co. 400
500 500

Illustration 7
The following errors, affecting the account for the year 2005 were detected in the books of Jain
Brothers, Delhi:
(1) Sale of old Furniture Rs. 150 treated as sale of goods.
(2) Receipt of Rs. 500 from Ram Mohan credited to Shyam Sunder.
(3) Goods worth Rs. 100 brought from Mohan Narain have remained unrecorded so far.
(4) A return of Rs. 120 from Mukesh posted to his debit.
(5) A return of Rs. 90 to Shyam Sunder posted as Rs. 9 in his account.
(6) Rent of proprietor's residence, Rs. 600 debited to rent A/c.
(7) A payment of Rs. 215 to Mohammad Sadiq posted to his credit as Rs. 125.
(8) Sales Book added Rs. 900 short.
(9) The total of Bills Receivable Book Rs. 1,500 left unposted.
You are required to pass the necessary rectifying entries and show how the trial balance would
be affected by the errors.
Solution
JOURNAL
Particulars L.F. Dr. Cr.
Amount Amount
Rs. Rs.
(1) Sales Account Dr. 150
To Furniture Account 150
(Rectification of sales of furniture treated
as sales of goods)
(2) Shyam Sunder Dr. 500
To Rama Mohan 500
(Rectification of a receipt from Ram Mohan
credited to Shyam Sunder)

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 RECTIFICATION OF ERRORS

(3) Purchases Account Dr. 100

To Mohan Narain 100
(Purchases of goods from Mohan
Narain unrecorded)
(6) Drawing Account Dr. 600
To Rent Account 600
(Rectification of Payment of rent of
proprietor's residence treated as payment
of office rent)

N.B. : For 4, 5, 7, 8, 9 no journal entry can be passed as they affect a single account. The
correction will be as under:
(4) Credit Mukesh's Account with Rs. 240.
(5) Debit the account of Shyam Sunder by Rs. 81.
(7) Debit the account of Mohammad Sadiq by Rs. 340.
(8) Credit Sales Account by Rs. 900.
(9) Debit Bills Receivable Account with Rs. 1,500.

Effect of the Errors on Trial Balance

1. No effect
2. No effect
3. No effect
4. Trial Balance credit total short by Rs. 240.
5. Trial Balance debit total short by Rs. 81.
6. No effect
7. Trial Balance debit total short by Rs. 340.
8. Trial Balance credit total short by Rs. 900.
9. Trial Balance debit total short by Rs. 1,500.
Illustration 8
The trial balance of Mr. W & H failed to agree and the difference Rs. 20,570 was put into
suspense pending investigation which disclosed that :
(i) Purchase returns day book had been correctly entered and totalled at Rs. 6,160, but had
been posted to the ledger.
(ii) Discounts received Rs. 1,320 had been debited to discounts allowed.
(iii) The Sales account had been under added by Rs. 10,000.
(iv) A credit sale of Rs. 1,470 had been debited to a cutomer account at Rs. 1,740.
(v) A vehicle bought originally for Rs. 7,000 four years ago and depreciated to Rs. 1,200 had
been sold for Rs. 1,500 in the beginning of the year but no entries, other than in the bank
account had been passed through the books.

2.122 COMMON PROFICIENCY TEST

Copyright -The Institute of Chartered Accountants of India

(vi) An accrual of Rs. 560 for telephone charges had been completely omitted.
(vii) A bad debt of Rs. 1,560 had not been written off and provision for doubtful debts should
have been maintained at 10% of debtors which are shown in the trial balance at
Rs. 23,390 with a credit provision for bad debts at Rs. 2,320.
(viii) Tools bought for Rs. 1,200 had been inadvertently debited to purchases.
(ix) The proprietor had withdrawn, for personal use, goods worth Rs. 1,960. No entries had
been made in the books.
Required :
(i) Pass rectification entries without narration to correct the above errors before preparing
annual accounts.
(ii) Prepare a statement showing effect of rectification on the reported net profit before
correction of these errors.
Solution
Particulars Dr. Cr.
(i) Suspense Account Dr. 6,160
To Return Outward A/c 6,160
(ii) Suspense Account Dr. 2,640
To Discount Allowed Account 1,320
To Discount Received Account 1,320
(iii) Suspense Account Dr. 10,000
To Sale Account 10,000
(iv) Suspense Account Dr. 270
To Customer Account 270
(v) Suspense Account Dr. 1,500
To Vehicle Account 1,200
To Profit on Sale of Vehicle Account 300
(vi) Telephone Charges Account Dr. 560
To Outstanding Expenses Account 560
(vii) Bad Debts Account Dr. 1,560 1
To Sundry Debtors Account 1,560
2
Provision for Doubtful Debts Account Dr. 164
To Profit and Loss Account 164
(viii) Loose Tools Account Dr. 1,200
To Purchases Account 1,200
(ix) Drawing Account Dr. 1,960
To Purchases 1,960

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 RECTIFICATION OF ERRORS

1
Bad debts will be debited in the profit and loss account.
2
Provision @ 10% of Rs. 2,156; Excess provision Rs. 164.

Working Notes :
(i) Sundry Debtors as per books 23,390
Deduction vide item (iv) 270
Bad Debts 1,560 1,830
21,560
(ii) Suspense Account
Rs. Rs.
To Return outward Account 6,160 By balance b/d 20,570
To Discount allowed Account 1,320
To Discount Received Account 1,320
To Sales 10,000
To Customers 270
To Vehicles 1,200
To Profit on Sale of Vehicle 300
20,570 20,570
Illustration 9
Show by means of Journal entries how the following matters should be adjusted when preparing
the Annual Accounts of a firm for the year ended 30th September, 2009.
(a) Goods sold and recorded as sales for Rs. 4,000 were packed and the invoice for them sent
to the customers. Stock taking intervened and the parcel of goods was not despatched but
was included in stock-in-hand.
(b) Several employees took their salary in advance in the month of September, 2005 which
was payable to them in October, 2003 amounting to Rs. 2,500.
(c) A cheque of Rs. 2,500 received for a loss of stock sustained by fire has been paid by the
proprietor into his private bank account and not recorded in the business books.
(d) A cheque for Rs. 1,250 received as Insurance claim for loss of goods in transit at the time of
import, was deposited by the proprietor into his private bank account. The full value of
the invoice was passed through the purchase book.
(e) A purchase was made for a staff member of Rs. 1,000 and the cost was included in
purchases. A deduction of similar amount was made from his salary and the net payment
to him posted to salaries account.
(f) Bill received from Mr. Anup for repairs to furniture Rs. 300/- and new furniture supplied
for Rs. 1,000 was entered in the invoice book as Rs. 1,100.

2.124 COMMON PROFICIENCY TEST

Copyright -The Institute of Chartered Accountants of India

(g) Furniture which stood in the books at Rs. 500 was sold for Rs. 275 in part exchange of
new furniture costing Rs. 875 and the new invoice of Rs. 600 was passed through the
purchase book.
Solution
JOURNAL
Adjustment Entries
Date Particulars Dr. Cr.
2009 Rs. Rs.
Sep. 30
(a) Sales Account* Dr. 4,000
To Sundry Debtors Account 4,000
(Entry for credit sales reversed as goods have not been
despatched to the customer)
(b) Prepaid Salaries Account** Dr. 2,500
To Salaries Account 2,500
(Salaries paid in advance for Oct. and debited to Salaries
Account, now transferred to Prepaid Salaries Account)
(c) *** (i) Insurance Company Account Dr. 2,500
(or Loss by Fire Account)
To Trading Account 2,500
(Being the claim admitted by the Insurance
Company for loss of stock due to fire)
(ii) Drawings Account Dr. 2,500
To Insurance Company Account 2,500
(Being the rectification of cheque received for loss of stock
due to fire deposited in the private account of the proprietor)
(d) Drawings Account Dr. 1,250
To Purchases Account 1,250
(Being the rectification of cheque received as insurance claim
for loss of goods in transit deposited into private bank
Account of the proprietor)
(e) Salaries Account Dr. 1,000
To Purchases Account 1,000
(Goods purchased for staff-member recorded as trade
purchases, new charged to Salaries Account)
Note : * Alternatively in (a) goods recorded as sales may not be reversed, instead may be
excluded from closing stock, as the goods have been ascertained and appropriated
according to the contract. This treatment is recommended if the title in the goods
have already passed to customer.

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 RECTIFICATION OF ERRORS

** In (b) it has been assumed that advance salary paid was for the month of Oct. 2005
and has been debited to Salaries Account.
*** In (c) it has been assumed that no entry has been passed in respect of the loss.
(f) Repairs Account Dr. 300
Furniture Account Dr. 1,000
To Purchases Account 1,100
To Mr. Anup 200
(Being the rectification of Bill received from Mr. Anup for repairs
to furniture Rs. 300 and new furniture supplied for Rs. 1,000
entered in the purchases book at Rs. 1,100)
(g) Furniture Account Dr. 375
Loss on sale of Furniture Account 225
To Purchases Account 600
(Being the rectification of net exchange of old and new
furniture passed through purchases day book)

Illustration 10
On going through the Trial balance of Ball Bearings Co. Ltd. you find that the debit is in excess
by Rs. 150. This was credited to "Suspense Account". On a close scrutiny of the books the
following mistakes were noticed:
(1) the totals of debit side of "Expenses Account" have beeen cast in excess by Rs. 50
(2) The "Sales Account" has been totalled in short by Rs. 100.
(3) One item of purchase of Rs. 25 has been posted from the day book to ledger as Rs. 250.
(4) The sale return of Rs. 100 from a party has not been posted to that account though the
Party's account has been credited.
(5) A cheque of Rs. 500 issued to the Suppliers' account (shown under Sundry Creditors)
towards his dues has been wrongly debited to the purchases.
(6) A credit sale of Rs. 50 has been credited to the Sales and also to the Sundry Debtors
Account.
(i) Pass necessary journal entries for correcting the above;
(ii) Show how they affect the Profits; and
(iii) Prepare the "Suspense Account" as it would appear in the ledger.

2.126 COMMON PROFICIENCY TEST

Copyright -The Institute of Chartered Accountants of India

 JOURNAL ENTRIES
Particulars L.F. Dr. Cr.
Rs. Rs.
Suspense Account Dr. 50
To Expenses Account 50
(Being the mistake in totalling of Expenses Account, rectified)
Suspense Account Dr. 100
To Sales Account 100
(Being the mistake in totalling of Sales Accounts rectified)
Supplier* Dr. 225
To Suspense Account 225
(Being the mistake in posting from Day Book to Ledger rectified)
Sales Returns Account Dr. 100
To Suspense Account 100
(Being the sales return from a party not posted to "Sales
Returns" now rectified)
Sundry Creditors Dr. 500
To Purchases Account 500
(Being the payments made to supplier wrongly posted to
purchases now rectified)
Sundry Debtors Dr. 100
To Suspense Account 100
(Being the sales wrongly credited to Customer's Account
now rectified)

*
It is assumed that the day-book is the Purchase Day Book in which case only the suppliers account would be posted wrongly
(creditor of Rs. 250 instead of Rs. 25). If however, by day-book is meant a book in which all transactions are recorded and posted
at the ledger therefrom, it would mean that both the Suppliers Account and Purchases Account are wrongly posted.

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 RECTIFICATION OF ERRORS

Suspense Account
Dr. Cr.
Rs. Rs.
To Expenses Account 50 By Difference in Trial Balance 150
To Sales Account 100 By Sundry Creditors 225
To Balance c/d 425 By Sales Returns Account 100
By Sundry Debtors 100
575 575
By Balance b/d 425

Since the Suspense Account does not balance, it is clear that all the errors have not been traced.
As a result of the above corrections the Net Profit will be :
Increased by Decreased by
Rs. Rs.
Mistake in totalling in "Expenses" 50
Mistake in totalling in "Sales" 100
Mistake in posting from day book to Ledger under
"Purchases" 500
Omission in posting under "Sales Returns" 100
650 100
Net Increase 550

As a result of these adjustments, the Profits will be increased by Rs. 550.

Illustration 11
Write out the Journal Entries to rectify the following errors, using a Suspense Account.
(1) Goods of the value of Rs. 100 returned by Mr. Sharma were entered in the Sales Day Book
and posted there from to the credit of his account;
(2) An amount of Rs. 150 entered in the Sales Returns Book, has been posted to the debit of
Mr. Philip, who returned the goods;
(3) A sale of Rs. 200 made to Mr. Ghanshyam was correctly entered in the Sales Day Book but
wrongly posted to the debit of Mr. Radheshyam as Rs. 20;
(4) Bad Debts aggregating Rs. 450 were written off during the year in the Sales ledger but
were not adjusted in the General Ledger; and
(5) The total of "Discount Allowed" column in the Cash Book for the month of September,
2005 amounting to Rs. 250 was not posted.

2.128 COMMON PROFICIENCY TEST

Copyright -The Institute of Chartered Accountants of India

Solution
JOURNAL
Particulars L.F. Dr. Cr.
Rs. Rs.
(1) Sales Account Dr. 100
Sales Returns Account Dr. 100
To Suspense Account 200
(The value of goods returned by Mr. Sharma
wrongly posted to Sales and omission of debt
to Sales Returns Account, now rectified).
(2) Suspense Account Dr. 300
To Mr. Philip 300
(Wrong debit to Mr. Philip for goods
returned by him, now rectified).
(3) Mr. Ghanshyam Dr. 200
To Mr. Radheshyam 20
To Suspense Account 180
(Omission of debit to Mr. Ghanshyam and wrong credit
to Mr. Radhesham for sale of Rs. 200, now rectited)
(4) Bad Debts Account Dr. 450
To Suspense Account 450
(The amount of Bad Debts written off not
adjusted in General Ledger, now rectified)
(5) Discount Account Dr. 250
To Suspense Account 250
(The total of Discount allowed during
September, 2003 not posted from the Cash
Book; error now rectified).

Illustration 12
The Trial balance of Messrs. A, B and C did not agree. A Suspense Account was opened with
the amount of the difference. The following errors were discovered on scrutiny:
(1) The addition of the Analysis Column of the Tabular Purchase Journal posted to Goods
Purchased for Resale Account was found to be short by Rs. 150 though the addition of the
total column was correct.
(2) A dishonoured B/R for Rs. 400 returned to the firm by bank had been credited to Bank
Account for collection of bills and debited to B/R Account. A cheque was later received
from the customer for Rs. 400 and was duly paid into the firm's bank account.

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 RECTIFICATION OF ERRORS

(3) An amount of Rs. 450 treated as paid in advance on account of insurance in the previous
year was not brought forward.
(4) Sales on approval amounting to Rs. 2,000 were included in the Sales Account. Half of
these were returned but no entries were passed in respect of these goods. However, the
returned goods have been included in the closing stock at their cost price of Rs. 500.
(5) Of the total amount of Rs. 38,356 shown as Sundry Debtors, Rs. 1,260 represent credits
given to customers when the payments against sales invoices were received. However,
these invoices themselves were not entered in the books. A discount of 10% is allowed on
the selling price in all such invoices.
You are required to pass rectifying entries making use, of the Suspense Account, wherever
necessary.
Solution
Journal of M/s. A, B and C
Particulars L.F. Dr. Cr.
Rs. Rs.
1. Purchase for Resale A/c Dr. 150
To Suspense Account 150
(Short debit to 'purchases for Resale Account' on
account of undercasting on now corrected)
2. Customers A/c Dr. 400
To Bill Receivable A/c 400
(Amount of dishonoured bill receivable previously
debited to Bills Receivable Account, error now rectified)
3. Insurance Account Dr. 450
To Suspense Account 450
(Prepaid insurance in the previous year not brought
forward now debited to the Insurance Account)
4. Sales Accounts Dr. 1,000
To Customer's Account 1,000
(Goods worth Rs. 1,000 returned by a customer on
sale or return basis, previously omitted to be recorded;
error now rectified)
5. Discount Account Dr. 140
Customers Account Dr. 1,260
To sales Account 1,400
(Credit sales of Rs. 1,400 previously omitted from the
books, error now corrected)

2.130 COMMON PROFICIENCY TEST

Copyright -The Institute of Chartered Accountants of India

Note : Payment being equal to 90% of the gross sale is Rs. 1,400, i.e., 1,260 100/90. 1/10 of
this amount is discount.
Since the discount of 10% is allowed in all cases, it would be better to treat the sale to be
Rs. 1,260 and not Rs. 1,400, the discount is trade discount for which no account is opened, the
sales being recorded, at the net amount.
Illustration 13
The trial balance of Anil Traders did not agree. The difference was put in the Suspense Account
and the following trial balance was drafted :
Trial Balance as on 31st March, 2009
Dr. Cr.
Capital Account 45,000
Drawing Account 6,500
Purchases Account 92,750
Sales Account 1,07,200
Salaries and Wages Account 12,250
Furniture and Fittings Account 17,500
Sundry Debtors Account 30,250
Sundry Creditors Account 21,250
Stationery Account 1,250
Cash at Bank 5,700
Cash in Hand 2,300
Bills Receivable Account 15,750
Bills Payable Account 9,000
Rent and Rates Account 3,200
Suspense Account 5,000
1,87,450 1,87,450
On scrutiny the following errors were subsequently detected :
(a) Goods drawn by Mr. Anil, the proprietor, for personal consumption of Rs. 1,500 have not
at all been recorded.
(b) Goods sold to Ram for Rs, 1,250 on credit was debited to Rahim account for Rs. 250 only.
(c) Wages paid for fittings Rs. 500 was debited to salaries and wages account.
(d) Goods Purchased from Atul for Rs. 2,500 on credit was wrongly debited to his account.
(e) Bill received from Arun, a debtor, for Rs. 500 was debited to Ajay's account.
(f) A credit sale of Rs. 1,500 was recorded in Purchased Day Book and a credit purchase of
Rs. 2,000 was entered in Sales Day Book.
You are required to pass the rectification entries and redraft the trial balance.

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 RECTIFICATION OF ERRORS

Solution
M/s Anil Traders
Journal
Particulars L.F. Dr. Cr.
Rs. Rs.
(a) Drawings Account Dr. 1,500
To Purchases Account 1,500
(Goods withdrawn for personal consumption
by the proprietor, now recorded)
(b) Ram (Debtor) Account Dr. 1,250
To Rahim (Debtor) Account 250
To Suspense Account 1,000
(Goods sold to Ram for Rs. 1,250 wrongly
debited to Rahim account for Rs. 250, now rectified)
(c) Furniture and Fittings Account Dr. 500
To Salaries and Wages Account 500
(Wages paid for fittings wrongly debited to
salaries and wages account, now rectified)
(d) Suspense Account Dr. 5,000
To Atul (Creditor) Account 5,000
(Goods brought on credit from Atul wrongly
debited to his account, now rectified)
(e) Suspense Account Dr. 1,000
To Arun (Debtor) Account 500
To Ajay (Debtor) Account 500
(Bill received from Arun wrongly debited to
Ajay Account, now rectified)
(f) Purchases Account Dr. 500
Sales Account Dr. 500
To Debtors Account* 500
To Creditors Accont* 500
(A credit sale and a credit purchase wrongly
entered in purchases day book and sales day
book respectively, now rectified)
* In the debtors' ledger and creditors' ledger, the affected individual accounts should be rectified
with the full amount. In other words, in the debtors' ledger the concerned debtors account
should be debited by Rs. 1,500 for credit sales and the debtor account wrongly debited for
credit purchase should be credited by Rs. 2,000.

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 Trial Balance of M/s. Anil Traders as on 31.3.2009

Particulars Dr. Cr.

Capital Account 45,000
Drawings Account 8,000
Purchases Account 91,750
Sales Account 1,06,700
Salaries and Wages Account 11,750
Furniture and Fittings Account 18,000
Sundry Debtors Account 29,750
Sundry Creditors Account 26,750
Stationery Account 1,250
Cash at Bank 5,700
Cash in Hand 2,300
Bills Receivable Account 15,750
Bills Payable Account 9,000
Rent and Rates Account 3,200
1,87,450 1,87,450

Working Notes :
1. Suspense Account
Dr. Cr.
Rs. Rs.
To Atul Account (entry 'd') 5,000 By Balance b/d 5,000
To Arun Account [entry 'e'] 500 By Ram Account (entry 'b') 1,000
To Ajay Account [entry 'e'] 500
6,000 6,000

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 RECTIFICATION OF ERRORS

2. Corrected Ledger Balances

Balance as per Rectification Reference Rectified
given trial effect (entry no.) balance
balance
Rs. Rs. Rs.
Drawings 6,500 (+) 1,500 (a) 8,000
Purchases 92,750 (-) 1,000 (a) & (f) 91,750
Sundry Debtors 30,250 (-) 500 (b), (e) & (f) 29,750
Furniture & Fittings 17,500 (+) 500 (c) 18,000
Salaries & Wages 12,250 (-) 500 (c) 11,750
Sundry Creditors 21,250 (+) 5,500 (d) & (f) 26,750
Sales 1,07,200 (-) 500 (f) 1,06,700

5.3 CORRECTION IN THE NEXT ACCOUNTING PERIOD

Rectification of errors discussed so far assumes that it was carried out before the books were
closed for the concerned year. However, sometimes, the rectification is carried out in the next
year, carrying forward the balance in the Suspense Account or even transferring it to the
Capital Account. Suppose, the Purchase Book was cast short by Rs. 1,000 in December, 2005
and a Suspense Account was opened with the difference in the trial balance. If the error is
rectified next year and the entry passed is to debit Purchase Account (and credit Suspense
Account), it will mean that the Purchases Account for year 2006 will be Rs. 1,000 more than
the amount relating to year 2006 and thus the profit that year 2006 will be less than the actual
for that year. Thus, correction of errors in this manner will 'falsify' the Profit and Loss Account.
To avoid this, correction of all amounts concerning nominal accounts, i.e., expenses and incomes
should be through a special account styled as "Prior Period Items" or "Profits and Loss
Adjustment Account". The balance in the account should be transferred to the Profits and Loss
Account. However, these Prior Period Items should be charged after deriving net profit of the
current year. 'Prior Period items' are material income or expenses which arise in the current
period as a result of errors or omissions in the preparation of the financial statements of one or
more periods. Prior Period Items should be separately disclosed in the current statement of
profit and loss together with their nature and amount in a manner that their impact on current
profit or loss can be perceived.
Illustration 14
Mr. A closed his books of account on September 30, 2009 inspite of a difference in the trial
balance. The difference was Rs. 830 the credits being short; it was carried forward in a Suspense
Account. In 2010 following errors were located :
(i) A sale of Rs. 2,300 to Mr. Lala was posted to the credit of Mrs. Mala.
(ii) The total of the Returns Inward Book for July, 2007 Rs. 1,240 was not posted in the ledger.
(iii) Freight paid on a machine Rs. 5,600 was posted to the Freight Account as Rs. 6,500.
(iv) White carrying forward the total in the Purchases Account to the next page, Rs. 65,590
was written instead of Rs. 56,950.

2.134 COMMON PROFICIENCY TEST

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(v) A sale of machine on credit to Mr. Mehta for Rs. 9,000 was not entered in the books at all.
The book value of the machine was Rs. 7,500. The firm has the practice of writing off
depreciation @10% on the balance at the end of the year.
Pass journal entries to rectify the errors. Have you any comments to make?
Solution
Journal of Mr. A
Date Particulars L.F. Dr. Cr.
Rs. Rs.
2010 (i) Mrs. Mala Dr. 2,300
Mr. Lala Dr. 2,300
To Suspense A/c 4,600
(Correction of error by which a sale of Rs. 2,300
to Mr. Lala was posted to the Credit of Mrs. Mala)
(ii) Profit and Loss Adjustment A/c Dr. 1,240
To Suspense A/c 1,240
(Rectification of omission to post the total of
Returns Inward Book for July, 2009)
(iii) (a) Machinery A/c Dr. 5,600
Suspense A/c Dr. 900
To Profit & Loss Adjustment A/c 6,500
(Correction of error by which freight paid for
a machine Rs. 5,600 was posted to Freight
Account at Rs. 6,500 instead of capitalising it)
(b) Profit & Loss Adjustment A/c Dr. 560
To Plant and Machinery A/c 560
(Depreciation @ 10% charged on freight paid
on a machine capitalised)
(iv) Suspense A/c Dr. 8,640
To Profit & Loss Adjustment A/c 8,640
(Correction of wrong carry forward
of total in the purchase Account to
the next page Rs. 65,590 instead of Rs. 56,950)
(v) Mr. Mehta Dr. 9,000
To Plant & Machinery A/c 6,750
To Profit & Loss Adjustment A/c 2,250
(Correction of omission of a sale of machine
on credit to Mr. Mehta for Rs. 9,000 with a
book value of Rs. 7,500 on which depreciation
@ 10% has been charged in 2009)

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 RECTIFICATION OF ERRORS

Comments
The Suspense Account will now appear as shown below :
Suspense Account
Dr. Cr.
Date Particulars Amount Date Particulars Amount
Rs. Rs.
2010 To Profit and Loss 2009 By Balance b/d 830
Adjustment A/c 900 Oct. 1 By Sundries
To Profit and Loss Mrs. Mala 2,300
Adjustment A/c 8,640 Mr. Lala 2,300
By Profit and Loss
Adjustment A/c 1,240
By balance c/d 2,870
9,540 9,540

Since the Suspense Account still shows a balance, it is obvious that there are still some errors
left in the books.
Profit & Loss Adjustment A/c
(For Prior Period Items)
Dr. Cr.
Date Particulars Amount Date Particulars Amount
2010 Rs. 2010 Rs.
To Suspense A/c 1,240 By Machinery A/c 5,600
To Plant and By Suspense A/c 900
Machinery A/c 560 By Suspense A/c 8,640
To Balance c/d 15,590 By Mr. Mehta 2,250
17,390 17,390

Illustration 15
A merchant's trial balance as on June 30, 2009 did not agree. The difference was put to a
Suspense Account. During the next trading period, the following errors were discovered :
(i) The total of the Purchases Book of one page, Rs. 4,539 was carried forward to the next
page as Rs. 4,593.
(ii) A sale of Rs. 573 was entered in the Sales Book as Rs. 753 and posted to the credit of the
customer.

2.136 COMMON PROFICIENCY TEST

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(iii) A return to a creditor, Rs. 510 was entered in the Returns Inward Book; however, the
creditor's account was correctly posted.
(iv) Cash received from C. Dass, Rs. 620 was posted to the debit of G. Dass.
(v) Goods worth Rs. 840 were despatched to a customer before the close of the year but no
invoice was made out.
(vi) Goods worth Rs. 1,000 were sent on sale or return basis to a customer and entered in the
Sales Book. At the close of the year, the customer still had the option to return the goods.
The sale price was 25% above cost.
You are required to give journal entries to rectify the errors in a way so as to show the current
year's profit or loss correctly.
Solution
Journal Entries
Particulars L.F. Dr. Cr.
Rs. Rs.
(i) Suspense Account Dr. 54
To Profit and Loss Adjustment A/c 54
(Correction of error by which Purchase
Account was over debited last year- Rs. 4,593
carried forward instead of Rs. 4,539.)
(ii) Profit & Loss Adjustment A/c Dr. 180
Customer's Account Dr. 1,326
To Suspense Account 1,506
(Correction of the entry by which (a) Sales
A/c was over credited by Rs. 180 (b)
customer was credited by Rs. 753 instead of
being debited by Rs. 573.)
(iii) Suspense Account Dr. 1,020
To Profit & Loss Adjustment A/c 1,020
(Correction of error by which Returns
Inward Account was debited by Rs. 510
instead of Returns Outwards Account being
credited by Rs. 510)
(iv) Suspense Account Dr. 1,240
To C. Dass 620
To G. Dass 620
(Removal or wrong debit to G. Dass and
giving credit to C. Dass from whom cash
was received).

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 RECTIFICATION OF ERRORS

(v) Customer's Account Dr. 840

To Profit & Loss Adjustment A/c 840
(Rectification of the error arising from non-
preparation of invoice for goods delivered)
(vi) Profit & Loss Adjustment A/c Dr. 200
Stock Account Dr. 800
To Customer's Account 1,000
(The Customer's A/c credited with Rs. 1,000
for goods not yet purchased by him; cost of
the goods debited to Stock and "Profit"
debited to Profit & Loss Adjustment Account)
(vii) Profit & Loss Adjustment A/c Dr. 1,534
To Capital Account 1,534
(Transfer of the Profit & Loss Adjustment A/c
balance to the Capital Account)
Will the students find out the difference in the Trial Balance?1
Illustration 16
Mr. Roy was unable to agree the Trial Balance last year and wrote off the difference to the
Profit and Loss Account of that year. Next Year, he appointed a Chartered Accountant who
examined the old books and found the following mistakes :
(1) Purchase of a scooter was debited to conveyance account Rs. 3,000.
(2) Purchase account was over-cast by Rs. 10,000.
(3) A credit purchase of goods from Mr. X for Rs. 2,000 entered as a sale.
(4) Receipt of cash from Mr. A was posted to the account of Mr. B Rs. 1,000.
(5) Receipt of cash from Mr. C was posted to the debit of his account, Rs. 500.
(6) Rs. 500 due by Mr. Q was omitted to be taken to the trial balance.
(7) Sale of goods to Mr. R for Rs. 2,000 was omitted to be recorded.
(8) Payment of Rs. 2,395 for purchase was wrongly posted as Rs. 2,593.
Mr. Roy used 10% depreciation on vehicles. Suggest the necessary rectification entries.

1
Credit side is short by Rs. 808

2.138 COMMON PROFICIENCY TEST

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Solution
Journal Entries in the books of Mr. Roy
Date Particulars Dr. Cr.
Rs. Rs.
(1) Motor Vehicles Account Dr. 2,700
To Profit and Loss Adjustment A/c 2,700
(Purchase of scooter wrongly debited to
conveyance account now rectified-capitalisation
of Rs. 2,700, i.e., Rs. 3,000 less 10% depreciation)
(2) Suspense Account Dr. 10,000
To Profit & Loss Adjustment A/c 10,000
(Purchase Account overcast in the previous
year; error now rectified).
(3) Profit & Loss Adjustment A/c Dr. 4,000
To P's Account 4,000
(Credit purchase from P Rs. 2,000, entered
as sales last year; now rectified)
(4) B's Account Dr. 1,000
To A's Account 1,000
(Amount received from A wrongly posted to
the account of B; now rectified)
(5) Suspense Account Dr. 1,000
To C's Account 1,000
(Rs. 500 received from C wrongly debited to
his account; now rectified)
(6) Sundry Debtors (Q) Dr. 500
To Suspense Account 500
(Rs. 500 due by Q not taken into trial
balance; now rectified)
(7) R's Account Dr. 2,000
To Profit & Loss Adjustment A/c 2,000
(Sales to R omitted last year; now adjusted)
(8) Suspense Account Dr. 198
To Profit & Loss Adjustment A/c 198
(Excess posting to purchase account last
year, Rs. 2,593, instead of Rs. 2,395, now adjusted)
(9) Profit & Loss Adjustment A/c Dr. 10,898
To Roy's Capital Account 10,898
(Balance of Profit & Loss Adjustment A/c
transferred to Capital Account)
(10) Roy's Capital Account Dr. 10,698
To Suspense Account 10,698
(Balance of Suspense Account transferred
to the Capital Account)
Note : Entries No. (2) and (8) may even be omitted; but this is not advocated, Entry (6) will not
be posted in Q's Account.

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 RECTIFICATION OF ERRORS

Profit and Loss Adjustment Account

(Prior Period Items)
Rs. Rs.
To P 4,000 By Motor Vehicles A/c 2,700
To Roy's Capital (transfer) 10,898 By Suspense A/c 10,000
By R 2,000
By Suspense Account 198
14,898 14,898

Suspense Account
Rs. Rs.
To Profit & Loss Adjustment By Sundry Debtors (Q) 500
Account 10,000 By Roy's Capital Account 10,698
To C 1,000 (Transfer)
To Profit & Loss Adjustment
Account 198
11,198 11,198

SELF EXAMINATION QUESTIONS

I. Pick up the correct answer from the given choices:
1. (i) Goods purchased from A for Rs. 10,000 passed through the sales book. The error will
result in
(a) Increase in gross profit. (b) Decrease in gross profit.
(c) No effect on gross profit. (d) Either (a) or (b).
(ii) If a purchase return of Rs. 1,000 has been wrongly posted to the debit of the sales
returns account, but has been correctly entered in the suppliers account, the total of
the
(a) trial balance would show the debit side to be Rs. 1,000 more than the credit
(b) trial balance would show the credit side to be Rs.1,000 more than the debit.
(c) the debit side of the trial balance will be Rs. 2,000 more than the credit side.
(d) the credit side of the trial balance will be Rs. 2,000 more than the debit side.
(iii) If the amount is posted in the wrong account or it is written on the wrong side of the
account, it is called
(a) error of omission. (b) error of commission.
(c) error of principle. (d) compensating error.

2.140 COMMON PROFICIENCY TEST

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 [Ans 1 : (i)-(a), (ii)-(c), (iii)-(b),]

2. Choose the most appropriate option from the given choices:

(i) Rs. 200 paid as wages for erecting a machine should be debited to
(a) Repair account. (b) Machine account.
(c) Capital account. (d) Furniture account
(ii) On purchase of old furniture, the amount of Rs. 1,000 spent on its repair should be
debited to
(a) Repair account; (b) Furniture account;
(c) Cash account; (d) Bank account
(iii) Goods worth Rs. 50 given as charity should be credited to
(a) Charity account; (b) Sales account;
(c) Purchase account. (d) Cash account
(iv) Goods worth Rs. 100 taken by proprietor for domestic use should be credited to
(a) Sales account; (b) Proprietors personal expenses;
(c) Purchases account (d) Expenses account.
(v) Errors of commission do not permit;
(a) Correct totalling of the balance sheet;(b) Correct totalling of the trial balance;
(c) The trial balance to agree. (d) None of the above
(vi) The preparation of a trial balance is for:
(a) Locating errors of commission; (b) Locating errors of principle;
(c) Locating clerical errors. (d) All of the above
(vii) Rs. 200 received from Smith whose account, was written off as a bad debt should be
credited to :
(a) Bad Debts Recovered account; (b) Smiths account;
(c) Cash account. (d) Bad debts account
(viii) Purchase of office furniture Rs. 1,200 has been debited to General Expense Account.
It is :
(a) A Clerical error; (b) An error of principle;
(c) An error of omission. (d) Compensating error.

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 RECTIFICATION OF ERRORS

(ix) Sales of office furniture should be credited to

(a) Sales Account; (b) Furniture Account.
(c) Purchase Account. (d) Cash Account
[Ans: 2 : (i) (b); (ii) (b); (iii) (c); (iv) (c); (v) (c); (vi) (c); (vii) (a); (viii) (b); (ix) (b);]

II. From the given information, choose the most appropriate answer.
1. Classify the following errors under (a) Errors of omission, (b) Errors of commission and
(c) Errors of principle, (d) Compensating errors
(i) The total of sales book was not posted to the ledger.
(ii) Sales to Heena Rs. 143 was posted to Meena as Rs. 143.
(iii) Goods taken away by the proprietor for personal use not recorded anywhere.
(iv) The total of a folio in the sales book Rs. 1,000 was carried forward as Rs. 100.
(v) Repairs of newly purchased second-hand machinery debited to repairs accounts.
[Ans: 1: (i)-(a), (ii)-(b), (iii)-(a), (iv)-(b), (v)-(c)]

2. Point out the type of the errors given below: (put 1 against errors of omission, 2 against
errors of commission, 3 against errors principle, 4 if it is not an error).
(a) Sale of Rs. 120 was written in the purchases book.
(b) Salary paid to Ram, has been debited to his account.
(c) Purchase of furniture has been entered in the purchases book.
(d) Rs. 120 received from Ganesh has been debited to his account.
(e) Freight paid on machinery has been debited to the freight account.
(f) The discount columns of the cash book have not been posted.
(g) Repairs to buildings have been debited to the buildings account.
(h) The total of the Sales Book is Rs. 100 short.
(i) The sale of worth Rs. 337 has been posted as Rs. 373.
(j) The amount of a dishonoured bill has been debited to general expenses account.
[ Ans : 2 : - 1 : (f); 2 : (a) (d) (h) (i); 3 : (b) (c) (e) (g) (j)]

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III. Given below are the questions containing multiple answers. Choose the correct
answer(s).
1. Which of the following errors will not be revealed by the Trial Balance:
(a) compensating errors; (b) errors of principle;
(c) wrong balancing of an account; (d) wrong totalling of an account;
[Ans : 1 : (a) and (b) will not be revealed]
2. Which of the following errors will be revealed by the Trial Balance:
(a) compensating errors; (b) errors of principle;
(c) wrong balancing of an account; (d) wrong totalling of an account;
[Ans : (c) and (d) will be revealed]

FUNDAMENTALS OF ACCOUNTING 2.143

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