BASICS OF ACCOUNTING

COURSE CODE: 1339 UNITS: 1–9

(I.COM / F.A)

Written by: Reviewed by:

Muhammad Munir Ahmad Prof. Dr. S.M. Amir Shah
Asia Batool Muhammad Munir Ahmad
Sohail Amjed Asia Batool
Syeda Faiza Urooj

DEPARTMENT OF COMMERCE
FACULTY OF SOCIAL SCIENCES & HUMANITIES
ALLAMA IQBAL OPEN UNIVERSITY, ISLAMABAD

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 (All rights Reserved with the Publisher)

Printing Coordinator ................. Printing Press Operations Committee

Printer........................................ Allama Iqbal Open University
Publisher ................................... Allama Iqbal Open University,
Islamabad

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 COURSE TEAM

Chairman: Prof. Dr. Syed Muhammad Amir Shah

Chairman Department of Commerce

Course Development Coordinator:

Asia Batool
Writers: 1. Sohail Amjed
2. Faiza Urooj
3. Muhammad Munir Ahmad
4. Asia Batool

Reviewers: 1. Prof. Dr. Syed Muhammad Amir Shah

2. Muhammad Munir Ahmad
3. Asia Batool

Editor: Humera Ejaz

Layout Design: Muhammad Shafique

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 CONTENTS
Unit 1: Basic Concepts of Accounting

Unit 2: Accounting Equation

Unit 3: Journal, Ledger and Trial Balance

Unit 4: Special Journals

Unit 5: Banking Transactions, Cash Book and Bank

Reconciliation Statement
Unit 6: Final Accounts: The Completion of Accounting Cycle

Unit 7: Adjustments and their effects on Final Accounts

Unit 8: Capital & Revenue and Rectification of Errors

Unit 9: Accounting for Bill of Exchange

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 PREFACE
In the contemporary business world, every individual should have basic
knowledge of accounting. A course of accounting is not only important for the
students but it is also one of the basic requirements to understand multiple
perspectives, principles and models of business.

Realizing its importance, the Department of Commerce of the University

introduced the subject of accounting in the early eighties at the intermediate level
especially for I.Com students. This course was launched as full credit course titled
as “Book Keeping and Accountancy” in Urdu. Keeping in view the feedback and
students convenience an English version of this book has been developed and then
segregated into two parts. First part pertains to “Basics of Accounting” and
second as “Business Accounting”. Now the Department of Commerce undertook
the responsibility of updating the course. Special considerations have been given
to the course requirements, student’s level of understanding. This book is
especially written for non-formal and distant learners, but it is equally helpful for
the students of formal education system.

I as Vice-Chancellor of Allama Iqbal Open University appreciate entire

course team. I shall be grateful to the teachers, students and readers for their
comments and suggestions for further improvement.

(Prof. Dr. Zia Ul-Qayyum)

Vice Chancellor
Alma Iqbal Open University, Islamabad

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 INTRODUCTION

In the contemporary business world, all people, regardless of job position,

should have basic knowledge of accounting. Its concepts can be applied to all job
specialties, its importance has been promoted in recent years, and it is useful in
people’s everyday lives. Everyone, not just business students, acquire an
understanding of accounting for personal benefit. People use accounting in their
daily lives when they study financial statements to make investment decisions,
assess interest rates to pay off their house mortgages, and calculate rates for car
payments. In the business world, accounting is utilized in much greater depth, but
each individual encounters some activities in his/her everyday life that requires
knowledge of accounting principles. Accounting is the most basic framework of
business. Without an accounting education, students would be unprepared for the
real world.

Realizing its importance, the Department of Commerce of the University

introduced the subject of Accounting in the early eighties at the intermediate level
also, especially for I.Com students. This course was launched as full credit course
titled as “Book keeping and Accountancy”. No doubt this is an era of
development and every moment new technological changes are taking place in
every sphere of human activities. Keeping this view the Department of Commerce
undertook the responsibility of updating the course of accounting from time to
time.
The Course Book keeping and Accountancy has been segregated into two
parts of nine units each i.e. 1st part “Basics of Accounting” and 2nd part
“Business Accounting”. This book is 1st part “Basics of Accounting” that book
will be used for Intermediate/I.Com students of AIOU. The course is very
special because the Department of Commerce of AIOU is offering the course
material in English as well as Urdu language for student’s convenience.

This edition is very useful for the beginners, who want to get knowledge
of accounting. It covers the basic concepts of accounting and the procedures of
accounting from recording of transactions to presentation of financial statements.
However, efforts have been made to present the material on the basis of Distance
Education Learning System, thus making it a self-study package where a student
may study the material without the help of tutor. A comprehensive summary has

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also been added at the end of each unit, which is very useful for the students for
learning and revision of the subject during the course of study.

The Department of Commerce is thankful to Prof. Dr. S.M Amir Shah,

Chairman Department of Commerce for designing and launching of New I.Com
Scheme of study and for making the course more interesting and understandable.

It is earnestly hoped that the book will amply fulfill the objectives for
which it has been designed. Many individuals have contributed their shares for the
development of this course and the department and we are highly thankful for
their valuable contribution, support and suggestions.

I owe a great deal and oblige to the efforts of Mr. Sohail Amjad, Mrs
Faiza Urooj, Ex. Lecturers and Muhammad Munir Ahmed, Lecturer of the
Department for their contribution in completion of this book. They wrote the units
of the book and put their efforts in completing the book.

Finally, I am again grateful to Dr. S.M Amir Shah, Chairman, and

Department of Commerce, whose supervision, support and guidance made the
completion of this book possible.

Asia Batool

Course Development Coordinator

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 COURSE OBECTIVES
The Basics of Accounting is an initial level first course in accounting for students
who have no previous training in accounting or business.

Upon successful completion of the course, you will be able:

1. To know the basic accounting equation, the effect of transactions on accounting

equation.

2. To understand double entry system.

3. To comprehend the accounting cycle and financial statements.

4. To understand the significance of transactions, the procedure of the banking

transactions, preparation and importance of the cash-book and bank
reconciliation.

5. To identify Capital, Revenue, Deferred Revenue expenditures and purpose of

differentiating Capital from Revenue items.

6. To know the different types of errors, the effect of errors on trial balance,
techniques to locate and rectify them.

7. To know about the importance of bill of exchange in the business world, its
various types and differentiate between trade bill and accommodation bill.

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Unit–1

BASIC CONCEPTS OF
ACCOUNTING

Written by: Sohail Amjed

Reviewed by: Muhammad Munir Ahmad
Asia Batool

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 CONTENTS
Introduction
Objectives
1. THE AREA OF ACCOUNTING
1.1 Background
1.2 Accounting Definitions
1.3 Accounting System

2. CLASSIFICATION OF BUSINESS
2.1 On the basis Organization
2.1.1 Sole Proprietor
2.1.2 Partnership
2.1.3 Joint Stock Company
2.2 On the basis of nature of operations
2.2.1 Service
2.2.2 Merchandising
2.2.3 Manufacturing

3. COMMERCIAL TERMS
3.1 Profession
3.2 Business
3.3 Transaction
3.4 Drawings
3.5 Goods / Merchandise
3.6 Purchases
3.7 Sales
3.8 Service Revenue
3.9 Purchase Return and Allowance
3.10 Sales Return and Allowance
3.11 Debtor
3.12 Creditor
3.13 Cash Discount
3.14 Trade Discount
3.15 Cash Transaction
3.16 Credit Transaction
3.17 Wholesale Trade
3.18 Retail Trade
3.19 Bad Debts
3.20 Assets
3.21 Liabilities
3.22 Total Sale
3.23 Voucher
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 3.24 Account
3.25 Sundry Expenses
3.26 Accounting Period

4. BOOK-KEEPING
4.1 Introduction to Bookkeeping
4.2 Importance of Book-Keeping and Accountancy
4.3 Why Book-Keeping and Accounting is Necessary
4.3.1 Memory
4.3.2 Assessment of Profit/Loss
4.3.3 Tax Considerations
4.3.4 Sale of Running Business
4.3.5 Bankruptcy
4.3.6 Disputes
4.4 Difference between Accounting and Book-Keeping
4.4.1 Accounting
4.4.2 Book-Keeping
4.5 Double entry system of book-Keeping
4.6 Advantages of Double Entry System of Book-Keeping

5. ACCOUNTING CYCLE
5.1 Journal
5.2 Ledger
5.3 Trial Balance
5.4 Adjustments
5.5 Adjusted Trial Balance
5.6 Financial Statements/Final Accounts
5.7 Closing Entries
5.8 Post Closing Trial Balance

6. SUMMARY OF THE UNIT

7. SELF ASSESSMENT
7.1 Fill in the blanks
7.2 Identify the correct or incorrect statements
7.3 Choose the appropriate term
7.4 Answers
REFERENCES/ BIBLIOGRAPHY

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4
INTRODUCTION
Regardless of the nature of business, type of the organization, accounting
is an essential function of every economic entity. Accounting, like any other
discipline, has its own assumptions, terminologies and limitations. It is only by
studying accounting, that one comes to know about the financial statements
prepared by the accounting system and make good use of the information
provided in these financial statements. This unit is about the introduction of the
accounting. In this unit Book-keeping and Accounting are defined and
differentiated. Various terms used in the business are explained. Double entry
system of bookkeeping and accountancy is explained.

OBJECTIVES
After studying this unit, you will be able to:
1. Define and compare Book-keeping and Accounting
2. Understand the common terms used in ordinary course of business
3. Appreciate the significance of accounting function.
4. Explain the basics of an Accounting System
5. Explain the double entry system of Book-keeping and Accountancy

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1. THE AREA OF ACCOUNTING
1.1 Background
We make many decisions in our everyday lives. These decisions based on
the information that we have regarding the subject matter thus the quality of
decision depends on the quality of information. We often listen that it is
information era and people having more information have more opportunities. We
also observe that well informed people make good decisions and get succeed.
Now you can better understand the importance of quality information.
In the same way success of a business vastly depends on the good
decisions made by the businessmen. The input for economic decisions is financial
information and this information is the output of accounting system of an
economic entity. One of the basic purposes of accounting is to produce useful
information to make rational economic decisions. Let us take an example you
have some saving and you want to invest your saving in a business that provide
you some return on this investment to finance your studies. Further you have
many choices. What will be the criteria to select an investment avenue?
Obviously first of all you would be interested to know the economic resources
and obligations of the business and second the source and volume of profits that a
business earns. The rational is to judge the capacity of the business to return your
investment and payment of profit. The next question arises from where you will
get such information? Answer is accounting records of the business. From the
above discussion it is clear that accounting information facilitates the economic
decisions. Therefore accounting is a mean to generate financial information of an
economic entity.
Accounting provides information to help in making decisions about
organizations. This information is like a map of an organization. Accounting
information helps decision makers determine where they are, where they have
been, and where they are going. Rather than measuring distances in miles or
kilometers, accounting measures an organization’s activities by the money
associated with these activities. The primary measurement unit for accounting
information is Rupees in Pakistan or the local currency for other countries.
It is commonly perceived that accounting is a highly technical field and
only highly qualified and professional accountants can practice accounting. It is a
false impression every one of us use accounting concepts in our daily lives for
example when you prepare a monthly budget of your home you are exactly
practicing the accounting concepts.

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1.2 Accounting Definitions
Early definition of accounting generally focused the record keeping
function of accounting no doubt it is an important part of accounting but not the
whole sum. For example in 1941 the American Institute of Certified Public
Accountants defined accounting in the following words.
“Accounting is the art of recording, classifying and summarizing
in a significant manner and in terms of money, transactions and
events, which are in part at least, of financial character, and
interpreting the result thereof.”
As the time passed the activities of business grown complex the role and
character of the Accounting also changed and the accountants have to reconsider
the scope of accounting. In 1970, AICPA redefined the accounting in the
following words.
“The function of accountancy is to provide quantitative
information, primarily financial in nature, about economic entities
that is intended to be useful in making economic decisions.”
(An economic entity is a business unit that has an independent
existence.)
Today accountant is concerned not only with the record keeping but also
with the whole range of activities involving planning and problem solving. The
primary area of interest for the accountant is ultimate needs of those who use
accounting information whether these user are inside or outside the business. It is
easy to conclude now that accounting is an information system that measures,
processes and communicates financial information about an identifiable economic
unit. This accounting information allows the users to make rational choices
among the alternative uses of scarce resources in the conduct of business and
economic activities.
1.3 Accounting System
Accounting system consists of personnel, procedures, devices and records
used by an organization to develop and to communicate accounting information to
decision makers. The need for accounting information varies from user to user
and organization to organization. Some economic units require very little amount
of accounting information to operate just like a tuck shop of your college. It needs
not to install a very sophisticated accounting system and record each and every
transaction. Whereas the need for accounting information of a bank is more
demanding and is essential for the smooth operations to keep the complete and up
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to date accounting information. The design and capabilities of accounting system
vary from one to the next.
To decide the design and capabilities of the accounting system there are
two important factors. (1) Need of accounting information (2) cost of producing
such information. Designing and installation of accounting system is a specialized
field. Large organizations have a team of system analysts, internal auditors and
other professionals who are responsible for the designing and improving the
accounting system. However medium and small scale organizations hire the
services of specialized Chartered Accountancy Firms for this purpose.
2. CLASSIFICATION OF BUSINESS
There are three basic forms of business organization: sole proprietorships,
partnerships, and joint stock companies. Accountants recognize each form as an
economic unit separate from its owners, although legally only the joint stock
company is considered separate from its owners. Other legal differences among
three forms are discussed briefly below. These business organizations are further
classified into three categories on the basis of these activities i.e. service
organizations, merchandising and manufacturing.
2.1 On the basis Organization
2.1.1 Sole Proprietor
A sole proprietorship is a business formed by one person. Sole proprietor
invests the money, time and his energies. He enjoys all the profit and bears all the
losses alone. Because he is the only owner of the business so he is called sole
trader or sole proprietor. The business owned by the sole proprietor is called the
sole trader-ship or sole proprietorship.
This form of business gives the individual a mean of controlling the
business apart from his or her personal interests. Legally, however the
proprietorship is the same economic unit as the individual. Proprietorship
represents the largest number of businesses in the Pakistan but typically they are
smallest in size. The life of the proprietorship ends when the owner wishes it to,
or at the owner’s death or incapacity.
2.1.2 Partnership
Partnership is the voluntary association of more than one person who
contribute money and talent to carry on a business. The partners share the profits
and losses of the partnership according to an agreed upon formula. Generally any
partner can bind the partnership to another party and if necessary personal
resources of each partner can be called on to obligations of the partnership. In
some cases one or more partners may limited their liability, but at least one
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partner must have unlimited liability. A partnership must be dissolved if the
ownership changes as when a partner leaves or dies. If the business continues, a
new proprietorship or partnership must be formed.
2.1.3 Joint Stock Company
A company is a business unit that is legally separate from its owners. The
owners whose ownership is represented by shares or stock in the company do no
directly control the operations of the company. Instead they elect a board of
directors who run the company for the benefit of the stockholders. In exchange for
limited involvement in the company’s actual operations stockholders enjoy
limited liability.
2.2 On the basis of nature of operations
2.2.1 Service
Service businesses do not provide any tangible product to its customers. It
provides intangible products those are called services for example transportation
providers, educational institutions, financial institutions, hospitals etc are all
examples of the service organizations.
Practically the pure service organizations are rare. Service organizations
also provide some tangible goods. Mostly service business provides a basket of
goods and services. For instance hotels are service business but they also provide
food and drinks.
2.2.2 Merchandising
Merchandizing business purchases the ready to sale goods with a view to
sell them on profit. It does not produce the goods itself neither process to change
their qualities. Merchants buy products from producer and sell them to the
customer at higher prices. The difference between the buying cost and selling
price is the profit of the business. Merchandising companies include both retailers
and wholesalers.
2.2.3 Manufacturing
Manufacturing business turned the raw material into finished goods for its
consumers by employing labor and factory overheads. They buy the raw material
and through various processes make the finished goods. The goods produced by
these units are either used by the ultimate consumer or other manufacturers for
further production.

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3. COMMERCIAL TERMS
Before proceeding further it is vital to discuss the basic terms used
frequently in this text so that understanding of the subsequent stuff would be easy
for you.
3.1 Profession
All those economic activities other than the business aimed to earn profit
are called profession. Before adopting any profession it is essential to acquire the
basic knowledge and skills. The people who earn money through profession are
called professionals. The services provided by the professionals are the result of
immense expertise, personal skills and basic knowledge of the field. For example
teaching, plumbing, law and medical practices are all professions. Businessman
hires the professionals to execute the operations of the business. The individuals
who render services for the contracted rewards are called professionals.
3.2 Business

Human activities

Economic activities Non economic activities

Profession Business

Industry Commerce

Trade Aids to trade

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 Business means an economic unit that aims to produce and sell goods and
services to customers at a price that will provide an adequate return to its owners.
All economic activities performed to earn profit are not business. As the figure
shows human activities are divided into the economic activities and non economic
activities. Economic activities are those activities in which one has to sacrifice or
get some material resources. Further we classify the economic activities into the
profession and business both are endeavors to earn profits but there is slight
difference between these two economic activities i.e. in profession the provision
of services is subject to the presence of professional because the professional
personally produces the services. While in business the presence is not essential
for businessman because it is not necessary that the businessman provide services
himself instead he can hire the professional to provide the services to its
customers. He earns profits for organizing the activities and bearing risk.
3.3 Transaction
Most enterprises engaged in countless economic activities every day.
Some of these activities are accounting transactions and others are merely
economic events. Accounting transaction is an economic activity that can be
objectively measured in terms of money and effect the assets and/or equities of
the enterprise. For instance the purchase of an asset is a transaction but the daily
usage of the asset for the operations of the enterprise is merely an activity.
Transaction is the raw material for the preparation of the organization’s financial
reports.
3.4 Drawings
When the owner of the business withdraws the cash he invested or the
goods of the business for his personal use the value of such goods is called the
drawings. Drawings reduce the capital of owner while net income and further
investment increases the capital of the owner.
3.5 Goods / Merchandise
The commodities purchased by the business with a view to earn profit by
resale of these commodities without changing their physical characteristics are
called goods or merchandise. The sole criteria for differentiation of merchandise
and other assets is the intention of the proprietor, not the nature of the commodity.
For example if a Mr. Zahid purchase cars with a view to resale them on profit
these cars are his merchandise but if he purchases to use them for the pick and
drop of his employees then these cars will not merchandise but operating asset of
the business.

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3.6 Purchases
Purchase means the process of buying commodities either for resale at
higher price or to use in the manufacturing of the finished goods. There are two
types of purchase cash purchase and credit purchase. If the cash is paid at the time
of purchase it is called cash purchase but if payment is promised at some future
date then it would be credit purchase.
3.7 Sales
When the business provides goods to the customers for a price to earn
profit it is called sale. Again there are two types of sale cash sale and credit sale.
In cash sale the price is charged in cash at the time of sale. But if the payment is
promised by the customer on some future date it is called credit sale.
3.8 Service Revenue
Service revenue is the reward of professional that he earns by providing
the services to the clients. If the services are provided and the payment is made
immediately it is called the service revenue earned but if the payment is promised
in some future date it is called the service revenue receivable and if the client paid
in advance prior to providing the services then it will be the unearned service
revenue for service provider.
3.9 Purchase Return and Allowance
Some time the buyer returns purchased goods to the supplier for certain
reasons this is called the purchase return. If the transportation cost is adequately
high or the seller deems it feasible he may ask the buyer not to return the goods.
In reward he grants some concession in price to the buyer to compensate the
damages due to his mistake and to retain the good business relations with the
aggrieved buyer. This concession in price is called allowance. Instead of keeping
separate records for goods returned and allowance the business may maintain a
single account called Purchase return and allowance. The goods are returned or
the allowance claimed in the following situations.
1. If the goods are damaged or are not according to the quality agreed.
2. If goods are excess in quantity than demanded.
3.10 Sales Return and Allowance
When the buyer returns the goods sold it is sales return for the seller. It is
also called return inward. The reasons are same as in case of purchase return.
3.11 Debtor
The person who borrows some goods or cash from another person the
borrower is known as debtor in accounting. He remains debtor until he finally
makes payment and settled the account. Debtors are the asset of the business.
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3.12 Creditor
Creditor is the person who lends the goods, services or cash to another
person. He remains creditor until he collects the amount from the borrower.
Creditors are the liability for the business.
3.13 Cash Discount
When the debtor pays cash before the due date the creditor may grant him
some concession on this early payment to encourage this tendency. This
concession is known as the cash discount. This concession is normally some
percentage of the amount due. For instance “A” borrowed Rs.1000 from “B” for
one year but “A” pays this amount after ten months means two months before the
due date. Now the “B” may grant him some concession for early payment this
concession will be in percentage. Suppose “B” grants “A” 1% cash discount then
“A” have to pay Rs.990 instead of Rs.1000 this concession is known as cash
discount.
3.14 Trade Discount
Trade discount is the concession that seller grants to the buyer on the list
price of the goods. This is the part of the list price. For example a shopkeeper
quotes the price of a fane Rs.500 and after bargain he ready to sell the same fane
at Rs.490 this Rs.10 is the trade discount. Trade discount is not recorded in the
books of accounts. Only cash discount is written in the ordinary circumstances.
EXAMPLE
List Price Rs. 500
Trade Discount 10
Invoice Price Rs. 490

3.15 Cash Transaction

Cash transactions are those transactions in which payment is made
immediately in cash. In these transactions neither credit nor any other
consideration is involved.
3.16 Credit Transaction
It means the trade or business on credit in which cash is not involved and
the payment is promised in some future date.
3.17 Wholesale Trade
Wholesale is the trade of the goods in large quantity to the retailers. The
seller involved in this trade is called whole seller. Whole seller purchases good in
large quantities from the producer and sells goods to the retailer and normally not
to the ultimate customers.
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3.18 Retail Trade
Retail trade means the trade in which goods sold to the ultimate consumers
in small quantities. The seller involve in such trade is known as the retailer. The
retailer purchases goods from the whole sellers in large quantities and sell those
goods to the ultimate consumers in small quantities as demanded.
3.19 Bad Debts
Now a days mostly business is on credit. If the creditor cannot recovered
the whole or a part of the debt this un-recovered debt is called bad debt in
accounting. It is the expense of the business. Businessman uses many tactics to
reduce these unwanted expenses.
3.20 Assets
Assets are economic resources owned by a business that are expected to
benefit future operations. In other words assets are probable future economic
benefits obtained or controlled by a particular entity as a result of past
transactions or events. Certain kinds of assets are monetary items such as
receivables from customers and cash and other are non monetary physical things
such as inventories, land, buildings and equipments. Still some assets are
nonphysical rights such as patents copy rights and goodwill.
3.21 Liabilities
Liabilities are the claims against the assets of the business. These claims
are both internal and external. Internal claims means the claims by the owners of
the business who provide initial finance to the business technically called capital
or owner’s equity. External claims are the obligations of the business toward the
outsiders who provide finance to the business for example financial institutions,
suppliers, employees etc.
3.22 Total Sale
It means all the sale of a particular period including cash and credit sale.
For example in the last quarter of 2004 the cash sale of the ABC Co. is Rs.40000
and credit sale is Rs.35000 then the total sale or output will be Rs.75000.
3.23 Voucher
The written evidence of a transaction is called voucher. In accounting all
transactions must be supported by the vouchers. No transaction can be recorded in
the books of accounts until supported by a documentary proof. This proof may be
bills, invoices, and receipts.

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3.24 Account
Account means a classified record of a particular person or a thing in
black and white. Each account has a unique title and all the transactions relevant
to that thing or person is recorded under this title. This is the classification process
in the accounting. We will discuss this term in great detail in the next unit.
3.25 Sundry Expenses
The day to day petty expenses of small amounts are recorded in a single
account called sundry expense or miscellaneous expenses to save the wastage of
stationery, energies and time.
3.26 Accounting period
The owner can know the profit and loss of the business at any time from
the books of accounts but for ease and to comply with the instructions of the
government institutions the owners have to decide the period for which the
financial statements are prepared. Normally this period is one year but the
organization may prepare the financial statements during the year at any time
these statements are called interim financial statements. It is not essential that
accounting period must parallel to the calendar year. Some firms or companies
close their accounting period in June while others in December. At the end of
each accounting period financial statements are prepared. The period must not
change frequently as the comparability of profit become difficult.
4. BOOK-KEEPING
4.1 Introduction to Book-keeping
As the name implied book keeping is the means of recording transactions
and keeping records in order and proper form. It is only a small part of accounting
consisting of recording phase of accounting. Accounting on the other hand,
includes the design of an information system that meets user needs. The major
goal of accounting is the analysis, interpretation and use of information. Book
keeping on the other hand is the clerical side of accounting i.e. recording of
routine transactions and day to day record keeping.
Personal record keeping often uses a simple single-entry system, in which
amounts are usually recorded in column form. Such entries include the date of the
transaction, its nature, and the amount of money involved. Record keeping of
organizations, however, is based on a double-entry system, whereby each
transaction is recorded on the basis of its dual impact on the organization’s
financial position or operating results or both.
Bookkeeping encompasses the record-keeping aspect of accounting and
therefore provides much of the data to which accounting principles are applied in
15
the preparation of financial statements and other financial information. In other
words bookkeeping means a systematic way of recording all the transactions in
black and white so that the business institutions can get the required information
from this data and can resolve the disputes that often arise among proprietor and
other concerned parties.
4.2 Importance of Book-Keeping and Accountancy
To appraise the importance of bookkeeping records, let’s suppose that
sometime during the night, every copy of every novel ever written were to
disappear. Could life proceed normally the next day? While the cultural loss
would be immeasurable, the normal activities of the next day would not be clearly
affected. What if television were suddenly gone when we woke up? While we
might wander around wondering what to do with our time, life would go on. But
what if we woke up tomorrow morning to find the bookkeeping records of all
businesses worldwide damaged during the night? Businesses that rely on up-to-
the- minute customers account information, such as banks, simply could not open
their doors. Retailers would have to insist on cash purchases, since no credit
records could be verified. Manufacturers would have to do a quick count of
existing inventories of raw materials and components to find out whether they
could keep their production lines running. Suppliers would have to call all their
customers, if they could remember who they were, to renegotiate purchase orders.
Attorneys would find themselves in endless arguments about their fees because
they would have no record of billable hours. Routine and dry as bookkeeping may
seem, the world simply could not function for one day without it.
Since the main object of any business is to earn the profit and expansion of
the business. For these reasons every businessman is anxious to know the profit of
a specific period and worth of the business. In the ancient days when the business
activities were limited little efforts were required to know the profitability. The
recording of the each and every transaction was not necessary because
transactions were few and simple. With the invention of machines and techniques
of mass production the transactions became complex. Memorizing the
transactions becomes impossible so recording the transactions in black and white
and keeping these records in order is essential now. If an organization does not
maintain proper books of account they cannot judge the financial position,
profitability and true direction of business. In case of any dispute if proper records
are not kept it becomes difficult to settle down the dispute. Moreover it is
requirement by government to maintain the proper books of accounts for many

16
businesses. For these reasons all business organizations hire the accountants to
fulfill these requirements.
For an ordinary trader it is not legally essential to maintain proper books
of accounts but many difficulties may arise due to the absence of proper
accounting records. So it is mandatory for every organization to record business
transactions in proper form.
4.3 Why book keeping and accounting is necessary
For any organization accounting is necessary on the following grounds.
4.3.1 Memory
Now-a-days due to complexity and expansion of the business dealings it is
not possible for a business man to remember all the transactions. So it is
necessary for every businessman to keep proper and complete records of his
business to get useful information about his business and to prevent the mistakes
and misunderstandings.
4.3.2 Assessment of Profit/Loss
Because the basic purpose of any business is to earn profit so every
entrepreneur wishes to know the profit of the specific period at the end of that
particular period. It is only possible to know the true profit or loss if he keeps the
complete and systematic records of the business activities. If he does not maintain
the proper books he‘ll not be able to know what he gained or lost in a specific
period.
4.3.3 Tax Considerations
Income tax has an important factor in the modern business environment. If
a businessman does not keep proper business records from that the profit or loss
can be judged with documentary proof than he will be on the disposal of the tax
authorities. He will have to pay the tax according to the income assessment of the
tax department. Normally the income assessed by the tax officers is more than the
actual income. So the businessman has to bear the loss of the additional tax. To
avoid this loss he should maintain the proper accounts to prove the incomes and
expenditures.
4.3.4 Sale of running business.
Due to many unforeseen circumstances sometime the businessman has to
sale out his business. If the entrepreneur kept the proper records he would be able
to easily determine the sale price of his business and also he will be in a position
to satisfy the buyer in this regard. But if he does not keep proper records he would
not be able to satisfy the buyer and would not assess the true worth of the business
to determine the actual sale price of the business.
17
4.3.5 Bankruptcy
If unfortunately the business fails the businessman has to face many
problems. Because he is unable to pay debts but repetitive demands of the
creditors creates anxiety for him. In these circumstances he has the only way to
approach the court and be declared as bankrupt. He can get the justice only if he
can prove in the court by organized records of the business that he is not intended
to cheat his creditors. If he has not maintained the proper records he has no such
privileges.
4.3.6 Disputes
If a businessman maintains the proper records in case of any dispute with
the customer or employee he will be in better position to settle down that dispute
because he has documentary evidence in shape of vouchers. In case any stake
holder file a suit against business the businessman can prove in court by his
accounting books.
4.4 Difference between Accounting and Book-keeping
Although accounting and book-keeping are two different things but
normally in small business units both the duties are performed by the same person
so the difference between accounting and book-keeping is ignored.
4.4.1 Accounting
Where the work of the book-keeper ends the work of the accountant starts.
For an accountant it is required that he must not only highly educated but also
must be highly trained and experienced. The accountant aggregates the records of
the book-keeper and judge the profit or loss of the business. The accountant
assists the management in developing the future plans. He also points out what
expenditures should be controlled and what should be expanded to maximize the
profit. He produces different statements after the analysis for the different
institutions according to the requirements of these institutions. In this way, he
plays key role in the management of the business. The accountant plays the role
of coordinator. He organizes the data collected by the book keeper in desired and
prescribed manners.
4.4.2 Book-Keeping
Book keeping means to write the business transactions in the books of
accounts. The person who performs this duty is called book-keeper or accounts
clerk. Higher education in accounting is not necessary for the book-keeper
because he works under an accountant who directly supervises the book keeper.
The work of book keeper is of clerical nature, he produces the records in routine
he has not to apply the complex techniques.
18
4.5 Double entry system of book-keeping
The first systematic presentation of double entry system of bookkeeping
appeared in 1494, two years after Columbus discovered America. It was described
in a mathematics book written by Fra Luca Pacioli, a Franciscan monk who was a
friend of Leonardo da Vinci. Geothe, the famous German poet and dramatist,
referred to double entry system of bookkeeping as one of the finest discoveries of
the human intellect.
Double entry system of book keeping is the complete and comprehensive
system in which the complete information regarding the transaction is brought
into the records in a very result oriented manner. The rationale behind this system
is to record each change in the accounts separately because a single transaction
affects more than one account. The double entry system is based on the principle
of duality, which means that all events of economic importance have two aspects-
effort and reward, sacrifice and benefit, sources and uses- that offset or balance
each other. In double entry system each transaction must be recorded twice in
such a way that the total amount of debits and total amount of credits equal each
other. Because of the way it is designed, the system as a whole is always in
balance and therefore always under control. All accounting systems no matter
how sophisticated are based on this principle of duality.
Without prior knowledge of accounting it is not possible to understand
how a single transaction has double effect but after studying the subsequent
chapters you will be able to recognize these impacts. The modern accounting has
the seven step accounting cycle given below.
4.6 Advantages of double entry system of book-keeping
The advantages of the double entry system are as under.
i. In this system both effected accounts are recorded immediately.
ii. Businessman can easily get complete and reliable information.
iii. The businessman can get up to date information regarding Debtors and
Creditors.
iv. In the books of accounts not only sale and purchase but also all the
expenses, losses, profits, assets and liabilities are recorded so the
businessman can easily know the profitability and financial position of the
business.
v. Future plans can be made to minimize the risk and maximize the profit.
vi. In the double entry system all the debits are equal to all credits. At the
time of totaling if total debits are not equal to the credits it means there is

19
 an error. By this way an error can be detected and corrected. It is the major
advantage of this system.
6. ACCOUNTING CYCLE
The eight steps of the accounting cycle are summarized as below.

Transaction

1.
8. Journalizing 2.
Post Closing Posting
Trial Balance

7. 3.
Closing Accounting Trial Balance
Entries cycle

6. 4.
Financial Adjustments
Statement \
Final Account 5.
Adjusted
Trial Balance

5.1 Journal
When a transaction took place it is recorded same day in a book called
journal. The purpose of this book is to avoid any omission in records. The process
of recording of the transaction in this first book is called journalizing.
20
Transactions are recorded chronologically thus it is also called chronological
book. It is also called day book because all the transactions of the day are
recorded in this book.
Special journals are used to record recurring transactions. These include a sales
journal, a purchases journal, a cash-receipts journal, and a cash-disbursements
journal. Transactions that cannot be accommodated by a special journal are
recorded in the general journal.
5.2 Ledger
In second step of accounting cycle the amounts that appear in the various
journals are transferred to the organization's ledger, a procedure called posting. A
ledger is a book having one page for each account in the organization's financial
structure. The page for each account shows its debits on the left side and its
credits on the right side, so that each account’s balance that is, the net credit or net
debit amount can be determined at the end of accounting period. The process of
transferring entries from journal to ledger is called posting. The ledger gives
detail information about all the transactions of a specific account.
In addition to the general ledger, variety of subsidiary ledgers is used to
provide information in greater detail about the accounts in the general ledger. For
example, the general ledger contains one account showing the entire amount owed
to the enterprise by all its customers; the subsidiary ledger breaks this amount
down on a customer-by-customer basis, with a separate subsidiary account for
each customer. Subsidiary accounts may also be kept for the wages paid to each
employee, for each building or machine owned by the company, and for amounts
owed to each of the enterprise's creditors.
5.3 Trial Balance
Posting data to the ledgers is followed by listing the balances of all the
accounts and calculating whether the sum of all the debit balances agrees with the
sum of all the credit balances because every transaction has been listed once as a
debit and once as a credit. This determination is called a trial balance. This
procedure and those that follow it take place at the end of the fiscal period. Once
the trial balance has been prepared successfully, the bookkeeping portion of the
accounting cycle has ended.
5.4 Adjustments
Once bookkeeping procedures have been completed, the accountant
prepares adjustments for the transactions involve more than one accounting
period. The following are the most common circumstances that require
adjustments: accrued revenue (for example, interest earned but not yet received);
21
accrued expense (wage cost incurred but not yet paid); unearned revenue (earning
subscription revenue that had been collected in advance); prepaid expense
(expiration of a prepaid insurance premium); depreciation (recognizing the cost of
a machine as expense spread over its useful economic life); inventory (recording
the cost of goods sold on the basis of a period's purchases and the change between
beginning and ending inventory balances); and receivables (recognizing bad-debt
expenses on the basis of expected uncollected amounts).
5.5 Adjusted trial balance
Once the adjustments are calculated and entered in the ledger, the
accountant prepares an adjusted trial balance—one that combines the original trial
balance with the effects of the adjustments (step five). With the balances in all the
accounts thus updated, financial statements are then prepared (step six). The
balances in the accounts are the data that make up the organization's financial
statements.
5.6 Financial statements/Final Accounts
Final accounts or financial statements are the end product of an accounting
cycle. There are four types of financial statements Income statement, Balance
Sheet, Statement of changes in owner’s equity and Cash Flow Statement. The
income statement shows the profitability of the business. The balance sheet shows
the financial position of the business. Statement of changes in owner’s equity
shows the changes in the capital of the owners and cash flow statement shows the
cash position of the business it clearly states the sources of cash and the uses of
cash.
5.7 Closing Entries
This procedure involves a series of bookkeeping debits and credits to
transfer sums from income-statement accounts into owners' equity accounts. Such
transfers reduce to zero the balances of non-cumulative accounts so that these
accounts can receive new debit and credit amounts that relate to the activity of the
next business period.
5.8 Post Closing Trial Balance
A post-closing trial balance is a listing of all balance sheet accounts
containing non-zero balances at the end of a reporting period. It contains balances
of permanent accounts (Assets, Liabilities and Equities) only because temporary
accounts (Revenue and Expenses) have already been closed and their balances
moved into the retained earnings account as part of the closing process.

22
6. SUMMARY OF THE UNIT
Accounting records provide the meaningful data to decision makers to
rationalize their decisions. Book-keeping is the tool to record and collect this data.
The difference between accounting and book keeping that is normally ignored is
nature of the duties that a book keeper and accountant perform. The job of the
book keeper is more descriptive while the work of accountant is inferential.
Book keeping is a very important activity for every business unit because
it is not only helpful to ascertain profit or loss and financial position of the
business but also helps to calculate tax and prevents disputes that may arise.
Double entry system of book keeping is a fool proof system that results a
lot of benefits besides the assurance of arithmetical accuracy. In this system
complete impact of a transaction on the business are recorded under the debit and
credit heads.
Accounts clerk that works under the accountant his duty is to journalize
and posting of the entries. Accountant is not only responsible for the supervision
of the routine functions but also for analysis and interpretation of the books of
accounts to prepare the useful and meaningful data for the management and
owners.
As accounting is a complete system, therefore a transaction moves through
various records before becoming complete information. This process is known as
accounting cycle. It starts from initial recording of transaction in journal and then
these records are posted in the ledger. At the end of the accounting period all the
accounts are totaled to find out their balance. These balances are recorded under
the debit and credit heads this summary is called trail balance and finally financial
statements are prepared from this summary. The consistent period of completion
of accounting cycle is known as accounting period.

23
 7. SELF-CORRECTION PROBLEMS
7.1 Fill in the blanks.
i. Book-keeping reduces the chances of ________________.
ii. It is not possible for a businessman to ______________ all the business
transactions.
iii. Income tax has an important ____________ in the modern business
environment.
iv. ______________ means disability to pay the debts of creditors.
v. For any reason if a businessman have to sell business accounting records
helps to determine the ____________ of the business.
vi. When a transaction take place it is recorded same day in a book called
________.
vii. The process of transfer of transactions from journal to ledger is called
________.
viii. Trial balance is the _________ of all the ledger accounts.
ix. The income statement shows the ___________ of the business.
x. __________ shows the financial position of the business at the end of
accounting period.
xi. ______________is the art of writing all the business transactions
systematically.
xii. The main objective of any ______________ is to earn profit and
expansion.
xiii. All those economic activities other than business aimed to earn profit are
called _____________.
xiv. _____________ is the voluntary association of more than one person who
contribute money and talent to carry on a business.
xv. ______________ is a business unit that is legally separate from its owners.
xvi. The investment of cash or other assets in the business by owner is called
___________.
xvii. Economic event that can be objectively measured in terms of money is
called ______________.
xviii. Withdraw of cash or other assets from business by the owner for personal
use is called __________________.
xix. Purchase is of two types’ _______________ and ________________.
xx. ____________ Discount is not written in the books of accounts.
xxi. Liabilities are the claims against the ____________ of the business.
xxii. The written evidence of a transaction is called ____________.
24
Followings are some statements followed by alternative answers. You are
required to mark the correct answer.
A. The main objective of any business
i. Is to provide job opportunities to the people.
ii. Is to produce quality goods.
iii. Is to earn profit.
B Economic activities are classified into
i. Profession and business
ii. Business and commerce
iii. Profession and commerce
C. Sole proprietor has
i. Limited liability
ii. Unlimited liability
iii. Limited liability up to its investment

D. Transaction means
i. Any deal among the businessman and outsiders
ii. Any important event that affect the business activities
iii. Any economic event that can be objectively measured in
terms of money.
E. Cash discount is the concession
i. That is granted by the seller on the list price.
ii. That is granted by the creditor on the list price at the time
of sale.
iii. That is granted by the creditor on amount due for early
payment of cash.
7.2 Identify the correct and incorrect statements.
i. It is legal requirement to maintain accounting records for all business
units. R/W
ii. There is no difference between accounting and book keeping. R/W
iii. Where the work of book keeper ends the work of accountant starts. R/W
iv. The duty of accountant is just to record all the business transactions. R/W
v. The basic principle of double entry system of book keeping is to record
the transactions twice in different books. R/W
vi. Profit and loss cannot be judged from the trial balance. R/W
vii. Accounting period is always equal to the calendar year. R/W

25
 viii. Non- Profit organizations need not to maintain proper books of accounts
as their basic aim is not to earn profit. R/W
ix. In book keeping there is no importance of proper records. R/W
x. There is no relation of transaction and book keeping. R/W
xi. Trading institutions can find out there profit or loss by book keeping. R/W
xii. Due to complexity manufacturing institutions can work without an
accountant. R/W
xiii. Business institutions have no direction from government to keep proper
books of accounts. R/W
xiv. Business does not means all those activities aim to earn profit. R/W
xv. Medical practice is an occupation not a business. R/W
xvi. In partnership only a single person is owner of the business. R/W
xvii. Single organization is also called sole proprietorship. R/W
xviii. Payment of salaries to employees is also a transaction. R/W
xix. Merchandizing business purchases the ready to sale goods with a view to
sell them on credit. R/W
xx. Trade discount is the concession granted by the seller on invoice price.R/W
xxi. The person who borrows some goods or cash from another person the
borrower is called creditor. R/W
7.3 Choose the appropriate term
Many important ideas and concepts that are discussed in this unit are
reflected in the following list of key terms. Test your understanding of these terms
by matching the appropriate definition with the terms. Record the number
identifying the most appropriate definition in the blank space next to each term.
a. ______ Accounting
b. ______ Assets
c. ______ Balance sheet
d. ______ Book keeping
e. ______ Business transaction
f. ______ Creditors
g. ______ Capital
h. ______ Debtors
i. ______ Liability
j. ______ Profit
k. ______ Partnership
l. ______ Revenue
m. ______ Sole proprietorship
26
i. A person or enterprise to whom a debt is owed.
ii. A financial report showing the assets, liabilities, and owner’s equity of an
enterprise on a specific date.
iii. The art of recording, classifying, reporting and interpreting the financial
data of an organization.
iv. An inflow of assets, not necessarily cash, in exchange for goods and
services sold.
v. A person or enterprise that owes a debt.
vi. The record keeping phase of accounting
vii. A property or economic resource owned by an individual or enterprise.
viii. A business owned by an individual.
ix. The equity of the owner of a business in the assets of the business.
x. The excess of revenue over expenses
xi. A right, claim or interest in property
xii. An economic event that can be measured in terms of money.
7.4 Answers
Fill in the blank
i. error ii. remember iii. factor iv. bankruptc
y
v. sale price vi. day book vii. posting viii. statement
ix. profit x. balance xi. book xii. business
/loss sheet keeping
xiii. professio xiv. partnership xv. compan xvi. capital
n y
xvii. transactio xviii. drawing xix. cash, xx. trade
n credit
xxi. assets xxii. voucher
Choose the correct answer
A. iii B. i C. ii D. iii
E. iii
Identify the correct and incorrect statements
i. W ii. W iii. R iv. W v. R
vi. R vii. W viii. W ix. W x. W
xi. W xii. W xiii. W xiv. W xv. R
xvi. W xvii. R xviii. R xix. W xx. W
xxi. W
27
Choose the appropriate term
ii. f iii. c iv. a v. l vi. h
vii. d viii. b ix. m x. g xi. j
xii. i xiii.
e

BIBLIOGRAPHY
Ahmad, M. M., Khan, S. A., Arshad, M., & Shah, S. M. (2013). Advanced
Financial Accounting. Islamabad: National Book Foundation Islamabad.
Dupree, D., & Marder, M. (1984). Principles of Accounting. Addison-Wesley.
Farooq, U., & Amir, S. M. (2008). Principles of Accounting. Islamabad: Allama
Iqbal Open University.
Hussain, K., Buttar, Z. U., Pirach, M. A., & Chaudhry, M. I. (1996). Accounting
Principles. Lahore: Orient Publishers Urdu Bazaar Lahore.
Mukherjee, A., & Hanif, M. (2003). Modern Accountancy I. Tata McGraw-Hill
Education.
Randall, H. (2005). Accounting. Cambridge University Press.
Wood, F., & Sangster, A. (2008). Business Accounting I. Pearson Education.

28
29
Unit–2

ACCOUNTING EQUATION

Written by: Asia Batool

Sohail Amjed
Reviewed by: Dr. S.M Amir Shah
Muhammad Munir Ahmad

30
 CONTENTS
INTRODUCTION
OBJECTIVES
1. EVENT
1.1 What is an event?
2. TRANSACTIONS
2.1 Classification of Transactions
2.1.1 Cash transactions
2.1.2 Credit transactions
2.1.3 Rules for deciding whether transaction in cash or credit
2.2 Analysis of transactions
2.2.1 Understanding of account
2.2.2 Types of accounts
2.2.2.1 Personal account
2.2.2.2 Impersonal account
2.2.2.3 Real account
2.2.2.4 Nominal account
2.2.2.5 Example of each type
2.3 Concepts of Debiting and Crediting
2.4 Rules of debiting and crediting
2.4.1 Account of asset
2.4.2 Account of liabilities
2.4.3 Account of owner‘s equity
2.4.4 Account of revenue
2.5 Conventional approach / British approach
2.6 Analysis of transaction a practical law
3. ACCOUNTING EQUATION
3.1 What is an accounting equation?
3.2 Concept of business entity
3.2.1 Assets
3.2.2 Liabilities
3.2.3 Owner’s equity
3.3 The effect of business transactions on the accounting equation
3.3.1 Examples
4. SELF ASSESSMENT QUESTIONS
4.1 Fill in the Blanks
4.2 Choose the Best Answer
31
 4.3 Best Match
4.4 Short Questions
4.5 Answers
5. PROBLEMS
5.1 Accounting Equation
5.2 Analysis of Transactions
6. SUMMARY OF THE UNIT
REFERENCES/BIBLIOGRAPHY

32
INTRODUCTION
This unit describes that how the transactions are recorded in the accounting
equation. Rules for debit and credit are also given to analyze the transactions so
that you may determine which accounts are involved in a transaction and which
accounts are to be debited and/or credited.

OBJECTIVES
After studying this unit, you will be able to:
1. Know the basic accounting equation.
2. Understand the effect of transactions on accounting equation.
3. Analyze the transactions using rules of debit and credit.
4. Record the transactions in the accounting equation.
5. Explain the double entry book keeping system.

33
1. EVENT
1.1 What is an event?
Any activity of human life is generally called event. In conventional
language “Event means anything that occurs or happens.” Events are classified
into two groups;
1.1.1 Monetary event
Those events which can be measured in monetary terms are known as
monetary events.
For example:
M. Naeem started a business with the capital of Rs. 600,000.
Mr. Hamza purchased books from MR. Ali s’ book shop Rs. 6,000.
Paid electricity bill Rs. 5,000.
1.1.2 Non-Monetary event
Event which is not related to money or if the financial position of a business
is not changed due to the happening of that Event is called Non-Monetary Event.
For example passing examination, winning the game and deliberation of speech
etc.
Events treated as transactions are recorded in the books of accounting.
Events other than transactions are not recorded in the books of accounts.
In every transaction of an individual or organization two parties or accounts are
involved. One party is seller and other party is buyer.
Events occurred measurable in terms of money are called transactions.
For example,
1- Purchased Books for cash Rs. 1,000/-
2- Sold Furniture on account Rs. 50,000/-
3- Salary payment Rs. 5,000/-
4- Tuition fees Received Rs. 10,000/-
Therefore, the exchanges of goods or services measurable in terms of money
which bring financial changes of a person or organization are called transactions.
2. TRANSACTION
A transaction is an economic activity of the business resulting in the
changes in financial position of business. Whenever any business transactions
takes place, values of some of the assets, liabilities or capital change.
Transactions are the subject matters of Accounting. Accounting means
maintaining of records of transactions systematically. For this reason one should
have clear conception of transaction before knowing techniques and principles of
accounting. Transactions are very important elements in Accounting.
34
Hermanson, Edward and Salmon say, “Transaction is a recordable happening
or event that affects the assets, liabilities, owner’s equity, revenue or expense of
event.”
2.1 Classification of transactions
2.1.1 Cash transactions
The-transactions which are settled for cash right after their occurrence are called
cash transactions. Products are sold in cash which means that buyers pay the money
immediately. Cash means money, cheque and bank draft etc.
Difference between cash and credit transactions is the timing of the
payment.
For example,
Mr. M. Naeem purchased furniture for cash Rs. 50,000 for use in his shop.
2.1.2 Credit transactions
Products are sold in credit which means that buyers does not pay the money
immediately but paid at later stage.
For example,
Mr. M. Naeem purchased Machinery on credit Rs. 50,000 from Miss Hareem
Fatima for use in his shop. That transaction is settled for credit because Mr.
Naeem is a buyer and he promised with Hareem, he will pay price of Machinery
after few days.
2.1.3 Rules for deciding whether transaction in cash or credit
Sometimes transactions are worded in such a way that it becomes difficult
to decide whether they are cash or credit transactions. The two rules will make
easy for that transaction is cash or credit:
(a) A transaction is regard as a cash transaction if:
The word “cash” is mentioned in the transaction. For example, Miss.
Hareem Fatima bought books for cash from Mali’s book shop.
(b) A transaction is regard as a cash transaction if:
 The words “on credit” or “on account” are mentioned in the transaction.
For example, Miss. Hareem Fatima bought books on credit from Mali’s
book shop.
 The name of the seller or buyer is mentioned in the transaction and the word
“cash” is not mentioned. For example, Miss. Hareem Fatima purchased
goods from Mr. Ali.

35
2.2 Analysis of transactions
Before preceding the analysis of transactions, it is necessary to understand
the concept of “Accounts”.
2.2.1 Understanding of account
The T account is helpful place to start the study of the double entry system.
As discussed in the first unit the simplest form of an account has three elements:
(1) a title, which is the name of the item recorded in the account; (2) a space for
recording increases in the amount of the item, in terms of money (3) a space for
recording decreases in the amount of the item also in monetary terms. It is called
T account because its similarity to the letter T.

Debit A/C Name Credit

Thus any entry made on the left side of the account is debit or debit entry
and any entry made on the right side of the account is credit or credit entry. What
is to be written on the debit side and what will be written on the credit side has a
set pattern i.e. called debit and credit rules‫۔‬
2.2.2 Concepts of debiting and crediting
The dictionary meaning of debit is an accounting entry that results in either
an increase in assets or a decrease in liabilities or net worth. Similarly credit
means transactions involving the transfer of money or other property on promise
of repayment usually at a fixed future date. The transferor thereby becomes a
creditor, and the transferee, a debtor; hence “credit” and “debit” are simply terms
describing the same operation viewed from opposite standpoints.
The terms, debit and credit, in accounting indicate whether the transactions
are to be recorded on the left hand side or right hand side of the account
2.2.3 Approaches
There are two approaches to comprehend the rules of debit and credit with
the same results. We will discuss both to better understand the concept.
a. American approach
b. British approach

36
2.2.3.1 American Approach
According to American approach rule regarding to debiting and crediting
are classified into six types of accounts theses are following;
i. Account of Assets
Increase in an asset will be debited.
Decrease in an asset will be credited.
ii. Account of liabilities
Increase in a liability will be credited.
Decrease in a liability will be debited.
iii. Account of owner ‘ s equity or capital
Increase in a capital will be credited.
Decrease in a capital will be debited.
iv. Account of revenue
Increase in revenue will be credited.
Decrease in revenue will be debited.
v. Account of expenses
Increase in an expense will be debited.
Decrease in an expense will be credited.
vi. Account of losses
Increase in a loss will be debited.
Decrease in a loss will be credited.
According to this approach all the accounts are classified into the six groups and the
changes in these groups are recorded as debit and credit by employing the following rules.
Accounts category Normal balance Increase Decrease
Assets Debit Debit Credit
Expenses Debit Debit Credit
Losses Debit Debit Credit

Liabilities Credit Credit Debit

Proprietorship/Owner’s
equity Credit Credit Debit
Revenues/Incomes Credit Credit Debit
As the table shows that normal balance of the assets, expenses and losses is
debit and it is written on the left side of the account. When increase take place it is
also written on the left side means this positive change increases their respective
balances. When a decrease takes place it is written on the right hand side that
decreases their balances. In the same way the normal balance of the liabilities,
37
incomes and capital is credit so it is written on the right hand side of the account
when an increase take place this increase is also written on the right hand side of
the account. Decrease in these accounts is debited and recorded on the left hand
side of the account.
2.2.3.2 Conventional Approach / British Approach
According to British approach rule regarding to debiting and crediting are
classified into three types of accounts theses are following;
 For Personal Accounts: Debit the account of the receiving person and
credit the account of the giving person.
 For Real Accounts: debit the account of property or goods coming in and
credit the account of property or goods going out.
 For Nominal Accounts: debit the account of expenses and losses and credit
the account of income and gains.
Personal A/C Real A/c Nominal A/c
Debit Recipient Comes in Expenses & Losses
Credit Provider Goes out Gains and revenues
2.2.4 Types of Accounts
It will be easy to comprehend the rules of debit and credit if we discuss the
types of the accounts first.
Accounts

Personal Accounts Impersonal Accounts

Real Accounts Nominal Accounts

a. Personal Account
Personal Account is the account which is in respect of a person, firm or a
company. Personal accounts are of two types the accounts receivable or accounts
payable. These accounts show the transactions with the customers, suppliers,
money lenders, the bank and the owner. A business may have many credit
38
transactions with the above persons or organizations. A separate account is to be
prepared for each of them. Persons or organizations with whom the business has
credit transactions are either debtors or creditors. If they have to give some money
to the firm, they are called debtors. Conversely, if the firm is to pay them some
money they are known as creditors. The main purpose of preparing personal
accounts is to ascertain the balances due to or due from persons or organizations.
b. Impersonal Account
Impersonal Accounts are those other then personal accounts. These
accounts include all expenses, incomes, assets and liabilities. Impersonal accounts
are further classified under the following two categories.
c. Real Accounts
All assets, liabilities and capital accounts are permanent accounts. All
permanent accounts are real accounts. Real accounts are balanced and carried
forward to the next accounting period. These accounts are accounts of assets and
properties such as land, building, plant, machinery, patent, cash, investment,
inventory, etc. When machinery is purchased for cash, the two accounts involved
are machinery and cash – both are Real Accounts. But if the same machine is
purchased from Z & Co on credit, the two accounts involved will be those of
Machinery and Z & Co., the former being a Real Account and the latter being a
personal Account. In other words real accounts are Balance Sheet Accounts and
balances of these accounts are transferred to next year.
d. Nominal Accounts:
These accounts are closed at the end of the financial year. The balances of
these accounts are not transferred to the next year for example wages paid,
discount allowed or received, purchases, sales, etc. These accounts generally
accumulate the data required for the preparation of Trading and Profit and Loss
Account.

39
e. Examples of each type
Impersonal Accounts
Personal Accounts Nominal
Real Accounts
Accounts
Humza’s Account Cash A/c Rent Expenses
Sohail’s Account Furniture A/c Salaries
Noor and Sons Mortgage Loan Interest earned
Amir’ s Account Buildings Bad debts.
Ahmed and Co. Land Sales.
Star Fabrics. Utility bills
Leather Inn Pvt, Ltd
2.2.5 Illustration -1
Analyze the given transactions and find out the accounts to be debited and
credited by employing both the approaches.
1. Started business with cash Rs.150, 000.
2. Opened a bank account in the name of business with Rs.30,000
3. Purchased goods for cash Rs.7, 000.
4. Purchased goods on credit Rs.8000 from Mr. Salman.
5. Additional investment of cash Rs.50000 was made by the owner.
6. A part payment of Rs.4000 was made for merchandise purchased on credit
from Salman.
7. Commission received Rs.5000.
8. Purchased furniture for Rs.1200. and payment was made by cheque.
9. Sold merchandise on account to Adnan Rs.6500.
10. Purchased computer from Usman for Rs.6000. on credit.
11. Cash sales Rs.4500.
12. Goods given away as a charity Rs.500.
13. Owner took away goods for his personal use Rs.500.
14. Paid telephone bill Rs.350.
15. Paid salaries to the employees Rs.1800.

40
SOLUTION
a. British or conventional approach
Account to
Sr. Nature of
Accounts involved be debited Reasons
No Account
or credited
Cash A/c Real Debit Cash came in
1.
Capital A/c Personal Credit Owner is provider
Bank A/c Personal Debit Bank is recipient
2.
Cash A/c Real Credit Cash went out
Purchases A/c Real Debit Merchandise came in
3.
Cash A/c Real Credit Cash went out
Purchases A/c Real Debit Merchandise came in
4.
Mr. Sulman A/c Personal Credit He is the provider
Cash A/c Real Debit Cash came in
5.
Capital A/c Personal Credit Owner is provider
Mr. Sulman Personal Debit He is recipient
6.
Cash A/c Real Credit Cash went out
Cash A/c Real Debit Cash came in
7.
Commission A/c Nominal Credit Commission is income
Furniture a/c Real Debit Furniture came in
8.
Bank A/c Personal Credit Bank is provider
Mr. Adnan A/c Personal Debit He is recipient
9.
Sales A/c Real Credit Goods went out
Office equipment Real Debit Equipment came in
10. A/c Personal Credit He is the provider
Mr. Usman A/c
Cash A/c Real Debit Cash came in
11.
Sales A/c Real Credit Goods went out
Charity A/c Nominal Debit Being expense
12.
Purchases A/c Real Credit Goods went out
Drawings A/c Personal Debit Owner is the recipient
13.
Purchases A/c Real Credit Goods went out
Telephone A/c Nominal Debit Being expense
14.
Cash A/c Real Credit Cash went out
Salaries A/c Nominal Debit Being expense
15.
Cash A/c Real Credit Cash went out

41
 b. American approach
Account to be
Sr. Nature of Increase or
Accounts Involved Debited or
No Account Decrease
Credited
Cash Asset Increase Debit
1.
Owner’s Equity Proprietorship Increase Credit
Bank Asset Increase Debit
2.
Cash Asset Decrease Credit
Purchases Asset Increase Debit
3.
Cash Asset Decrease Credit
Purchases Asset Increase Debit
4.
Mr. Sulman Liability Increase Credit
Cash Asset Increase Debit
5.
Owner’s Equity Proprietorship Increase Credit
Mr. Sulman Liability Decrease Debit
6.
Cash Asset Decrease Credit
Cash Asset Increase Debit
7.
Commission Income Increase Credit
Furniture Asset Increase Debit
8.
Bank Asset Decrease Credit
Mr. Adnan Asset Increase Debit
9.
Sales Income Increase Credit
Office equipment Asset Increase Debit
10.
Mr. Usman Liability Increase Credit
Cash Asset Increase Debit
11.
Sales Income Increase Credit
Charity Expense Increase Debit
12.
Purchases Asset decrease Credit
Drawings Proprietorship Decrease Debit
13.
Purchases Asset Decrease Credit
Telephone expense Expense Increase Debit
14.
Cash Asset Decrease Credit
Salaries expense Expense Increase Debit
15.
Cash Asset Decrease Credit

42
Note: The word sales and purchases are used only for debiting or crediting
merchandise account, for other operating assets the name of that particular
asset is written. When the goods are given away as charity or taken by the
owner for personal use the purchases account is credited instead of sales
account.
2.3 Analysis of Transaction a practical view
According to the rules of double entry system of bookkeeping a single
transaction has at least two effects. It means there must be one or more accounts
debited and one or more accounts credited. Further total debits must equal the
total credits reason is, these are two views of the same transaction.
Note how the debit and credit entries are made in the accounts.

Transaction No.1: Mr. Ali started

Dr Cash Cr
1- 150,000 business with cash Rs.150, 000
Analysis: Assets increase. Capital
increased
Rules: increases in assets are
Dr Capital Cr
recorded by debits. Increases in
1- 150,000 Capital are recorded by credits.
Entry: Increase in assets is
recorded on the debit side of the
cash account and increase in
Capital is recorded on the credit
side of the capital account.
Dr Bank Cr Transaction No. 2: Opened a bank
account in the name of business
2- 20,000
with cash Rs.20, 000.
Rules: Increase in assets is
recorded by debits. Decrease in
Dr Cash Cr assets is recorded by Credits.
1- 150,000 2- 20,000 Entry: Increase in bank account is
recorded on the debit side of the
bank account and decrease in the
cash account is recorded on the
credit side of the cash account.

43
 Transaction No. 3: Purchased
Dr Purchases Cr
goods on credit from Mr. Imran for
3- 15,000 Rs.15, 000.
Rules: increase in assets is
recorded by the debits and increase
Dr Mr. Imran Cr
in the liability is recorded by the
3- 15,000 credits.
Entry: hence goods are asset
increase in the goods is recorded
on the debit side of the purchase
account and Mr. Imran is creditor
so increase in liability is recorded
on the credit side of the personal
account of the Imran.
Transaction No. 4: Additional
Dr. Cash Cr
investment of cash Rs.20000 in
1- 150,000 2- 20,000 business by the owner.
4- 20,000 Rules: Increases in assets are
recorded by the debit side and
Dr. Capital Cr increases in the capital account are
1- 150,000 recorded by the credit side.
4- 20,000 Entry: Increase in cash account is
recorded on the debit side of the
cash account and increase in the
capital account is recorded on the
credit side of the capital account.
Dr Salaries Cr Transaction No. 5: Paid salaries
to the employees Rs.6000.
5- 6000
Rules: Increase in expenses is
recorded by debits and decrease in
Dr Cash Cr assets is recorded by the credit.
1- 150,000 2- 20,000 Entry: Salary expenses will be
4- 20,000 5- 6,000 recorded on the debit side of the
salaries account and decrease in
cash is recorded on the credit side
of the cash account.

44
 In the above illustrations you are learned the process of recording the
transactions in the ledger accounts directly. This method was used because it is a
simple and useful way of analyzing the effect of transactions. However there are
three steps to be followed in the Recording Process.
1. Analyze the transactions from the source documents
2. Enter the transactions into the journal
3. Post the entries to the ledger
3. ACCOUNTING EQUATION
3.1 What is an accounting equation?
Financial position of an entity is presented by Balance Sheet. In this
statement on one side the resources belonging to an economic entity are presented
and on the other side the sources or claims against these resources are represented.
The two side of the balance sheet are always equal because these two side reflect
the same thing but with two different angles. In brief balance sheet represents the
following phenomena.
Assets = Liabilities + Owner’s equity
This is also known as accounting equation. There are three basic elements
of accounting (assets, liabilities and owner’s equity). It is the foundation of
double entry system. All the accounting systems either they are very simple or
highly sophisticated based on this equation. We are also called mini balance sheet
of the business.
3.2 Concept of Business Entity
In accounting business is considered a separate entity apart from private
affairs of its owner so all the transactions must recorded from the business point
of view. The personal matters of the owner are kept separate from the affairs of
the business. For example owner lends some money from his private funds to his
friend. This deal is not a business transaction and has no connection with the
business so it should not be recorded in the books of accounts of the business. If
owner provides funds to business from his private estate then it is treated as an
obligation by the business and if he withdraws from the business it reduces the
obligation. In the same way if business earns profit this profit belongs to the
owner so the obligation of the business increase and if business suffers loss it also
belongs to the owner so loss reduce the obligation of the business towards the
owner. This concept is called business entity concept.
For example Aslam took away cloth worth Rs.500 from his shop for his
personal use. It does not mean he is the owner so he can take the merchandise
without any record in the books of accounts. It is a transaction between the owner
45
and the business it reduces the obligation of the business so this transaction is
recorded in the books of business. We will debit his drawing account and parallel
to its credit the merchandise account and if he takes Rs.100 cash for his personal
use we will debit his drawing account and credit the cash account with the said
amount.
3.2.1 Assets
Assets are economic resources that are owned by a business and are
expected to benefit future operations. In other words assets are probable future
economic benefits obtained or controlled by a particular entity as a result of past
transactions or events.
Assets may be divided into following two categories:
i. Current Assets
These are assets, which have short life or duration, and consist of cash or
those items, which will ultimately be expended or converted into cash
within the course of one year. The example is cash at bank, stocks, debtors
or receivables, advances or prepayments etc.
ii. Fixed Assets
The assets whose life is more than one year; there are further two types
tangible and intangible; for example building, plant & machinery, vehicles ,
goodwill, patent &right, etc. is called fixed assets.
3.2.2 Liabilities
Liabilities are debt. They describe future cash out flows for the enterprise.
He is a person or a party to whom payment is to be made at some future date. All
businesses have liabilities; even the largest and most successful organizations
often purchase merchandise, supplies and services on credit or on account.
The transaction involves an increase in the liabilities due to purchases on
credit, which is recorded on the right side of the liability account in accounting
equation.
There are three main classifications of liabilities:
i. Current liabilities (short-term liabilities) are liabilities that are due and
payable within one year. Account payable, interest payable, income taxes
payable, bills payable, accrued expenses and short term loans.
ii. Non-current liabilities (long-term liabilities) are liabilities that are due
after a year or more. Bonds payable, long-term notes payable, mortgage
payable, capital lease.
iii. Contingent liabilities are liabilities that may or may not arise depending on
a certain event. Lawsuits and product warranties.
46
3.2.3 Owner’s equity
Represent the owner’s claim against the assets of the business. Owner
equity is always equal to total assets minus liabilities. For example
Owner’s equity = Assets - Liabilities
i. Increase in owner’s equity
The capital in a business comes from two sources, one is investments of
cash or other assets by the owner and second is earning from profitable
operation of the business.
For example:
Mr. Ali started business with cash Rs. 100, 0000 and furniture Rs50, 000.
ii. Decrease in owner’s equity
Capital decreases with two reasons; one is withdrawal of cash or another
thing by owner and second is losses from unprofitable operation of the
business.
For example
Mr. Ali drew cash from business for his personal use.
Example- To complete the missing amount in each of the following cases:
Assets = Liabilities + Owner’s equity
i. 1,500,000 = 255,000 + ?
ii. 1,500,000 = ? + 950,000
iii. ? = 625,000 + 875,000
Answer – i- (1,245,000) ii-(550,000) iii-(1,500,000)
3.3 The effect of business transactions on the accounting equation.
Examples of Accounting Equation
i. Suppose Mr. Hammad started a business with cash Rs.100, 000 at this
moment the accounting equation will be as follows.
Assets = Liabilities + Owner’s Equity
100,000 = 0 + 100,000
Explanation: At this time the business owns Rs.100, 000 cash parallel to it
business has also liability towards owner for this asset. In other words cash is
resource of business and the source of this asset is owner.
ii. Assume that he purchased machinery from Mr. Ali for Rs.50, 000 on credit.
After this transaction the accounting equation will be as follows.
Assets = Liabilities + Owner’s Equity
150,000 = 50,000 + 100,000
Explanation: After this transaction the business owns assets of Rs.150000 i.e.
Rs.100000 cash and machinery Rs.50000. There are certain claims of people over
47
these assets these people are outsiders as well as owner himself. The claim of
owner is called owner’s equity to differentiate it from the claims of outsiders.
iii. Business earned cash Rs.10, 000, following changes will take place in the
equation of the business.
Assets = Liabilities + Owner’s Equity
160,000 = 50,000 + 110,000
Explanation: As you can observe that the income on one side increased the assets
of the business and on the other hand also increased the claim of the owner over
the assets of the business because all the profits and losses belong to owner.
iv. Owner withdrew cash Rs.2, 000 for his personal use. The equation will
represent this transaction in the following manners. When owner take away
anything from business for his personal uses that called drawing and that is
deducted from his capital.
Assets = Liabilities + Owner’s equity/capital
158,000 = 50,000 + 108,000
Explanation: After withdrawal of cash by the owner the assets of the business
have reduced and this withdrawal also reduces the claim of the owner over the
assets of the business.
If you observe all the transaction carefully you can easily conclude why
both side of the balance sheet or accounting equation remains equal.
If we present the above transactions in detail it will look like this.
Sr. No Assets Liabilities & Owner’s equity
Cash Machinery Creditor Owner’s equity
i. 100,000 50,000 50,000 100,000
ii. 100,000 50,000 50,000 100,000
+10,000 +10,000
iii. 110,000 50,000 50,000 110,000
-2,000 -2,000
iv. 108,000 50,000 50,000 108,000
158,000 158,000
Illustration No. 2
Dr. Hassan Raza, a medical practitioner, opened a clinic in his home town.
After one month, the business had the following assets: Cash Rs.2, 000; debtors
Rs.680; office supplies Rs.3, 000; office equipment Rs.15, 000 and the car
Rs.50,000. Creditors on the same day were Rs.25, 000. During a short period of
time the following transactions were completed:
1. Paid one month’s rent Rs.350.
48
2. Billed patient Rs.150 for services rendered.
3. Made payment to the creditors Rs.300.
4. Paid staff salaries Rs.300
5. Received Rs.800 cash from patients.
6. Withdraw Rs.500 cash for personal use.
7. Paid telephone bill Rs.120
8. Received Rs.500 from the debtors.
9. Purchased additional office equipment on credit Rs.3000.
10. Purchased office supplies on credit for Rs.500.
Required: Arrange the assets, liabilities and owner’s equity in an equation.
Solution
Liabilities &
Assets
owner’s equity
Sr. Owner’s
Cash Debtors Supplies Equipment Car Creditors
No equity
2000 680 3000 15000 50000 25000 45680
1 -350 -350
1650 680 3000 15000 50000 25000 45330
2 +150 +150
1800 680 3000 15000 50000 25000 45480
3 -300 -300
1500 680 3000 15000 50000 25000 45180
4 -400 -400
5 1100 680 3000 15000 50000 25000 44780
+800 +800
1900 680 3000 15000 50000 25000 45580
6 -500 -500
1400 680 3000 15000 50000 25000 45080
7 -120 -120
1280 680 3000 15000 50000 25000 44960
8 -500 -500
780 680 3000 15000 50000 24500 44960
9 3000 3000
780 680 3000 18000 50000 27500 44960
10 500 500
780 680 3500 18000 50000 28000 44960
72960 72960

49
Illustration No. 3
Mr. Jafar started law practice. He completed the following transactions soon
after starting the practice:
A. Began his practice by depositing Rs.40000 in a newly created bank account,
cash Rs.12000 and investing his personal law library, valued at Rs.15000, in
the law practice.
B. Purchased used office equipment for Rs.12000.
C. Paid one month’s rent of office Rs.1500.
D. Purchased office supplies on credit for Rs.3000
E. Completed his first contract, for which he was paid Rs.1500 cash.
F. Collected revenue of Rs.300 from each of the four clients.
G. Withdrew cash Rs.200 for personal use.
Assets Liabilities &
owner’s equity
Sr. Owner’s
Cash Bank Library Equipment Supplies Creditors
No equity
A 22000 40000 15000 77000
B -12000 12000
10000 40000 15000 12000 77000
C -1500 -1500
8500 40000 15000 12000 75500
D 3000 3000
8500 40000 15000 12000 3000 3000 75500
E 1500 1500
10000 40000 15000 12000 3000 3000 77000
F 1200 1200
11200 40000 15000 12000 3000 3000 78200
G -200 -200
11000 40000 15000 12000 3000 3000 78000
81000 81000
Illustration No. 4
Mr. Kamran started business by introducing a machine valuing Rs.2, 000:
Goods worth Rs.25, 000 and Cash Rs.13, 000.
1. Purchased furniture for office Rs.5,000
2. Bought good from Jafar Sons Rs. 8,000
3. Sold goods costing Rs.3000 for Rs.4000 cash
4. Sold goods to Kashif on credit for Rs.3000 costing Rs.2500
50
5. Paid Rs.4000 to Jafar Sons
6. Purchased machinery from Khalil for Rs.12000 on credit
7. Paid sundry trade expenses Rs.200
8. Paid for office stationary Rs.250
9. Received cash from Kashif Rs.1500
10. Purchased furniture for Rs.700
11. Sold a part of unused machine costing Rs.4000 for Rs.3500.
12. Paid insurance premium Rs.250
13. Paid rent Rs.200
14. Drew merchandise for personal use worth Rs.500
Required: Arrange the above transaction in the accounting equation form.
Liabilities &
Assets
owner’s equity
Sr. Owner’s
Cash Goods Machine Furniture Debtors Creditors
No equity
1 13000 25000 2000 40000
-5000 +5000
8000 25000 2000 5000 40000
2 +8000 +8000
8000 33000 2000 5000 8000 40000
3 +4000 -3000 +1000
12000 30000 2000 5000 8000 41000
4 -2500 +3000 +500
12000 27500 2000 5000 3000 8000 41500
5 -4000 -4000
8000 27500 2000 5000 3000 4000 41500
6 +12000 +12000
8000 27500 14000 5000 3000 16000 41500
7 -200 -200
7800 27500 14000 5000 3000 16000 41300
8 -250 -250
7550 27500 14000 5000 3000 16000 41050
9 +1500 -1500
9050 27500 14000 5000 1500 16000 41050
10 -700 +700
8350 27500 14000 5700 1500 16000 41050
11 +3500 -4000 -500
51
 11850 27500 10000 5700 1500 16000 40550
12 -250 -250
11600 27500 10000 5700 1500 16000 40300
13 -200 -200
11400 27500 12000 5700 1500 16000 40100
14 -500 -500
11400 27000 10000 5700 1500 16000 39600
TOTAL 55600 55600
No doubt accounting equation is a helpful tool to analyze the transactions.
But in case of medium or large scale business, it is difficult if not impossible to
record and present many and complex transaction in this form. Practically
increases and decreases in the various accounts are recorded in the journal and
ledger accounts in a very sophisticated way. In the next section you will learn
how to record the transactions in Journal.
4. SELF ASSESSMENT QUESTIONS
4.1 Fill in the blanks.
i. In _____________ all the transactions of the day are recorded on the same
day they take place.
ii. The process of recording transactions in the journal is called
_________________.
iii. The right side of the account is called ________ side and left side is called
______ side.
iv. Increase in assets is _________ and decrease is ___________.
v. A brief explanation of the transaction in the journal is called
________________.
vi. After journalizing, the entries are ____________ posted into ledger
accounts at convenient intervals.
vii. The _________ shows all information about a transaction in single place.
viii. The journal shows all the transactions in ___________ order.
ix. An account has three elements the _________ of the account,
______________ and _____________.
x. In journal the amount is written parallel to the ____________ on the same
line.

52
4.2 Choose the best answer
You are required to choose the best option from the given multiple options
against each statement:
i. Impersonal accounts are classified into.
A. Real and nominal accounts.
B. Cash and non-cash accounts.
C. Tangible and intangible accounts.
ii. The amount recorded on the left side of account is called
A. Credit entry
B. Debit entry
C. None of the above
iii. Normal balance of the following is always debit
A. Owner’s equity
B. Incomes
C. Expenses
iv. Expenses are
A. Real accounts
B. Impersonal accounts
C. Nominal accounts
v. Mortgage loan is
A. Personal account
B. Real Account
C. Nominal account
vi. Which of the following is correct?
A. Capital = Asset + Liabilities
B. Assets = Liabilities - Capital
C. Liabilities = Capital + Assets
D. Capital = Assets - Liabilities
vii. Recording of transaction in the journal is called:
A. Posting
B. Journalizing
C. Tallying
4.3 Best Match
Referring to the terms listed in the left column, place the appropriate letter
next to the corresponding description.
a. Journalizing
b. Cross-indexing
53
c. Simple journal entry
d. Charge
e. Posting
f. Compound journal entry
g. Trial balance
h. Double entry
i. Journal
j. Real accounts
k. Debit side
l. Credit side
m. Expense s
i. ________Entry involving more than one debit and/or credit.
ii. ________Recording in the ledger the information contained in the
journal.
iii. ________This procedure is related to the duality concept indicating
that every transaction has a two-sided effect.
iv. ________Synonym for debit.
v. ________Provides a proof of the arithmetic accuracy of the recording
process by listing the ledger accounts and their debit or credit
balances.
vi. ________Entry only one debit and one credit balance.
vii. ________Is a chronological record of all business transactions and
may also be called the book of original entry.
viii. ________Placing of the ledger account numbers in the posting
reference column of the journal and placing the journal page number
in the posting reference column of the ledger account.
ix. _________Entering of a transaction in the book of original entry.
x. _________The right side of an account.
xi. _________Cost of the use of services or things for the purpose of
generating revenue.
4.4 Short Answer Questions
i. Explain the meaning of the accounting equation.
ii. Justify the statement that the Accounting Equation (A = L+C) holds well
under all circumstances. Give at least three transactions to show that the
equality condition holds three goods.
iii. What is owner’s equity? Give an equation for calculating owner’s equity.
iv. Give two transactions that will:
54
v. Explain the rules of debit and credit.
vi. Explain the meaning of double entry book keeping.
vii. What is a general journal?
viii. What is the meaning of an account?
ix. On which side of the account are the following decreases recorded:
A. Assets
B. Liabilities
C. Owner’s equity
D. Revenues
E. Expenses
Indicate the nature (debit or credit) of normal balance in the following accounts:
F. Cash
G. Accounts receivable (debtors)
H. Accounts payable (creditors)
I. Furniture
J. Merchandise
K. Capital
L. Miscellaneous expenses
M. Rent payable
N. Salaries paid
ANSWER
Fill in the blank
i- Day Book ii- iii-credit - iv- debit - v-narration
journalizing debit credit
vi- vii- ledger viii- ix- title, credit x-Account
transferred chronological side–debit side Name
Choose the best answer
i-C ii-A iii-B iv-C
v-C vi-B vii-D viii- B
Best Match
i. f ii. e iii. h iv. k v. g
vi. c vii. i viii. b ix. a x. l
xi. m

55
5. PROBLEMS
Accounting Equation
Problem 01: Prepare the accounting equation from the following information
(a) Mr. Zahid started business with cash Rs.50,000
(b) Purchased furniture with cash Rs.10, 000.
(c) Purchased merchandise from Zia worth Rs.10, 000 on account.
(d) Sold merchandise Rs.8000 on cash, costing Rs.7, 500.
(e) Mr. Zahid (owner) took merchandise worth Rs.500 for personal use.
(f) Paid cash to Mr. Zia and receive discount @2%.
(g) Purchased merchandise worth Rs.12000 from Mr. Imran paying Rs.2, 000
cash and the balance is payable.
(h) Sold merchandise to Mr. Khalid Rs.15, 000 receiving cash Rs.5, 000 and
balance on credit.
(i) Purchased stationary Rs.500 for office use.
(j) Paid electricity bill Rs.200.
Problem 02: Mr. Humza started his own business in his hometown. He executed
the following transaction in the first month of his business.
1. Humza started business with cash Rs.50000.
2. Purchased furniture with cash Rs. 7000.
3. Purchased merchandise for Rs.10000 on account from Kamran.
4. Purchased merchandise on cash Rs.5000.
5. Paid electricity bill Rs.200.
6. Sold merchandise costing Rs.3000 to Mr. Sulman for Rs.4000.
7. Owner took merchandise for his personal use worth Rs.700
8. Paid rent of shop Rs.500.
9. Purchased Computer for Rs.3000 on account from Nazir.
10. Paid Rs.150 as charity.
Required: You are required to prepare accounting equation for the month.
Problem 03: Mr. Maqsod started business with cash Rs.450000 and furniture
Rs.30000 the transactions, completed during June 2006 the first month of
operations, are as under.
2. Opened a bank account in the name of business with Rs.150000.
5. Acquired a shop on the monthly rent of Rs. 3000 after paying cash Rs.
36000 as advance rent.
6. Purchased show cases and counters for Rs.18000 payment made by cheque.
9. Purchased goods costing Rs.50, 000 and payment made by cheque.
11. Bought goods from Mr. Ibrar on account Rs.26, 000.
56
13. Cash sale Rs.32, 000.
17. Sold goods on credit Rs. 6000 to Rahim.
21. Returned the defective goods to Rauf and Co. costing Rs.7000.
23. A regular customer complained about the quality of goods has been granted
an allowance of Rs.1000.
25. Received cheque from Rahim amounting Rs.5000 same day it was
deposited into the Bank.
Required: You are required to prepare Accounting Equation for the month.
Problem 04: Mr. Majid Started business soon after completing the I.Com.
Following are the transactions, completed during the first month of June 2018.
June 01: Commenced business with cash Rs.850, 000.
03: Purchased merchandise for Rs.200, 000.
04: Bought office furniture for Rs.18, 000 from Naeem & Co.
07: Sold merchandise for Rs.70, 000
11: Paid insurance expenses Rs.100.
12: Sold goods to Mr. Akber for Rs.5, 000
20: Purchased machinery for Rs.100, 000
23: Received Rs.5, 000 from Mr. Akber
28: Paid salary Rs.10, 000
30: Mr. Majid withdraws Rs.15, 000 for personal use.
Required: You are required to prepare Accounting Equation for the month.
Problem 05: Mr. Hamza started his own business. He executed the following
transaction in the first month of his business.
2018
April 01: Mr. Numan started business with cash Rs.250, 000, Furniture
Rs.200, 000 and building Rs.800, 000.
02: Opened a bank account with cash Rs.80, 000.
03: Paid Rs.1, 000 for office expense.
05: Purchased stationary for office use Rs.50.
07: Bought goods from Mr. Zahid for Rs.15, 000, paying cash
Rs.5, 000 and balance after one month.
10: Withdraw cash from bank for office use Rs.8000.
13: Sold goods to Tanveer & Co for Rs.15, 000 and paid carriage
Rs200 for delivery.
21: Cash received from Tanveer & Co Rs.2, 000.
24: Issued a cheque of Rs.1, 000 for advertisement.
28: Withdraw from bank Rs.8, 000 for personal use.
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 31: Goods amounting Rs.500 were given as charity.
Required: You are required to prepare Accounting Equation for the month.
Analysis of Transactions
Problem 06: Analyze the given transactions and find out the accounts to be
debited and credited.
a. Started business with cash Rs.50, 000 and furniture Rs.15, 000.
b. Purchased goods for cash Rs.7, 000.
c. Purchased goods on credit Rs.8000 from Salman.
d. Additional investment of Rs.50, 000 was made by the owner.
e. A part payment of Rs.4, 000 was made for merchandise purchased on credit
from Salman.
f. Commission received Rs.5, 000.
g. Purchased furniture for cash Rs.1, 200.
h. Sold merchandise on account to Adnan Rs.6, 500.
i. Purchased computer from Usman for Rs.6000.
j. Purchased goods for Rs.10, 000; Rs.7, 000 is paid immediately and the
balance to be paid later on, to Aslam.
k. Cash sales Rs.4, 500.
l. Goods taken away by the owner for his personal use Rs. 500.
m. Goods costing Rs.500 given as charity.
n. Paid telephone bill Rs.350.
o. Paid salaries to the employees Rs.1, 800.
Problem 07: Find out the accounts to be debited and credited in each of the
following transactions.
1. Started Business with cash Rs.50, 000, furniture Rs.12, 000 and machinery
Rs.30, 000.
2. Purchased stationary for office use Rs. 450.
3. Purchased goods on credit Rs.10, 000 from Mr. Jafer.
4. Purchased goods for cash Rs. 1,700.
5. The owner purchased a vehicle for business use from his personal funds
Rs.30, 000.
6. Paid Rs.5, 000 to the local cable operator for advertisement.
7. Sold goods on credit Rs.3, 000 to Mr. Bilal.
8. Cash sales Rs.1, 400.
9. Paid Electricity bill Rs. 600.
10. Paid rent Rs.12.000.

58
6. SUMMARY OF THE UNIT
Double entry system of accounting is based on the equation rule i.e. assets
are always equal to the liabilities plus owners’ equity. Balance sheet is simply
expansion of this accounting equation. All the accounting systems based on this
equation. Accounting equation is a valuable tool to understand and analyze the
transactions.
Business transactions result in changes in the three elements of the basic
accounting equation. A transaction that increases total assets must also increase
total liabilities and owner's equity. Similarly, a transaction that decreases total
assets must simultaneously decrease total liabilities and owner's equity. Some
transactions increase one asset and reduce another. Regardless of the nature of the
specific transaction, the accounting equation must stay in balance at all times.
Debit and Credit are two frequently used terms in business world. In
accounting these terms are used to express the overall effect of a transaction on a
particular account. These rules are expressed with two different approaches with
the same results. The assets expenses and the losses have normal balance debit
and increase in these account is debited and decrease is credited. On the other
hand liabilities incomes and owner’s equity has credit normal balance and
increase in these accounts are credited and decrease is debited.
BIBLIOGRAPHY
Ahmad, M. M., Khan, S. A., Arshad, M., & Shah, S. M. (2013). Advanced
Financial Accounting. Islamabad: National Book Foundation Islamabad.
Dupree, D., & Marder, M. (1984). Principles of Accounting. Addison-Wesley.
Farooq, U., & Amir, S. M. (2008). Principles of Accounting. Islamabad: Allama
Iqbal Open University.
Hussain, K., Buttar, Z. U., Pirach, M. A., & Chaudhry, M. I. (1996). Accounting
Principles. Lahore: Orient Publishers Urdu Bazaar Lahore.
Mukherjee, A., & Hanif, M. (2003). Modern Accountancy I. Tata McGraw-Hill
Education.
Randall, H. (2005). Accounting. Cambridge University Press.
Wood, F., & Sangster, A. (2008). Business Accounting I. Pearson Education.

59
Unit–3

JOURNAL, LEDGER AND

TRIAL BALANCE

Written by: Sohail Amjed

Reviewed by: Muhammad Munir Ahmad
Asia Batool

60
 CONTENTS

INTRODUCTION
OBJECTIVES
1. THE JOURNAL
1.1 Need of Journal
1.2 Starting point of Double Entry System
1.3 Definition
1.4 Objectives of the Journal
1.5 Columns of General Journal
1.6 Simple Journal Entry
1.7 Compound Journal Entry
2. LEDGER
2.1 Meaning of Ledger
2.2 What is posting?
2.3 Definition of Ledger
2.4 Chart of Accounts
2.5 General Ledger and Subsidiary Ledgers
2.6 Need for the Ledger
2.7 Significance of the Ledger
3. FORMS OF THE LEDGER
3.1 Periodic Ledger Account or Standard Ledger Account
3.1.1 Details of Columns
3.2 Running Balance Ledger or Self Balancing Ledgers
3.2.1 Details of Columns
3.3 Posting
3.4 Illustration 01
3.5 Balancing of Account
4. THE TRIAL BALANCE
4.1 Need of Trial Balance?
4.2 Definition of Trial Balance
4.3 Purpose of Trial Balance
4.4 Illustration
5. EXAMPLES
6. SELF ASSESSMENT QUESTIONS
6.1 Choose the Best Answer from the Given Options
6.2 Match the Statement in Column
61
 6.3 Give the Short Answers of the following Questions
7. PROBLEMS
8. SUMMARY
9. REFERENCE/BIBLIOGRAPHY

62
INTRODUCTION
After recording the transactions in General Journal there is need to post the
transactions from Journal to Ledger account. This unit describes the introduction
of ledger and its various types. The procedure of posting transactions from
journal to ledger account is described in this unit with illustration. The preparation
of trial balance is also discussed in this unit. At the end of the unit self assessment
questions and various problems are given for the better understanding of the topic
covered in this unit.

OBJECTIVES
After studying this unit, you will be able to:
1. Explain and construct a chart of accounts
2. Understand the difference between Subsidiary Ledgers and General Ledger
3. Understand the important forms of the ledger.
4. Post the transactions from journal to the ledger.
5. Balance the accounts at the end of the accounting period.
6. Prepare the Trial Balance

63
1. THE JOURNAL
1.1 Need of Journal
As illustrated in the previous section of this unit, transactions can be
recorded directly into the Ledger accounts. When this method is used it is difficult
to follow individual transactions with the debit recorded in one account and the
credit in another account. Especially when there are a large number of
transactions involved it become difficult to locate an error that may occur while
recording the transactions.
Therefore business transaction is initially recorded in an accounting record
called the journal. After the transaction has been recorded in the journal the debit
and credit changes in the accounts are then entered in the ledger. Since the journal
is the accounting record in which transaction is recorded first so it is called the
book of original entry. It is also called the day book because all the transactions of
a day are recorded chronologically in this book.
1.2 Starting point of Double Entry System
As recording a transaction in a journal is the starting point for the double-
entry bookkeeping system. Each and every transaction is identified by its two or
more aspects or dimensions, referred to as its debit (or left side) and credit (or
right side) aspects, and each of these aspects has its own effect on the financial
structure of the organization. As you have learned certain accounts are increased
with debits and decreased with credits; other accounts are increased with credits
and decreased with debits. For example, the purchase of merchandise for cash
increases the merchandise account (a debit) and decreases the cash account (a
credit). If merchandise is purchased on the basis of a promise to make a future
payment, a liability would be created, and the journal entry would record an
increase in the merchandise asset account (a debit) and an increase in a liability
account (a credit). Recognition of wages earned by employees entails recording
an increase in the wage-expense account (a debit) and an increase in a liability
account (a credit). The subsequent payment of the wages would be a decrease in
the cash asset account (a credit) and a decrease in the liability account (a debit).
These procedures how an account increases and how an account decreases have
already been discussed in detail in the previous sections.

64
1.3 Definition
The journal can be defined as follows.
“The journal is a permanent chronological record of debits and the
credits resulting from transactions, together with all necessary
explanations of the transaction”
The information recorded about each transaction include the date of the
transaction, the debit and credit changes in specific accounts, and a brief
explanation of the transaction. After journalizing, entries are transferred to the
ledger accounts at convenient intervals. In practice a transaction is not journalized
until written evidence (voucher) of that transaction is produced.
The sequence of recording transaction may be diagrammed as follows.

Transaction Voucher Journal Ledger

1.4 Objectives of the journal

The record provided by a journal is useful in several ways. Each transaction
is recorded in its entirety in one place, whereas in the ledger a portion of a
transaction is recorded in one account and remaining in one or other accounts. It
is therefore easier to determine from a journal the correctness of the analysis of a
transaction. There is also more space in journal for recording details or
explanations of complex transactions. The basic objectives of the journal are
summarized below:
i. The journal shows all information about a transaction in one place and also
provides an explanation of the transaction.
ii. The journal shows all the information in chronological order so it is easy to
retrieve the records of certain day or month.
iii. The use of journal reduces the chances of errors because the debit and credit
affects of the transaction are recorded at same place.
1.5 Columns of General Journal
Before proceeding further it is mandatory to understand the format of the
Journal. There are various kinds of journals. The number and the type used in
particular business depend upon the size of the business and the nature of its
operations. The simplest form of journal has only two amount columns and may
be used for recording all transactions of the business. Given below is the example
of General Journal.

65
 Date Description Ref Debit Credit
Salary Expenses 10000
2018.
1. To Cash account 10000
July
Paid salaries for the month of June
Bashir and sons account 5200
3. To Cash account 5200
Paid cash to Bashir and sons.
Cash account 28600
7. To Sales account 28600
Cash sale for the day
i. In the first column of the journal the date of the transaction is recorded. As
we mention that any transaction that takes place it is recorded on the same
day. This chronological order helps to retrieve any transaction easily.
Therefore any error in record or any disputed transaction can be detected
with little effort.
ii. In the second column the accounts effected by transaction are recorded and
also a brief explanation of the transaction that is called narration. The
account that is to be debiting is written first on the extreme left hand side.
The name of the account to be credited is entered in the line below the debit
entry and is indented, that is, placed about one inch to the right of the date
column. A brief explanation of the transaction begins on the line
immediately below the last account credited. This explanation includes any
data needed to identify the transaction, such as the name of the customer or
supplier. The explanation is not indented. A blank line should be left after
each transaction for separation of the two entries.
iii. Third column LF (Ledger Folio) or Ref (Reference) just left blank at the
time of making the journal entry. When the debits and credits are later
transferred to ledger accounts, the page numbers of the ledger accounts is
written. This number serves as cross reference.
iv. The fourth column is used for the amount of the debited accounts. The
amount is written parallel to the account name on the same line.
v. The last column is used for the amount of credit accounts. The amount of
credit is also written in front of the specific account on the same line.
While journalizing you must observe the following points:
i. The year is written in small figures at the top of the first column. It is not
written again on a page unless the year changes.

66
ii. The month of the first transaction is written on the first line in the first
column. The name of the month is entered again only at the top of a new
page or at the beginning of a new month.
iii. The day of each transaction is written in the second column on the first line
used by each transaction. It is repeated for each transaction regardless of the
number of transactions completed on the same day.
iv. The explanation, while not necessarily limited to one line should be as brief
as possible without omitting essential information.
v. In journalizing you must be very careful that the debit amount always equal
to the credit. This is the logic behind the double entry system and
accounting equation.
1.6 Simple Journal Entry
The journal entry in which only one account is debited and one account is
credited is called simple Journal Entry.
1.7 Compound Journal Entry
The entry in which more than two accounts are involved is called
compound Journal Entry for example if businessman started business with Cash
Rs.50,000, machinery Rs.20,000 and furniture Rs.15,000. If a single entry will be
passed to give effect to this transaction this entry will be called compound journal
entry.
Illustration No. 1
Mr. Humza after doing his B.Com intended to start his own business as he
learned a lot about the printing press business during his internship. He could
arrange only Rs.154000 from his private state to start this business. The
transactions completed during his first month of business October, 2018 are as
under.
1. Opened a bank account in the name of business with Rs.25000.
3 Purchased machinery from Ahmed Machinery Store for Rs.140000 after
paying Rs.70000 cash and promised to pay remaining amount after two
months.
7. Purchased office supplies on account from Mirza Stationers for Rs.4500.
8. Paid Rs.200 cash for newspaper advertisement.
10. Purchased office supplies for Rs.350 payment made by cheque.
13. Charged Rs.4500 from a customer for services.
15. Paid part time assistant Rs.1700 for two weeks’ salary.
19. Paid cash to Mirza Stationers Rs.2,500.
20. Received Rs.9,200 cash from the sale of these days.
67
25. Provide services to Ali who promised to pay Rs.5,600 in next month.
31. Paid Rs.1200 for telephone bill for the month.
31. Paid Rs.600 for electricity bill for the month.
31. Withdraw Rs.1500 cash for personal use.
General Journal
Date Description Ref Debit Credit
2018 Cash A/c 154,000
Oct 1 To Capital A/c 154,000
Started business on Oct 1,2004 with
cash
1 Bank A/c 25,000
To Cash A/c 25,000
Opened bank account with MCB
Acc.No.2779-9

3 Machinery A/c 140,000

To Cash A/c 70,000
To Ahmed Machinery Store 70,000
A/c
Bought WXC-8 print unit
7 Office Supplies A/c 4,500
To Mirza Stationers A/c 4,500
Purchase supplies on account
8 Advertisement expenses A/c 200
To Cash A/c 200
Paid for advertisement in “Jung”
10 Office supplies A/c 350
To Bank A/c 350
Purchased supplies payment made
by cheque No.12547
13 Cash A/c 4500
To Service Revenue A/c 4500
Cash received from a customer
15 Salaries A/c 1700
To Cash A/c 1700
Paid salary to part time assistant.
19 Mirza Stationers A/c 2500
68
 To Cash A/c 2500
Paid cash to Mirza Stationers.
20 Cash A/c 9200
To Sales Revenue A/c 9200
Cash collected from the customers
25 Ali ‘s Account 5600
To Service Revenue A/c 5600
Provide services proceeds yet
received.
31 Telephone bill A/c 1200
To Cash A/c 1200
Paid telephone bill
31 Electricity bill A/c 600
To Cash A/c 600
Paid electricity bill
31 Drawings A/c 1500
To Cash A/c 1500
Withdraw cash for personal use.
Explanation
Mr. Humza started business with cash Rs.50000 on 1st January 2018.
If we observe this transaction closely we will find out that there are two
accounts involved. The first account is Cash that is asset of the business and the
investment by the owner that is capital or owner’s equity. Both the accounts are
increasing as we mentioned above that the assets if increase those are debited and
if the owner’s equity increases that will be credited. Thus the journal entry will be
passed in the like manners.
Think from another perspective because cash is real account and is coming
in so it will be debited and the capital account is personal account and owner is
giving person so his account will be credited. As we discussed earlier owner is a
separate entity apart from business therefore he is deemed as outsider who
provides funds to the business and business consider it as a liability.
Date Description Ref Debit Credit
2018 Cash account 50,000
June 1 To capital account 50,000
Mr. Humza started business
with cash Rs.50000.

69
On 2-1-18 Mr. Humza bought merchandise on cash costing Rs.20000.
In this transaction two accounts are involved cash and merchandise both are
assets of the business. Merchandise is increasing and cash is decreasing. So the
merchandise account should be debited and the cash should be credited. You must
remember that when merchandise are bought or sold the word sales and purchases
are used instead of merchandise. And when this merchandise are returned to or
returned by the separate accounts are opened titled Purchase Return and
Allowance and Sales Return and Allowance.
Date Description Ref Debit Credit
2018 Purchase account 20000
June 1 To cash account 20000
Bought merchandise on cash
invoice No.432
Mr. Humza sold goods to Kashif on cash Rs.5000 on 4-1-18.
It is cash sale and accounts involved are cash and merchandise both are
assets one is decreasing and other is increasing the account of cash is increasing
so it should be debited and merchandise account is decreasing so it should be
credited. The journal entry would be as follows.
General Journal
Date Description Ref Debit Credit
2018 Cash account 5000
July 1 To sales account 5000
Sold merchandise to Kashif
on cash invoice No.1
In the same way first of all determine what accounts are involved in the
transaction and then determine whether those are assets liabilities expenses or
revenues and then apply the above-mentioned technique for debiting and
crediting.
2. LEDGER
2.1 Meaning of Ledger
The entries in the general journal tell the accountant what is to be debited
and what is to be credited. With this record as a guide, it is a simple matter for
him to enter the information in the individual accounts affected. As a result of this
procedure, a permanent and classified record is obtained of every element
involved in the business. The accountant actually uses printed forms for his
account records. Each account is kept on a separate form called a ledger sheet. All
the accounts together constitute a ledger.
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2.2 What is posting?
Ledger contains all the accounting records of the business in classified
manner. Normally the accounts are arranged in Balance Sheet order. Posting
simply mean updating the ledger accounts for the effects of transactions recorded
in journal. While posting no new information is added simply the transaction is
reproduced and classified according to their type. This is why ledger is called
book of classified records. It is the second step of accounting cycle entries relating
to a particular item are collected to find out the exact position of that particular
item of financial character.
In ledger separate pages are allocated to each account. At the start
alphabetically arranged index is given by which specific account could be easily
and quickly accessed. When a new account is opened its name and page number
is written in the index for convenient retrieval in future.
2.3 Definition of Ledger
Ledger can be defined as:
“It is a book of final entry summarizing all of a company's financial
transactions under their respective heads, through offsetting debit and
credit accounts.”
2.4 Chart of Accounts
Since there are likely to be many different accounts in a set of business
records, it is necessary to establish a plan for identifying each account and
locating it quickly. Identification of accounts is easier and location quicker if page
numbers as well as names are assigned to all accounts. In developing an index or
chart of accounts, blocks of numbers are assigned to accounts according to
“families” that is, types of account. For example assets are assigned the block of
numbers from 100 to 199; liabilities 200 to 299 and so on. These numbers help
identify the type of account.
Blank numbers are ordinarily left within each block so that additional
accounts may be added in the appropriate sequence from time to time as required.
The example of chart of account is as under:
Page No. Name of Account
100-199 ASSETS
101 Cash
111 Debtors
141 Equipment
200-299 LIABILITIES
201 Creditors
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202 Bank Loan
203 Debentures
300-399 OWNER’S EQUITY
301 Capital
305 Drawings
308 Income and Expense Summary

400-499 EXPENSES
401 Cost of Sales
405 Rent Expenses
412 Discount Expenses

500-599 REVENUES
502 Sales Revenue
505 Interest Revenue
510 Commission Revenue
2.5 General ledger and Subsidiary ledgers
The book in which all the accounts of a business are kept is called general
ledger. In case of large organization thousands of accounts are maintained most of
them are of similar nature like the debtor’s accounts and creditor’s accounts.
Recording these accounts individually in general ledger becomes difficult. A
separate ledger is maintained for each group of similar nature accounts that is
called subsidiary ledger. The aggregate of subsidiary ledger is only recorded in
the general ledger. Subsidiary ledgers are maintained for debtors, creditors
inventories etc. Subsidiary ledgers provide details of the accounts kept in it and a
clear picture of each account as well.
2.6 Need for the ledger
In journal information regarding a particular account are scattered all over
the journal. In order to get information about an account accountant has to search
the entire journal and even than he may not be able to find out the exact position
of the account. Therefore accountants maintain the separate record for each
account so that whenever they want they can obtain the ready to use information
easily and quickly. If the ledger accounts are not maintained at the time of closing
the collection of data regarding each financial item become difficult. Therefore
accountant transfers the information into the ledger with convenient intervals.

72
2.7 Significance of the ledger
Ledger has a great importance in the books of accounts. All the transactions
are recorded in the ledger in organized and easy to use manners. Following are the
information that is available at the time of closing or at a particular day.
a. The net cash and the bank balances available at the time of closing or at a
particular day.
b. Amount receivable from debtors and payable to creditors collectively as
well as individually.
c. Total expenses and revenues for a particular accounting period these could
be collected month wise or in any order desired.
d. The assets and liabilities generated during a particular period and the net
balances at the time of closing.
e. Capital and drawings of the owner.
As we have already discussed that all the transactions of business are
recorded in the ledger so it can be called book of complete records. All the further
statements and accounts are prepared with the help of information contained in
the ledger accounts. In practice whenever need arise to confirm any transaction or
to settle any disputed amount accountants consult the ledger. In ledger page
number of journal could be located where required information regarding the
transaction is available i.e. narration of the transaction and voucher number. Once
the transactions are posted to the ledger further references and processing is made
through this book.
3. FORMS OF THE LEDGER
There are two forms of the ledgers widely used in business we will discuss
each one in detail as both have great practical importance with same results.
Printed ledgers are easily available from markets in both of these forms.
 Periodic Ledger account or Standard ledger account
 Running Balance Ledger or Self Balancing Ledger
3.1 Periodic Ledger account or Standard ledger account
This form of ledger is widely used in the small organizations where
accounting period is short and accounts are frequently closed. Index is given at
the start and the page numbers are printed on the subsequent pages. Normally
each account is assigned a separate page if the number of transactions are large,
more than one page are allocated to the account depending upon the nature of the
account.

73
 Transactions are posted to the ledger daily and accounts are balanced at the
end of the accounting periods. The specimen of this form of account is given
below.
Page No. 26
Name of Account._________________________
Dr. Cr.
Particulars J.F Amount Date Particulars J.F Amount
Date

TOTAL TOTAL
3.1.1 Details of Columns
Page number is given at the top of each page after that name of the account.
In this form pages are vertically divided in two parts. Each part has four columns.
The left hand side is debit side and right hand side is called credit side. The detail
of each column is given below:
 In the first column date of the transaction is given in two lines, first line the
year and the second line, name of month and the date is written.
 In the second column the name of the source account is written. For
instance in the cash account Cash is written on top in particulars we will
write the name of source account for which cash is debited or credited.
 In the third column the page number of the journal where this transaction is
recorded is written.
 And finally in the fourth column the amount to be debited or credited is
written same for the other side of the account.
3.2 Running Balance Ledger or Self Balancing Ledgers
This form of ledger is used in the large organizations where accounting
period is long and books are closed annually. In this form after each and every
transaction accounts are balanced and debit and credit balances are readily
available. The specimen of this form is given below.

74
Page No. 26
Name of the account ________________________
Date Particulars J.F Debit Credit Dr/Cr Balance

TOTAL
3.2.1 Details of columns:
In the first column date of the transaction is written in second column name
of the source account in third column page number of the journal in the fourth
column the amount to be debited and in the fifth column the amount to be credited
is written in the sixth column the nature of balance if debit Dr and in case of
credit Cr and in last column the balancing figure is written.
The process of posting in this form will be discussed in the next section in detail.
3.3 Posting
Posting requires great accuracy as after posting accountant rely on ledgers
for preparation of final accounts and future references. In the manual posting
there are chances of errors therefore some organizations also maintain
computerized accounts to ensure the accuracy. We will discuss the manual
accounting in detail and overview of the computerized accounts.
Example
On January 12, 2018 Mr. A started business with cash Rs.125000

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General Journal
Page No. 1
Date Description L.F Debit Credit
2018 Cash Account 60 125000
Jan 1 To Capital Account 90 125000
Commenced business with cash

General Ledger
Name of Account: Cash
Page No. 60
Dr. Cr
Date Particulars J.F Amoun Date Particulars J.F Amount
t
Jan1 By Capital 1 125000
A/cc

TOTAL TOTAL

Page No. 90 Name of Account: Capital

Dr. Cr
Date Particulars J.F Amoun Date Particulars J.F Amount
t
Jan1 To Cash 1 125000
A/cc

TOTAL TOTAL

Note: In this example we assigned the hypothetical page numbers to journal and
ledger accounts. In practice page numbers are printed on the pages those
numbers serves as the cross reference. As shown in the diagram in the J.F
(journal folio) column we enter the page number of the journal and in the
L.F (ledger folio) column we enter the page numbers of the accounts
assigned to the accounts

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3.4 Illustration No.2
Mr. Sultan started a car wash business. Following are the transactions
resulted from the first month of the business operations. You are required to
record these transactions into journal and post them into ledger accounts.
1. Invested cash Rs. 120000 into business.
2. Deposited into bank Rs.5000.
3. Purchased stationary from Mr. Idnan on account for Rs.500
4. Purchased building for cash Rs.45000
5. Received service revenue Rs.8000
6. Paid salaries to employees Rs.4000.
7. Paid advertisement expenses by cheque Rs.250
8. Electric charges paid Rs.700
Page No.1 General Journal
Date Description Ref Debit Credit
Cash A/c 1 120000
To Capital 140 120000
Started business with cash
Bank A/c 3 5000
To cash A/c 1 5000
Opened a bank account in the name
of business
Stationary expenses A/c 50 500
To Mr. Idnan A/c 14 500
Purchased stationary on credit
Building A/c 10 45000
To cash A/c 1 45000
Purchased building
Cash A/c 1 8000
To service revenue A/c 60 8000
Earned service revenue
Salaries Expenses A/c 58 4000
To cash A/c 1 4000
Paid salaries to employees
Advertisement Expense A/c 52 250
To bank A/c 3 250
Paid advertisement expenses
Electricity Expense A/c 55 700
To cash A/c 1 700
Paid electricity bill

77
a. Periodic ledger accounts
Page No. 1 Cash
Date Particulars Ref Amount Date Particulars Ref Amount
To Capital A/c 1 120000 By Bank A/c 1 5000
To Service 1 8000 By Building A/c 1 45000
revenue By Salaries Exp 1 4000
By Electricity 1 700
Exp 73300
Balance C/F
TOTAL 128000 TOTAL 128000
Page No. 3 Bank
Date Particulars Ref Amount Date Particulars Ref Amount
To Cash A/c 1 5000 By Advertisement 1 250
Balance C/F 4750
5000 5000
Page No. 10 Building
Date Particulars Ref Amount Date Particulars Ref Amount
To Cash A/c 1 45000 Balance C/F 45000
45000 45000
Page No. 14 Mr. Adnan
Date Particulars Ref Amount Date Particulars Ref Amount
Balance C/F 500 By Stationary 1 500
Exps
500 500
Page No. 50 Stationary Expense
Date Particulars Ref Amount Date Particulars Ref Amount
To Mr. Adnan 1 500 Balance C/F 500
500 500
Page No. 52 Advertisement Expense
Date Particulars Ref Amount Date Particulars Ref Amount
To Bank A/c 1 250 Balance C/F 250
250 250
Page No. 55 Electricity Expenses
Date Particulars Ref Amount Date Particulars Ref Amount
To Cash A/c 700 Balance C/F 700
700 700

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Page No. 58 Salaries expense
Date Particulars Ref Amount Date Particulars Ref Amount
To Cash A/c 1 4000 Balance C/F 4000
4000 4000
Page No. 60 Service revenue
Date Particulars Ref Amount Date Particulars Ref Amount
Balance C/F 8000 By Cash A/c 1 8000
8000 8000
Page No. 140 Capital
Date Particulars Ref Amount Date Particulars Ref Amount
Balance C/F 120000 By Cash A/c 1 120000
120000 120000
b. Running balancing ledgers or self balancing ledgers
Page No. 1 Cash
Date Particulars Ref Debit Credit Dr/Cr Balance
Capital A/c 1 120000 Dr 120000
Bank A/c 1 5000 Dr 115000
Building A/c 1 45000 Dr 70000
Service Revenue 1 8000 Dr 78000
Salaries 1 4000 Dr 74000
Electric Charges 1 700 Dr 73300

Page No. 3 Bank

Date Particulars Ref Debit Credit Dr/Cr Balance
Cash A/c 1 5000 Dr 5000
Advertisement 1 250 Dr 4750
expense

Page No. 10 Building

Date Particulars Ref Debit Credit Dr/Cr Balance
Cash A/c 1 45000 Dr 45000

Page No. 14 Mr. Adnan

Date Particulars Ref Debit Credit Dr/Cr Balance
Stationary expense 1 500 Cr 500
A/c
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Page No. 50 Stationary Expense
Date Particulars Ref Debit Credit Dr/Cr Balance
Mr. Adnan 1 500

Page No. 52 Advertisement Expense

Date Particulars Ref Debit Credit Dr/Cr Balance
Bank A/c 1 250 Dr 700

Page No.55 Electricity Charges

Date Particulars Ref Debit Credit Dr/Cr Balance
Cash A/c 1 700 Dr 700
Page No. 58 Salaries Expenses
Date Particulars Ref Debit Credit Dr/Cr Balance
Cash A/c 1 4000 Dr 4000
Page No.60 Service Revenue
Date Particulars Ref Debit Credit Dr/Cr Balance
Cash A/c 1 8000 Cr 8000

Page No.140 Capital

Date Particulars Ref Debit Credit Dr/Cr Balance
Cash 1 120000 Cr 120000
3.5 Balancing of Account
In case of Running Balance, the balance of an account is computed after each
and every transaction by adding or subtracting the change in account as in the above
illustration. For Periodic ledger Accounts, balance of account is computed by:
1. Adding the figures on each side.
2. Subtracting the smaller total from larger to obtain the balance.
For Example
Page No. 1 Cash
Date Particulars Ref Amount Date Particulars Ref Amount
To Capital A/c 1 120000 By Bank A/c 1 5000
To Service 1 8000 By Building 1 45000
revenue A/c 1 4000
By Salaries Exp 1 700
By Electricity
Exp 73300
By Balance c/d
TOTAL 128000 TOTAL 128000
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4. THE TRIAL BALANCE
4.1 Need of Trial Balance?
After all the transactions of an accounting period are posted into ledger
accounts then balances of the accounts are ascertained normally at the end of
accounting period. It is the time to prepare the final accounts, to judge the results
of operation for the accounting period and financial position of the business at
that date. In order to ensure the accuracy of the final accounts accountant must
test accuracy of his recording activities for the period before preparing the
statements. Commonly used testing device for this purpose is the Trial Balance.
4.2 Definition of Trial Balance
“It is a list of all ending or closing balances of accounts, which is prepared
on particular date to check the arithmetical accuracy of accounts”.
As it was explained in the first unit of the book that every entry on left
(Debit) side is matched by an entry of equal amount on the right (Credit) side.
Since the books started with equality and continued that equality in the recording
process, it follows that the sum of debit balances should equal the sum of credit
balances when all transactions have been posted. If both are not equal it means
there is an error that should be located and rectified.
4.3 Purpose of Trial Balance
It serves the following purposes:
 It checks the mathematical accuracy and ensures that all closing debit and
credit balances of accounts are equal.
 It serves the first step towards the preparation of final accounts.
 It is helpful for the identification and rectification of errors.
4.4 Illustration No.3
Prepare the Trial Balance of Mr. Sultan from the data used in previous
Mr. Sultan, Trial Balance
As at 30th June, 2012
Title of Accounts A/c. No. Debit Balances Credit Balances
Cash 1 73300
Bank 10 4750
Building 14 45000
Mr. Idnan 15 500
Stationary expenses 50 500
Advertisement expenses 52 250
Electricity expenses 55 700
Salaries expenses 58 4000
Service revenue 60 8000
Capital 140 120000
TOTAL 128500 128500

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5. EXAMPLES
Example 01
Asgher Ali informs you that the transactions occurred during May 2013, the
first month of business operations.
May 1. Asgher Ali transferred Rs. 15000 cash from a personal bank account
and equipment with a value of Rs. 4000 to his business.
1. A building costing Rs. 39000 and land costing Rs. 20000 were
purchased. Cash in the amount of Rs. 5000 was paid and a Note
payable was given for the remaining.
2. Premium for property insurance was paid in the amount of Rs. 1500
for May.
3. Supplies costing Rs. 500 and equipment costing Rs. 6000 were
purchased on account.
15. Cash received for professional services performed, Rs. 5600; other
clients were billed for services in the amount of Rs. 2430.
16. Paid cash to creditors on account, Rs. 1800.
20. Returned portion of the supplies costing Rs. 240 since they were not of
the proper grade.
22. Received Rs. 1880 cash from clients on account.
31. Paid utility bill, Rs. 500.
31. Paid monthly salaries, Rs. 3000.
31. Recorded additional amount owed by clients for services performed in
May, Rs. 4900; payment is due within 30 days.
You are required to;
a) Prepare the General Journal
b) Ledger Accounts
c) Trial Balance
Asgher Ali
General Journal
a. Page 1
Date Account Titles and Explanation Post Ref. Debit Credit
2013
1-May Cash 11 15,000
Equipment 16 4,000 19,000
Jay Latt, Capital 31
Mr. Asghar Ali started business with
Cash and equipment
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 1. Building 17 39,000
Land 18 20,000
Cash 11 5,000
Mortgage Note Payable 25 54,000
Bought Land and Building by paying
Cash and issued N/P for the Balance
2. Insurance Expenses 53 1,500
Cash 11 15,000
Paid Insurance Expenses
3. Supplies 13 500
Equipment 16 6,000
Accounts Payable 21 6,500
Performed Services on Cash and Credit
15. Cash 11 56,000
Accounts Receivable 12 2,430
Revenue from Services 41 8,030
Performed Services on Cash and on
Credit
16. Accounts Payable 21 1,800
Cash 11 1,800
Paid amount due to creditors
20. Account Payable 21 240
Supplies 13 240
Defective supplies returned to creditors
22. Cash 11 1,880
Accounts Receivable 12 1,880
Received Cash from Debtors
31. Utility Expense 52 500
Cash 11 500
Paid Utilities Expenses
31. Salary Expense 51 3,000
Cash 11 3,000
Paid Salaries Expenses
31. Accounts Receivable 12 4,900
Revenue from Services 41 4,900
Performed Services on Credit

83
b. General Ledger Page No. 11
Cash
Date Explanation Post Ref. Dr. Cr. Balance
2013
May 1 1 15000 15000
1 1 5000 10000
2 1 1500 8500
15 1 5600 14100
16 1 1800 12300
22 1 1880 14180
31 1 500 13680
31 1 3000 10680

Accounts Receivable 12
Date Explanation Post Ref. Dr. Cr. Balance
2013
May 1 2430 2430
15 1 1880 550
22 1 4900 5450
31
Supplies on Hand 13
Date Explanation Post Ref. Dr. Cr. Balance
2013
May 1 2430 2430
15 1 1880 550
22 1 4900 5450
31
Equipment 16
Date Explanation Post Ref. Dr. Cr. Balance
2013
May 3 1 4000 4000
20 1 6000 10000

84
 Building 17
Date Explanation Post Ref. Dr. Cr. Balance
2013
May 1 1 39000 39000

Land 18
Date Explanation Post Ref. Dr. Cr. Balance
2013
May 1 1 20000 20000

Accounts Payable 21
Date Explanation Post Ref. Dr. Cr. Balance
2013
May 3 1 6500 6500
16 1 1800 4700
20 1 240 4460

Mortgage Note Payable 25

Date Explanation Post Ref. Dr. Cr. Balance
2013
May 1 1 54000 54000

Asgher Ali, Capital 31

Date Explanation Post Ref. Dr. Cr. Balance
2013
May 1 Cash 1 14000 19000
Equipment 5000
Revenue from Services 41
Date Explanation Post Ref. Dr. Cr. Balance
2013
May 15 1 8030 8030
31 1 4900 12930

85
Salary Expense 51
Date Explanation Post Ref. Dr. Cr. Balance
2013
May 31 1 3000 3000

Utility Expense 52
Date Explanation Post Ref. Dr. Cr. Balance
2013
May 31 1 500 500

Insurance Expense 53
Date Explanation Post Ref. Dr. Cr. Balance
2013
May 2 1 1500 1500

c. Asgher Ali, Trial Balance

May 31, 2013
Sr. No Account Title A/c No Debit Credit
1 Cash 11 10,680
2 Accounts Receivable 12 5,450
3 Supplies 13 260
4 Equipment 16 10,000
5 Building 17 39,000
6 Land 18 20,000
7 Accounts Payable 21 4,460
8 Mortgage Note Payable 25 54,000
9 Asgher Ali, Capital 31 19,000
10 Revenue from Services 41 12,930
11 Salary Expense 51 3,000
12 Utility Expense 52 500
13 Insurance Expense 53 1, 500 _________
TOTAL Rs.90390 Rs.90390
Example 02
Transaction of Shah & Sons for the month of June, 2018 is given below; record
them in proper Journal form, post them into ledger and prepare a trial balance.
June 01 The business was started with Rs. 80,000 in the form of cash Rs.
10,000 in the form of furniture and stock of Rs. 40,000.
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June 02 Goods sold for Rs. 10,000.
June 03 Equipment of Rs. 5,000 were purchases from Steel Decorators, the
payment was to be made later on.
June 05 Goods were sold on credit basis to Aslam & Co, for Rs. 8,000.
June 07 Paid Rs. 5,000 to Steel Decorators.
June 09 Goods of the list price Rs. 1,000 were sold at 10% trade discount.
June 13 Received Rs. 3,000 from Aslam & Co. allowing them Rs. 50/- as
discount.
June 15 Purchases goods for Rs. 15,000 from Punjab House on credit basis.
June 17 Goods amounting Rs. 1,000 were used by the owner for his private
use.
June 19 Furniture of the Book Value Rs. 1,000 was sold for Rs. 700.
June 20 Goods costing Rs. 2,000 were destroyed by fire, insurance
company accepted a claim for Rs. 1,500.
June 22 Goods were sold for Rs. 12,000 in exchange of cash.
June 24 Paid electric bill of the shop Rs. 1500 paid telephone bill of the
shop Rs. 500.
June 26 Goods sold to Aslam & Co on credit for Rs. 5,000 carriage paid
Rs. 1200 carriage was to be charged to Aslam.
June 30. Salary paid to salesman Rs. 500
SOLUTION
Date Description L.F Dr. Cr.
2018
June 01 Cash A/c. 1 80,000
Furniture A/c. 2 10,000
Stock A/c 3 40,000
To Capital A/c 101
(Invested into business in the of cash, 1,30,000
furniture and goods)
June 02 Cash A/c 1 10,000
To Sales A/c 301 10,000
Goods sold for cash
June 03 Equipment A/c 4 5,000
To Steel Decorators 102 5,000
(Equipment purchases on credit)
June 05 Aslam & Co. 5 8,000
To Sales A/c 301 8,000
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 (Goods costing Rs. 6,400 were sold
on credit
June 07 Steel Decorators A/c 102 5,000
To Cash A/c 1 5,000
(Payment made to steel decorators)
June 09 Cash A/c 1 900
To Sales A/c 301 900
(Goods sold for cash at 10% trade
discount)
June 13 Cash 1 3,00
Discount expense 201 50
To Aslam & Co 5 3,050
Received cash and allowed discount
June 15 Purchases A/c 3 15,000
To Punjab House 102 15,000
Merchandise purchased on credit
June 17 Drawing A/c 130 1000
To Purchases A/c 3 1000
Goods used by the owner
June 19 Cash A/c 1 700
Profit & loss account 202 300 1000
To Furniture A/c
Furniture sold at a loss
June 20 Insurance Company 104 1500
Loss by fire A/c 203 500
To Purchases A/c 3 2000
Goods of Rs./ 2,000 were destroyed
by fire, a claim of Rs. 1,500 was
accepted by Insurance Company.
June 22 Cash A/c 1 12,000 12,000
To Sales A/c 301
Goods Rs. 10,000 were sold for cash
June 24 Electric charges A/c 204 1,500
Telephone charges A/c 205 500
To Cash A/c 1 2,000
Paid electric & Telephone bill
June 26 Aslam & Co. 5 5,100
88
 To Sales A/c 5,000
To Cash A/c 100
Goods sold on account, carriage paid
but charged to Aslam
June 30 Salary expenses A/c 206 500
To Cash A/c 1 500
(Paid salary to salesman)
Posting in periodic form of ledger
Cash Account A/C No. 1
Date Description L. Amoun Date Description L. Amoun
F t F t
June To Capital 80000 June 7 By steel 5000
01 To sales A/c 10000 June decorators
June To sales A/c 900 24 By Electric 1500
02 To Ahmed & 3000 Charges A/c
June Co 700 June By telephone 500
09 To Furniture 12000 24 Charges A/c 100
June A/c By Aslam & 500
13 To sales A/c June Co 99000
June 26 By Salary A/c
19 106600 June By Balance 106600
June 30
22 June
30

Furniture Account A/C No. 2

Date Description L. Amoun Date Description L. Amoun
F t F t
June To Capital 10000 June 19 By Cash 700
01 June 19 By Profit &
Loss 300
June 30 A/c 9000
_____ By Balance _____
10000 10000

89
 Purchases Account A/C No. 3
Date Description L.F Amount Date Description L.F Amount
June To Punjab 15000 June 17 By Drawing 1000
15 House June 20 By Insurance 1500
Co 500
June 30 By loss by fire 12000
_____ By balance _____
15000 15000
Stock Account A/C No. 6
Date Description L.F Amount Date Description L.F Amount
June To Capital 40,000 June By Balance 40,000
15 ______ 30 ______
40,000 40,000
Equipment AccountA/C No. 4
Date Description L.F Amoun Date Description L.F Amount
t
June To steel June
03 Decorators 5000 30 By balance 5000
____ ____
5000 5000
Aslam & Co account A/C No. 5
Date Description L.F Amount Date Description L.F Amount
June To Sale A/c 8000 June By Cash 3000
03 To Sale A/c 5000 13 A/c 50
June To Cash A/c 100 By 10050
20 ______ June Discount
June 131000 30 A/c ______
26 By Balance 131000
Capital Account A/C No. 101
Date Description L.F Amount Date Description L.F Amount
June 30 To Balance 130000 June By Cash 80000
01 By Furniture 10000
By Stock 40000
______ ______
130000 130000

90
 Steel decorators Account A/C No. 102
P11 Description L.F Amount Date Description L.F Amount

June 7 To Cash A/c 5000 June By 5000

____ 03 equipment ____
5000 A/c 5000
Drawing Account A/C No. 103
Date Description L.F Amount Date Description L.F Amount
June 7 To Purchase 1000 June By Balance 1000
____ 30 ____
1000 1000
Discount Expense Account A/C No. 201
P11 Description L.F Amount Date Description L.F Amount

June To Aslam & 50 June By Balance 50

13 Co A/c 30
__ __
50 50
Profit & Loss Account A/C No. 202
Date Description L.F Amount Date Description L.F Amount
June To Furniture 300 June By Balance 300
13 A/c ___ 30 ___
300 300

Loss by fire Account A/C No. 203

Date Description L.F Amount Date Description L.F Amount
June To Purchases 1500 June By Balance 1500
20 A/c ____ 30 ____
1500 1500
Electric Charges Account A/C No. 204
Date Description L.F Amount Date Description L.F Amount
June To Cash A/c 1500 June By Balance 1500
24 30
____ ____
1500 1500

91
 Insurance Company A/C No. 104
Date Description L.F Amount Date Description L.F Amount
June To Purchase 1500 June By Balance 1500
20 A/c 30
____ ____
1500 1500
Telephone Charges Account A/C No. 205
Date Description L.F Amount Date Description L.F Amount
June To Cash A/c 500 June By Balance 500
24 30
___ ___
500 500
Salary Expense Account A/C No. 206
Date Description L.F Amount Date Description L.F Amount
June To Cash A/c 500 June By Balance 500
30 30
___ ___
500 500
Sales Account A/C No. 301
Date Description L.F Amount Date Description L.F Amount
June To Balance 35900 June By Cash A/c 10000
30 02 By Aslam & 8000
June Co 900
05 By Cash A/c 12000
June By Cash A/c 5000
_____ 09 By Aslam & ____
35900 June Co 35900
22
June
26
Punjab House Account A/C No. 302
Date Description L.F Amount Date Description L.F Amount
June To Purchases 15000 June By Balance 15000
15 A/c 30
___ ___
15000 15000

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 Posting in running balance form of ledger
Cash Account A/C No. 1
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 01 Capital 80000 - 80000
June 02 Sales A/c 10000 - 90000
June 07 Steel decorators - 5000 85000
June 09 Sales A/c 900 - 85900
June 13 Ahmed & Co 3000 - 88900
June 19 Furniture A/c 700 - 89600
June 22 Sales A/c 12000 - 101600
June 24 Electric charges A/c 1500 100100
June 24 Telephone charges 500 99600
June 26 A/c 100 99500
June 30 Aslam & Co 500 99000
Salary A/c

Furniture Account A/C No. 2

Balance
Date Description L.F Debit Credit
Dr. Cr.
June 01 Capital A/c 10000 - 10000 -
June 19 Cash A/c 700
Profit & Loss A/c 300 9000
Equipment Account A/C No. 4
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 03 Steel Decorators 5000 5000
Stock Account A/C No. 6
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 01 Capital A/c 40000 40000

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Purchases Account A/C No. 3
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 15 Punjab House 15000 - 15000
June 17 Drawing A/c 1000 14000
June 20 Insurance Company 1500
A/c 500 12000
Loss by fire A/c
Aslam & Co Account A/C No. 5
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 05 Sales A/c 8000 - 8000
June 13 Cash A/c - 3000
Discount A/c 50 4950
June 20 Sales A/c 5000 -
Cash A/c 100 - 10050
Capital Account A/C No. 101
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 01 Cash A/c 80000
Furniture A/c 10000
Stock A/c 40000 130000
Steel Decorators Account A/C No. 102
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 03 Equipment A/c 5000 5000
June 07 Cash A/c 5000 - -- -
June 15 Purchases A/c - 15000 -- 15000
Drawing Account A/C No. 103
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 17 Purchases A/c 1000 - 1000 -
Discount Account A/C No. 201
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 13 Aslam & Co 50 - 50

94
 Profit and Loss Account A/C No. 202
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 19 Furniture A/c 300 - 300
Loss by Fire Account A/C No. 203
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 20 Purchases A/c 500 - 500
Electric Charges Account A/C No. 204
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 24 Cash A/c 1500 - 1500
Insurance Company Account A/C No. 104
Date Description L.F Debit Credit Balance
Dr. Cr.
June 20 Purchases A/c 1500 - 1500
Telephone Charges Account A/C No. 205
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 24 Cash A/c 500 - 500
Salary Account A/C No. 206
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 30 Cash A/c 500 - 500
Sales Account A/C No. 301
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 02 Cash A/c 10000 10000
June 05 Aslam & Co. 8000 18000
June 09 Cash A/c 900 18900
June 22 Cash A/c 12000 30900
June 26 Aslam & Co. 5000 35900
Punjab House Account A/C No. 302
Balance
Date Description L.F Debit Credit
Dr. Cr.
June 15 Purchases A/c 15000 15000

95
 Shah & Sons
Trial Balance
As at 30th June, 2012
Title of Account A/c No Debit Balance Credit Balance
Cash A/c 01 99000
Furniture A/c 02 9000
Purchases A/c 03 12000
Equipment A/c 04 5000
Aslam & Co. 05 10050
Stock A/c 06 40000
Capital A/c 101 - 130000
Steel Decorators 102 - -
Drawing A/c 103 1000 -
Insurance Company A/c 104 1500
Discount A/c 201 50 -
Profit & Loss A/c 202 300 -
Loss by fire A/c 203 500 -
Electric Charges A/c 204 1500 -
Telephone charges A/c 205 500 -
Salary A/c 206 500 -
Sales A/c 301 - 35900
Punjab House A/c 302 - 15000
______ ______
TOTAL 180900 180900
6. SELF ASSESSMENT QUESTIONS
6.1 Choose the best answer from the given options:
i. Ledger is called:
a) Book of original entry b) Book of final entry
c) Book of compound entry
ii. Transactions are primarily recorded in:
a) Journal b) Ledger
c) Trial balance d) Balance sheet
iii. The arithmetical accuracy of books of account is verified through:
a) Journal b) Ledger
c) Trial Balance d) None of the above

96
iv. The difference of the totals of the two sides of an account is called:
a) Brought forward b) Carry forward
c) Balance d) None of the above
v. The right hand side of an Account is called:
a) Debit side b) Credit side
c) Both debit and credit d) None of the above
vi. The left hand side of Account is called:
a) Credit side b) Debit side
c) Both debit and credit d) None of the above
vii. Cash purchases from Khalid will be posted to debit side of:
a) Khalid account b) Cash account
c) Purchases account d) Creditor’s account
viii. Building purchased for cash will be posted to building account on the:
a) Debit side b) Credit side
c) Both sides d) None of the above
xi. The ruling of a trial balance is similar to that of:
a) A journal b) A ledger
c) A balance sheet d) None of the above
x. In case, the trial balance is not prepared, it will be an almost impossible to
prepare:
a) The journal b) The ledger
c) The financial statements d) None of the above
xi. The ledger is the book for the;
a) First entry b) Second entry
c) Third entry d) Fourth entry
xii. The main purpose of a trial balance is to:
a) Help balance the bank account
b) Check the accuracy of the books of original entry
c) Help check the arithmetical accuracy of the double entry
d) None of the above.
xiii. A trial balance is:
a) A balance sheet
b) A rough draft of the final accounts
c) A list of the balances in the ledger
d) None of the above

97
xiv. If the two sides of an account are equal, that account will show:
a) Zero balance b) Debit balance
c) Credit balance d) None of the above
xv. Excess of credit over debit is called:
a) Debit balance b) Credit balance
c) Opening balance d) None of the above
xvi. While balancing an account the difference of the two sides’ is recorded on:
a) Larger side b) Small side
c) Both larger and smaller side d) None of the above
xvii. Ledger is a book in which:
a) Only real accounts are opened
b) Only real and personal accounts are opened
c) All the real, personal and nominal accounts are opened
d) None of the above
xviii. The process of recording a transaction in ledger is called:
a) Posting b) Journalizing
c) Entry d) Recording
xix. Excess of debit over credit is called:
a) Debit balance b) Credit balance
c) Closing balance d) Opening balance
xx. The debits and credits of journalized transactions are transferred to:
a) Chronological book b) Ledger
c) Journal d) Purchase book
Answer of the Question
1 (b) 6 (b) 11 (b) 16 (b)
2 (a) 7 (c) 12 (c) 17 (c)
3 (c ) 8 (a) 13 (c) 18 (a)
4 (a) 9 (a) 14 (a) 19 (a)
5 (b) 10 (c) 15 (b) 20 (b)

6.2 Match the statement in column ‘A’ with column ‘B’ and write in
column ‘C’
Column A Column B Column C
1) Ledger a) Recording process in ledger
2) Self balancing form b) Arithmetically accurate
3) Posting c) Zero balance
4) Balancing d) Book of accounts
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 5) Both sides of an e) adding the both debit and
account are equal credit side and deducting
smaller from larger side
6) More than total debit f) Assets accounts
7) Credit balance g) Liabilities accounts
8) Debit balance h) Ledger
9) Trial balance i) Credit balance
10) More than total j) Form of ledger accounts
credit
Answers
1. (c) 2. (i) 3. (a) 4. (e) 5. (h)
6. (i) 7. (g) 8. (d) 9. (b) 10. (j)
6.3 Give the short answers of the following questions
i. What is ledger? Why it is called the book of permanent record?
ii. Differentiate between journal and ledger.
iii. What are the two important forms of ledgers?
iv. Define Trial Balance. Why it is prepared?
v. What do you know about the chart of accounts?
vi. Elaborate the whole process of posting.
7. PROBLEMS
Problem 01: Journalize the given transactions Mr. Ayaz for the month of
December, 2018.
10. Mr. Ayaz invested cash Rs.25000, vehicle Rs.40000, and furniture
Rs.15000 in business.
4. Hired a shop on monthly rent of Rs.500 after paying Rs. 2000 as advance
rent.
7. He bought machinery on credit Rs.2000, from OKARA Machinery Store,
paying Rs. 800 in cash and balance to be paid after two months to.
12. Purchased stationary Rs.100.
17. He sublet a part of his shop to another person from where he received
Rs.200 rent of the month.
23. Mr. Ayaz withdraw cash Rs.1000 and merchandise Rs.750 for his personal
use.
28. Paid electricity bill Rs.100 telephone bill Rs.300 and salaries Rs.600.

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Problem 02: Mr. Maqsod started business with cash Rs.450000 and furniture
Rs.30000 the transactions, completed during June 2006 the first month of
operations, are as under.
2. Opened a bank account in the name of business with Rs.150000.
5. Acquired a shop on the monthly rent of Rs. 3000 after paying cash Rs.
36000 as advance rent.
6. Purchased show cases and counters for Rs.18000 payment made by cheque.
9. Purchased goods costing Rs.50000 and payment made by cheque.
11. Bought goods from Mr. Ibrar on account Rs.26000.
13. Cash sale Rs.32000.
17. Sold goods on credit Rs. 6000 to Rahim.
21. Returned the defective goods to Rauf and Co. costing Rs.7000.
23. A regular customer complained about the quality of goods has been granted
an allowance of Rs.1000.
25. Received cheque from Rahim amounting Rs.5000 same day it was
deposited into the Bank.
Problem 03: Mr. Hameed Asgher Started business soon after completing the
internship of B.Com. Following are the transactions, completed during the first
month of June 2018.
June 01: Commenced business with cash Rs.150, 000.
03: Purchased merchandise for Rs.20,000.
04: Bought office furniture for Rs.15000 from Mohsin & Co.
07: Sold merchandise for Rs.10000
11: Paid insurance expenses Rs.100.
12: Sold goods to Mr. Rizwan for Rs.5,000
16: Paid cash to Mohsin & Co Rs 14900 in full settlement of his
account.
20: Purchased goods for Rs.10000
23: Received Rs.5000 from Mr. Rizwan.
28: Paid salary Rs.2300
30: Mr. Hameed Asgher withdraws Rs.500 for personal use.
Required: Journalize the above transactions, post them into ledgers accounts
and also prepare a trial balance.

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Problem 04: Record the following transaction in the General Journal, post them
into Ledger Accounts and also prepare Trial Balance.
2018
March 01: Mr. Zia started business with cash Rs.20000, Furniture
Rs.10000 and building Rs.50000.
02: Opened a bank account with cash Rs.10000.
03: Paid Rs.1000 for office expense.
05: Purchased stationary for office use Rs.50.
07: Bought goods from Mr. Zahid for Rs.15000, paying cash
Rs.5000 and balance after one month.
10: Withdraw cash from bank for office use Rs.8000.
13: Sold goods to Tanveer & Co for Rs.6000 and paid carriage Rs200
for delivery.
16: Returned goods to Mr. Zahid for Rs.2000.
18: Returned goods by Tanveer & Co Rs.500.
21: Cash received from Tanveer & Co Rs.2000.
24: Issued a cheque of Rs.1000 for advertisement.
28: Withdraw from bank Rs.4000 for personal use.
31: Goods amounting Rs.500 were given as charity.
Problem 05: Following are opening balances of various accounts in the books of
Majid and Sons as on 31st December 2018.
Account Titles Debit Rs. Credit Rs.
Cash 25,000
Debtors 20,000
Creditors 15,000
Furniture 15,000
Building 50,000
Purchases 12,000
Sales 35000
Salaries 5,000
Capital 88,000
Drawings 12,000
Sales Return and Allowance 500
Purchase Return and Allowance 1,500
139,500 139,500

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These transactions were completed during the month of January 2018.
01: Received from debtors Rs.8, 000
05: Sold goods for Rs.4, 000
09: Purchased merchandise on account Rs.12, 000
12: Paid to creditors Rs.6000
17: Paid salaries Rs.2,200
19: Paid rent Rs.1500
22: Goods amounting Rs.600 were taken by the proprietor for personal use.
29: Returned goods for Rs.500, which were purchased on 9 th January.
Required: Record the above transactions in Journal, post them into the ledger
accounts (by taking the opening balances) and prepare Trial Balance
for the month of January 2013.
Problem 06: After graduation from AIOU, Aftab Ahmad entered into private
practice. The transactions of the business are as follows:
March 01: Started business with Equipment Rs. 25000.
03: Deposited Rs. 20000 in his business bank account.
09: Paid Rs. 300 for two months rent in advance.
12: Purchased medical supplies for Rs. 2000 from Mr. Ijaz.
15: Purchased equipment on credit from Jaffar Bros for Rs. 4000,
making one-fourth down payment.
18: Paid Rs. 1900 by cheque to Mr. Ijaz in full settlement of his
account.
27: Provided services for a fee of Rs. 3500.
28: Made a partial payment of Rs. 50 on the equipment purchased.
30: Paid a utility bill for Rs. 40.
Required:
i) Record the above entries in the journal
ii) Post them into ledger accounts.
iii) Prepare a trial balance.
Problem 07: Selected transactions for Raja Travels, began on June 1, 2012 by
Raja Arif, are as follows:
a. Raja Arif invested Rs. 600,000.
b. A truck was purchased by the business for Rs. 430,000.
c. Equipment purchased on credit for Rs. 9,000.
d. A bill of Rs. 7,200 for transporting goods was sent to Mr. Ashraf Abbasi, a
customer.
e. Cash of Rs. 6,000 is received from the customer who was billed in d.
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f. Received Rs. 22,300 in cash for transporting goods.
g. A payment of Rs. 5,000 was made on the equipment purchased in c.
h. Paid expenses of Rs. 1,700 in cash.
i. Cash of Rs. 1,200 was withdrawn from business by owner for personal use.
Required: Journalize the above transactions post them into ledgers and
prepare Trial Balance.
8. SUMMARY
Journal is the book of original entry where the transactions are recorded
right after the completion. It is also called day book because all the transactions
of the day are recorded in it. The process of recording transactions in the journal
is called journalizing. Journalizing is the first step of accounting cycle. The debit
and credit aspects of transaction are recorded at the same place to avoid the errors.
All the transactions are transferred to the ledger accounts from the journal this
process is called posting.
Account is a classified record of a particular business item, the book
containing all these accounts called ledger. Transactions are transferred to this
book after recording in journal. The process of transferring transactions from
journal to the ledger is called posting. Chart of accounts is an index or plan for the
organization of the accounts contained in the ledger it help in identification of
account type and easy access.
The book in which all the accounts of a business are kept is called general
ledger. A separate ledger is maintained for each group of similar nature accounts
that is called subsidiary ledger. Subsidiary ledgers provide a detailed record of the
individual items comprising the balance of a general ledger controlling account.
There are two forms of the ledgers widely used in business (i) Running Balance
Ledger (ii) Self Balancing Ledger. Small business units where the transactions are
few Running balance form of ledger is used. Transactions are posted to the ledger
daily but the accounts are balanced at the end of accounting period. Self balancing
ledgers are widely used in the medium and large scale business. Accounts are
balanced on perpetual basis in this form.
After journalizing, transactions are transferred to the ledger accounts with
convenient intervals. The process of transferring transactions form the day book
(Journal) to the book of permanent record (ledger) is called posting. Reference
columns are used both in journal and ledger for cross referencing.
Ascertaining the balance of an account after totaling all the debits and
credits for a given period is called balancing the account. As in self balancing
ledger the accounts are balanced on perpetual basis but in case of running balance
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form it is normally done at the end of accounting period or whenever the final
accounts are need to be prepared.
In a trial balance, separate debit and credit columns are used to list the
balances of the individual ledger accounts. The two columns are then totaled to
prove the equality of the debit and credit balances. This process provides
assurance that (1) the total of the debits posted to the ledger was equal to the total
of the credits and (2) the balances of the individual ledger accounts were correctly
computed. While a trial balance proves the equality of debit and credit entries in
the ledger, it does not detect such errors as failure to record a business transaction,
improper analysis of the accounts affected by the transaction, or the posting of
debit or credit entries to the wrong accounts.

BIBLIOGRAPHY
Ahmad, M. M., Khan, S. A., Arshad, M., & Shah, S. M. (2013). Advanced
Financial Accounting. Islamabad: National Book Foundation Islamabad.
Dupree, D., & Marder, M. (1984). Principles of Accounting. Addison-Wesley.
Farooq, U., & Amir, S. M. (2008). Principles of Accounting. Islamabad: Allama
Iqbal Open University.
Hussain, K., Buttar, Z. U., Pirach, M. A., & Chaudhry, M. I. (1996). Accounting
Principles. Lahore: Orient Publishers Urdu Bazaar Lahore.
Mukherjee, A., & Hanif, M. (2003). Modern Accountancy I. Tata McGraw-Hill
Education.
Randall, H. (2005). Accounting. Cambridge University Press.
Wood, F., & Sangster, A. (2008). Business Accounting I. Pearson Education.

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105
Unit–4

SPECIAL JOURNALS –
SUBDIVISION OF JOURNAL

Written by: Sohail Amjed

Reviewed by: Muhammad Munir Ahmad

106
 CONTENTS
INTRODUCTION
OBJECTIVES
1. LEDGER
1.1 Why the Journal is Subdivided:
1.2 The Documentary Evidences of Transactions
1.2.1 Bill
1.2.2 Cash Memo
1.2.3 Cheque
1.2.4 Bank Advice
1.2.5 Credit Note
1.2.6 Debit Note
1.2.7 Statement of Account
1.3 Need for Specialized Journal
2. TYPES OF SPECIALIZED JOURNALS
2.1 List of Subsidiary Journals
2.2 Advantages of Special Journals
2.3 Purchase Journal
2.3.1 Format of Purchase Journal
2.3.2 Preparation of Purchase Journal
2.4 Purchase Returns & Allowance Journal
2.4.1 Illustration No. 2
2.5 Sales Journal
2.5.1 Format of Sales Journal
2.5.2 Preparation of Sales Journal
2.5.3 Illustration No. 3
2.6 Sales Return and Allowance Journal
2.6.1 Format of Sales Return & Allowance Journal
2.6.2 Preparation of Sales Return Journal
2.6.3 Illustration No. 4
2.7 Bills Receivable Journal
2.7.1 Preparation of Bill Receivable Journal
2.7.2 Illustration No. 5
2.8 Bills payable journal
2.8.1 Illustration No. 6

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 2.9 Cashbook
2.9.1 Petty Cashbook
2.9.2 Illustration No.7
3. SELF ASSESSMENT QUESTIONS
3.1 Choose the Best Answer from the Given Options
4. PROBLEMS
5. SUMMARY
REFERENCES/BIBLIOGRAPHY

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INTRODUCTION
Last units describe the procedure of recording the transactions in one
journal and ledger, which are maintained by small organizations because of less
number of transactions. But in case of large organizations, transactions can’t be
recorded in one journal due to huge volume of transactions. This unit describes
that how the journal is divided into parts, that is known as “Subdivision of
Journal”. Formats of Various types of special journals are described and also
illustrated. At the end of the unit self assessment questions and various problems
are given for the better understanding of the topics covered in this unit.

OBJECTIVES
After studying this unit, you will be able to:
1. Identify and use the source documents of various transactions.
2. Appreciate the need for special purpose books
3. Make cost benefit analysis of the special journals
4. Understand and prepare the format of various specialized journals
5. Journalize the transactions into their relevant books

109
1. INTRODUCTION TO SUBSIDIARY JOURNALS
1.1 Why the journal is subdivided?
As we have discussed in first and second unit that all business transactions
are first of all recorded in the journal and then posted into the ledger accounts.
Journalizing of each and every transaction and then posting them into the ledger is
lengthy task. Moreover by recording each and every transaction in the General
Journal the subdivision of work become difficult. The journal is therefore sub
divided in such a way that a separate book is used for each class of transaction.
1.2 The documentary evidences of transactions
For recording business transactions in books of accounts there must be
some written proof of the transaction. In routine business activities many
transactions are executed verbally these types of transactions are not recorded in
the books of accounts until these are supported by documents. A good
businessman always keeps the documentary evidence of the transactions for
future references.
The written evidence of the transaction is called voucher. Voucher can be
any document that contains full particulars of the transaction. There is no any
standard format of voucher. Businessman can develop style of voucher according
to his own needs. In the business world documents those are generally used as
voucher are Bills, Cash Memo, Cheque, Bank Advice, Credit Note, Debit Note
and Statement of Account. Brief introduction of these documents is as under.
1.2.1 Bill
It is the document prepared by the sales section at the time of credit sale.
Normally three copies of bill are prepared one copy is sent to the buyer with the
consignment second is sent to the accounts section and third is kept in the sales
section for record and future correspondence.
1.2.2 Cash Memo
In case of cash transaction (sale) Cash memo is prepared instead of bill. Its
three copies are prepared like bill and sent to the concerned departments.
1.2.3 Cheque
According to the nature, cheques are of two types first the businessman
issued for the payment and second those collected by the businessman as
collection of debt. He receives voucher from the creditors for payment and sends
vouchers to his debtors for receipt of the payment.
1.2.4 Bank Advice
Through this document bank informs its clients about the status of their
accounts.
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 This document is initiated either on the request of the client or at any
unusual
event like the dishonor of cheque.
1.2.5 Credit Note
When any customer returns goods the vendor sends a credit note to that
customer to inform that the specific amount is credited from his account and the
account is updated accordingly.
1.2.6 Debit Note
When the businessman returns goods to supplier he also sends a debit note
along with goods to inform him that the value of the goods is debited in his
account and he is no more liable for this amount.
1.2.7 Statement of Account
This document is the copy of the account of buyer in the books of seller that
seller sends to the buyer at the end of each month. There are two objectives to
send this statement. First one is let the buyer know what amount is payable and
second to remind the buyer for payment of this amount. If the buyer found any
difference he may contact the seller to reconcile the account.
1.3 Need for Specialized Journal
Special Journals have been designed to systemize the original recording of
major recurring transactions while general Journal is used for all transactions that
cannot be entered readily in one of the special journals each of the special journal
is a record of original entry which contains the data which will be posted to ledger
accounts later.
When business activities were not so complex and there were no large
business organization and daily transactions were few all the transactions were
recorded in the General Journal and even now-a-days small business with few
transactions records their transactions in the general journal i.e. a book of
accounting record where all the transactions of the day are recorded. But as the
business activities grown complex it is felt that it is not easy for an individual to
record many transactions in the general journal daily. For instance if a business
sell goods on credit to one hundred customers daily so it will have to record these
hundred transactions individually and repeatedly. The following journal entry will
be repeated hundred times.
Date Particulars L.F Debit Credit

…. Personal A/C of customer …..

To sales A/c …..
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 In the same way if a business buys goods from hundred different vendors it has
to repeat this journal entry same times.
Date Particulars L.F Debit Credit

…. Purchases A/c …..

To Personal A/c of Seller …..

There are many routine transactions that take place many times in a day for
example purchases, sales, purchase returns, sale returns and cash transactions. It is
useless and wastage of time to repeat same transaction. To avoid this laborious
and time taking repetition, specialized journals are used to record the
homogeneous transactions. For this purpose many other specific purpose journals
are used along with the General Journal. Use of specialized journals depends on
the information need of the businessman and the volume of the business
transactions.
Specialized journals can be of many types but the journals mostly used are as
follows.
2. TYPES OF SPECIALIZED JOURNALS
2.1 List of Subsidiary journals
There are many types of specialized journals used in business but most
commonly used specialized journals are following.
i. Purchase journal
ii. Purchase return journal
iii. Sales journal
iv. Sales return journals
v. Bills receivable journal
vi. Bills payable journal.
vii. Cash book
viii. Petty cash book
2.2 Advantages of special journals
2.2.1 Division of Work
The use of special journals offers the flexibility to journalize the
transactions by more than one person therefore the work load can be divided.
When the journalizing is assigned to different persons it not only ensures the
efficiency but also quality of work.

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2.2.2 Ready to Use information
In these journals transactions are grouped according to their nature it
become easy and quick to locate the transaction. These journals contain the
homogeneous transactions therefore it becomes possible to know the status of a
particular business item. For example from the sales journal it is easy to know the
position of the sale periodically without consulting ledger account. Therefore
specialized journals are up to date record of the particular item.
2.2.3 Time saving
When the General Journal is used to record all transactions a single person
has to record all the transaction no other person can help him to complete the task
early and he has to sit at late hours to complete the work of Journalizing. Due to
division of workload more than one person can be deputed to complete the task in
time.
2.2.4 Purchase Journal
Purchase journal is the most important journal and is used almost by all the
large and medium scale organizations. It is the book of accounting record in
which all the credit purchase transactions are recorded. It is important to note that
in this journal only credit purchases are recorded and cash purchase is recorded in
the cashbook. Normally at the end of each month purchase journal is totaled and
the balance is transferred to ledger account. In this way it become easy to know
the volume of monthly credit purchase
2.3 Purchase journal
There is slight difference between the format of General Journal and
Purchase Journal. In the first column of the Purchase Journal date of the entry, in
second column date of invoice, in third column Invoice Number, in fourth column
account to be credited, in fifth column Ledger folio and in last column amount is
written.
2.3.1 Format of Purchase Journal
The format of Purchase Journal is as follows:
Purchases journal
Date
Date of Invoice Particulars of Account Amount
of L.F.
Invoice No Credited Rs.
Entry

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2.3.2 Preparation of purchase journal.
The procedure of recording transactions in the purchase journal is explained with
the help of the following illustration:
Illustration No. 1
Following are the credit purchase transactions of a merchant for the month
of February 2012; record these transactions in the purchase journal.
Feb 02: Purchased 200 yards of Latha from M. Aslam at Rs.40 per yard
vide bill no.202 dated 1st of February.
Feb 15: Purchased 400 yards of Silk at Rs.75 per yard from Mr.
Iqbal, bill No.1015, dated 10 February.
Feb 22: Bought from Ijaz and Co, 20 blankets at an invoice price of Rs.250
each, Invoice No.32, dated 20 February.
Solution:
PURCHASES JOURNAL
Date of Date of Particulars of Amount
Invoice No L.F.
Entry Invoice Account Credited Rs.
Feb. 2 Feb. 1 202 M. Aslam 8000

Feb. 15 Feb. 10 1015 Iqbal & Bros 30000

Feb. 22 Feb.20 32 Ijaz & Co 5000

Total Credit 43000

Purchase
While recording transactions in the Purchase Journal you should be very
careful about the following things:
i. Bill number and dates should be clearly written in the relevant columns.
ii. Trade discount should be ignored because in the books of accounts only
payable amount is recorded.
iii. If the sale agreement contains that the expenditures on purchase like freight,
octori duty and carriage etc, will be borne by the buyer, then the amount of
these expenditures should be added in the cost of the goods.

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2.4 Purchase Return & Allowance Journal
When purchase order is placed all the terms and conditions are specified
including the price, quantity, quality and time of delivery. If the buyer found any
discrepancy he may return the goods to the seller. This is called purchase return.
Keeping in view transportation cost, reputation of business etc. etc. seller may
request the buyer not to return the goods and offer some concession in price in
reward. This concession is called allowance. Both purchase return and allowance
are recorded in the same book that is called Purchase Return and Allowance
Journal.
Two copies of debit note are prepared one is sent to the seller with the
goods and other is sent to the accounts section. Account section records the
purchase return from this copy. To explain this procedure let’s take an example.
2.4.1 Illustration No. 2
Mr. Gohar purchased 15 computers from Syed Computers, at Rs.25000 per
computer. On receipt of the computer it is found that three computers were not
according to the specification. These three computers were returned to the
supplier and a debit note was sent along with theses computers. Following is the
debit note prepared for this purpose.
Debit Note
No. 108
Date: November 21, 2012

Gohar Khan, Syed Computers,

Super Market, Noor Plaza, Chandni Chowk,
F-7, Islamabad. Rawalpindi.

We debit your account as follows:

Three Dell Optiplex computers @ Rs. 25000 Rs. 75000/-
Not according to the specification (Seventy five thousand only)

Sd/-
(Gohar Khan)
Managing Director

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 This transaction will be recorded in the purchase return journal in the
following manner
Date D/N No. Account Debited L.F Amount
2005
Nov.21 108 Syed Computers 75000

Purchase return and allowance journal is balanced at the end of each month
and the total is posted in the ledger account only once in the month instead of
every time.
2.5 Sales Journal
Sales Journal is the book in which all the credit sales are recorded. Cash
sales are not entered in this Book. Source document for journalizing the credit
sale is the copy of invoice/bill that is sent to the customer with the goods
delivered. Like other specialized journal sales journal is also balanced at the end
of each month and balance is posted in the ledger once at the end of each month.
The sales book is written up daily from the duplicate copies of such invoices.
A separate Account is opened in the ledger for each customer to whom
goods have been sold on credit and the customer’s account is debited with the
amount of each Sale. At the end of the month the amounts entered in the Sales
Book are added and the total is credited to Sales Account in the Ledger.
2.5.1 Format of Sales Journal
Sales Journal has normally five columns. In the first column date of
transaction in second column Bill number in third column account to be debited in
fourth column ledger folio and in last column amount is recorded. The
journalizing procedures are the same as in the Purchase Journal.
Date Bill. No Particulars of Account Debited L.F Amount

2.5.2 Preparation of Sales Journal

Procedures, for journalizing the Credit sale transactions, are explained with
the help of the following illustration:

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2.5.3 Illustration No. 3
Following are the credit sale transactions of a trader for the month of
February 2012.
Feb. 05: Sold 1200 yards of Latha at Rs.75 per yard and 20 blankets at
Rs.175 per blanket to Mr. Afzal vide bill No.105.
Feb. 17: Sold 120 yards of silk at Rs.50 per yard to Mr. Iqbal on account
and sent Bill No.109 for this amount.
Feb. 24: 80 yards of cloth were sold to Mr. Amin and sent bill No.116 for
Rs.3200.
Sales journal
Date Bill. No Particulars of Account Debited L.F Amount
2012.
Feb. 05 105 Mr. Afzal
Feb. 17 109 Mr. Iqbal 6000
Feb. 24 116 Mr. Amin 3200

TOTAL 9200
The balance of the sales journal of Feb is transferred to the sales journal at
the end of the month.
2.6 Sales Return and Allowance Journal
Sometimes the buyer returns goods to the seller if he found any discrepancy
in quality, quantity or terms and conditions of the transaction. He sends a debit
note along with the goods to intimate the seller for this return. If the seller found
that the complaint of the buyer is right he may offer him some concession in price
and ask him not to return the goods. This concession is called allowance.
Allowance and sales return are recorded in the same book that is called Sales
Return and Allowance Journal.
If the seller deems that the return was for solid reason he send a credit note
to the buyer to intimate him the acceptance of sales return. Two copies of credit
note are prepared one is sent to the buyer and other is sent to the accounts
department. From this copy Accounts department record the transaction in this
Journal. Whole the procedure is explained with help of following example.
2.6.1 Format of Sales Return & Allowance Journal
Date Cr. Note No. Particulars of Account L.F Amount
Credited

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2.6.2 Preparation of Sales Return Journal
Procedures for journalizing the sale return and allowance journal
transactions, are explained with the help of the following illustration:
2.6.3 Illustration No. 4
Mr. A sold 50 pairs of shoes to Mr. B on credit for Rs.120 per pair. Mr. B
returned 10 pairs of shoes to Mr. A because size of these shoes was not according
to the order. Mr. A accepted this mistake and issued a credit note of Rs.1200,
equal to the invoice price of these ten pair of shoes. He prepared two copies of the
credit note one is sent to Mr. B and other is sent to the Accounts Section.
Following is the specimen of credit note.
CREDIT NOTE
No. 124
December 3, 2012

From, To,
Mr. A Mr. B
Shop No. 123, 226-B Satellite Town
I-8/1, Islamabad Rawalpindi

We credit your account as follows:

10 pairs of Shoes @ Rs. 120 each Rs. 1200/-
Rupee one thousand two hundred only.

Mr. A
Sd/-
This transaction will be recorded in the sales return and allowance journal
in the following manner.
Date Cr. Note No. Particulars of Account Credited L.F Amount
2012.
Dec.03 124 Mr. B 1200
Just like other special journals Sales Return and Allowance Journal is
totaled at the end of each month and the balance is transferred to the General
Ledger.

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2.7 Bills receivable journal
The sales on credit may be made on an open account system or the seller
may insist on the buyer to accept the bill for the value of goods purchased. A bill
in such a case, is bill receivable for the seller, whereas, bills payable for the
purchaser. If the bills are received against credit sales, the seller may record the
bills so received in a separate book which helps in getting the full information
about the bills. The format of Bills Receivable Book is given below.
Bill Receivable Journal
Date From whom received Term Due Date L.F Amount

2.7.1 Preparation of Bill Receivable Journal

Procedures for Journalizing the Bill Receivable transactions are explained
with the help of the following illustration:
2.7.2 Illustration No. 5
Enter the following transactions in the bill receivable journal:
2012.
Jan 02: A bill of exchange at 3m/d is drawn on Zia Bros for Rs.1700
Jan 05: Acceptance received from Baber & Co at 1 m/d for Rs.2800
Jan 15: Mr. Noshad gave his acceptance at 3m/d for Rs.1500
Jan 27: Drew a bill of exchange on Mr. Bashir at 2m/d for Rs.3700
Bill Receivable Journal
Date From whom received Term Due Date L.F Amount
2012
Jan 02 Zia Bros 3 m/d Mar 05 1700
Jan 05 Baber & Co 1 m/d Feb 08 2800
Jan 15 Mr. Noshad 3 m/d Mar 18 1500
Jan 27 Mr. Bashir 2 m/d Mar 30 3700
2.8 Bills payable journal
When the bills are more commonly accepted to acknowledge debt, it is
better to maintain the record of bills accepted in a separate book. The format of
Bills Payable Book is given

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Bill Payable Journal
Date To whom paid Term Due Date L.F Amount

2.8.1 Illustration No. 6

Enter the following transactions in the bills payable book
2012.
Jun 03: Accepted a bill of exchange at 2 m/d for Rs.5000 drawn by Mr.
Shakeel
Jun 12: Acceptance given to Mr. Yousaf Mirza at 3m/d for Rs.4000
Jun 22: Accepted a bill drawn by Mr. Sajid at 4 m/d for Rs.4500
Jun 25: Gave acceptance at 2m/d for Rs.2500 to Khalid Bros.
Bill Payable Journal
Date To whom paid Term Due Date L.F Amount
2012
Jun:03 Mr. Shakeel 2 m/d Aug 06 5000
Jun:12 Mr. Yousaf Mirza 3 m/d Sep 15 4000
Jun:22 Mr. Sajid 4 m/d Oct 25 4500
Jun:25 Khalid Bros 2 m/d Aug 28 2500
2.9 Cashbook
As the name implied Cashbook is used to record the cash transactions. All
cash receipts and payments are recorded in this book. It serves the purpose of
journal as well as ledger (cash) account. Since cash book is considered as book of
original entry, cash transactions are recorded in cash book and not in the journal.
Since it is also a ledger account, posting to cash account is not required. This
implies that for all the transactions recorded in cash book, only one posting is
required, unlike in case of entries recorded in journal, where two postings are
required.
The amount column in the cash book may be more than one depending
upon the needs of the organization. If the organization has only cash transactions,
cash book with single amount column on either side is maintained. This is usually
referred to as ‘simple cash book’. However, this is a remote possibility in today’s
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world, where we can think even of personal transactions purely in cash because of
security and legal considerations the transactions have to be routed through
banking system. This requires addition of one more amount column on that cash
and bank transaction may be recorded separately and simultaneously. We will
discuss Cash Book in more detail in the next unit.
2.9.1 Petty Cashbook
Normally in business payments are made through cheques but it is not
feasible to make day to day petty expenses through cheques such as conveyance
telegram, entertainment etc. These are generally repetitive in nature. If all these
payments are handled by the cashier and are recorded in the main cash book, the
procedure is found to be very cumbersome. The cashier may be overburdened and
the cash book may become very bulky. To avoid this, large organizations
normally appoint one more cashier (petty cashier) and maintain a separate cash
book to record these transactions. Such a cash book maintained by petty cashier is
called petty cash book. The petty cashier works on the imprest system. Under this
system, a definite sum, says Rs. 5,000, is given to the petty cashier at the
beginning of a certain period. This amount is called imprest money. The petty
cashier goes on making all small payments out of this imprest amount, and when
he has spent the substantial portion of the imprest amount say Rs. 4,780, he gets
reimbursement of the amount spent from the main cashier. Thus, he again has the
full imprest amount in the beginning of the next period. The reimbursement may
be made on a weekly, fortnightly or monthly basis, depending on the frequency of
small payments. In certain cases, the petty cash system is operated through the
main cash book itself. In such instances, the petty cash book is not maintained
independently. The petty cash book generally has a number of columns for the
amount on the payment side (credit) besides the first total amount column. Each
of the other amount columns is allotted for items of specific payments which are
most common. The last amount column is designated as ‘Miscellaneous’ followed
by a ‘Remarks’ column. In the miscellaneous column those payments are
recorded for which a separate column does not exist. In the remarks column the
nature of payment is recorded. At the end of the period, all amount columns are
totaled. The total amount column will show the total amount spent and to be
reimbursed. On the receipt (debit) side, there is only one amount column.
Columns for the date, voucher number and particulars are common for both
receipts and payments. The format and entries in the petty cash book are
illustrated below:

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2.9.2 Illustration No. 7
A petty cashier is paid Rs. 3,000 as imprest money on Monday, January 1,
2013. During the month his expenses were as under:
January Voucher Particulars of Payment Amount Rs.
No.
1 1. Taxi fare for manager 125
2. Courier charges for the letters 75
dispatched
3. Stationery purchased 185
4. Cartage 45
5. Refreshments 95
4 6. Courier charges 50
7. Cartage 35
8. Taxi fare 185
9. Refreshments 175
11 0. Taxi fare 150
11. Revenue stamps purchased 50
12. Cartage 45
13. Refreshments 115
18 14. Conveyance 85
15. Refreshments 125
16. Stationery 125
25 17. Taxi fare 145
18. Cartage 95
19. Courier charges 75
20. Refreshments 65
31 21. Courier charges 45
22. Refreshments 75
23. Office cleaning expenses 175

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 Petty Cash Book
Cash Date Particulars Folio V. Total Postage Traveling Refresh Misc
Stationary
Receive No. payment Expense ment
Rs. 2013 To Bank
3000 Jan 1 Account 125 125
By traveling 75 75
exp 185 185
By postage 45 45
By stationery 95 95
4 By stationery 50 50
By refreshment 35 35
By postage 185 185
By stationery 175 175
11 By traveling 150 150
By refreshment 50 50
By traveling 45 45
By 115 115
18 miscellaneous 85 85
By stationery 125 125
By refreshment 125 125
22 By traveling 145 145
By refreshment 95
By stationery 75 75 95
By traveling 65 65
31 By stationery 45 45
By postage3 75 75
By refreshment 175 175
By postage
By refreshment
By
miscellaneous
Total 2340 245 690 530 650 225
By balance c/d 660

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3. SELF ASSESSMENT QUESTIONS
3.1 Choose the best answer from the given options:
i. The book used to record all credit purchase is called:
a. Sales Journal
b. Purchase Journal
c. Cash book
d. Recording book
ii. All the transactions related to credit sale are recorded in:
a. Sales return and allowance Journal
b. Cash book
c. Sales Journal
d. Debtors’ book
iii. Subsidiary books are called books of:
a. Original entry
b. Secondary entry
c. Temporary entry
d. Basic entry
iv. The book in which transactions are recorded as they take place from
day to day in a classified manner are known as:
a. Subsidiary books
b. Voucher books
c. Recording books
d. Receipts books
v. Cash sale is recorded in:
a. Cash book
b. Sales Journal
c. Sales return and allowance Journal
d. None of the above
Answer
i. b ii. c iii. a iv. a
v. a
3.2 Give the short answers of the following questions
i. What do you know about the subsidiary books?
ii. Why the special journals are prepared?
iii. What do you know about the Petty Cash Book?
iv. Differentiate between cash book and petty cash book.
v. Describe the methods of preparing the Petty cash book.
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vi. What do you know about the imprest system of petty cash book?
vii. Define the Debit Note.
viii. Define the Credit Note.
ix. What is the difference between “Sales Journal” and the “Sales Account”?
x. What is meant by the term “Purchase Allowance”?
4. PROBLEMS
Problem 01: Record the following transactions for the invoices received for the
month of November 2012, in the Purchase Journal of Tariq & Co.
01: Purchased goods from Mr. Ali Asgher Rs.2000, invoice No.113
06: Purchased goods from Saleem Enterprises Rs.4800, invoice No.231
09: Purchased goods from Jafar Bros. Rs.1600, invoice No.31
19: Purchased goods from Mian Bros. Rs.5000, invoice No.23
26: Purchased goods from Rupali Fabrics Rs.19000, invoice No.217
29: Purchased goods from Black and White Rs.2600, invoice No.312
Problem 02: You are required to prepare Sales Journal from the following
transactions of Mr. Hameed for the month of June 2013.
05: Sold merchandise to Ms. Saima Rs.6000 vide invoice No.613
12: Sold merchandise to Ms. Shaista Rs.3000 vide invoice No.614
17: Sold merchandise to Ms. Smera Rs.1800 vide invoice No.615
21: Sold merchandise to Ms. Sadia Rs.2400 vide invoice No.616
27: Sold merchandise to Ms. Sara Rs.8000 vide invoice No.617
Problem 03: From the following credit notes received from the supplier, prepare
the Purchased Return and Allowance Journal.
Jan 09: Returned merchandise to F & Co. for Rs.1250 vide credit note No.50.
11: M & Co. agreed to grant allowance and issued a credit not No.19 for
Rs.1500
16: Credit Note No.196, received from B& Co for Rs.1050 for adjustment in
invoice
23: Returned goods to C & Co. for Rs.350 vide Credit Note No.30.
Problem 04: Enter the following transactions in the Sales Book and post them
into the Ledger
July 2013
1: Sold goods to Bashir & Sons Rs.5150/-.
10: Goods sold to Zamir & Co. Rs.7125/-.
15: Forwarded goods to Nazir Rs.1850/-.
20: Delivered the Second installment of goods to Bashir & Sons Rs.2150/-.
25: Sold goods to Nazir Rs.1575/-.
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31: Sold goods to Ahmad sons Rs.350/-
Problem 05: Enter the following transactions in Journal and in other subsidiary
books. Post there-from into Ledger.
a) Bought on credit from Mahmood and Electric Motor for Rs.800/-.
b) Sent a Credit Note for Rs.200 to Shafiq & Co.
c) Goods valued Rs.70/- were stolen away by an employee.
d) Goods worth Rs.150/- were given away as charity.
e) An Iron Safe valued Rs.250 purchased on credit from Eno & Co.
f) Returned goods to Mahmood Rs.300 being inferior in quality.
g) Sold goods to Huma & Co for Rs.1200.
h) Received a Bill from Sufi Sons for Rs.200/-.
i) Gave a Bill to Huma & Co. for Rs.1000/- payable after one month.
j) Goods returned by Huma & Co. for Rs.70/-.
k) Purchased goods from Peako & Co. for Rs.2500/-.
l) Sold goods to Farhan Brothers for Rs.1400/-.
m) Sold goods to Furqan Brothers for Rs.1500/-.
n) Purchased the following articles on credit from Munir & Co.
i) Type-writer Rs.3000
ii) Adding, listing machine 2400
iii) Wall clock 500
Problem 06: Enter the following Transactions in the appropriate Books and Post
there-from into Ledger.
1. Purchase goods from Enco. & Co. Rs.1100/-.
2. Sold goods to Tippo & Co. Rs.600/-.
3. Sold goods to A. H. Chaudhary Rs.475/-.
4. Bought goods from Khalid Rs.1300/-.
5. Bought goods from Pupoo & Co. 450/-.
6. Sold goods to Peacoo & Co. Rs.975/-.
7. Goods returned by Tippo & Co. Rs.225/-.
8. Goods returned to Pupoo & Co. Rs.175/-.
9. Returned to Peacoo & Co. Rs. 125/-.
10. Sold to Chaudhary & Co. Rs.125/-.
11. Bought office clock from Tanveer & Co. Rs.200/-.
12. Bought Type Machine from Munir Sons Rs.1400/-.
13. Bought a cycle from Shabeer Traders Rs.300/-.
14. Sold goods to Aftab & Co. Rs.130/-.
15. Sold goods to Jamil & Co. Rs.220/-.
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16. Goods returned from Aftab & Co. Rs.30/-.
Problem 07: Enter the following transactions in suitable subsidiary Books and
Post there-from into Ledger.
June 2013 Rs.
1. Sold goods to Ahmad & Co. 1000
3. Sold goods for Cash 800
6. Sold goods to Khurshid & Co. 900
8. Received Cash from Ahmad & Co. 700
15. Bought goods from Farkan 600
16. Bought goods for Cash 500
19. Paid Sundry Trade Expenses 100
21. Returned goods to Farhan 200
24. Paid into Bank 1000
25. Paid Sundry Trade Expenses 50
26. Paid Office Rent 600
27. Paid Cash for Stationery 20
28. Received a Cheque and deposited into Bank 500
29. Paid Electric Bill 60
30. Paid Salary to Staff 1200
Problem 08: Enter the following transactions in suitable Books and Post there-
from into Ledger.
June, 2013
1. Jamshed Mirza started business with Cash Rs.25000/-.
1. He opened his bank account with Rs.15500/-.
2. Bought goods for cash Rs.1200/-.
3. Purchased office furniture and paid the same by Cheque Rs.1200/-.
4. Sold to Rashid Rs.500/-.
7. Cash Sales Rs.1900/-.
12. Purchased goods from Mahmood Rs.4500/-.
12. Carriage paid on above Rs.60/-.
14. Sold goods to Karim Rs.1000/-.
16. Goods worth Rs.100 were given away as charity.
19. Received cash from Rashid Rs.300/-.
21. Paid to Mahmood Rs.2500 by Cheque, discount received Rs.10/-.
23. Purchases goods worth Rs.6500 subject to 5% Trade Discount.
27. Drew from Bank for personal use Rs.500/-.
30. Paid Salaries by Cheque Rs.700/-.
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30. Paid Sundry expenses in cash Rs.55/-.
Problem 09: Record the following transactions of Mr. Yahya in the Bills
Receivable Journal
2012.
Dec 03: Received an acceptance from Mr. Jalal at 3 m/d for Rs.6000
Dec 08: Drew a bill on Mr. Jafar at 2 m/d for Rs.5500 that was duly accepted.
Dec 11: Bill at 4 m/d was drawn on Mr. Kashif for Rs.3600 was accepted
Dec 18: Mr. Idnan gave his acceptance at 3 m/d for Rs.4400.
Dec 22: Mr. Gulam Abbas returned the bill after acceptance at 2 m/d for
Rs.2400
Dec 29: Acceptance received from Mr. Zia at 3 m/d for a bill Rs.4400
Problem 10: Record the following transactions in the appropriate book of M/s
Jafar Bros.
2013.
Jul 01: Accepted a bill at 3 m/d for Rs.12000 drawn by Mr. Kamran
Jul 09: A bill drawn by Mr. Majid at 2 m/d for Rs.2500 was duly accepted.
Jul 16: Acceptance at 30 days for Rs.4200 given to Sher Ali
Jul 29: Accepted a bill drawn by Mr. Khalid at 4 months for Rs.3600
Problem 11: What is Petty Cash Book? Why it is prepared? Discuss this with
special reference of “Imprest System”.
Problem 12: Record the following transactions into Petty Cash Book for the
month of February 2013. Usually cash month is started with Rs.200 in the hands
of petty cash Incharge.
2013
February 1 Postage Rs.6.50, Telegram Rs.3.50.
3 Stationery Rs.5.50, Paper Weight Rs.4.00.
4 Ink Pot Rs.1.00, Tonga hire Rs.2.00.
6 Coolie wages Rs.3.50, Railway freight Rs.8.00.
8 Soap Rs.1.50, Towel Rs.2.50, Comb Rs.1.00.
9 Postage Rs.2.50, Printing Rs.3.00.
10 Telegram Rs.7.00, Telephone Call Rs.2.50.
11 Cartage Rs.10.00, Cleaning Rs.5.00.
13 Stationery Rs.3.70.
14 Table glass Rs.10.00, Table Diary Rs.5.00.
15 Waste Basket Rs.3.00, Table tray 6.00.
18 Taxi charges Rs.6.00.
20 Gum Rs.0.40, Common pins Rs.4.00.
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 23 Red pencils Rs.1.00, Paper clips Rs.2.00.
25 Paper cutter Rs.2.00, Red ink Rs.1.00.
26 Cartage Rs.3.50, Carriage Rs.4.40.
27 Telegram Rs.3.00, Tonga hires Rs.2.00.
28 Printing Rs.10.00, Postage Rs.5.00.
28 Sweeper, pay Rs.30.00.
28 Chowkidar pay Rs.30.00
Problem 13: Enter the following transactions in an Analytical Petty Cash Book
maintained under the Imprest System for the month of January 2014.
Rs.
January 1 Cashier received an Imprest Cash of : 50.00
Paid postage stamps 1.50
Paid travelling expenses 3.25
Paid for stationery 2.75
5 Paid postage stamps 1.25
Paid for stationery 1.75
10 Paid office expenses 4.75
Paid for purchasing new lock 2.25
15 Paid for stationery 1.50
25 Paid office expenses 2.75
Paid traveling expenses 1.25
5. SUMMARY
Special journals are accounting records or devices designed to record a
specific type of transaction in a highly efficient manner. Because special journals
are used only to record a specific type of transaction, the journal may be located at
the transaction site and maintained by employees other than accounting personnel.
Thus special journals reduce the time, effort, and cost of recording routine
business transactions. Various types of special journals are in use. Each
organization uses the special journals according to their needs. The mostly used
special journals are Purchase journal, Purchase Return and Allowance Journal,
Sales journal, Sales Return and Allowance Journal, Bills Receivable Journal and
Bills Payable Journal, Cash book, Petty Cash Book, The balances of these
specialized journals are calculated normally at month end and balance is posted to
the ledger. But the accounts debited or credited in specialized journals are posted
to the relevant accounts on perpetual basis.

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BIBLIOGRAPHY
Ahmad, M. M., Khan, S. A., Arshad, M., & Shah, S. M. (2013). Advanced
Financial Accounting. Islamabad: National Book Foundation Islamabad.
Dupree, D., & Marder, M. (1984). Principles of Accounting. Addison-Wesley.
Farooq, U., & Amir, S. M. (2008). Principles of Accounting. Islamabad: Allama
Iqbal Open University.
Hussain, K., Buttar, Z. U., Pirach, M. A., & Chaudhry, M. I. (1996). Accounting
Principles. Lahore: Orient Publishers Urdu Bazaar Lahore.
Mukherjee, A., & Hanif, M. (2003). Modern Accountancy I. Tata McGraw-Hill
Education.
Randall, H. (2005). Accounting. Cambridge University Press.
Wood, F., & Sangster, A. (2008). Business Accounting I. Pearson Education.

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131
Unit–5

BANKING TRANSACTIONS,
CASH-BOOK AND BANK
RECONCILIATION STATEMENT

Written by: Sohail Amjed

Reviewed by: Muhammad Munir Ahmad
Asia Batool

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 CONTENTS
INTRODUCTION
OBJECTIVES
1. BANKING TRANSACTIONS
1.1 Introduction of Banking Transactions
1.2 The Advantages of Transaction with the Bank
1.3 The Way of Transactions with the Bank
1.4 Important documents of Bank
1.4.1 Pay-in-Slip Book
1.4.2 Cheque-Book
1.4.3 Bank Statement
1.5 Journal Entries of Banking Transactions
2. CASH-BOOK AND ITS TYPES
2.1 Single Column Cash-Book
2.1.1 Format of Cash-Book
2.2 Double Column Cash-Book
2.2.1 Format of Cash-Book
2.3 Three Column Cash-Book
2.3.1 Contra Entries
2.3.2 Format of Cash-Book
3. BANK RECONCILIATION STATEMENT
3.1 Reasons of Disagreement
3.2 Explanation of some of the Items that Cause a Difference
3.2.1 Un-presented (Cheques Issued but not Presented)
3.2.2 Un-credited Cheques (Cheques Deposited but not Yet Collected)
3.2.3 Bank charges not Entered in the Cash-Book
3.2.4 Interest Credited by Bank not Entered in the Cash-Book
3.2.5 Amount Directly Deposited into Bank by Debtors
3.2.6 Credit Transfer
3.2.7 Standing Order
3.2.8 Direct Debit
3.3 Preparation of Bank Reconciliation Statement
3.3.1 Starting with Cash-Book Balance
4. SELF ASSESSMENT QUESTIONS
4.1 Choose the best Answer from the Given Options
4.2 Give the Short Answers of the Following Questions
4. PROBLEMS
5. SUMMARY
REFERENCES/BIBLIOGRAPHY
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INTRODUCTION
Banks provide many valuable services to the business enterprises.
Execution of transaction through banks is not only efficient but also deemed
secure. In this unit the Banking transactions are described and illustrated. Various
types of cash-book are explained with suitable examples. Finally, the most
important, the method preparation of Bank Reconciliation Statement is explained
in this unit. At the end of the unit, self-assessment questions and various problems
are given for the better understanding of the topics covered in this unit.

OBJECTIVES
After studying this unit, you will be able to:
1. Understand the significance of transactions with and through the bank.
2. Learn the procedure of the banking transactions.
3. Recording of the banking transactions.
4. Know the need and importance of the cash-book.
5. Record the transactions in the cash-book.
6. Explain the meaning and need of bank reconciliation.
7. Prepare the bank Reconciliation Statement.

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1. BANKING TRANSACTIONS
1.1 Introduction of Banking Transactions
The services of the banks for business have got greater importance as the
business activities grown complex. All the business units weather small or large
use the services of banks for efficient execution of the business transactions and
efficient use of business resources.
Mostly the receipts and payments of business are made through the bank.
Businessman deposits their excess cash into the bank and withdraws when needed
from bank by cheque or ATM (Automatic Teller Machine). In case of need, the
bank also grant him overdraft facility by which he can withdraw more than his
deposits.
1.2 The Advantages of Transaction with the Bank
A bank is a financial institution that receives deposits, lends money, makes
collections and renders a variety of other valuable services, such as providing
vaults for the safe-keeping of valuables, handling trust funds and buying and
selling securities and insurance for its customers. The following are the few
advantages of transactions with the banks.
 In bank the cash and other valuables are safer than office
 Businessman need not to count and carry cash for large payments rather
payments of millions of rupees are made without any inconvenience.
 Fund transfer is easier
 In case of need bank offer overdraft facility to its credit worthy customers
 Bank facilitates business decisions and provides required financing.
 The internal control over the cash becomes easy.
1.3 The Way of Transactions with the Bank
To open an account with the bank, it is necessary to obtain the approval of
an official of the bank to make an initial deposit. Cheque, bank drafts, money
orders and other cash items usually are accepted for deposit, subject to their
verification as to amount and validity.
Banks usually require new depositors to sign their names on a card or form
as an aid in verifying the depositor’s signatures on the cheques that may be
issued, on cash items that may be indorsed for deposit and on other business
papers that may be presented to the bank. The form a depositor signs to give the
bank a sample signature is called a signature card. If desired, depositors may
authorize others to sign cheques and other business forms on their behalf.

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1.4 Important Documents of Bank
Normally the bank does not make a new person his customer until an
existing customer does not introduce him. In this way the bank verify the
particulars of the potential customer. The bank provides the three booklets to the
customer.
 Pay-in-slip Book
 Cheque-Book
 Bank Statement
1.4.1 Pay-in-slip book
To make deposit with a bank it is necessary to use certain forms prescribed
by that bank. A printed form with a detailed listing of items being deposited is
called pay-in-slip. Banks provides these forms to depositors free of cost. This
book contains ten, fifty or hundred leaves or forms.
When the businessman has to deposit the cash in the bank account, he has to
fill the required columns of this form. Normally the information required to fill in
is the date of deposit, amount the account number, name and signatures of the
depositor. This form is deposited along with cash on the cash counter to the
cashier. The cashier after counting cash returned the duly signed and stamped
smaller part of this form. This serves as the voucher for this transaction.
1.4.2 Cheque Book
A piece of commercial paper drawn on funds in a bank account and payable
on demand is called cheque. Cheque involves three parties (1) the drawer who
order the bank to pay certain amount of money (2) the bank which the drawer has
a deposit (3) the person directed to receive the money known as the payee.
Cheques provided to customers are usually bound in the form of a book i.e. called
a cheque-book. The account number of the customer is printed on all the cheques
contained in the cheque-book.
To the left of each cheque is a small form called counter-folio that contains
space to record all relevant information about the cheque. The information
contained in the counter-folio includes the cheque number, date, payee, amount
along with the bank balance before the cheque was issued, current deposit if any
and the resulting balance after issuing the cheque.
When the businessman wants to withdraw some cash from his account, he
fills in particulars in cheque and counter folio properly. Counter folio is kept for
the record and cheque is presented to the bank for payment. The bank makes
payments after verification of the particulars of the cheque. For the encashment of
cheque, it is necessary that all particulars provided in the cheque are correct.
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1.4.3 Bank Statement
A statement of account issued to each depositor at least once a year by a
bank. Bank statement reflects the details of the transactions recorded in the
account of the customer by bank. Customer’s account is usually maintained in the
form of a personal account same like a businessman maintain the account of a
debtor or creditor in his ledger. Bank statement is the copy of the ledger account
of the customer maintained by the bank. The bank periodical sends this
statement to his customer but in case of need, the customer may also demand
bank statement anytime normally at the end of each month.
1.5 Journal Entries of Banking Transactions
The businessman records banking transactions in the following manners in
his books.
a. When businessman deposits the cash into the bank account
Date Particulars L.F Debit Credit
Bank A/c 25000
To Cash A/c 25000
Opened bank account with MCB
Acc.No.2779-9
b. When the Cash is drawn from the bank for business use:
Date Particulars L.F Debit Credit
Cash 10000
To Bank A/c 10000
Withdraw Cash from the bank for office
Use.
c. When the Cash is drawn from the bank for personal use by the
businessman
Date Particulars L.F Debit Credit
Drawings A/c 5000
To Bank A/c 5000
Withdraw Cash from the bank for
personal use
d. When businessman make payment to any creditor by cheque
Date Particulars L.F Debit Credit
Personal A/c of Creditor 10000
To Bank A/c 10000
Payment made to creditor by cheque
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e. When the bank paid any expenses on behalf of customer
(Standing order)
Date Particulars L.F Debit Credit
Insurance Premium A/c 2000
To Bank A/c 2000
Bank paid amount of insurance premium
on instruction.
f. When the businessman receives the cheque from a debtor and deposits
the cheque into the bank account on the same day.
Date Particulars L.F Debit Credit
To Bank A/c 10000
To Personal A/c of Debtor 10000
Cheque received from debtor and
deposited into bank on the same day
g. When the businessman receives the cheque from any debtor but do not
deposit this on the same day into the bank. This cheque is treated as cash.
Date Particulars L.F Debit Credit
To Cash A/c 10000
To Personal A/c of Creditor 10000
Cheque received from debtor but not
deposited into bank
h. When the bank receive collection charges or any other charges for his
services.
Date Particulars L.F Debit Credit
Bank Charges A/c 10000
To Bank A/c 10000
Amount Charged by bank as Bank
Charges
i. When deposited cheque into the bank get dishonored (bank refuse to
make payment for any reason) the entry will be
Date Particulars L.F Debit Credit
Debtors Personal A/c 10000
To Bank A/c 10000
To record the dishonored of Cheque

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j. When the bank charges interest on overdraft.
Date Particulars L.F Debit Credit
Interest Account A/c 10000
To Bank A/c 10000
Amount Charged by bank as Interest
expenses
k. When the bank gives interest on deposit to customer
Date Particulars L.F Debit Credit
Bank A/c 10000
To Interest Revenue A/c 10000
To Record the collection of interest on
deposit from bank
2. CASHBOOK AND ITS TYPES
As we have discussed in the previous unit that for most frequently occurred
transactions, special journals are used. Cashbook is the most important accounting
book that is composed of especially for cash receipts and disbursements.
Cashbook serves the dual function it is the book of primary entry but its format
and information contained in it are ready to use for reference like a ledger
account. The transactions are recorded in the cashbook same day they take place.
It is balanced periodically and balance is posted to the ledger accounts
accordingly.
There are three types of cashbooks mostly used in the business.
 Single column cashbook (For recording cash transactions only)
 Two/Double column cashbook (For recording cash and discount
transactions)
 Three/Treble column cashbook (For recording cash discount and bank
transactions)
2.1 Single Column Cashbook
All cash transactions are recorded in the cashbook in chronological order.
Each page of cashbook is divided in two equal vertical parts. The receipts are
recorded on the left hand side that is called the debit side and disbursements are
recorded on the right hand side that is called credit side. In a simple cashbook
single column is provided on both receipt and payment sides for amount.

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2.1.1 Format of Cashbook
Following is the mostly used format of single column cashbook.
Dr. Cashbook Cr.
Date Particulars V.N L.F Amount Date Particulars V.N L.F Amount

The transactions recorded in the cashbook are posted into the relevant ledger accounts
also.
As you have seen that there are two sides of the cashbook with similar
columns on both sides. The recording procedures are explained with the help of
following illustration.
Illustration No. 1
From the following transactions write up single column Cashbook for the
month of January 2012.
01: Cash in hand Rs.1275
05: Paid to Rustam Bros. Rs.400
07: Purchased goods for cash Rs.150
10: Received from Hameed & Co. Rs.700
15: Cash sales Rs.500
17: Paid Saleem Trading & Co. Rs.300
20: Received from Rahim Rs.1400
24: Paid wages Rs.70 and Carriage Rs.25
28: Bought machinery for cash Rs.1500
31: Paid rent Rs.150
Dr. Cashbook Cr
Date Particulars V.N L.F Amount Date Particulars V.N L.F Amount
2012 2012
Jan 1 To Balance b/d 1275 Jan 5 By Rustam Bros 400
10 To Hameed & 700 7 By Purchases 150
15 Co 500 17 By Saleem Trading 300
20 To Sales 1400 24 Co 70
To Rahim 24 By Wages 25
28 By Carriage 1500
31 By Machinery 150
By Rent 1280
By Balance c/d
TOTAL 3875 TOTAL 3875
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2.2 Double Column Cashbook
Two-column or Double Column cashbook is simply extension of the single
column cashbook, it is used by the business units where sale and purchases are
made on credit basis. When a business unit sold goods on credit and the creditor
makes payment before due date, a concession is granted for this early payment.
This concession is called cash discount. It is provided on the total amount due. It
is normally some percentage of the principal amount. Similarly when the firm
makes payments before the due date the debtors may also grant cash discount. To
record the cash discount an additional column is provided in the cashbook on both
sides.
Cash column represents Cash Account of the ledger, no separate account for
cash is opened in the ledger but in respect of discount column, the Cashbook
continues to be just a book of original entry. At the end of a specific period, usually a
month, the aggregate of the debit side of the discount column of the Cashbook is
posted to the discount allowed account in the ledger. Similarly the aggregate of the
credit side of the discount column of the cashbook is posted to the credit side of the
Discount Received Account, maintained in the ledger.
2.2.1 Format of Cashbook
Following is the mostly used format of Double column cashbook.
Dr. Cashbook
Cr.
Date Particulars V.N L.F Disc Amount Date Particulars V.N L.F Disc Amount

Illustration No. 2
Mr. X sold goods to Mr. Y for Rs.10000 on credit term 2-10/n-60.
Mr. X sold goods on account to Mr. Y for Rs.10000 that is subject to 2% of cash
discount if payment is made within ten days otherwise Mr. Y will have to pay full
amount within thirty days. If Y will make payment within ten days, he will have
to pay, Rs.9800 cash for the full payment of Rs.10000. In the cashbook of Mr. X
Rs.9800 will be recorded in the debit side of the cashbook, Rs.200 will be
recorded on the debit side because it is an expense of X. While in the books of Y
cash payment will be recorded on the credit side and the discount will also be
recorded on the credit side because it is an income for Y.

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Solution
Books of Mr. X
Dr. Cashbook Cr
Date Particulars V.N L.F Disc Amount Date Particulars V.N L.F Disc Amount
Mr. Y A/cc 200 9800

Books of Mr. Y
Dr. Cashbook Cr
Date Particulars V.N L.F Disc Amount Date Particulars V.N L.F Disc Amount
Mr. X A/cc 200 9800

Illustration No. 3
From the following transactions draw up Two Column Cashbook in the
books of a trader for the month of December 2013:
01. Cash in hand Rs.12750
05. Paid to Rustom Bros. Rs.3950; discount received Rs.50
10. Purchased good for Rs.1500
15. Received from Hameed Co, Rs.6900; discount allowed Rs.100
17. Cash sale of Rs.5000
20. Paid to Saleem Bros. Rs.3000
24. Cash received from Rahim Rs.13890 discount allowed Rs.110
28. Paid wages Rs.700 and Carriage Rs.1500
29. Bought machinery for Cash Rs.1500
30. Paid rent for the month Rs.2000
Solution
Receipts (Dr) Cashbook Payments (Cr)
Discount Amount Discount Amount
Date Particulars L.F Date Particulars L.F
Rs. Rs Rs. Rs.
2013 2013
Dec.1 To Balance 12750 Dec.5 By Rustom 50 3950
15 b/d 100 6900 10 Bros. 1500
17 To Hameed 5000 20 By Purchases 3000
24 Co 110 13890 28 By Saleem 700
To Sales 28 Bros 1500
To Rahim 29 By Wages 1500
30 By Carriage 2000
By 24390
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 Machinery
By Rent
By Balance
c/d
Total 210 38540 Total 50 38540
2.3 Three Column Cashbook
Now a day’s mostly receipts and payments are made through bank, to
record these transactions a bank column is maintained in the cashbook. This type
of cashbook is called three columns cashbook because it represents three account
viz. cash, discount and bank separately. The bank account maintained by the
enterprise is a personal account. For recording transactions in the Bank Column of
the Cashbook, the rule of debit and credit is applicable to the personal account
should be followed, for instance receiver-debit and giver-credit. Thus for cash
deposited into bank, the bank would be receiver and would be debited in the Bank
Column of the Cashbook. Similarly for cash withdrawn from the bank, the bank
would be provider and would be credited in the Bank Column of Cashbook.
Rather than keeping three accounts apart from each other, the Three
Column Cashbook enables us to keep these accounts side by side. This is more
convenient and we can quickly see how much cash and bank balance we have
altogether. It is important to note that Cash and bank accounts are balanced and
posted to the ledger accounts if maintained in the ledger but discount columns are
separately totaled and the aggregate amounts are transferred to separate ledger
accounts as mentioned earlier.
2.3.1 Contra Entries
In an account you can only have one-half of entry. An account cannot receive
and give both at the same time; but in the three column cashbook we have two
accounts the Cash account and bank account, (discount is not treated an account
because it is not balanced rather debit and credit columns are simply aggregated) it
is possible to have both a debit entry and a credit entry at the same time.
Those entries which are recorded on the both sides of the cashbook are
known as contra entries. Both the cash and bank accounts are involved in this type
of transactions. So, in recording such types of transactions the letter “C” is written
in ‘L.F’ column, to highlight the contra entry.
Contra entries are a very important part of the three columns Cashbook: they
occur because there are two accounts side by side and it is quite untrue to say as
thoughtless students often do that the cashbook is the only account that can have a

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debit entry and a credit entry on it at the same time. The cashbook is not an account
rather it is two accounts laid side by side for the greater convenience of the cashier.
2.3.2 Format of Cashbook
Following is the mostly used format of three column cashbook.
Date Particulars V.N LF Disc Cash Bank Date Particulars V.N LF Disc Cash Bank

TOTAL TOTAL

Illustration No. 4
From the following particulars prepare a three column cashbook of Humza
Ahmed for the month of January 2013.
1. Balance of cash Rs.4000, Credit balance of bank (overdraft) Rs.10000.
2. Received for cash sales Rs.6000
3. Deposited a cheque for Rs.1500 received from Idnan and allowed him
discount Rs.100.
5. Mr. Iqbal settled his account by cheque of Rs.1800 after a discount of
Rs.300 was allowed.
10. Paid to Mr. Zia by cheque of Rs.1250 and received a discount of Rs.50.
17. Paid cheques into bank received earlier for Rs.3000.
18. Paid wages by cash Rs.1100.
25. Drew cash Rs.100 for personal use by proprietor
30. Drew from bank Rs.400 for office use.
Dr. Cashbook Cr.
Date Particulars V.N LF Disc Cash Bank Date Particulars V.N LF Disc Cash Bank

2013 2013
Jan1 To Balance 4000 Jan1 By Balance b/f 10000
2 b/f 6000 10 By Zia A/c 50 1250
3 To Sales A/c 100 1500 17 By Bank C 3000
5 To Idnan A/c 300 1500 18 By Wages 1100
17 To Iqbal A/c C 3000 25 By Drawings C 100
30 To Cash C 400
To Bank 5350 By balance c/d 6300
To balance c/d
TOTAL 400 10400 11350 TOTAL 50 10400 11350

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3. BANK RECONCILIATION STATEMENT
As we have discussed in the three column cashbook that we keep our bank
account in the Cashbook. It is updated every day, and we debit in account all
cheques deposited in bank and credit from the account all cheque paid. We shall
also have several contra entries every month, recording cash taking paid in or cash
drawn out when required for office use. We therefore, have in our cashbook a
bank balance (balance as per the cashbook).
The bankers also keep a record of customer’s account in its ledger, and they
also enter into our account everyday what is paid in and what is drawn out. The
book in which accounts of customers are kept is called a passbook. At the end of
any day they can tell us our bank balance by a statement of our account that is
called bank statement (balance as per the bank statement).
Bank reconciliation simply means comparing the account balance entered in
the cashbook with the balance appearing in the bank's records (passbook), and
being able to explain any discrepancy. Any difference in balances is often due to a
delay from when the transaction is entered in to the cashbook and when that
transaction is recorded in the bank’s books, e.g., outstanding cheques, collection
of service charges and interest payments.
3.1 Reasons of Disagreement
By principle cashbook and pass book balances should be equal and opposite
(because bank account is an asset for customer while customer account is liability
for the bank) on a stated date. But usually these two balances do not agree. There
are three main reasons for the disagreement of both the balances i.e. the balance
of cashbook and the balance as per bank statement or passbook.
a. Lack of Knowledge; One party may lack knowledge of the action
performed by the other. For some transactions, the bank may know earlier
and it adjusts its records before the business. Some difference may arise
from the banks actions that have not been intimated to the customer. For
example interest credited by the bank or the bank charges debited by the
bank. The customer comes to know of these transactions only when he
receives the Bank Statement or debit or credit memorandums.
b. Timing Gape; There is always an unavoidable delay between one party
doing something and the other party knowing about it. For example, when a
cheque is issued to a party by customer, it is recorded immediately in the
customer’s book, but the bank will record it only when it will make
payment against that cheque. Similarly, when a cheque is deposited it is

145
 recorded in the Cashbook immediately, but the bank will record it only
when it collects money in respect of that cheque.
c. Error; Some difference in balance may arise due to errors committed by
bank or by the person responsible for preparing the Cashbook. For the first
two reasons, discussed above, neither of the parties is wrong nor would it be
a mistake to correct them. But for the present reason, the books are to be
properly rectified.
3.2 Explanation of some of the Items that Cause a Difference
3.2.1 Un-presented (Cheques issued but not presented)
When a cheque is issued to someone for payment it is immediately credited
in the cashbook this has the effect of reducing the bank balance, in case of
overdraft it will increase the unfavourable balance. The person to whom the
cheque is issued may not present the cheque to the bank for payment immediately,
the bank debits the cheque in the customer’s account only when the cheque is
presented and paid for. So long as it is not presented, the balance shown in the
pass book will be different from the Cashbook.
For Example; Mr. F has an opening debit balance of Rs.10000 it means the
customer has Rs.10000 in his account, If Mr. F issued a cheque of Rs.5000 to Mr.
G. he will immediately credit the bank account in the cashbook. The balance on
hand right after this transaction will be Rs.5000.
3.2.2 Un-credited Cheques (Cheques deposited but not yet collected)
Whenever a person receives cheque from a third person and deposits it into
the bank, he debits Bank Account and credits the account of the person from
whom the cheque has been received immediately. The bank, however takes some
time in collecting the cheque; and it would credit the customer’s account only
when the amount has been realized. Until the cheque has been collected, the
balance appearing in the Pass Book would be less than the balance appearing in
the Bank Account or Cashbook.
For Example; Opening favourable balance as per the Cashbook and Pass Book
was Rs.2000. a cheque was received from P for Rs.500 and deposited into the
Bank.
If the bank fails to collect the cheque during this period, it would not credit
the customer’s account with Rs.500. So, the balance as per the Bank Statement
would show Rs.500 less than the balance as per the Cashbook.
3.2.3 Bank Charges not Entered in the Cashbook:
The bank charges some amount from each customer by way of incidental
charges, collection charges, and the like and debits his account for this reason
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from time to time. As soon as these charges are made, the bank debits the
customer’s account in its own books and this reduces the bank balance. But the
customer learns about these charges only, when he receives the Bank Statement or
Debit Memorandum, and then he credits Bank Account in his own books. Until
then, the bank balance as per the Pass Book would be less than the bank balance
as per the Cashbook or Bank Account.
For Example; opening favourable balance as per the Cashbook and Pass Book
was Rs.2000. The bank has charged Rs.50 as bank charges. The Pass Book
balance has decreased from Rs.2000 to Rs.1950, whereas the Cashbook balance
remained unchanged.
3.2.4 Interest Credited by Bank not Entered in the Cashbook:
When the bank allows interest to a customer, it credits the customer’s
account and his bank balance would increase. But the customer comes to know
about it only at the end of the month, and then he would pass an appropriate entry.
Until then, the bank balance as per the Pass Book would be more than the balance
as per the Cashbook or Bank Account.
For Example; opening favourable balance per the Cashbook and Pass Book was
Rs.2000.The balance of the Pass Book/Bank Statement has increased from
Rs.2000 to Rs.2100 whereas the Cashbook balance has remained at Rs.2000.
3.2.5 Amount Directly Deposited into Bank by Debtors:
When any amount is directly deposited by a debtor into the Bank Account
of the customer, the bank would credit the depositor’s account immediately but
the customer would know about it only after receiving advice from his bank. Until
then, the bank balance, as per the Passbook would show more than the balance as
per the Cashbook.
For Example; opening favourable balance as per the Cashbook and Pass Book
was Rs.2000. Mr. B, a debtor, has deposited Rs.500 directly into the bank but is
yet to receive any information from the bank. The balance of the Pass Book/Bank
Statement has increased from Rs.2000 to Rs.2500, whereas the Cashbook balance
has remained at Rs.2000.
3.2.6 Credit Transfer:
A business may receive into its bank account revenue from a variety of
sources without direct knowledge of those. He may receive regular payments such
as rent from property owned or dividends or interest from investments. When the
bank collects dividends, it would credit the customer’s account and his bank
balance will increase. But the customer would know about it only after receiving

147
advice from the bank. Until then, the bank balance as per the Pass Book would be
more than the balance as per the Cashbook.
For Example; opening favourable balance as per the Cashbook and Pass Book
was Rs.2000. The bank has collected a dividend of Rs.1000 but nothing has been
intimated by bank in this respect to the customer. The balance of the Pass
Book/Bank Statement has increased from Rs.2000 to Rs.3000, whereas the
Cashbook balance has remained at Rs.2000.
3.2.7 Standing Order
A standing order is an instruction to a bank by a customer to make a fixed
payment regularly on stated days to some third party. When a business unit
requires making regular payments for an item like salaries, the business unit may
save itself the trouble or remembering to write several cheques and hand these
over to the employees each month by making a standing order at the bank to pay
salaries to its employees. The bank will then automatically pay the employees the
same amount of money each month until further notice is received from the
business unit. Since the business unit does not prepare cheques for its employees
each month, these will be unrecorded in the cashbook. When the business unit
receives the bank statement, it will check that salaries have been paid in
accordance with standing orders and then make the necessary double entries in the
ledger. The regular payment made by the bank may be monthly, quarterly,
annually or at any convenient interval.
3.2.8 Direct Debit
Direct debit is an instruction given to a bank by its customer to allow
charges to be made periodically to the account at the instance of some third party.
Therefore, a direct debit is also a standing order with the exception that the
receiver can alter the date or the amount of payment. Direct debits are used where
the date and the amount of the payment due vary from one period to the next, for
example, electricity or telephone bills. A business unit gives authority to the
recipient of the payment to change the date or the amount paid. In this way, the
business unit serves the trouble of frequently altering the amount payable on a
standing order. A bank generally accepts direct debit instructions only in respect
of approved third parties. The banker also undertakes to identify the customer if
the facility is improperly used.
Payment through standing order / direct debit will lead to difference
between the balance as per Cashbook and Pass Book. For example, when the bank
pays insurance premium on behalf of its customer will know about it only after

148
receiving advice from the bank. Until then, the bank balance as per the Pass Book
would be more than the balance as per the Cashbook.
For Example; opening favourable balance per the Cashbook and Pass Book was
Rs.2000. The bank has paid insurance premium of Rs.500 as per standing order
but nothing has been intimated by the Bank in this respect. The balance of the
Pass Book/Bank Statement has increased from Rs.2000 to Rs.3000, whereas the
Cashbook balance has remained at Rs.2000.
The idea of bank reconciliation statement is to discover these types of
differences. It is important to note that bank reconciliation statement is not a
rectification tool rather it is a gage to measure the accuracy of the records of both
banker and the customer.
3.3 Need and Significance of Bank Reconciliation Statement
As you have leaned that Bank Statement balance may not agree with the
balance in the Cashbook due to the above mentioned reasons. Hence, a bank
reconciliation statement needs to be drawn up to reconcile the difference in the
balance between the Bank Statement and the Cashbook.
Bank reconciliation statement is an important tool of internal control for
management. It provides the opportunity to detect and prevent any fraud and
mistake in the accounting records. It helps to judge the true balance of the bank
account at a particular day. It also helps to detect the delayed payments by the
debtors.
3.4 Preparation of Bank Reconciliation Statement
Bank Reconciliation statement is prepared in one of the following two
ways:
3.4.1 Starting with Cashbook Balance:
Consider the following information from Mr. F‘s Cashbook and the Bank
statement. For simplicity, we have shown the names of the persons instead of
cheque numbers in the bank statement.
Dr. Cashbook (Bank Column Only) Cr.
Date Particulars Amount Date Particulars Amount
Feb 1 To Balance 22500 Feb 2 By G’s A/cc 4760
10 To A’ A/cc 5075 14 By H’ s A/cc 2850
17 To B’ A/cc 6262 19 By I’ s A/cc 3670
28 To C’ A/cc 7350 By Balance c/d 29907

41187 41187

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Bank Statement
F’s account with National Bank Limited
Date Details Debit Credit Dr/Cr Balance
Feb Balance b/f Cr 22500
1 Mr. G 4760 Cr 17740
2 Mr. A 5075 Cr 22815
12 Mr. H 2850 Cr 19965
16 Bank Charges 525 Cr 19440
16 Mr. B 6262 Cr 25702
17 United Bank Limited (bonds) 1258 Cr 26960
28
Hence the two books are the two views of the same account but as we saw
that the balances are not same. It is because of three reasons we have studied
earlier now we will look into detail that how we can reconcile them.
After comparison of the two we found the following facts:
a. The balances do not agree according to the Cashbook, it has debit balance
of Rs.29907 while according to the bank records (Bank Statement) it has
Credit Balance of Rs.26960
b. The cheque paid to “I” on 19th February, has not been presented by “I” for
payment.
c. The cheque of “C” deposited in the bank has not been credited by bank.
d. The bank has charged Rs.525 as Bank Charges, Mr. F did not know about
this deduction from his funds, but now he does know he should clearly put
it right by deducting it from his Cashbook.
e. The bank has collected Rs.1258 interest from the UBL on behalf of Mr. F.
he again did not know so he could not record it.
“d” and “e” points are examples of lack of knowledge existing between
Mr. F and his banker. Mr. F did not know that the bank had taken away, nor
received on his behalf, these moneys. “b” and “c” points are examples of timing
difference.
In examination you are asked to reconcile the two balances using all the
items that are outstanding, but in business the following is the procedure;
a. Compare the two accounts and note all the items of disagreement, as we
have done in the above example.
b. Adjust all the items that can be put right in the Cashbook- items which are
only wrong because of our lack of knowledge of what the banker have
done.
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c. Reconcile the rest in a reasonable statement, starting with one balance and
finishing with other.
d. If we cannot reconcile them, there must be some mistake, either on our part
or on the bank’s part. Carefully scrutinize every figure.
Our calculations now look like this.
Dr. Revised Cashbook (Bank Column Only) Cr
Particulars Amount Date Particulars Amount
Date
Feb To Balance 22500 Feb 2 By G’s A/cc 4760
1 To A’ A/cc 5075 14 By H’ s A/cc 2850
10 To B’ A/cc 6262 16 By Bank Charges 525
17 To C’ A/cc 7350 19 By I’ s A/cc 3670
28 To Interest 1258 By Balance c/d 30640
28
42445 42445
Bank Reconciliation Statement
As at February 28th
Adjusted balance as per Cashbook (Dr.) Rs. 30640
Add back the cheque not yet presented 3670
(Because the bank has not yet been asked for payment) 34310
Less Un-Cleared Cheques
Balance as per Bank Statement (Cr) 26960
Illustration No. 5
The cashbook of Mr. Tahir only (bank column) is given below for the
month of July 2013.
Rs. Rs.
Balance b/d 8442 Payments 93120
Remits 90438 Balance c/d 5760
98880 98880
On comparing the Cashbook with the Bank Statement the following
discrepancies were noted:
a) Bank charges of Rs.2100/- shown on the Bank Statement have not been
recorded in the Cashbook.
b) A cheque from Mr. Umer for Rs.1080/- has been returned dishonoured by
the bank but not written back in the Cashbook.
c) Three cheques issued to the suppliers for Rs.12840/-, Rs.22200/- and
Rs.1800/- have not yet been presented to the bank.
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d) A pay-in-slip of the month of July, showing a deposit of Rs.92520/- has not
yet been credited by the bank.
e) Cheques amounting Rs.24000/- were deposited but not yet credited by
bank.
f) Dividend Rs.1200/- collected and credited by bank was not recorded in the
Cashbook.
Required: 1) Revise the Cashbook for the month of July 2013.
2) Prepare a Bank Reconciliation Statement as on 31-07-2013.
Solution
Dr. Revised Cashbook Cr.
Date Particulars L.F Amount Date Particulars L.F Amount
Balance b/d 8442 Payments 93120
Remits 90438 a) Bank charges 2100
f) Dividend 1200 b) Mr. Umer 1080
Balance c/d 3780
Total 100080 100080

Mr. Tahir
Bank Reconciliation Statement
For the month of July 2013.
Adjusted balance as per Cashbook (Adjusted) Dr. Rs. 3780
Add: Uncredited Cheques 24000
Uncredited Deposits 92520
Dividend collected and credited 1200
Less: Unpresented Cheques 36840
Balance as per Pass Book Cr. 84660
Illustration No. 6
From the following particulars, prepare a Bank Reconciliation Statement of
Mr. Khalid as on 30th April 2018 with the help of revised Cashbook.
a) Balance as per Cashbook Rs.50000/-.
b) Balance as per Bank Statement Rs.60000/-.
c) Cheques amounting Rs.16000/- were deposited into bank out of which only
cheques amounting Rs.10000/- were credited up to 30 th April 2018.
d) Out of cheques for Rs.12000/- issued in April, only cheques amounting
Rs.7000/- were presented for payment.
e) Mr. Humza directly deposited an amount of Rs.11200/-.
f) The bank credited Interest Rs.500/- into the account.
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g) Bank charges Rs.700 appeared in the bank statement were not recorded in
the cashbook.
Solution
Revised Cashbook (Only bank column of the Cashbook)
Dr. Cashbook Cr.
Date Particulars L.F Amount Date Particulars L.F Amount
By Balance b/d 50000 g) To bank Charges 700
e) By Mr. Humza 11200 Balance c/d 61000
f) By Interest 500
Total 61700 Total 61700
Mr. Khalid
Bank Reconciliation Statement
As on 30th April 2018

Balance as per Cashbook (Adjusted) Dr. Rs.61000

c) Less: Uncredited Cheques (6000)
d) Add: Unpresented Cheques
Balance as per Bank Statement Cr. 60000
Where the bank balance as per the cashbook is a credit balance (overdraft)
take the adjusted balance of the cashbook add to it all cheques drafts etc. paid into
bank but not yet collected and credited by bank and deduct from it all un-
presented cheques. The new balance will then agree with the balance of the Bank
Statement.
Illustration No. 7
The following facts relate to the business of Zaheer, a client of yours who
required you to reconcile the Bank Pass Book balance with his Cashbook
Balance:
Balance as per Cashbook (overdraft) Rs.800
Un-presented cheques 1440
Un-credited cheques 1200
In addition you ascertain the following:
i. A cheque for Rs.200/- paid to Mohsin has been entered in error in cash
column.
ii. Bank commission of Rs.80/- has not been entered in the Cashbook.
iii. The debit side of the Cashbook (Bank Column) has been under cast
Rs.500/-.

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 Solution
Mr. Zaheer
Bank Reconciliation Statement
Balance as per Cashbook Cr. Rs. 800
Add: Bank Commission 80
Un-credited cheques 1200
Erroneously entered in cash column 200
Less: Un-presented Cheques 1440
Debit side of cashbook under cast 500
Balance as per Bank Statement Dr. Rs. 340
3.4.2 Starting with the Bank Statement Balance:
Where the Bank Statement Balance is credit balance (favorable balance),
add to it all cheques drafts etc paid into bank but not yet credited by the bank and
deduct from it all cheques drawn on the bank but not yet presented for payment.
Add back the bank charges and direct debits and deduct the direct deposits and all
other credit transactions.
Illustration 08:
The above example of Mr. Khalid can also be solved by using the Balance as per
the Bank Statement

Solution
Mr. Khalid
Bank Reconciliation Statement
As on 30th April 2018

Balance as per Bank Statement Cr Rs.60000

c) Add: Uncredited Cheques 6000
g) Bank Charges
d) Less: Unpresented Cheques 5000
e) Direct deposit by Mr. Humza 11200
f) Interest credited by Bank 500
Balance as per Cashbook Dr Rs.50000
In case Bank Statement shows a debit balance (Overdraft) add all un-
presented cheques and deduct all the un-credited cheques. Deduct all the direct
debit entries already made by the bank including bank charges and add back the
transactions credited in the customer’s account by bank.

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Illustration No. 9
On 31-3-2018 the Bank Statement of Mr. Noor Ahmed showed a debit
balance of Rs.20500/- but it does not agree with the balance as per Cashbook. An
investigation in to the difference gives the following information.
1) Cheques amounting Rs.7800/- were issued on 23-3-2018 of which cheques
for Rs.5500/- were enchased up to 31-3-2018.
2) A wrong debit of Rs.400/- was given by the banker in the Bank Statement.
3) A cheque of Rs.100/- was credited by bank but was not recorded in the
cashbook.
4) Cheques amounting to Rs.10500/- were deposited for collection. But
cheques for Rs.3700/- have been credited in the pass book till 31-3-2018.
5) A cheque for Rs.50/- returned dishonored was not recorded in the
Cashbook.
6) Interest and bank charges amount to Rs.50/- were recorded in the Bank
Statement but not recorded in the Cashbook.
7) A cheque of Rs.250/- was debited in the Cashbook but was not paid into the
bank.
Required: Prepare a Bank Reconciliation Statement as on 31-3-2018.
Mr. Noor Ahmed
Bank Reconciliation Statement
For the month of March 2018
Balance as per Bank Statement Dr. Rs.20500
Add: Un-presented Cheques 2300
Cheque credited by bank 100
Dishonored cheque 50
Less: Wrongly debited by bank 400
Un-credited Cheques 6800
Interest and Bank charges 50
Cheque debited in the Cashbook 250
Balance as per Cashbook Cr. Rs.15450
4. SELF-ASSESSMENT QUESTIONS
4.1 Choose the best answer from the given options
i. Cashbook is:
a. Subsidiary Journal
b. Ledger Account
c. Subsidiary journal and ledger account
d. None of the above
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 ii. The imprest system is used in relation to:
a. Cashbook
b. Purchase book
c. Sales Book
d. Petty Cashbook
iii. The basic objective of a bank reconciliation statement is:
a. To Detect cashbook errors
b. To make sure the cashbook includes all bank interest and charges.
c. To Highlight items in transit within the banking system
d. None of the above
iv. Which of the following is not a book of prime entry?
a. The petty cashbook
b. The cashbook.
c. The journal
d. The bank reconciliation
v. A cheque payment that is recorded in the cashbook but is not in the
bank statement is called:
a. An unrecorded cheque
b. An unpresented cheque
c. A direct debit
d. A bounced cheque
Answer
i. c ii. d iii. c iv. d
v. b
4.2 Give the short answers of the following questions
i. What do understand by contra entry?
ii. What do you know about imprest system?
iii. Define the petty cashbook.
iv. Write the name of columns of three column cashbook
v. What is the purpose of bank reconciliation statement?
vi. Differentiate between cashbook and pass book.
vii. Define Pay-in-slip.
viii. Write down the three causes of disagreement of pass book and
cashbook
ix. Describe the methods of preparing bank reconciliation statement
x. Define the un-cleared cheque.

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5. PROBLEMS
Problem 01: Record the following transactions in a Simple Cashbook, and draw
the Cash Balance.
Jan
2018 Ahmad started business with cash Rs.140000.
1 Bought goods for cash Rs.60000.
2 Paid carriage on the above Rs.1000.
4 Sold goods for cash Rs.35000.
6 Sold goods to Anwar for cash Rs.17000.
5 Purchased goods for cash Rs.12000.
10 Sold goods for cash Rs.9000.
13 Bought goods for cash Rs.3000.
15 Paid wages Rs.700.
17 Paid Telephone Bill Rs.670.
19 Bought Almirah Rs.2000.
22 Paid electric bill Rs.630.
27 Paid entertainment bill Rs.670.
29 Paid Newspaper bill Rs.220.
30 Paid rent of shop Rs.1000.
30 Paid salary to salesmen Rs.1200.
30
Problem 02: Record the following transactions in a simple Cashbook and draw
the Cash Balance.
2018
July 1 Cash in hand Rs.8000.
2 Received from Mazhar Rs.1000.
3 Paid to Saeed and Co. Rs.800.
4 Purchased goods from Naseem on credit Rs.700.
5 Received from Jawaid Rs.1100.
6 Cash sales Rs.1200.
7 Paid to Markazi Kitab Khana Rs.2000.
8 Remitted to Majeed Book Depot Rs.300.
9 Purchased furniture for cash Rs.400.
12 Cash sales Rs.1900.
14 Received from Zahid Rs.2000.
16 Paid to Rahim and Sons Rs.500.
19 Purchased an iron safe Rs.450.
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 22 Bought a cycle for Rs.300.
25 Sold goods for cash Rs.900.
27 Sold goods to Zafar Stall on credit Rs.1400.
31 Paid the sundry expenses Rs.1250.
Problem 03: Record the following transactions in a Two Column Cashbook, and
draw the Cash Balance.
2018
August Aashiq commenced business with cash Rs.600000.
2 Bought machinery for Rs.25000.
2 Bought electric motor for Rs.10000.
3 Purchased goods for cash from Farhan & Co. for
4 Rs.20000 subject to 7% cash discount.
Sold goods for cash Rs.20000 and allowed discount
6 10%.
7 Sold goods for cash Rs.25000 to Furqan & Co. subject
to trade discount 5%.
8 Paid to Anwar & Co. Rs.25000.
10 Purchased goods from Rashid for cash Rs.450 and
from Hanif on credit Rs.3500.
12 Paid carriage on the above Rs.150.
16 Purchased iron safe of Rs.6500 and Typewriter
19 Rs.17500.
23 Returned goods to Farhan & Co. for Rs.3600.
25 Returned goods by Furqan & Co. Rs.2700.
30 Paid commission to the Agents Rs.3000.
31 Sold goods for cash Rs.47000.
31 Paid salaries Rs.4000.
Paid office rent Rs.2000.
Problem 04: Enter the following transactions in Three-Column Cashbook, and
draw the Cash and Bank Balances.
2018
Jan. 2 Paid cheque to Malik & Co. in full settlement of their
account balance Rs.1100 and received discount Rs.25.
3 Sold goods to Ghani & Co. Rs.1750.
4 Received cash from Rahi & Co. Rs.1450.
5 Received cheque from Pervaiz Rs.650.
8 Bought goods from Rana & Co. Rs.940.
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 9 Sold goods to Riaz Brothers Rs.1300.
11 Purchased goods from Patay Khan Rs.700.
14 Received cheque from Riaz Brothers Rs.1100 and
16 allowed discount Rs.30.
17 Received cash from Ghani & Co. Rs.1000.
19 Sent cheque to Patay Khan Rs.600.
20 Sent landlord cheque for office rent Rs.300.
23 Paid for stationery Rs.40.
25 Sold goods for cash Rs.1900.
26 Gave cheque for club fee Rs.70.
Sold old furniture and received cheque, which was
27 deposited on the same day Rs.1600.
Received a cheque from Haji Chiragh Din & Sons and
28 deposited into the Bank Rs.3000.
29 Withdraw from the personal use of the proprietor
30 Rs.1500.
30 Received a bank draft from Tanveer and deposited
into the bank Rs.1200.
Received interest on loan Rs.100.
Paid the interest on loan Rs.60.
Problem 05: Enter the following transactions in Three-Column Cashbook and
draw the Cash and Bank Balances.
2018
March Drew from Bank for Petty Cash Rs.200.
1 Purchased goods from Javaid & Co. Rs.900.
2 Sent draft to Javaid & Co. Rs.900.
3 Sold goods to Dar Sons Rs.550.
6 Sold goods for cash Rs.400.
7 Sold goods on credit to Dada Bhoy subject to Trade
8 Discount 5% for Rs.300.
Sold goods for cash, which sum paid into Bank on the
10 same day Rs.450.
11 Paid Ejaz cheque in settlement of his account Rs.460
and received discount Rs.20.
13 Paid into Bank cash Rs.200.
14 Made cash purchases and paid by cheque Rs.160 and
received discount Rs.15.
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 16 Drew from Bank cash for self Rs.500.
17 Sold goods to Peaco & Co. received cheque Rs.4650
and allowed them discount Rs.25.
19 The above cheque was deposited in the Bank.
20 Paid to office staff Bonus by cheque Rs.1500.
22 Paid telephone bill by cheque Rs.200.
23 Paid office rent by cheque Rs.250.
24 Paid repair bill by cheque Rs.1800.
27 Received a bank draft from Human Traders Rs.4700.
30 Paid staff salaries by cheque Rs.1600.
Problem 06 Record the following transactions into Petty Cashbook for the
month of February 2014. Usually cash month is started with
Rs.2000 in the hands of petty cash Incharge.
2014
Feb. 1 Postage Rs.65, Telegram Rs.35.
3 Stationery Rs.50, Paper Weight Rs.40.
4 Ink Pot Rs.10, Tonga hire Rs.20.
6 Coolie wages Rs.35, Railway freight Rs.80.
8 Soap Rs.15, Towel Rs.250.
9 Postage Rs.25, Printing Rs.30.
10 Telegram Rs.70, Telephone Call Rs.25.
11 Cartage Rs.10, Cleaning Rs.50.
13 Stationery Rs.37.
14 Table glass Rs.10, Table Diary Rs.50.
15 Waste Basket Rs.30, Table tray 60.
18 Taxi charges Rs.60.
20 Gum Rs.14, Common pins Rs.40.
23 Red pencil Rs.10, Paper clips Rs.20.
26 Cartage Rs.150, Carriage Rs.140.
27 Telegram Rs.30, Tonga hires Rs.20.
28 Printing Rs.10, Postage Rs.50.
28 Pay Rs.30 to sweeper.
Problem 07
On 31st December 2018 the Cashbook of Nadeem Bros., showed a bank
balance of Rs.5000/-. This did not agree with the pass book balance due to the
following:

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1) Cheques had been issued for Rs.2500/- out of which Cheques worth
Rs.2000/- only were presented for payment.
2) Cheques worth Rs.700/- were paid into bank on December 29, but had not
been credited by the bank. One cheque for Rs.250/- was entered in the
cashbook on December 30, but was banked on 3rd January 2018.
3) A cheque from Mujahid for Rs.200/- was paid in on December 26, but was
dishonored and memo was received on 2nd January 2018.
4) Pass book showed bank charges Rs.10/- debited by the bank. It also showed
Rs.400/- collected by the bank as interest.
5) One of the debtors deposited a sum of Rs.250/- in the account of the firm on
December 20, intimation in the respect was received from the bank on 4 th
January 2018.
6) The payment side of the cashbook was under cast by Rs.150/-.
7) Dividend amounting to Rs.200/- was received directly by the bank.
Required: Prepare a Bank Reconciliation Statement as on 31-12-2018.
Problem 08
Shahid’s Cashbook showed a bank overdraft of Rs. 15,000 of 31st March,
2018. On comparison of the two books, the following differences were noted down:
a. An outstation cheque for Rs. 1400, lodged on 30th March, 2018 did not
appear in the Pass Book.
b. Cheques issued to totaling Rs. 21,000 had not been presented at the bank.
c. Interest on overdraft debited in to the Passbook was Rs. 200 but not
recorded in the Cashbook.
d. Insurance premium paid and debited by the bank in the Passbook Rs. 1000
but not entered in to the Cashbook
e. Interest on investment collected by the bank appeared in to the Pass Book
only Rs. 300
f. Dividend on shares collected by the bank Rs. 300 credited in the Passbook
g. In March, the trader had got a bill discounted by his bank for Rs. 990 and
entered the amount in the Cashbook as Rs. 1000 but the proceeds credited
in the Pass Book were Rs. 990.
Required:
i. What will be the revised balance of Cashbook (after making necessary
adjustments)
ii. Prepare a Bank Reconciliation Statement as on 31st March, 2018

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Problem 09
A trader has two Bank Accounts- A/c No. 1 and A/c No. 2. The following
particulars relating to A/c No.1 are available on 31 st March, 2018.
i. Pass Book balance (overdraft) Rs. 30,000.
ii. Cheques drawn prior to 31st March but not presented as yet Rs. 8,000.
iii. Cheques paid into the bank on 31st March, 2018 but not yet credited Rs.
14,000.
iv. Interest debited by the bank but not entered in to the Cashbook as yet Rs. 800
v. Transfer from A/c No. 2 to A/c No. 1recorded by the bank on 31st March,
but not entered in the Cashbook Rs. 6,000.
vi. Bank charges debited by the bank but not recorded in to the Cashbook as
yet Rs.20.
vii. One outgoing cheque for Rs. 700 was recorded twice in to the Cashbook.
Required: Prepare a Bank Reconciliation Statement as at 31 st March, 2018
Problem 10
From the following particulars of Mr. Haris, Prepare the Bank
Reconciliation Statement as on 30-04-2018
i Balance as Per Cashbook (Over Draft) 48,600
ii A Cheque deposited as per Bank Statement but not recorded in Cashbook 2,100
iii Debit side of Bank Column cast short 300
iv A Party's cheque returned dishonored as per Bank Statement only 1,590
v Cash Collected directly by bank from a customer 10,500
vi Bank Service Fee recorded twice in the cashbook. 75
vii Cheques deposited but not yet collected by the Bank 6,960
viii Cheques issued but not yet presented. 3,750
Problem 11
From the following particulars of Bashir & Sons, prepare a Treble Column
Cashbook for the month of March, 2013.
March 1: Cash in hand Rs. 80,000 Cash at bank (overdraft) Rs. 20,000.
March 2: Cash deposited into bank Rs. 50,000.
March 4: Received a cheque from Javaid for Rs. 12,000 less cash discount 5%.
March 10: Dividend collected by bank Rs. 4,000.
March 13: Received cheque from Kabir and paid into bank Rs. 3000
March 18: Javaid’s Cheque deposited into bank.
March 20: Bought furniture from Lahore furnishers Rs. 15000.
March 24: Javiad’s cheque dishonored by bank.
March 29: Paid Haseeb by Cheque Rs. 6000
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March 30: Issued order to the bank for stopping payment of cheque issued to
Haseeb.
March 31: Cash sales Rs. 150000 and deposited Rs. 50000 into bank out of them.
Problem 12
From the following particulars write up three column cashbook of Anas
Trading Co. for the month of March, 2014:
March 01 Cash in hand Rs. 2,000, Balance Overdrawn at bank Rs. 4,000
March 02 Cash Sales Rs. 5,000, Banked Cash Rs. 2,000
March 03 Paid Sultan & Co. by Cheque Rs. 1,500
March 05 Received Mobeen’s Cheque Rs. 8,500 and paid it into bank.
March 08 Paid Salaries in Cash Rs. 2,500. Bought Goods though Cheque Rs.
1,400
March 10 Drew from bank for office use Rs. 1,600
March 13 Received Cheque from Aftab Ahmed Rs. 3,600, discount Rs. 100.
March 15 Deposited Aftab Ahmed’s Cheque into Bank
March 16 Sent a Cheque to Ahsan for Rs. 1,750, discount received Rs. 100.
March 18 Bank Returned Aftab’s Cheque as dishonoured.
6. SUMMARY
Cash transactions can be executed more efficiently through bank.
Cashbook is used to record the transactions of a bank account. The debit and
credit sides of the cashbook, which refers to the cash or bank account, can be used
as a part of the nominal ledger, rather than posting the entries to cash or bank
accounts held directly in the nominal ledger. Three types of cashbooks are there to
record the cash transactions but treble column cashbook is mostly used to record
the cash as well as the bank related transactions of the business. Petty cashbook is
used to record the small payments or expenditures of the business, which are
maintained by the petty cashier. One of the methods may be used to maintain the
petty cashbook, Imprest system or fixed amount system.
At the end of each specific period, the balance of cashbook is compared
with the balance of passbook, which is maintained by the bank to keep the record
of transactions of each individual customer but most of the times both balances
differ from each other due to some errors or lack of information. To reconcile the
balances of cashbook and passbook a statement is prepared, that is known as Bank
Reconciliation Statement. All the disagreements are removed through
reconciliation and correct balances are extracted.

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BIBLIOGRAPHY
Ahmad, M. M., Khan, S. A., Arshad, M., & Shah, S. M. (2013). Advanced
Financial Accounting. Islamabad: National Book Foundation Islamabad.
Dupree, D., & Marder, M. (1984). Principles of Accounting. Addison-Wesley.
Farooq, U., & Amir, S. M. (2008). Principles of Accounting. Islamabad: Allama
Iqbal Open University.
Hussain, K., Buttar, Z. U., Pirach, M. A., & Chaudhry, M. I. (1996). Accounting
Principles. Lahore: Orient Publishers Urdu Bazaar Lahore.
Mukherjee, A., & Hanif, M. (2003). Modern Accountancy I. Tata McGraw-Hill
Education.
Randall, H. (2005). Accounting. Cambridge University Press.
Wood, F., & Sangster, A. (2008). Business Accounting I. Pearson Education.

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165
Unit–6

FINAL ACCOUNT:
THE COMPLETION OF
ACCOUNTING CYCLE

Written by: Muhammad Munir Ahmad

Reviewed by: Dr. S.M. Amir Shah

166
 CONTENTS
INTRODUCTION
OBJECTIVES
1. FINAL ACCOUNTS
2. ELEMENTS OF FINAL ACCOUNTS
2.1 Revenue
2.1.1 Direct Revenue
2.1.2 Indirect Revenue
2.2 Expenses
2.2.1 Direct Expenses
2.2.2 Indirect Expenses
2.3 Assets
2.3.1 Fixed Assets
2.3.2 Current Assets
2.4 Liabilities
2.4.1 Long Term Liabilities
2.4.2 Short Term Liabilities
2.5 Owner’s Equity
3. COMPONENTS OF FINAL ACCOUNTS
3.1 Manufacturing Accounts
3.2 Trading Account
3.3 format for the Manufacturing/Trading Account
3.4 Explanation
3.4.1 Credit Side
3.4.2 Debit Side
3.5 Profit and Loss Account
3.6 Format of Profit and Loss a/c
3.7 Explanation
3.7.1 Administrative & Office Charges
3.7.2 Selling Expenses
3.7.3 Other/Miscellaneous Expenses
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 3.7.4 Other Revenues
3.8 Balance Sheet
3.9 format of Balance Sheet
4. SELF-ASSESSMENT QUESTIONS
4.1 Choose the Best Options
4.2 Give the Short Answers of the Following Questions
5. PROBLEMS
6. SUMMARY
REFERENCES/BIBLIOGRAPHY

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INTRODUCTION
This unit described the Final stage of Accounting Stage named as “Final
Accounts”. In this unit all types of final accounts prepared by the different
business concerns are discussed, particularly the Preparation of Trading and Profit
and Loss Account and Balance sheet. A detailed format of Trading and Profit and
Loss Account and the Format of Balance sheet is given with the complete details
of the Elements of the Final Accounts. At the end of the unit, solved examples are
given for the understanding of the topic and various problems are also described
for better grooming of the students.

OBJECTIVES
After studying this unit, you will be able to:
1. Understand the Components of Final Accounts
2. Know the elements of Final Accounts.
3. Differentiate between the Trading and Profit & Loss Account
4. Learn the method of preparation of the Trading Account, Profit and Loss
Account and the Balance Sheet.
5. Explain the various items mentioned in the Final Accounts.

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1. FINAL ACCOUNTS
Owners of a business are interested whether business earned profit or
suffered loss in a certain specific time period and what is position of assets and
liabilities on some specific point in time. The purpose of accounting is to
accumulate the accounting data in such a way that the amount of profit or loss
may be found out at the end of each particular period. Final Accounts help to
achieve the objectives of getting profit or loss and financial position of business.
Final accounts present a complete summary of the business about its operation
during a particular period, whether is it profitable or not? It also tells the financial
strength of an entity that how much assets any business owns and how much
liabilities it owes at the end of specific period.
1.1 Definition
“Final accounts are those accounts which are prepared at the end of each
accounting period to ascertain the profit or loss and the financial position of an
entity”
2. ELEMENTS OF FINAL ACCOUNTS
Before proceeding to format of the final accounts, we should know about
the elements of Final Accounts. There are five elements of final accounts, which
are used to prepare the above mentioned different accounts or statements. The
elements of final accounts are as follows:
 Revenue
 Expenses
 Assets
 Liabilities
 Owner Equity
EXPLANATION
The explanation of the elements of final account is as follows:
2.1 Revenue
The entire amount received or to be received from selling of goods or by
performing services are categorized under the head of the Revenue Account. The
revenue may be classified in two broad categories as: (i) Direct Revenue and (ii)
Indirect Revenue:
1.1.1 Direct Revenue
The revenue earned from the Primary operation of business or normal
business activities is called direct revenue or major revenue. i.e. for a cloth
merchant, sales proceeds from selling of cloth; from a property dealer,
commission earned from purchasing or selling of property etc.
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 The entire amount of direct revenue will be shown on the credit side of the
Trading or Manufacturing A/c
1.1.2 Indirect Revenue
Any type of revenue earned from other than primary operation of business
or normal business activities is named as indirect revenue. i.e. for a cloth
merchant, interest earned from the amount deposited into bank account is indirect
revenue, because it not the normal business activity of cloth merchant.
Indirect revenue will be recorded on the credit side of the Profit or Loss
A/c.
2.2 Expenses
The economic costs which a business incurred through its operation to earn
the revenue are termed as expenses. For example, purchase of goods, freight in,
rent expenses, salaries expenses and selling expenses etc. Like the revenue,
expenses may also be categorized in two broad categories: (i) Direct expenses (ii)
Indirect expenses
2.2.1 Direct expenses:
The expenses directly attributable to purchase or manufacturing of goods
are categorized as direct expenses. These are the expenses which are incurred on
the goods up till the goods are ready for sale. For example, carriage in, wages,
factory rent, manufacturing expenses etc.
Direct expenses are recorded on the debit side of the Manufacturing or
Trading A/c.
2.2.2 Indirect expenses:
All those expenses which are incurred in the operation of business other
than the direct expenses are categorized under the head of indirect expenses. The
main categories of indirect expenses are Selling and Administrative expenses. For
example, office rent, bank charges, salaries, insurance and depreciation etc.
All the indirect expenses will be recorded at the debit side of the profit and loss
A/c. It is better to record the indirect expenses under different classifications,
however it may be recorded in any order to get the profit or loss.
2.3 Assets
Assets are the resources owned and controlled by the business such as plant
and machinery, building, office equipment, stock and cash etc. All types of assets
are recorded on the one side of the balance sheet, while preparing the Final
Accounts.

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 There are two main categories of the assets: (i) Fixed Assets (ii) Current
Assets
2.3.1 Fixed Assets
All those assets which provide the benefits to business more than one
accounting year are called fixed assets. These may be classified in two broad
categories (a) Tangible Fixed Assets (b) Intangible Fixed Assets.
a. Tangible fixed assets have the physical appearance, they can be touched or
seen, such as Office / Factory building, Office Equipment, Plant &
Machinery, Furniture and Fixture etc.
b. Those fixed assets which don’t have any physical appearance, nor can be
touched or seen but provide the benefits to business for more than one
accounting period are known as Intangible fixed Assets. For example,
Goodwill, Patents, Copy rights etc.
2.3.2 Current Assets
Those assets which are in the form of cash or equivalent to cash or can be
converted into cash or can be consumed or expired within one accounting year are
classified as current assets, such as cash in hand or at bank, Account Receivable,
Prepaid Insurance, Stock, Accrued Revenue etc.
Current assets also have two types (a) Liquid Assets (b) Floating Assets
2.4 Liabilities
Amounts payable by business to others are the liabilities of business. For
example, bank loan, note payable etc. liabilities may also be classified in two
categories, (i) Long Term Liabilities (ii) Short Term Liabilities:
2.4.1 Long Term Liabilities
Liabilities which are payable by business in more than one accounting
period are called Long Term Liabilities or Fixed Liabilities, i.e. Bank Loan,
Debentures, Bond Payable etc.
Short Term Liabilities
Short Term Liabilities are usually payable within one accounting period,
that’s why these are called short term or current liabilities, i.e., Account Payable,
Unearned Revenue, and Expenses Due etc.
2.5 Owner’s Equity
It is claim against the assets of the business by its owner. Generally it is the
amount invested into the business by its owner plus the accumulated profit or
Reserves etc. Owner’s Equity may also be called as the Internal Equities or
Liabilities, because this debt is claimed by the owner of the business and is
payable on the liquidation of the business.
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Owner’s equity is recorded on the liabilities side of the balance sheet.
3. COMPONENTS OF FINAL ACCOUNTS
The final accounts consist of different accounts or statements which may be
categorized as under according to the nature of the business:
Final Accounts for Manufacturing Concerns:
i. Manufacturing Account
ii. Profit and Loss Account
iii. Balance Sheet
Final Accounts for Trading Concerns:
i. Trading Account
ii. Profit and Loss Account
iii. Balance Sheet
Final Accounts for Service Concerns:
i. Profit and Loss Account
ii. Balance Sheet
Final Accounts for Non-Trading Concerns:
i. Receipt and Payment Account
ii. Income and Expenditure Account
iii. Balance Sheet
3.1 Manufacturing Account
Manufacturing Account is prepared by those organizations which are
engaged in manufacturing or production businesses to ascertain to gross profit or
loss resulted in manufacturing process. In manufacturing business raw material is
purchased and converted it into finished or semi finished goods after processing
through various plant and machinery, i.e. oil refinery, flour mills, textile mills
etc.
3.2 Trading Account
Trading account is prepared by those organizations which are engaged in
purchasing goods in bulk quantity and sell them into small quantity with some
profit margin. Like the manufacturing account, trading account is prepared to
ascertain the gross profit or loss resulting in trading business.
As the purpose of Manufacturing A/c and Trading A/c is same, so the
format of both of the account is also same, except some items. In manufacturing
account more items are shown due to manufacturing process, whereas in trading
A/c less items are recorded because it doesn’t involve production process.

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3.3 Format for the Manufacturing/Trading Account
Name of Organization
Manufacturing/Trading Account
For the period ended on -------
Dr Cr
Particulars Rs. Particulars Rs.
Opening Stock xxxxx Sales xxxxx
Purchases xxxxx Less: Return Inward xxxxx
Less: Return outward Sales Discount xxxxx
xxxxx Net Sales xxxxx
Purchase Discount xxxxx Closing Stock xxxxx
xxxxx Gross Loss (transferred to P & L
Net Purchases xxxxx A/c) xxxxx
Direct Expenses: xxxxx
Freight in xxxxx
Carriage in xxxxx
Transportation in xxxxx
Wages/Wages and xxxxx
Salaries xxxxx
Insurance in transit xxxxx
Import/Custom duty xxxxx
Clearing charges xxxxx
Dock charges xxxxx
Excise Duty xxxxx
Oil, Gas, Fuel, Water xxxxx
Manufacturing expenses xxxxx
Factory insurance xxxxx
Factory rent xxxxx
Store consumed xxxxx
Heat and light xxxxx
Factory Labour
Royalty xxxxx
Motive Power
Gross Profit(Transferred
to P&L a/c)

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3.4 EXPLANATION
Here each item mentioned in the above manufacturing account on debit and
credit sides both.
3.4.1 Credit Side
i. Sales
All those items which are manufactured or produced by the business for the
purpose of sale are categorized under the head of goods. Sales include all goods
sold on cash or credit during a particular period of the business. Sales will be
shown on the credit side of the manufacturing or trading account.
ii. Returns Outward
All those goods which are sold to customer and returned back due to any
reason are known as Sales returns or returns outward. In manufacturing account,
sales returns will be deducted from the total gross sales
iii. Sales Discount
Discount on Sales will be deducted from the gross sales and net sales will
be shown in manufacturing account.
iv. Closing Stock
Goods remain unsold at the end of the accounting period will be written on
the credit side of the manufacturing account.
3.4.2 Debit Side
i. Opening Stock
Goods remaining unsold in the last accounting period will become the
opining stock for the next period or those goods which a business has at the
beginning of the accounting period is called the opening stock and will be shown
on the debit side of the manufacturing/trading account.
However, there will be no opening stock at that year when business is
commenced.
ii. Purchases
All those items which are manufactured or bought for the purpose of sale,
are called the goods, and when the goods are purchased in finished form or raw
form these are categorized as purchases.
All the purchases either on cash or on credit will be recorded on the debit
side of the manufacturing or trading account.
iii. Return Outwards
Goods purchased and returned back to supplier are called return outwards or
purchases return. These will be deducted from the gross purchases in the
manufacturing or trading account.
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iv. Purchase Discount
Discount received on purchases will be deducted from the purchases and net
purchases will be shown on the trading/manufacturing account.
v. Freight In
The sum paid for conveyance of goods by sea is known as freight in. It is
direct expenses and will be shown on the debit side of the account.
vi. Carriage In
Carriage expenses paid for carrying goods by land, carriage in expenses are
paid usually to bring goods to warehouse.
vii. Transportation In
Transportation in is also categorized as direct expenses and will be shown
on the debit side of the account. These expenses also paid for carrying goods by
road.
viii. Wages/Wages and Salaries
The remuneration paid to factory workers on the basis of hourly, daily or
piece work are called the productive wages and would be classified as direct
expenses.
ix. Insurance in Transit
When goods or raw material is purchased from outside, there may be
chances of loss of goods due to theft, accident, or fire. Such type of loss may be
insured against to insurance that goods may reach safely to warehouse. The
premium paid for that type of insurance will be charged to trading account.
x. Import/Custom Duty
Import/Custom duty is paid when goods are imported from abroad. These
expenses are treated as direct expense and will be charged to trading account.
xi. Clearing Charges
If clearing agent is appointed to get delivery of the goods from the customs,
then the importer has to pay some amount to clearing agent for his services. This
amount is called clearing charges and would be recorded on the debit side of the
trading account.
xii. Dock Charges
These amount are levied on ships and their cargoes when entering or
leaving docks. Dock charges paid for the purchase of goods would be recorded on
the debit side of the trading account.
xiii. Excise Duty
Excise duty is imposed on goods produced or manufactured or consumed in
the country. This duty is charged by the government.
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xiv. Oil, Gas, Fuel, Water
In case of manufacturing business, gas, fuel, oil, water is used in the factory
for the production of the finished goods. All these items will be charged to
manufacturing account.
xv. Manufacturing expenses
All those expenditures which are incurred in factory to convert the raw
material into finished or semi finished goods would be categorized as
manufacturing expenses and would be charged to manufacturing account.
xvi. Factory Insurance
Premium paid for the insurance of plant and machinery and factory
premises, where goods are produced or converted into finished or semi-finished
goods, is direct expense and would be charged to manufacturing or trading
account.
xvii. Factory Rent
Rent paid for factory is also direct expenses and recorded in debit side of
the manufacturing account.
xviii. Store Consumed
These are the items which are used to keep the plant and machinery in
working condition, i.e. oil grease, cotton waste, soap or engine oil etc. such type
of all expenses will be charged to manufacturing/ trading account.
xix. Heat and light
Heat and light used in factory for the working of plant and machinery is
recorded on the debit side of manufacturing account.
xx. Factory Labour
All type of remuneration paid to factory worker, who are engaged in
manufacturing process, is categorized as direct expenses.
xxi. Royalty
Amount paid for use of rights to produce or manufacture of goods is known
as royalty. This amount is charged to manufacturing or trading a/c.
xxii. Motive Power
Any type of energy consumed to run the plant and machinery in the factory
is called Motive Power or Power, i.e. gas, electricity, steam, coal or coke etc.
3.5 Profit and Loss Account
After finding the gross profit or loss from the trading a/c the next step is to
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ascertain the net results of operation of the business in shape of net profit or net
loss. Profit and Loss account is an account which is prepared to know that
whether the business earned net profit or suffered in loss from the operation
during a particular period.
All types of indirect revenues are shown on the credit side of the account
and all indirect expenses are recorded on the debit side of the profit and loss
account.
3.6 Format of Profit and Loss a/c:
Name of Organization
Profit and Loss Account
For the period ended on -------
Dr Cr
Particulars Rs. Particulars Rs.
Gross Loss (Transferred from Gross Profit (Transferred
Trading a/c) xxxx from Trading a/c) xxxxx
Administrative & Office x Rent Received xxxxx
Expenses: Discount Received xxxxx
Office Salaries Commission (Cr) xxxxx
Rent and Rates xxxx Interest (Cr) / received xxxxx
Printing & Stationery x Other Revenues xxxxx
Communication Charges xxxx Net Loss (transferred to
Selling Expenses: x Capital A/c) xxxxx
Sales Salaries xxxx
Advertisement Expenses x
Bad Debts xxxx
Sales Commission x
Carriage Outward
Other Expenses: xxxx
Repair Expenses x
Depreciation Expenses xxxx
Audit and Accountancy Charges x
Legal Expenses xxxx
Bank Charges x
Net Profit (Transferred to Capital xxxx
A/c) x
xxxx
x
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 xxxx
x
xxxx
x
xxxx
x
xxxx
x
xxxx
x

xxxx
x
3.7 Explanation
3.7.1 Administrative & Office Charges
All types of expenses related to the management of the business office are
indirect expenses and will be categorized under the head of Administrative &
office expenses, like, office salaries and other fringe benefits which are paid to
office workers.
3.7.2 Selling Expenses
It is also the type of indirect expenses, which are recorded on the debit side
of profit and loss account. Selling expenses are known as marketing expenses,
because these are directly or indirectly connected to the selling of goods and
increases or decreases with the increase or decrease in the volume of the sales.
3.7.3 Other/Miscellaneous Expenses
All types of indirect expenses or losses which are not recorded under the
head of administrative and selling expenses will be recorded under this head.
3.7.4 Other Revenues
Revenues recorded on the credit side of the profit and loss account are those
revenues which are not received from the primary source of business. For
example, rent received, dividend received, bad debts recovered and provision for
discount on creditors etc.
3.8 Balance Sheet
Balance sheet is an important part of the Final Accounts that summarizes a
company's assets, liabilities and shareholders' equity at a particular time.
It may be defined as:
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 “It is a statement which is prepared by every business or organization to
ascertain the financial position of an entity at a specific time”
Here the financial position mean that how much company owns and much it
owes to others. In short, it tells us the position of assets, liabilities and equity of
an organization at a given time period.
3.9 Format of Balance Sheet
The main objective of the balance sheet statement is to ascertain the
financial position of an entity, to achieve this objective the assets, liabilities or
equity are stated in such a manner that anyone may easily asses the financial
position of an entity. The order or method or arrangement in which assets,
liabilities and equity are stated in balance sheet is known as Marshalling or
Grouping of assets and Equities. Balance sheet may be prepared in different order
or format, following are some pattern of balance sheet:
i. In order of Permanency preferences
ii. In order of Liquidity preferences
iii. Mixed Order
Balance sheet will be prepared according to the second method, in order of
liquidity preferences, throughout this chapter.
NAME OF ORGANIZATION
BALANCE SHEET
AS ON _________

ASSETS AMOUNT LIABILITIES AMOUNT

Current Assets: Current Liabilities:
Cash in Hand xxxxx Account Payable xxxxx
Cash at Bank xxxxx Note/Bill Payable xxxxx
Sundry Debtors xxxxx Unearned Revenue xxxxx
Note / Bill Receivable xxxxx Expenses Payable xxxxx
Supplies xxxxx
Stock xxxxx Long Term Liabilities:
Prepaid Expenses xxxxx Bank Loan xxxxx
Debentures xxxxx
Investment xxxxx
Owner Equity:
Fixed Assets: Capital xxxx
Office Equipment xxxxx Add Net Profit
Furniture & Fixture xxxxx /(Less): /(Loss) xxxx
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 Plant & Machinery xxxxx Less: Drawings xxxx xxxxx
Building xxxxx
Goodwill xxxxx
Patents xxxxx
Copy Rights xxxxx
TOTAL xxxxx TOTAL xxxxx
3.10 Explanation
The detail of the assets has been described above, however some of the
items are explained as under:
i. Note/Bill receivable
It is a written promise by the debtor of the business to pay some amount of
cash on future date. Usually it is receivable within 12 months so it is classified as
current assets.
ii. Supplies
Supplies remain unused at the end of the period are recorded as current
assets in the balance sheet. Supplies may be categorized as (i) office supplies (ii)
sales supplies (iii) factory supplies
a) Office supplies include the stationery consumed in the office, i.e. paper,
pen, ink, carbon, stapler pins, etc.
b) Sales supplies include the material used for packing the goods, like,
cartoons, packing material etc.
c) Factory supplies are the consumables, used for cleaning and keeping the
machine in working condition, like, lubricants, rags, cleaning material etc.
d) Stock:
Stock or goods remained unsold at the end of the accounting period is
shown in assets side of the balance sheet.
iii. Prepaid Expenses
Expenses paid in advance are the assets of the business and will be shown
in the balance sheet.
iv. Investment
Investment means the amount invested in shares, debentures, or any other
securities will be recorded on the assets sides of balance sheet.
v. Goodwill
It is the value of favourable characteristics, which are related to the
business. These include exceptional management, a desirable location, good
customer base, skilled employees, high-quality products, and harmonious
relations with labour unions etc.
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 It is an intangible fixed asset which is usually recorded in the books of
accounts when business is purchased.
vi. Patents
Patent is a type of fixed intangible assets and is recorded in the balance
sheet. It is an exclusive right to manufacture, use or sell of an invention or
product.
Copy Rights
It is the right to protect the production and sale of the published material
related to literacy or artistic.
vii. Debentures
It is the document/certificate issued by business to general public to acquire
the debt. It is a long term liability of the business.
Illustration No. 01
From the following balances extracted from the books of Mansoor & Sons, on
31st August, 2013, You are required to prepare a Trading and Profit and Loss account
and a Balance Sheet. Closing stock was valued at Rs. 518,000

Debit Balance Plant 107,800

Office Equipment 490,000 Insurance 105,000
Opening Stock 245,000 Rent & Rates 24,500
Purchases 525,000 Bills Receivable 154,000
Sales Return 19,600 Investment in Shares 112,000
Freehold Land &
420,000 Drawings 63,000
Building
Carriage Inward 10,500 Cash in Hand 248,150
Carriage Outward 20,500 Credit Balance
Sundry Debtors 336,000 Bank Overdraft 33,500
Cash at Bank 25,000 Capital 1,085,000
Wages & Salaries 150,000 Purchases Returns 14,000
Manufacturing
28,500 Sales 1,750,000
Expenses
Trade Expenses 2,450 Sundry Creditors 175,000
Interest on Overdraft 10,500 Bank Loan 40,000

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Solution
MANSOOR & SONS
TRADING, PROFIT AND LOSS ACCOUNT
FOR THE PERIOD ENDED ON 31st AUGUST, 2013
Particulars Amount Particulars Amount
Opening Stock 245,000 Sales 1,750,000
Purchases 525,000 Less: Sales Return 19,600
Less: Purchase Returns 14,000 Net Sales 1,730,400

Net Purchases 511,000

Direct Expenses: Closing Stock 518,000
Carriage Inward 10,500
Wages & Salaries 150,000
Manufacturing Expenses28,000 189,000
Gross Profit (Balancing
Amount) 1,303,400

2,248,400 2,248,400

Indirect Expenses: Gross Profit 1,303,404

Insurance 105,000
Rent & Rates 24,000
Carriage Outward 20,000
Trade Expenses 2,450
Interest on Overdraft 10,000

Net Profit (transferred to

Capital Account) 1,140,450

1,303,400 1,303,400

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 MANSOOR & SONS
BALANCE SHEET
AS ON 31st AUGUST, 2013
Assets Amounts Liabilities Amounts
Current Assets: Current Liabilities:
Cash in Hand 248,150 Sundry Creditors175,000
Cash in Bank 25,000 Bank Overdraft 33,500 208,500
Sundry Debtors 336,000
Bills Receivable 154,000
Closing Stock 518,000 1,281,150 Long Term Liabilities:
Bank Loan 40,000 40,000
Investment in Shares 112,000
Owner’s Equity:
Fixed Assets: Capital 1,085,000
Office Equipment 490,000 Add: Net Profit 1,140,450
Plant 107,800 Less: Drawings 63,000 2,162,450
Freehold Land & Building420,000 1,017,800

2,410,950 2,410,950
4. SELF ASSESSMENT QUESTIONS
4.1 Choose the best options:
i. Trading account is prepared to determine the:
a. Net Profit
b. Gross Profit
c. Gross Loss
d. b&c
ii. The purpose of Profit and Loss account prepared to ascertain the:
a) Net Profit only
b) Net operating results
c) Net Loss only
d) Amount of capital
iii. Cost of goods sold is equal to:
a. Sales – Purchases
b. Purchases + closing stock – sales
c. Sales + closing stock – (purchases +opening stock + Direct
expenses)
d. purchases +opening stock + Indirect expenses- closing stock
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iv. Manufacturing expenses are:
a) Direct Revenue
b) Direct Expenses
c) Indirect Revenue
d) Indirect Expenses
v. Drawings are deducted from:
a. Sales
b. Net profit
c. Expenses
d. Capital
vi. Capital + Liabilities =:
a) Assets
b) Revenue
c) Drawings
d) None of the above
vii. Marshalling of balance sheet means:
a) Totaling of liabilities
b) Deducting capital from assets
c) Totaling of assets
d) Ordering of assets and liabilities
viii. Those assets which have no physical existence:
a) Tangible assets
b) Fixed assets
c) Intangible assets
d) Current assets
ix. Those assets which have no market value are called as:
a) Tangible assets
b) Fixed assets
c) Intangible assets
d) Fictitious assets
x. Excess of expense over revenues is called:
a) Net Profit
b) Gross Profit
c) Net Loss
d) Gross Loss

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Answer
i. d ii. b iii. d iv. b v. d
vi. a vii. d viii. c ix. d x. c
4.2 Give the short answers of the following questions:
i. What do you know about financial statements?
ii. List down the components of Final Accounts
iii. What are the elements of final accounts?
iv. Define the term balance sheet.
v. Differentiate trading account from profit & loss account.
vi. What do you know about marshalling of balance sheet?
vii. Define the fictitious assets.
viii. What is the difference between quick assets and current assets?
ix. Describe the term wasting assets?
x. What do you know about working capital?
5. PROBLEMS
Problem 01
Following is the extract of balances from the books of Mr. Akbar as at 31 st
December, 2017
Particulars Amounts Particulars Amounts
Capital Account 21,250 Purchases Return 1,455
Drawings 3,550 Sales 59,530
Sundry Debtors 16,000 General Expenses 2,200
Sundry Creditors 5,525 Sales Returns 1,050
Cash in Hand 240 Rent and Rates 1,600
Bad Debts 240 Rent and Rates 1,600
Plant & Machinery 4,750 Rent (Cr). 400
Bank Overdraft 1,200 Stock on 1-1-2017 7,300
You are required to prepare a trading profit and loss account and a balance
sheet as at 31st December 2017, closing stock amounts to Rs. 23,000.
Problem 02
From the under mentioned Trial Balance of Mr. Jameel, on 31 st December,
2018, Prepare a Trading and Profit and Loss account and a Balance Sheet.
Closing stock was valued at Rs. 370,000
Debit Balance Furniture & Fixture 77,000
Plant & Machinery 350,000 Advertisements 75,000
Opening Stock 175,000 Rent & Rates 17,500
Purchases 375,000 Bills Receivable 110,000
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 Sale Return 14000 Salaries 80,000
Freehold Land & 300,000 Drawings 45,000
Building
Carriage Inward 7,500 Cash in Hand 177,250
Carriage Outward 17,500 Credit Balance
Sundry Debtors 240,000 Sales 1,250,000
Wages 125,000 Purchases Returns 10,000
Coal and Coke 17,500 Bills Payable 52,000
Gas and Water 1,750 Sundry Creditors 125,000
Bad Debts 7,500 Capital 775,000
Problem 03
From the following information prepare Trading, Profit and Loss account
for the year ended on 31st may, 2018 and the Balance Sheet on as that date,
closing stock was valued at Rs. 18,000
Particulars Debit Credit
Capital Account 48,000
Purchases 80,000
Trade Creditors – 14,800
Sales – 108,000
Trade Debtors 20,400 –
Carriage Inward 1,440 –
Carriage Outward 1,720 –
Discounts 2,280 1,640
Bank Balance 4,400 –
Rent and Taxes 4,600 –
Salary 4,800
General Expenses 1,600 –
Motor Vans 5,600 –
Insurance 1,600 –
Fixture and Fitting 6,000 –
Bad Debts 2,400 –
Opening Stock 20,000 –
Drawings 17,600 –
Returns 3,120 3,400
Bills Payable – 1,720
TOTAL 177,560 177,560
Problem 04
From the following trial balance of Malik & Brothers, you are required to
prepare final account for the year ended on 30th September, 2017.

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 Particulars Debit Credit
Capital Account – 16,500,000
Drawings 1,500,000 –
Plant & Machinery 6,300,000 –
Office Furniture 750,000 –
Sundry Debtors and 6,375,000 2,220,000
Creditors
Advances 1,500,000 –
Purchases and Sales 14,250,000 26,700,000
Returns inwards & 270,000 330,000
outwards
Rent 577,500 –
Postage & Telegram 97,500 –
Wages 1,800,000 –
Manufacturing Expenses 555,000
Opening Stock 1,800,000 –
Cash in Hand and at Bank 1,852,500 –
Printing & Stationery 126,000 –
Commission 774,000 –
Carriage Inward 430,500 –
Salary 2,097,000 –
Motor Van 3,195,000 –
Investments 1,500,000 –
TOTAL 45,750,000 45,750,000
Stock in hand on 30th September, 2018 was Rs. 2,040,000
Problem 05
The following balances are extracted from the books of Tanvir & Sons
Particulars Amounts Particulars Amounts
Capital 108,000 Sale 540,000
Drawings 18,000 Sales Return 7,200
Furniture & Fitting 9,360 Discount Allowed 5,760
Bank Overdraft 15,120 Discount Received 7,200
Creditors 49,680 Taxes & Insurance 7,200
Business Premises 72,000 General Expenses 14,400
Stock on 1-7-2016 79,200 Salaries 32,400
Debtors 64,800 Commission (Dr.) 7,920
Rent (Cr.) 3,600 Carriage 6,480
Purchases 396,000 Bad Debts 2,880

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 You are required to prepare the Trading and Profit & Loss Account for the
year ended on 30th June, 2017 and Balance Sheet as at date. Closing Stock as on
30th June, 2017 was Rs. 75,000.
6. SUMMARY
The process or procedure through which accounting works flow is known as
the accounting cycle. Accounting cycle starts with the recording of transactions in
Journals and end with the preparation of Final Accounts. Final accounts are those
accounts which are prepared at the end of each accounting period to ascertain the
profit or loss and the financial position of an entity. Final accounts present the
complete summary of the business about its operation during a particular period,
whether is it profitable or not? And also tells the financial strength of an entity that
how much assets any business owns and how much liabilities it owes at the end of
specific period. There are five elements of Final Accounts, which are used to
prepare the financial statements or the final accounts. The five elements are Assets,
Liabilities, Equity, Revenue and Expenses. All these five elements are further
classifies in sub heads i.e., current and fixed assets, short and long term liabilities,
direct and indirect revenue and in the same way the direct and indirect expenses.
There are five components or parts of the final accounts which are prepared
by every type business. Usually the manufacturing businesses prepare the Trading
account, Profit and Loss account and Balance Sheet. To know the gross results of
the business trading Account is prepared, where as the purpose of profit and loss
account is to get the net profit or loss account resulting in the operation of
business. The balance sheet is prepared at the particular date to know the financial
position of business, describing the detail of assets, liabilities and equity balances
as on that date.
BIBLIOGRAPHY
Ahmad, M. M., Khan, S. A., Arshad, M., & Shah, S. M. (2013). Advanced
Financial Accounting. Islamabad: National Book Foundation Islamabad.
Dupree, D., & Marder, M. (1984). Principles of Accounting. Addison-Wesley.
Farooq, U., & Amir, S. M. (2008). Principles of Accounting. Islamabad: Allama
Iqbal Open University.
Hussain, K., Buttar, Z. U., Pirach, M. A., & Chaudhry, M. I. (1996). Accounting
Principles. Lahore: Orient Publishers Urdu Bazaar Lahore.
Mukherjee, A., & Hanif, M. (2003). Modern Accountancy I. Tata McGraw-Hill
Education.
Randall, H. (2005). Accounting. Cambridge University Press.
Wood, F., & Sangster, A. (2008). Business Accounting I. Pearson Education.
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Unit–7

ADJUSTMENTS AND THEIR

EFFECTS ON FINAL ACCOUNTS

Written by: Muhammad Munir Ahmad

Reviewed by: Dr. S.M. Amir Shah

190
 CONTENTS

INTRODUCTION
OBJECTIVES
1. INTRODUCLTION
1.1 Definitions and Explanation of Important Terms
1.1.1 Accounting Period
1.1.2 Adjustments
1.1.3 Adjusting Entries
1.1.4 Accounting System
2. TYPES OF ADJUSTMENTS
2.1 Closing Stock
2.2 Accrued Expenses
2.3 Accrued Revenue
2.4 Prepaid Expenses
2.5 Unearned Revenue
2.6 Depreciation
2.6.1 Methods of Recording Depreciation
2.7 interest on Capital
2.8 Interest on Drawings
2.9 Provision for Bad and Doubtful Debts
2.9.1 Classification of Debts
2.9.2 Accounting for Provision of doubtful Debts
2.9.3 Formulae for Calculation
3. ILLUSTRATIONS
4. SELF-ASSESSMENT QUESTIONS
4.1 Choose the Best Options
4.2 Give the Short Answers of the Following Questions
5. PROBLEMS
6. SUMMARY
REFERENCES/BIBLIOGRAPHY

191
INTRODUCTION
This unit describes the concept of adjustments in the “Final Accounts”. In
this unit various types of adjustments are discussed with their description and
effects on the final account. The effects of each adjustment are illustrated
following the description of adjustments. At the end of the unit, solved examples
are given for understanding of the topic and various problems are also described
for the better practice of the students.

OBJECTIVES
After studying this unit, you will be able to:
1. Understand the concept of adjustments
2. Differentiate between cash basis and accrual basis accounting
3. Know the impacts of adjustments on Final Accounts
4. Journalize the adjusting entries
5. Solve the exam oriented questions related to adjustments

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1. INTRODUCTION
Final accounts have to be prepared by every business at the end of its
accounting period; which is generally a year. Owners and all other stakeholders
are interested to know whether the business earned profit or sustained loss in the
accounting year and what is the position of its assets and liabilities at that point in
time. Hence all ledgers are closed and their balances are worked out. The
balances are transferred to trial balance to check the accuracy of the ledgers. But
before preparing final accounts, it becomes necessary to examine whether all the
expenses and incomes for the accounting period for which accounts are prepared
have been duly provided for and included in the accounts. It is just possible that
some transactions are missed for recording, some are not recorded properly.
These transactions must be properly dealt with before the preparation of final
accounts, so that correct profit or loss may be ascertained. The recording of such
transactions in the books is known as adjustments.
Besides this, there are some incomes or expenses, which are related to the
next year but have been received or paid during the current year. Before preparing
trading and profit & loss accounts, adjustments are necessary in these accounts.
Final accounts must observe the matching principle. If a transaction entered is not
related to the current year, fully or partly, that portion of income or expense must
be excluded. This process is made through adjusting entries in the books of
accounts. If we ignore to make the necessary adjustments, the final accounts-
trading, profit & loss accounts and balance sheet fails to depict true and fair view
of the financial affairs of the business of that particular year. This situation defeats
the very purpose of final accounts. Therefore, adjusting entries play an important
role in presenting correct picture of accounts.
1.1 Definitions and Explanation of Important Terms
Before we start the discussions upon various types of adjustments we
should understand some key concepts relating to this chapter:
1.1.1 Accounting Period
“The span of time covered by an income statements or Profit & Loss A/c is
known as accounting period of an entity”.
The activities of an organization may be divided into specific time periods
such as a year, a six month interval, a quarter, or a month. Most entities use a year
as their primary period. Final accounts covering a one-year period are known
Annual Final Accounts. Many businesses also prepare annual accounts covering
one, three, or six months of activities, known as interim final accounts.

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1.1.2 Adjustments
Adjustments may be defined as:
“To make a correct record of a transaction which has not been entered or
which has been entered only in an incomplete or wrong way”.
The purpose of adjustments is to prepare a perfectly accurate set of Final
Accounts for accounting period under review, and a perfectly true Balance Sheet
as at the present date.
Adjusting Entries
“Those entries which are passed at the end of each accounting period to
update the balances of accounts are known as adjusting entries”.
Every adjusting entry is posted in two ledger accounts. One impact may be
on revenue or expenses account and other impact on the assets or liabilities or
owner’s equity. So we may say that, every adjusting entry will affect the Trading,
Profit & Loss A/c and the Balance Sheet.
1.1.3 Accounting System
The system through which profit or loss of the business is ascertained is
known as accounting system. There are two main types of accounting system (a)
cash system (b) accrual system.
(a) Cash Basis Accounting System
“The system under which profit or loss of the business is calculated on the
basis of only the items of revenue received in cash and the items of expenses paid
in cash whether they relate to the current accounting period or not is known as
cash basis accounting system”.
Under this system of accounting, amount received is considered as revenue
and amount paid is treated as expenses, while calculating the profit or loss of the
business. All those revenues which have been earned but not received, like credit
sales, will not be treated as revenue and those expenses which have been incurred
but not paid will not be considered as expenses until cash is paid. It means that
the cash basis net profit or loss for the period is the difference between cash
receipts and cash payments.
(b) Accrual Basis Accounting System
“The system under which profit or loss of the business is ascertained by
considering all items of revenues either cash received or not and all items of
expenses either cash paid or not which relate to current accounting period”.
Under this system of accounting, revenue earned, whether received or
receivable, and expenses incurred, whether paid or payable, are taken into account
for calculating the profit or loss of the business for accounting period. Accrual
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basis system of accounting uses the adjusting process to recognize revenue when
earned and expenses when incurred (matched with revenues).It is commonly held
that accrual system is better to reflect business performance than cash basis
accounting.
2. TYPES OF ADJUSTMENTS
The following are the some important adjustments, which are usually made
at the end of the each accounting period:
i. Closing Stock
ii. Accrued Expenses
iii. Accrued Revenues
iv. Prepaid Expenses
v. Unearned Revenues
vi. Depreciation
vii. Interest on Capital
viii. Interest on Drawings
ix. Provision for Bad and Doubtful Debts
2.1 Closing Stock
Stock remained unsold at the end of the accounting period is known as
closing stock. Every business prepares a list of unsold inventory at the end of the
accounting period and puts value against it. Stock may be valued at cost or market
price, whichever is less.
2.1.1 Adjusting Entry
Closing Stock A/c……….Dr
Trading A/c…………Cr
2.1.2 Effects
i. Closing Stock will be shown on the credit side of Trading A/c.
ii. Being the real account, it will be shown the assets side of the Balance Sheet
as the Current Assets.
TRADING ACCOUNT
For the period ended on -------
Dr Cr
Particulars Amount Particulars Amount
By Closing Stock Xxxx

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 BALANCE SHEET
As on ---------
Assets Amount Liabilities Amount
Closing Stock xxxx

2.1.3 Hint
Closing stock is normally shown at the bottom of trial balance as an
adjustment, but sometimes opening and closing stocks are adjusted through
purchases. In this case, closing stock appears in the debit side of Trial Balance
will not be shown on the credit side of the Trading Account but will be shown on
the assets side of Balance Sheet only.
2.2 Accrued Expenses
Those expenses which have been incurred during the current period but not
paid and recorded in the books of accounts till the end of accounting period are
known as accrued expenses, outstanding expenses, expenses due or expenses
payable etc. In other words, services or benefits from these expenses have been
received but payments have not been made till the end of period.
2.2.1 Example
Mr. Ali closed his books of accounts on December, 2012. At the end of the
accounting period he comes to know that Salary of an employee for the month of
December, 2012 amounting Rs. 5,000 is not paid.
2.2.2 Adjusting Entry
Date Particulars Debit Credit
31/12/12 Salaries Expenses A/c Rs. 5,000
Salaries Payable A/c Rs. 5,000
2.2.3 Effects
i. Salaries Expenses will be recorded in the debit side of Profit & Loss A/c
ii. Salaries Payable will be shown as current liability in the liabilities side of
Balance Sheet.
PROFIT & LOSS ACCOUNT
For the period ended on -------
Dr Cr
Particulars Amount Particulars Amount
To Salaries Expense A/c 5,000

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 BALANCE SHEET
As on ---------
Assets Amount Liabilities Amount
Salaries Payable 5,000

2.3 Accrued Revenue

Those revenues which have been earned but not received and recorded in the
books of accounts till the end of accounting period are known as accrued revenues, or
revenue receivable etc. In other words, services rendered by a business or properties
of the business used by someone, but the remunerations for services rendered or
return of the property used is not received during the current period, will be
considered as accrued revenue.
2.3.1 Example
Rs. 8,000 interest on investment is due on June 30th, 2013 and not received
till the end of accounting period.
2.3.2 Adjusting Entry
Date Particulars Debit Credit
30/06/13 Interest Receivable A/c Rs. 8,000
Interest on Investment Rs. 8,000
A/c

2.3.3 Effects
i. Interest on Investment will be recorded on credit side of Profit & Loss A/c
ii. Interest Receivable will be shown as current assets in of Balance Sheet.
PROFIT & LOSS ACCOUNT
For the period ended on -------
Dr Cr
Particulars Amount Particulars Amount
By Interest Revenue A/c 8,000

BALANCE SHEET
As on ---------
Assets Amount Liabilities Amount
Interest Receivable 8,000

2.4 Prepaid Expenses

The expenses which have been paid during the current accounting period
197
but the services or benefits from those expenses have not been received till the
end of period in which these expenses are paid and the benefits from these
expenses will be received in next accounting period are known as prepaid
expenses, expense paid in advance or unexpired expenses. In other words,
expenses of next period paid in current accounting period are considered as
prepaid expenses.
2.4.1 Methods of Recording:
Prepaid or unexpired expenses may be recorded in two ways:
a. Prepaid expenses initially recorded as expenses
b. Prepaid expenses initially recorded as assets
2.4.2 Example
On November 1st 2012, Mr. Yellow paid rent of office building for the next
six months amounting Rs. 18,000. He closes his books at the end of each year.
Pass the necessary entries as on November 1st and December 31st.
a. Amount paid in advance initially recorded AS EXPENSES
Date Particulars Debit Credit
01/11/12 Rent Expenses A/c Rs. 18,000
Cash A/c Rs. 18,000
To record the payment of rent
expenses
Adjusting Entry
31/12/12 Prepaid Rent A/c Rs. 12,000
Rent Expenses A/c Rs. 12,000
To record the unexpired portion
of rent expenses. (18,000 x4/6)
Effects
i. Amount of Rs. 12,000 will be deducted from the rent expenses given in the
trial balance and Rs. 6,000 will be shown on the debit side of Profit & Loss
A/c
ii. Rs. 12,000 will be shown as current assets in Balance Sheet.
PROFIT & LOSS ACCOUNT
For the period ended on -------
Dr Cr
Particulars Amount Particulars Amount
Rent Expenses Rs. 18,000
(-) Prepaid Rent Rs. Rs. 6,000
12,000
198
 BALANCE SHEET
As on ---------
Assets Amount Liabilities Amount
Prepaid Rent Rs. 12,000

b. Amount paid in advance initially recorded AS ASSETS

Date Particulars Debit Credit
01/11/12 Prepaid Rent A/c Rs. 18,000
Cash A/c Rs. 18,000
To record the payment of rent
expenses
Adjusting Entry
31/12/12 Rent Expenses A/c Rs. 6,000
Prepaid Rent A/c Rs. 6,000
To record the unexpired portion
of rent expenses. (18,000 x2/6)
Effects:
i. Amount of Rs. 6,000 will be shown on the debit side of Profit & Loss A/c
ii. Amount of Rs. 6,000 will be deducted from the Prepaid Rent given in the
trial balance and Rs. 12,000 will be shown as current assets in Balance
Sheet.
PROFIT & LOSS ACCOUNT
For the period ended on -------
Dr Cr
Particulars Amount Particulars Amount
Rent Expenses Rs. 6,000

BALANCE SHEET
As on ---------
Assets Amount Liabilities Amount
Prepaid Rent Rs.
18,000 Rs. 12,000
(-) Rent expired Rs.
6,000

199
Hint
This payment may be divided into two portions. The portion, for which
benefits have been received, is recorded as expenses and the portion for which
benefit is to be received in the coming accounting period is known as prepaid or
unexpired expenses.
Remember that, whichever method is used for recording the prepaid
expenses, the expired portion will be shown as expenses in Profit & Loss A/C and
the unexpired portion will be recorded as assets in Balance Sheet.
2.5 Unearned Revenue
That amount of revenue which has been received in advance but the
services have not been provided fully or partly against that revenue till the end of
accounting period is known as unearned revenue or revenue received in advance.
Unearned Revenue is a liability to render services in future for which payment has
been received.
2.5.1 Methods of Recording:
Like the prepaid expenses, unearned revenue may be recorded in two ways:
a. Unearned revenue initially recorded as revenue.
b. Unearned revenue initially recorded as Liability.
Example
On August 1st 2012, Mr. Blue signed a contract with his client to perform
repair and maintenance services for next six months, and received amounting Rs.
12,000 in advance against the repair services. He closes his books at the end of
each year. Pass the necessary entries as on August 1st and December 31st.
a. Amount received in advance initially recorded AS REVENUE
Date Particulars Debit Credit
01/08/12 Cash A/c Rs. 12,000
Repair Revenue A/c Rs. 12,000
To record the receipt of revenue
in advance
Adjusting Entry:
31/12/12 Repair Revenue A/c Rs. 2,000
Unearned Repair Revenue A/c Rs. 2,000
To record the Unearned portion of
Repair Revenue. (12,000 x1/6)
Effects
i. Amount of Rs. 2,000 will be deducted from the Repair Revenue given in the
trial balance and Rs. 10,000 will be shown on the credit side of Profit &
200
 Loss A/c
ii. Rs. 2,000 will be shown as Unearned Repair Revenue in current Liability of
Balance Sheet.
PROFIT & LOSS ACCOUNT
For the period ended on -------
Dr Cr
Particulars Amount Particulars Amount
Repair Rev Rs.
12,000 Rs. 10,000
(-)Unearned Rev Rs.
2,000
BALANCE SHEET
As on ---------
Assets Amount Liabilities Amount
Unearned Repair Revenue Rs. 2,000

a. Amount paid in advance initially recorded AS LIABILITY

Date Particulars Debit Credit
01/08/12 Cash A/c Rs. 12,000
Unearned Repair Rs. 12,000
Revenue A/c
To record the receipt of revenue
in advance as Liability
Adjusting Entry:
31/12/12 Unearned Repair Revenue A/c Rs. 10,000
Repair Rs. 10,000
Revenue A/c
To record earned portion of
revenue.(12,000 x 5/6)
Effects
i. Amount of Rs. 10,000 will be shown on the credit side of Profit & Loss A/c
as Repair Revenue.
ii. Amount of Rs. 10,000 will be deducted from the Unearned Repair Revenue
given in the trial balance and Rs. 2,000 will be shown as current liability in
Balance Sheet.

201
 PROFIT & LOSS ACCOUNT
For the period ended on -------
Dr Cr
Particulars Amount Particulars Amount
Repair Service Rs. 10,000
Revenue

BALANCE SHEET
As on ---------
Assets Amount Liabilities Amount
Unearned Repair Rs.
12,000 Rs. 2,000
(-) Revenue Earned Rs.
10,000
Hints
The amount received in advance may be divided into two portions. The
portion, for which services have been performed, is recorded as revenue and the
portion for which services are to be performed in the coming accounting period is
known as unearned revenue.
Whichever method of recording is used in respect of unearned revenue, in
both of the cases the earned portion will be shown as revenue in Profit & Loss
A/C and the unearned portion will be recorded as liability in balance sheet.
2.6 Depreciation
Depreciation may be defined as “The process of allocating the cost of Fixed
Assets to expenses throughout the accounting periods benefiting its use”.
Depreciation is charged only on fixed tangible assets, except the land,
which are used in business operations and have useful life of more than one
accounting period. The cost of these fixed tangible assets is allocated as expenses
gradually over the periods of use. This gradual conversion cost into expenses is
termed as depreciation. Depreciation doesn’t measure the decrease in market
value each period, nor does it determine the physical deterioration of assets due to
wear and tear or obsolescence.
2.6.1 Methods of Recording Depreciation:
There are various methods to calculate depreciation on fixed tangible assets.
The methods of calculating depreciation vary according to the requirement of
business and according to the nature of assets. Some of the methods of calculating
depreciation are as follows:
202
i. Original cost /Fixed Installment/Straight line depreciation method
ii. Reducing balance method
iii. Sum of year digit method
iv. Units of production method
In most of the examples and problems original cost method for calculating
the depreciation is used in this unit, except some examples where stated clearly
the other method of depreciation.
2.6.2 Example
On January 1st 2010, Mr. Akmal bought an office equipment of Rs.
140,000. Depreciation is to be charged @10% p.a on the original cost. Mr. Akmal
closes his books at the end of each calendar year. Pass the necessary entry to
record the depreciation as on 31st December, 2012. Trial balance shows the
accumulated balance of depreciation Rs. 28,000.
2.6.3 Adjusting Entry:
31/12/12 Depreciation expenses A/c Rs. 14,000
Accumulated Dep. A/c Rs. 14,000
To record the depreciation on
the office equipment for the
year. (140,000x10%)
2.6.4 Effects
i. Amount of Rs. 14,000 will be recorded as expenses on the debit side of
Profit & Loss A/c.
ii. Rs. 14,000 will be added in accumulated depreciation and will be deducted
from the cost of equipment and will be shown in fixed assets of Balance
Sheet.
PROFIT & LOSS ACCOUNT
For the period ended on -------
Dr Cr
Particulars Amount Particulars Amount
Depreciation Expenses Rs. 14,000
BALANCE SHEET
As on ---------
Assets Amount Liabilities Amount
Office Equipment Rs.
140,000 Rs. 98,000
(-) Acc. Dep. Rs.
42,000
203
2.6.5 Hints
If the amount of depreciation expenses is shown in the trial balance, then no
need to pass adjusting entry, just the amount of depreciation will be added in
accumulated depreciation and deducted only from the cost of respective assets in
balance sheet.
2.7 Interest on Capital
Amount of interest charged by the owner on the amount invested into the
business, would be considered as interest on capital.
Sometimes, in partnership business, owner desired to get the fixed percentage on
the amount invested into the business apart from profit. This interest would be
treated as expense for the business and profit for the owner of the business.
2.7.1 Example
Mr. Ijaz and Mr. Sajjad have capital balances Rs. 100,000 and Rs. 150,000
respectively. It is agreed that interest on capital @ 10% would be allowed. Make
necessary entry to record the interest on capital.
2.7.2 Adjusting Entry
31/12/12 Interest on Capital A/c Rs. 25,000
Mr. Ijaz’s Capital A/c Rs. 10,000
Mr. Sajjad’s Capital A/c Rs. 15,000
To record the interest on capital
@ 10%.
2.7.3 Effects
i. Amount of Rs. 25,000 will be recorded as expenses on the debit side of
Profit & Loss A/c.
ii. Rs. 10,000 and Rs. 15,000 will be added in the respective Capital accounts
of the owner’s in Balance Sheet.
PROFIT & LOSS ACCOUNT
For the period ended on -------
Dr Cr
Particulars Amount Particulars Amount
Interest on Capital Rs. 25,000

204
 BALANCE SHEET
As on ---------
Assets Amount Liabilities Amount
Mr. Ijaz’s Capital Rs. 100,000
(+) Interest Rs. 10,000 Rs. 110,000

Sajjad’s Capital Rs. 150,000

(+) Interest Rs. 15,000 Rs. 165,000
2.8 Interest on Drawings
Interest paid by the owner to the business on the amount of cash or goods
drawn for personal use.
If the owner desired to get fixed percentage on the capital invested into the
business, then it is more logical that the owner should pay the interest on
drawings to the business. Interest on drawings is revenue for the business and
expenses for the owner.
2.8.1 Example
Mr. Black and Mr. White have capital balances Rs. 200,000 and Rs.
300,000 and withdraw cash Rs. 20,000 and Rs. 15,000 respectively. It is agreed
that interest on drawings @ 10% would be charged. Make necessary entry to
record the interest on drawings.
2.8.2 Adjusting Entry:
31/12/12 Mr. Black’s Drawing A/c Rs. 2,000
Mr. White’s Drawing A/c Rs. 1,500
Interest on Drawings A/c Rs. 3,500
To charge interest on Drawings @ 10%.
2.8.3 Effects
i. Amount of Rs. 3,500 will be recorded as revenue on the credit side of Profit
& Loss A/c.
ii. Rs. 2,000 and Rs. 1,500 will be deducted from the respective Capital
accounts in Balance Sheet.
PROFIT & LOSS ACCOUNT
For the period ended on -------
Dr Cr
Particulars Amount Particulars Amount
Interest on Drawings Rs. 3,500

205
 BALANCE SHEET
As on ---------
Assets Amount Liabilities Amount
Black’s Capital Rs.
200,000 Rs. 198,000
(-) Interest Rs.
2,000
Rs. 298,500
White’s Capital Rs.
300,000
(-) Interest Rs.
1,500
2.8.4 Hints
It is better to add the interest on drawings in the amount of drawings and the
cumulative amount is deducted from the capital account.
2.9 Provision for Bad and Doubtful Debts
Every business sells goods on cash and credit both to increase the volume of
sales, because in this era of competition, no business can grow without providing
credit facility. When the goods are sold on credit to customer, then the customer
becomes the “Debtor” of the business and the amount due from the debtor is
termed as “Debts”.
2.9.1 Classification of Debts
Amount due from the debtor may be classified as follows from the recovery
point of view:
a. Good Debts
b. Bad Debts
c. Doubtful Debts
c. Good Debts
That portion of debts which has been recovered fully by the business from
the debtor is classified as Good Debts and the concerned debtor is called Good
Debtors. When the amount is received from the debtor, the following journal
entry will be passed:
Date Particulars Debit Credit
xxxxx Cash A/c xxxxx
Debtor’s A/c xxxxx
To record the receipt of cash from
debtor.
206
d. Bad Debts
That portion of debts which are irrecoverable or cannot be realized in future
also from the debtors is classified as Bad debts or Uncollectible and the debtor
from whom the business fails to recover the debt is known as Bad Debtors.
Debtors turned into bad debts due to the following reasons:
 Death of the debtors
 Insolvency of the debtors
 Disappearance of debtor’s business
 Unforeseen causes
2.9.2 Example
Mr. Waseem sold goods to Mr. Hanif on credit amounting Rs. 20,000 on
October 25, 2012. On due date, Mr. Hanif fails to pay the debt due to bankruptcy.
Pass the necessary journal entries to record the bad debts.
Date Particulars Debit Credit
25/10/2012 Bad Debts A/c Rs. 20,000
Mr. Hanif’s A/c Rs. 20,000
Amount of debts written off as bad
debts.
31/12/2012 Profit & Loss A/c Rs. 20,000
Bad Debts A/c Rs. 20,000
Transfer the bad debts to profit &
loss a/c .
2.9.3 Effects
Bad Debts are the loss for business and will be charged to profit and loss
account. The account of debtor will be credited and closed also.
2.9.4 Recovery of Bad Debts
Sometimes debts which have been written off as bad debts may be
recovered. The bad debts recovered will be treated as revenue for the business.
In continuation of the last example, supposed that on August 08, 2013, Mr. Hanif
paid the amount due to him, the following journal entry will be passed:

Date Particulars Debit Credit

08/08/2013 Cash A/c Rs. 20,000
Bad debts recovered A/c Rs. 20,000
To record the recovery of bad
debts.

207
e. Doubtful Debts
The debts, whose recovery is uncertain or doubtful, are termed as “Doubtful
Debts”. These debts may or may not become the loss for the business.
2.9.5 Difference between doubtful debts and bad debts
Sr. Point of
Doubtful Debts Bad debts
No Difference
It is expected loss for the
It is confirmed loss for the
1. Loss business, which may or may not
business
occur.
No provision is necessary
Provision is required for the for the bad debts, because
2. Provision
doubtful debts provision has been already
made against possible loss
It is recorded in balance sheet
under the head
It is just shown in profit &
3. Presentation “Provision/Allowance for
Loss A/c as expenses
Doubtful Debt” and deducted
from Balance Sheet
There is no possibility of
Chance of There is chance of recovery in recovery, however, in rare
4.
Recovery future. cases, Bad Debts may be
recovered.
2.9.6 Provision for Doubtful Debts
Amount set aside out of profit for the expected loss or liability, whose
amount cannot be determined exactly, is termed as Provision.
Provision for Doubtful Debts or Allowance for uncollectible means the
amount setting aside out of current profit to meet the possible loss on account of
bad debts. Provision for doubtful debts is charged to Profit & Loss A/c as
expenses and is deducted from the sundry debtors A/C in balance sheet.

2.9.7 Reasons for Provision

Due to the following two reasons, provision is made against the doubtful
debts:
a) The loss on account of bad debts should be charged to that accounting
period in which revenue is earned, instead of actually occurrence period
(Matching Principle).
208
b) The true value of sundry debtors should be shown in the balance sheet.
2.9.8 Example
M/s Asad & Bro. sold goods to M/s Rahim & Sons amounting Rs. 50,000
on March 25, 2013 and recovered Rs. 30,000 from debtor during April 2013. A
provision is required @ 5% for doubtful debts at the end of accounting period as
on June 30, 2013.
Date Particulars Debit Credit
30/06/2013 Profit & Loss A/c Rs. 1,000
Provision for Doubtful debts Rs. 1,000
A/c
To record provision for doubtful
debts @ 5%.
2.9.9 Accounting for Provision of Doubtful Debts
If the accounting period start with the balance of Provision of Doubtful
Debts then the actual bad debts will be closed to provision of doubtful debts, (if
occurred). There may be two conditions:
a) If the Actual Bad debts are equal to or less than the provision of Doubtful
Debts then the whole amount of Bad Debts will be closed to Provision A/c, as:
Provision for Doubtful Debts A/c…………. Dr
Bad Debts A/c ……………………………..Cr
b) If the Actual Bad Debts exceeds than the Provision for Doubtful Debts then
the Excess amount will be charged to Profit & Loss A/c, as:
Provision for Doubtful Debts A/c…………. Dr
Profit & Loss A/c………………………… Dr
Bad Debts A/c ……………………………..Cr
2.9.10 Formulae for Calculation
The following formulae may be used for calculation and accounting
treatment of the bad debts:

Old Bad Debts (Given in T.B Debit Side) xxxxx

(+) New Bad Debts (Given in Adjustments) xxxxx
(+) New Allowance for Doubtful Debts (Given in Adjustments) xxxxx
Subtotal xxxxx
(-) Old Allowance for Doubtful Debts (Given in T.B Credit Side) xxxxx
Balance Transferred to P & L A/c xxxxx

209
 If the amount of subtotal (Old & New Bad Debts and New Allowance)
exceeds than the Old Allowance/ Provision, then the excess amount will be shown
as loss/expenses on the debit side of Profit & Loss Account.
In case, old Allowance exceeds than the Sub-total then the excess amount
will be shown as income on credit side of Profit & Loss A/c.
In Balance Sheet, New Bad Debts and New Allowance/Provision will be
deducted from Sundry Debtors A/c and the net Debtors will be shown in Asset
Side.
2.9.11 Example
On December 31, 2012 the trial balance shows the following balances:
Bad Debts ......................................................................... Rs. 9,000
Sundry Debtors ................................................................ Rs. 85,000
Provision for Doubtful Debts ........................................... Rs. 12,000
Bad Debts written off amounting Rs. 5,000 and provision is provided @ 10% for
Bad & Doubtful Debts. Pass the necessary adjusting entries and show the effects
on Profit & Loss A/c and Balance Sheet.
Date Particulars Debit Credit
31/12/2012 Bad Debts A/c Rs. 5,000
Sundry Debtor A/c Rs. 5,000
Debts are written off as Bad Debts
31/12/2012 Provision for Bad Debts A/c Rs. 5,000 Rs. 5,000
Bad Debts A/c
Bad Debts written off transferred
31/12/2012 Profit & Loss A/c Rs. 8,000 Rs. 8,000
Provision for Bad debts A/c
To record the Provision for Doubtful
Debts

Old Bad Debts Rs. 9,000

(+) New Bad Debts 5,000
(+) New Allowance for doubtful Debts (85,000-5000 * 10%) 8,000
Subtotal
22,000
(-) Old Allowance for Doubtful Debts 12,000
Balance Transferred to P & L A/C Rs. 10,000

210
 PROFIT & LOSS ACCOUNT
For the period ended on December 31, 2012
Dr Cr
Particulars Amount Particulars Amount
Bad Debts Expenses Rs. 10,000

BALANCE SHEET
As on December 31, 2012
Assets Amount Liabilities Amount
S. Debtors Rs. 85,000
(-) Bad Debts 5,000
80,000
(-) Provision for B.D 8,000 Rs. 72,000
3. ILLUSTRATIONS
Illustration No. 1
Debit Credit
Rs. Rs.
Opening Stock 115,200
Cash in hand 10,800
Cash at bank 52,600
Purchases 813,500
Returns inward (Sales return) 13,600
Wages 169,600
Fuel & power 94,600
Carriage on sales 64,000
Carriage on purchases 40,800
Building 640,000
Land 200,000
Machinery 400,000
Salaries 300,000
General expenses 60,000
Drawings 12,000
Insurance 104,900
Sundry Debtors 290,000
Sales 1,975,600
Returns outwards (Purchase returns) 10,000
Capital 1,090,000
211
Sundry Creditors
126,000
Rent Received 180,000
Total 3,381,600 3,381,600
* Closing stock is valued at Rs. 136,000
* Salaries for the month of March 2013 amounting to Rs. 30,000 are unpaid
* Insurance is paid in advance to the extent of Rs. 13,000
* Rent receivable is Rs. 20,000
Pass the Adjusting
a) Entries.
b) Prepare Trading and Profit and Loss A/C, and
c) Balance Sheet as on 31-03-2013
Solution
Adjusting Entries
Date Particulars Debit Credit
31/03/2013 Closing Stock A/c Rs. 136,000
Trading A/c Rs. 136,000
To record the stock at the end of
the accounting period
31/03/2013 Salaries Expenses A/c Rs. 30,000
Salaries Payable A/c Rs. 30,000
To record the accrued Salaries
31/03/2013 Prepaid Insurance A/c Rs. 13,000
Insurance Expenses A/c Rs. 13,000
To record the unexpired portion of
Insurance expenses
31/03/2013 Rent Receivable A/c Rs. 20,000
Rent Revenue A/c Rs. 20,000
To record the accrued rent revenue
Naeem Traders
Trading and Profit and Loss A/C
For the year ended on 31-03-2013
Amount Amount
Particulars Particulars
Rs. Rs.
To Opening Stock 115,200 By Sales
To Purchase 813,500 1,975,600 1,962,000
Less: Purchases Return 10,000 803,500 Less Sales Return 13,600
212
To Fuel & Power 94,600 136,000
To Wages 169,600 Closing Stock
To Carriage on Purchase 40,800
Gross Profit c/d 874,300

2,098,000 2,098,000

To Salaries 300,000 874,300

Add: Outstanding Salaries 30,000 330,000 Gross Profit b/d

To. Gen. Exp By Rent Received 180,000 200,000

To Carriage on Sale Add: Rent Received 20,000
To Insurance 104,900
Less Prepaid Insurance 13,000 91,000
To Depreciation on Machinery 40,000
To Depreciation on Building 64,000

Net Profit 424,400

Total 1,074,300 Total 1,074,300
Naeem Traders
Balance Sheet
As on 31-03-2013
Assets Amount Rs Liabilities Amount Rs
Cash at Bank 52,400 Accounts Payable / 126,000
Cash in Hand 10,800 Creditors 30,000
Accounts Receivable / Debtors 290,000 Outstanding Salaries
Rent Receivable 20,000
Prepaid Insurance 13,000
Closing Stock 136,000

Machinery 400,000
Less: Depreciation 40,000 360,000

Building 640,000 Capital 1,090,000

Less: Depreciation (2) 64,000 576,000 Add: Net Profit 424,400 1,502,400
Land 200,000 Less: Drawings 12,000
Total Assets 1,658,400 Total Liabilities 1,658,400
213
Illustration No. 2
The following Trial Balance was extracted from the books of Salman Traders
on 31-12-2013
Investment Purchases Debit Rs. Credit Rs.
Investment 200,000
Purchases 300,000
Returns 8,000 10,000
Opening Stock 60,000
Plant 350,000
Discount 15,000 10,000
General Expense 10,000
Telephone Expenses 35,000
Salaries 45,000
Loan from MCB 100,000
Traveling 15,000
Accounts Receivable 90,000
Repair Expense 10,000
Advertisement 20,000
Furniture 60,000
Cash in Hand 32,000
Capital 600,000
Sales 470,000
Accounts Payable 60,000
1,250,000 1,250,000
Adjustments
1. Closing Stock Valued at 31-12-2013 for Rs. 40,000.
2. Interest on Investment is receivable @ 10% per year.
3. Interest on Loan from MCB is Payable @ 12% per year.
4. Telephone Expense for the month of March 2011 is still Payable Rs. 8,000.
5. Charge depreciation on Plant and Furniture @ 10%.
Required
a) Prepare Trading and Profit and Loss A/C, and
b) Statement of Financial Position as on 31-12-2013

214
Solution
Salman Traders
Trading and Profit and Loss A/C
For the year ended on 31st December, 2013
Amount Amount
Particulars Particulars
Rs. Rs.
To Opening Stock 60,000 By Sales 470,000
To Purchase 300,000 Less Sales Return 8,000
462,000
Less: Purchases Return 10,000 290,000
To Unloading Charges Closing Stock 40,000
Gross Profit c/d 152,000
502,000 502,000
To Salaries 45,000 Gross Profit b/d 152,000
Add: Outstanding Salaries 45,000
To discount Allowed 15,000 By Interest on Investment 20,000
To Telephone Exp 35,000 By Discount Received 10,000
Add: Exp Payable 8,000 43,000
To Gen Exp 10,000
To Travelling 15,000
To Repair 10,000 Net Loss 29,000
To Advertisement 20,000
To Interest on Loan 12,000
To Depreciation on Plant 35,000
To Depreciation on furniture 6,000
Total 211,000 Total 211,000
Salman Traders
Statement of Financial Position
As on 31st December, 2013
Amount Amount
Assets Liabilities
Rs. Rs.
Cash in Hand 32,000 Accounts Payable /Creditors 60,000
Accounts Receivable 90,000 Telephone Exp Payable 8,000
Interest Receivable 20,000 Interest on Loan 12,000
Closing Stock 40,000
Loan from MCB 100,000
Investment 200,000

215
 Furniture Capital 600,000
Less: Acc. Depreciation 6,000 54,000 Less: Net Loss 29,000
571,000

Plant 350,000
Less: Acc. Depreciation 35,000
315,000
Total Assets 751,000 Total Liabilities 751,000
Illustration No. 3
From the following Trail Balance of Chaudry & Co, you are required to
prepare Trading and Profit and Loss Account for the year ending 31st December,
2013 and a Balance Sheet as at that:
Dr. Dr.
Particular
Rs Rs
Land & Building 25,000
Furniture & Fixtures 26,000
Opening Stock 80,600
Drawings and Capital 64,000 280,000
Purchases & Sales 220,000 408,000
Debtors & Creditors 60,800 48,000
Returns 12,000 10,000
Loan from Bank 80,000
Wages & Salaries 53,000
Office Supplies 6,200
Bad Debts 8,400
Provision for Doubtful Debts 6,760
Cash in Hand 51,760
832,760 832,760
Total 1,665,520 1,665,520
Adjustments:
1. Closing Stock was valued at Rs. 100,000
2. Depreciate, Land & Building at 10%
3. Write off Rs. 4,800 bad debts from debtors and maintain reserve for
doubtful bets at 8%.
4. The manager is entitled to a commission of 10% on the net profit after
charging such commission.
5. Office Supplies on hand Rs. 1,200
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Solution
Chaudry & Co
Trading, Profit and Loss Account
For the Period ended on 31st December, 2013

Amounts Amounts
Particulars Particulars
Rs. Rs.
Opening Stock 80,6000 Sales 408,000
Less: Sales
Purchases 220,000 Return 12,000
Less: Purchase Returns 10,000 Net Sales 396,000
210,000
Closing Stock 100,000
Direct Expenses:
Wages & Salaries 53,000
Gross Profit (Bal c/d) 152,400
496,000 496,000
Gross Profit (Bal b/d) 152,400
Indirect Expenses:
Office Supplies (6,200-1,000) 5,000
Depreciation Expenses 25,000
(250,000*10%)
Bad Debts 8,400
Bad Debts Written Off 4,800
Reserve for Doubtful Debts
(60,800-4,800)*8%
17,680 10,920
Less: Old Provision
Manager’s Commission 10,135
(111,480*10/110)
Net Profit (Transferred to 101,345
Capital Account) 152,400 152,400

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 Chaudry & Co
Balance Sheet
As on31st December, 2013
Amounts Amounts
Assets Liabilities
Rs. Rs.
Current Assets: Current Liabilities:
Cash in Hand 51,760 Sundry Creditors 48,000
Sundry Debtors 60,800 Commission Payable 10,135
Bad Debts Written Off (4,800)
Provision for Debts (4,800) 51,520
Office Supplies 1,200
Closing Stock 100,000 Long Term Liabilities:
Bank Loan 80,000
Fixed Assets:
Land & building 250,000 Owner’s Equity:
Less: Acc. Dep. (25,000) 225,000 Capital
Furniture & Fixture 26,000 Add: Net Profit 101,345
Less: Drawings (64,000) 317.345

455,480 455,480
4. SELF ASSESSMENT QUESTIONS
4.1 Choose the best options:
i. Revenues are only recorded, when cash is received under the:
a. Single System
b. Double System
c. Cash Basis system
d. Accrual System
ii. Revenues are only recorded, when earned under the:
a. Accrual System
b. Single System
c. Cash Basis System
d. None of Above
iii. Those expense which are paid in advance are known as:
e. Accrued Expenses
f. Prepaid Expenses
g. Outstanding Expenses
h. Expenses Payable
218
 iv. The expense Due but not paid are called:
a. Accrued Expenses
b. Expenses Payable
c. Outstanding Expenses
d. All of the above
v. Bad debts are _______ for the business:
e. Assets
f. Revenues
g. Expenses
h. Income
vi. Interest on drawing is:
a. Revenues
b. Assets
c. Expenses
d. Loss
Answer
i. c ii. a iii. b iv. d v. c
vi. a
4.2 Give the short answers to the following questions:
i. Define the term bad debts.
ii. Why adjusting entries are passed?
iii. Differentiate accrual accounting system from the cash basis
system.
iv. Describe the term unearned revenue.
v. Why the provision for bad debts is created?
vi. What is accrued revenue?
vii. Pass the adjusting entry for interest on capital
viii. What do you understand by accumulated depreciation?
ix. Calculate the value of gross profit/Loss; if sales Rs. 500,000,
Direct Expenses Rs. 50,000, Purchases Rs. 250,000, Return in
wards Rs. 10,000, opening stock Rs. 35000, closing Stock Rs.
60,000
x. Classify the debts in various categories.

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5. PROBLEMS
Problem No 01
From the following balances taken from the books of Masood sons, Prepare
trading and profit and loss account for the year ended 31 st December, 2013 and a
balance sheet as on the data:
Particulars Amounts Rs. Particulars Amounts
Rs.
Capital 81,000 Rent 3,750
Returns Inward 4,500 Furniture 120,000
Sales 262,500 Rates & Taxes 2,250
Purchases 150,000 Discount Allowed 3,750
Returns Outward 1,500 General Expenses 22,500
Commission Received 56,250 Debtors 42,000
Custom Duty 11,250 Stock 33,750
Creditors 39,750 Cash at Bank 30,000
Cash in Hand 5,250 Drawings 12,000
Adjustments
1. Prepaid rent Rs. 750
2. Unearned commission Rs. 3,750
3. Closing Stock Rs. 41,000.
4. Depreciation on furniture @ 7.5% p.a
5. Rates & Taxes Payable Rs. 850.

Problem No 02
From the following trial balance, prepare a trading and profit and loss A/C
for the year ended on 31st December 2013 and balance sheet as at that date.
Particulars Debit Rs. Credit Rs.
Capital – 87,500
Motor Vehicle 19,000 –
Drawings 7,500 –
Purchases 260,000 –
Supplies 10,750 –
Accumulated Depreciation 3,800
Carriage in 9,250 –
Returns 8,000 6,000
Sales – 326,200
Salaries & Wages 16,250 –
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 Rent Expenses 5,000 –
Stock (1-1-13) 25,000 –
B/R and B/P 22,750 28,500
Cash in Hand 68,500 –
Total 452,000 452,000
Adjustments:
1. Outstanding Salary Rs. 750
2. Supplies on hand Rs. 3,750
3. Closing Stock Rs. 17,000.
4. Depreciation Motor Vehicle @ 10%
5. Goods drawn by proprietor for personal use Rs. 1,800.
Problem No 03
From the following Balances extracted from the books of Hussain Bros, on
st
31 March, 2014. You are required to prepare a Trading and Profit and Loss
account and a Balance sheet.
Debit Balance Plant 21,560
Office Equipment 98,000 Insurance 21,000
Opening stock 49,000 Rent & Rates 4,900
Purchases 105,000 Bills Receivable 30,800
Sales Return 3,920 Investment in Shares 22,400
Freehold Land & Building 84,000 Drawings 12,600
Carriage Inward 2,100 Cash in Hand 49,630
Carriage Outward 4,100 Credit Balance
Sundry Debtors 67,200 Bank Overdraft 6,700
Cash at Bank 5,000 Capital 217,000
Wages & Salaries 30,000 Purchases Returns 2,800
Manufacturing Expenses 5,700 Sales 350,000
Trade Expenses 490 Sundry Creditors 35,000
Interest on Overdraft 2,100 Bank Loan 8,000
Adjustments
1. Closing stock was valued at Rs. 103,600.
2. Trade Expenses due amounting Rs. 550.
3. Provide 5% on debtors for bad debts and 2% for discount.
4. The manager is entitled to a commission of 10% on net profit before
charging such commission.
5. Allow interest on Capital @ 4% p.a.

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Problem No 04
The following balances are extracted from the books of Bilal Corporation.
Particulars Amounts Particulars Amounts
Rs. Rs.
Capital 388,800 Sale 1,944,000
Drawings 64,800 Sales Returns 25,920
Furniture & Fitting 33,696 Discount Allowed 20,736
Bank Overdraft 54,432 Discount Received 25,920
Creditors 178,848 Taxes & Insurance 25,920
Business 259,200 General Expenses 51,840
Stock on 1-7-2012 285,120 Salaries 116,640
Debtors 233,280 Rent Expenses 28,512
Unearned Commission 12,960 Dock Charges 23,328
Purchases 1,425,600 Bad Debts 10,368
You are required to prepare the Trading and Profit & Loss Account for the
year ended on 30th June, 2013 and Balance Sheet as at date after considering the
following information:
1. Closing Stock as 30th June, 2013 was Rs. 75,000
2. Charge interest on drawings Amounting Rs. 1,200
3. Interest on Bank Overdraft is due amounting Rs. 2,200
4. Commission revenue earned amounting Rs. 10,000
5. Charge depreciation on Furniture & Fitting and Business Premises @ 10%
and 15% respectively.
6. SUMMARY
Accounting Period
The span of time covered by an income statements or Profit & Loss A/c is
known as accounting period of an entity.
Adjustments
To make a correct record of a transaction which has not been entered or
which has been entered only in an incomplete or wrong way.
Adjusting Entries
Those entries which are passed at the end of each accounting period to
update the balances of accounts are known as adjusting entries.
Cash Basis Accounting System
The system under which profit or loss of the business is calculated on the
basis of only the items of revenue received in cash and the items of expenses paid
in cash whether they relate to the current accounting period or not is known as
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cash basis accounting system.
Accrual Basis Accounting System
The system under which profit or loss of the business is ascertained by
considering all items of revenues either cash received or not and all items of
expenses either cash paid or not which relate to current accounting period.
Closing Stock
Stock remained unsold at the end of the accounting period is known as
closing stock. Every business prepares a list of unsold inventory at the end of the
accounting period and puts value against it.
Accrued Expenses
Those expenses which have been incurred during the current period but not
paid and recorded in the books of accounts till the end of accounting period are
known as accrued expenses, outstanding expenses, expenses due or expenses
payable etc
Accrued Revenue
Those revenues which have been earned but not received and recorded in
the books of accounts till the end of accounting period are known as accrued
revenues, or revenue receivable etc.
Prepaid Expenses
The expenses which have been paid during the current accounting period
but the services or benefits from those expenses have not been received till the
end of period in which these expenses are paid and the benefits from these
expenses will be received in next accounting period are known as prepaid
expenses, expense paid in advance or unexpired expenses
Unearned Revenue
That amount of revenue which has been received in advance but the
services have not been provided fully or partly against that revenue till the end of
accounting period is known as unearned revenue or revenue received in advance.
Depreciation
The process of allocating the cost of Fixed Assets to expenses throughout
the accounting periods benefiting its use.
Interest on Capital
Amount of interest charged by the owner on the amount invested into the
business, would be considered as interest on capital.
Interest on Drawings
Interest paid by the owner to the business on the amount of cash or goods
drawn for personal use.
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Bad Debts
That portion of debts which are irrecoverable or cannot be realized in future
also from the debtors is classified as Bad debts or Uncollectible and the debtor
from whom the business fails to recover the debt is known as Bad Debtors
Doubtful debts
The debts, whose recovery is uncertain or doubtful, are termed as “Doubtful
Debts”. These debts may or may not become the loss for the business.
Provision for Doubtful Debts
Amount set aside out of profit for the expected loss or liability, whose
amount cannot be determined exactly, is termed as Provision.
BIBLIOGRAPHY
Ahmad, M. M., Khan, S. A., Arshad, M., & Shah, S. M. (2013). Advanced
Financial Accounting. Islamabad: National Book Foundation Islamabad.
Dupree, D., & Marder, M. (1984). Principles of Accounting. Addison-Wesley.
Farooq, U., & Amir, S. M. (2008). Principles of Accounting. Islamabad: Allama
Iqbal Open University.
Hussain, K., Buttar, Z. U., Pirach, M. A., & Chaudhry, M. I. (1996). Accounting
Principles. Lahore: Orient Publishers Urdu Bazaar Lahore.
Mukherjee, A., & Hanif, M. (2003). Modern Accountancy I. Tata McGraw-Hill
Education.
Randall, H. (2005). Accounting. Cambridge University Press.
Wood, F., & Sangster, A. (2008). Business Accounting I. Pearson Education.

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225
Unit–8

CAPITAL & REVENUE AND

RECTIFICATION OF ERRORS

Written by: Syeda Faiza Urooj

Reviewed by: Dr. S.M. Amir Shah

226
 CONTENTS
INTRODUCTION
OBJECTIVES
1. INTRODUCLTION
1.1 Capital and Revenue Expenditures
1.1.1 Capital Expenditures
1.1.2 Revenue Expenditures
1.2 Capital and Revenue Transactions: Why the Distinction is Important?
1.3 Capitalized or Deferred Expenditures
1.4 Capital and Revenue Receipts
1.4.1 Capital Receipts
1.4.2 Revenue Receipts
1.5 Capital and Revenue Profit
1.5.1 Capital Profit
1.5.2 Revenue Profit
1.6 Capital and Revenue Losses
1.6.1 Capital Losses
1.6.2 Revenue Losses
2. RECTIFICATIOON OF ERRORS
2.1 Classification of Accounting Errors
2.1.1 Errors which Affect Trial Balance
2.2 Types of Errors
2.2.1 Errors of Omission
2.2.2 Errors of Principle
2.2.3 Compensating Errors
2.2.4 Errors of Commission
2.3 Locating Errors
2.4 Stages of Correction of Accounting Errors
2.5 Suspense Account
3. SELF-ASSESSMENT QUESTIONS
3.1 Fill in the Blanks
3.2 Classify the following as True or False
3.3 Complete the following Sentences
4. PROBLEMS
5. SUMMARY
REFRENCES/BIBLIOGRAPHY

227
INTRODUCTION
The purpose of financial statements is to depict the true financial position
and accurate operating results of the business. To achieve this objective, it is very
necessary to differentiate between capital and revenue items and the financial
statements must be free from any type of errors. This unit not only describes the
detail of capital and revenue items but also explain the various types of errors
which may occur during the preparation of accounts of the business. At the end of
the unit self-assessment questions and various problems are given for better
comprehension of the topics to be covered in this unit.

OBJECTIVES
After studying this unit, you will be in position:
1. Know the purpose of differentiating Capital from Revenue items.
2. Identify Capital, Revenue and Deferred Revenue Expenditures.
3. Differentiate between capital and revenue items.
4. State various types of errors.
5. Know the effect of errors on trial balance and techniques to locate them
6. Detect and rectify errors.
7. Create the Suspense account.

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1. CAPITAL AND REVENUE
You will have learnt in the previous units that how transactions and events
in a business concern are recorded and classified in its books of accounts. You
will have also comprehended the preparation of trial balance. Stakeholders of a
business concern are interested to know the net results of its business operations
after a certain period of time. But neither the trial balance nor the books of
accounts reveal the net results of the business. For this, certain financial
statements are prepared. The main financial statements are termed as Trading and
Profit and Loss Account and Balance Sheet. ‘Matching Principle’ governs the
preparation of these two statements. According to this principle, the revenues and
relevant expenditures incurred during a particular period should be matched. Thus
a proper distinction must be accounted for between capital and revenue
transactions.
Business transactions can be capital or revenue in nature. Expenditure
becomes revenue in nature when its benefit lasts within one year’s time period.
All expenses incurred in running a business such as salaries, wages, rent, lighting,
stationary etc. are classed as revenue expenditure. Beside expenses incurred in
putting the fixed assets in proper order by repairs and renewals are also revenue
expenditures.
Capital expenditure is the amount spent either in the acquisition of an asset
or an improvement or extension to an existing asset as result of which the earning
capacity of that asset is increased. These are the expenditure that gives benefit to
the business unit for long term. Improving the earning capacity may be termed as
either increasing the output or reducing the cost of production. Capital
expenditure involves the cost of machinery, goodwill, freehold land and building
and the legal charges incurred in this connection etc.
In finalizing the accounts of a given year, the company takes into account
only the revenue items. From the income, revenue expenditure is deducted to
arrive at the net profit/loss. The question is why are capital items not considered
in while calculating the profit and loss of the year? The answer is these items
(capital items) result in benefits not merely for the current year, but also for future
years. It would not be fair for the current year to ``suffer'' for the whole of the
expenditure, when a fair portion of the benefits is going to be enjoyed by future
years.
For instance, machinery that was purchased paying Rs 1, 00,000 can be
used for, say, next five years. This means that each of the five years has to take a
share of the total expenditure of Rs 1, 00,000. It so happens that the expenditure
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was incurred in the current year, but the benefits will accrue for the future years as
well. The current year need just take a share of the expenditure proportionate to
its use.
So, in other words, the machinery having five years of useful life should be
written off over the five years, and if, an equal proportion is allocated to each of
the years, the current year and four subsequent accounting periods will be charged
with Rs 20,000 each. This is called depreciation and is dealt with in greater detail
in later units.
If we ask a question, what are the broad criteria to determine whether an
item of expenditure is to be treated as a capital item or a revenue item? The
answer may be, the company's size and operations play an important part in this.
A huge corporation may prefer to treat an expenditure of Rs 10,000 incurred on a
printer as revenue, even though it could be used for future years. A small
company might capitalize an equipment costing Rs 5,000 and spread the
expenditure to the useful life of the equipment. In both the cases, the companies
concerned will be aware that if they capitalize expenditure, the immediate effect
will be to improve the current profitability.
1.1 Capital and Revenue Expenditures
As discussed earlier, the various types of expenditure that a business
organization can possibly incur can be classified into two broad categories. The
first category consists of items incurred for carrying on the day-to-day operations
of the organization. These expenses have to be incurred ``to keep things going''.
Salaries paid to employees, expenditure on rent incurred, interest payments,
factory expenses, administrative expenses and sales commissions are examples of
this category.
The other category relates to assets purchased by the company, which can
be put to use for a number of years to come. They result in increased productivity
or greater efficiency and are expected to contribute to improve the earning
capacity of the comp- any. Purchase of new machinery, renovation of buildings,
purchase of furniture and fixtures, computer equipment and office vehicles are
examples. The former category is called revenue expenditure and the latter capital
expenditure.
The benefits of revenue expenditures are limited to one financial year only
while the benefits of capital expenditures are availed beyond one year. By
segregating expenditures in these two kinds the placement of revenue and capital
expenditures in profit and loss or balance sheet is determined. In making vouchers
and final accounts it is very important to record revenue and capital expenditures
230
in their proper places otherwise the accounts prepared will not show the true
position of the business.
It can be best understood with the help of the following example. If an
organization makes a room for office use in its existing building, the costs
incurred on that room are capital expenditures because that room benefits the
organization for more than one year. If this cost is mistakenly recorded as revenue
expenditure then it will go into the profit and loss of that year and ultimately the
profit is underestimated. But as the benefit of that room is spread into several
years, it is important to spread the cost to those several years as well.
There are no certain fixed rules for separating the revenue and capital
expenditures because same type of expenses are recorded as revenue expenditure
in one point of time and capital expenditure in another point of time. Following
are certain rules with the help of which we can segregate revenue expenditures
from capital expenditures.
1.1.1 Capital Expenditures:
Capital expenditure consists of expenditure, the benefit of which is not fully
enjoyed in one accounting period but spread over several accounting periods. It
includes assets acquired for the purpose of earning income or increasing the
earning capacity of the business or effecting economy in the operation of an asset.
These are not meant for sale. Expenditure incurred for improving assets and
extending an existing asset is also capital expenditure. These capital items appear
on the assets side of balance sheet.
The cost of assets will be written off by way of depreciation over a period
of its life. The amount of depreciation is revenue expenditure and is debited to
profit and loss account. The reason for charging depreciation to revenue i.e. profit
and loss account is that the asset is used for earning revenue. Hence the
depreciation is charged to profit and loss account.
Following are capital expenditures:
a) Those costs which are incurred on purchase of fixed assets are known as
capital expenditures. It includes all those costs which are incurred to bring
that asset to usable condition. For example, if a piece of land is purchased
for making factory building then besides its own cost, the amount which is
spent on its registry and legal procedures is also included in capital
expenditure. Similarly, if a machine is purchased then the cost of
installation is also treated as capital expenditure.
b) The costs which increase the earning capacity of the business or decrease
the productive, administrative or selling expenses are treated as capital
231
 expenditures. For example, if an accounting machine decreases the number
of employees from 15 to 10 in accounts department then the cost of this
machine will be treated as capital expenditures.
c) The preliminary expenses of a business are also treated as capital
expenditures because the benefit of these expenses is not limited to one year
only.
d) The costs which are incurred on increasing the productivity of present fixed
assets are also included in capital expenditures.
1.1.2 Revenue Expenditures
Revenue expenditure consists of expenditure incurred in one period of the
accounting, the full benefit of which is enjoyed in that period only. This does not
increase the earning capacity of the business but it is incurred in order to maintain
the existing earning capacity of the business. It includes all expenses which arise
in normal course of business. The benefit of such expenditure is for a short period,
say, one year only and it is not to be carried forward to the next year. The
expenditure is of a recurring nature i.e. incurred every year.
All these items appear on the debit side of trading and profit and loss
account, in case of trading concerns or income and expenditure account, in case of
non-trading concerns. All the costs other than capital expenditures are known as
revenue expenditures. Following are expenses which are termed as revenue
expenses:
a) Depreciation charged on fixed assets or the amount spent on the
maintenance of fixed assets is revenue expenditure.
b) The cost of assets which are purchased for sale and the amount which is
used for production activity such as raw material, stores, fuel etc.
c) Administrative expenses like salary of office employees, traveling
expenses, office rent, stationary etc.
d) Costs incurred for sales and distribution of goods.
e) Miscellaneous expenses like taxes, interest, commission etc.
1.2 Capital and Revenue Transactions: Why the distinction is important
For convenience, we can use the word transaction or item to refer to either a
receipt or a payment. The reason why it is important to distinguish between
capital and revenue transactions is because revenue transactions are dealt within
the profit and loss account, whereas capital transactions are dealt within the
balance sheet.
You might have noticed already how the profit and loss account brings all
the revenue transactions together in one statement. Income from the sale of goods
232
is matched with the cost of earning that income, such as the cost of sales and the
day to day running expenses.
Capital transactions are dealt within the balance sheet because their effect is
to alter the makeup of the business capital (the net assets) rather than to increase
or decrease the total.
If a business spends Rs 100,000 on buying a factory, notice what happens:
 One of the asset (cash ) is reduced by Rs 100,000 but
 Another asset (building) has increased by Rs 100,000, and so
 The total capital has remained the same.
It is important to distinguish between capital and revenue items for the sake
of preparing financial statements.
Illustration No. 1
Examine following items of expenses and specify whether the item is capital or
revenue expenditure.
(i) Rs.5000 were paid as wages for construction of a factory
(ii) Rs.5000 was paid as wages for manufacture of yarn by a textile mill.
(iii) Rs.5000 was paid as wages for installation of a machine.
Solution
(i) This is capital expenditure because the factory building is a fixed or capital
asset
(ii) This is revenue expenditure as it has been incurred for manufacture of
saleable goods.
(iii) This is capital expenditure as the machine installed is a fixed or capital
asset, unless this machine becomes operational, call cost like installation
will be capitalized.
1.3 Capitalized or Deferred Expenditures:
Deferred Revenue Expenditures are those expenditures which have been
incurred in an accounting period and they do not create any assets but their benefit
is spread in more than one accounting period such as heavy expenditure on
advertising a new product. The benefit of advertising cost will last quite a few
years. It will be better to write off the expenditure may be in three or four but not
in the first year only. According to Prof. A.W. Johnson, "Deferred Revenue
Expenditure includes those non-recurring expenses, which are expected to be of
financial nature, distributed to several accounting periods of indeterminate total
length. These are of revenue nature but are deferred or postponed."

233
When loss of a specially heavy and exceptional nature is sustained, it can also be
treated as deferred revenue expenditure. But, it should be noted, that loss resulting
from transactions entered into, such as speculative purchase or sale of a large
quantity of a commodity, cannot be treated as deferred revenue expenditure. Only
loss arising from circumstances beyond one's control can be treated so.
Such types of expenditures are charged to profit and loss account, over a
period of 3 to 5 years depending upon the benefit accrued.
From the above discussion the students may get confused in differentiating
between revenue and deferred revenue expenditure. Therefore, the following
characteristics of deferred revenue expenditure will clearly mark the difference
and remove the ambiguity.
a) No asset is recorded in the balance sheet
b) Benefit is enjoyed for more than one year
c) It is non-recurring in nature
1.3.1 Examples are:
a) A business pays insurance premium in advance say for three years.
b) Preliminary expenses incurred before commencement of the business.
c) Advertisement of new products
d) Advertisement for more than one accounting period.
e) Legal expenses
f) Stamp duty
g) Carriage freight
h) Research and development expenditures
i) Abnormal loss arising out of fire or lightning (in case the asset has not been
insured).
1.4 Capital and Revenue Receipts
A receipt is inflow of money into the business which indicates the money
received by a business enterprise. A receipt of money may be of capital or
revenue nature. A clear distinction therefore should be made between capital
receipts and revenue receipts. Just as expenditures are classified into Capital or
Revenue Expenditure, in the same way receipts are classified into:
a) Capital Receipts, and
b) Revenue Receipts
1.4.1 Capital Receipts
The receipts which do not arise out of normal course of business are known
as Capital Receipts. A receipt of money is considered to be as capital receipt
when a proprietor contributes towards the capital of the business or a contribution
234
of capital to the business by someone outside the business etc. They are fixed in
nature and do not affect the profitability of the firm. Some examples of capital
receipts are:
a) Receipts from sale of fixed assets
b) Additional capital introduced by the company
c) Loans raised
1.4.2 Revenue Receipts
The receipts which arise out of normal course of business are known as
revenue receipts. They are the one which affect the profitability of the company
like day to day incomes. They appear on the credit side of P & L A/c. Some
examples of revenue receipts are:
a) Income from sale of goods
b) Rent received from letting out the business property
c) Dividend received on shares
d) Interest received on investment
Illustration No. 2
State whether the following receipts are of Capital or Revenue nature:
a) Sale of goods
b) Money received as loan from a bank
c) Interest received on deposits
d) Dividend received
e) Sale of machinery
f) Rent received from a tenant
g) Money received from proprietor as additional capital
h) Amount received from the issue of shares
Solution
Revenue a), c), d), & f)
Capital b), e), g), & h)
Illustration No. 3
A machine costing Rs.10000 was sold for Rs.12000. Cash Rs.12000 was
received immediately. Should Rs.12000 be included in the sales?
Solution
No! This is not a revenue sale. It would not be included in sales. The journal
entry would be:
Cash A/c 12,000
To Machine A/c 10,000
To Gain on sale of machine A/c 2,000
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1.5 Capital and Revenue Profit:
In order to find out the correct profit and the true financial position, there
must be a clear distinction between capital profit and revenue profit.
1.5.1 Capital Profit
Capital profit is the profit which arises not from the normal course of the
business. Profit on sale of fixed asset is an example of capital profit.
1.5.2 Revenue Profit
Revenue profit is the profit which arises from the normal course of the
business. i.e., Net Profit – the excess of revenue receipts over revenue
expenditures.
1.6 Capital and Revenue Losses
In order to ascertain the loss incurred by a firm, it is important to distinguish
between capital losses and revenue losses.
1.6.1 Capital Losses
Capital losses are the losses which arise not from the normal course of
business. Loss on sale of fixed asset is an example of capital loss.
1.6.2 Revenue Losses
Revenue losses are the losses that arise from the normal course of the
business. In other words, ‘net loss’ – i.e., excess of revenue expenditures over
revenue receipts.
Illustration 04
Fashion Textiles gives the following transactions of their firm during the
year 2008, you are required to classify the transactions into capital or revenue.
a) Rs. 2,500 spent on purchasing a tire for their lorry.
b) They had old machinery of value Rs.10,000 was sold for Rs.9,500.
c) They received Rs.5000 towards dividend from their investments in shares.
d) They were able to sell cotton ‘T’ shirts (cost Rs. 1,200) for Rs.1,500.
e) Rs.600 was spent on alteration of machinery in order to reduce power
consumption.
Solution
a) Revenue expenditure – as it spent to replace a part of the lorry.
b) Capital loss Rs.500 – as they have incurred a loss on sale of fixed asset and
Rs.9,500 will be a capital receipt as it is a sale of fixed asset.
c) Revenue receipt – earned in the ordinary course of business.
d) Revenue receipt – Rs.300 is received in the ordinary course of business.
e) Capital expenditure – as it reduces cost of production.
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Illustration No. 5
ABC Company has incurred the following expenditure. You are required to
identify the capital, revenue and deferred revenue expenses.
a) Rs.60,000 travelling expenses of their sales manager who traveled to Japan
to attend meeting in order to increase sales.
b) Rs.500 spent for installing machinery.
c) Rs.600,000 spent on research and development.
d) Rs.500 paid for fuel.
Solution
a) Deferred revenue expenditure – benefit likely to be enjoyed for more than
one year.
b) Capital expenditure- amount is spent to bring the asset into use.
c) Deferred revenue expenditure – the benefit can be spread for more than one
year.
d) Revenue expenditure- spent for the normal functioning of the firm.
2. RECTIFICATION OF ERRORS
Once the journal is prepared in the recommended manner, similar types of
accounts are gathered at one place. This process in know as posting to the ledger
accounts. In this process, the book keeper has to identify and sort out all similar
types of accounts from the journal and place them in one place under the similar
heading called “ledger account”. This process becomes very tedious when there is
a large number of accounting entries appearing in the journal. Chances of errors
increase with the increasing number of transactions. Accountants prepare trial
balance to check the correctness of accounts. If total of debit balances does not
agree with the total of credit balances, it is an indication that certain errors have
been committed while recording the transactions in the journal or posting to the
ledger accounts.
Trial balance is an important part of the accounting cycle. If balanced, it is
considered that the books of accounts prepared up till that point are correct. But
we should not forget another important point that there are chances of accounting
errors even when the trial balance is in agreement (both sides of the trial balance
are equal to each other). The reason is that the effects of the errors are reflected on
both sides of trial balance.
The above discussion concludes that the agreement of trial balance is not an
absolute proof of accuracy of accounting records. A tallied trial balance only

237
proves, to a certain extent, that the posting to the ledger is arithmetically correct.
But it does not guarantee that all the entries recorded in journal are correct.
A comprehensive definition of accounting error is “non-fraudulent discrepancy
in financial documentation.”
2.1 Classification of accounting errors
The accounting errors may be divided into the following two broad areas:
 Errors which affect trial balance
 Errors which do not affect trial balance.
2.1.1 Errors which affect trial balance
These errors are due to the mistake having being committed on one side of
the account. They may happen at any of the stages of the accounting process, like
recording, posting, balancing, etc. Examples of this group of errors are: errors of
partial omission, error of casting (totaling), error of carrying forward, error of
balancing, error of posting to the correct account but with wrong amount, error of
posting to the correct account but on the wrong side, posting to the wrong side
with the wrong amount and omitting to show an account in the trial balance etc.
2.1.1.1 Steps to Locate Errors:
Following steps should be taken to locate the error when the trial balance
does not agree.
i. Check the columnar totals of trial balance
ii. Check that the balances of all accounts (including cash and bank balances)
in the ledger have been written and are written in the correct column of trial
balance i.e. debit balance in the debit column and credit balance in the
credit column.
iii. Find the exact figure of difference with trial balance and see that:
a. No account of a similar balance has been omitted to be shown in the
trial balance
Or
b. A balance amount which is half of the amount of difference amount
but is written on the wrong side of the trial balance.
iv. Re-check the totals of special purpose books.
v. Check the balancing of the various accounts in the ledger.
vi. If the difference is still not traced, check each and every posting from the
journal and various special purpose books, one by one in the ledger.
2.1.1.2 Techniques to Find Trial Balance Difference
There are some quick techniques to find the trial balance difference;

238
i. If the amount of trial balance difference can be divided by 9 (means no
fraction) then it means interchange of figures. For example if actual amount
is 91000 but wrongly posted as 19000, the difference will be 72000 which
can be divided by 9. So you can trace the error.
ii. If the amount is posted to the wrong side, i.e. debit instead of credit, then
there will be double effect. It means if Rs.500 is posted on the wrong side,
then the trial balance difference will be Rs.1000.
2.1.2 Errors which do not Affect Trial Balance
You have already learnt that if the totals of the two columns of a trial
balance tally, it is not a conclusive proof of the accuracy of accounts. Reason
being that in the above case the debits and credits are affected simultaneously by
the same amount. There may still be some accounting errors. These errors may
not be immediately traced but may be detected at much later stage. These are
rectified as and when detected. Errors which do not affect the trial balance are
committed in two or more accounts (error of omission, error of principal and
compensating error). Examples of these errors are: omission to pass an entry in
the books of original entry, wrong amount of transaction recorded in the journal,
journal entry is posted twice, complete omission of the posting of accounts in the
ledger, error of principal, posting of correct amount on the correct side but to a
wrong account, offsetting errors in recording the amount of a transaction etc.
It is the responsibility of an accountant to locate these errors and rectify
them, only then the final accounts can be prepared. One way to get it corrected is
to simply erase or overwrite the incorrect entry and replace it with the correct one
but this practice is not allowed in accounting. We have to rectify/correct the
incorrect entry by passing another entry.
As the above discussion indicates that all types of errors are not revealed by
the trial balance as some of the errors do not affect the total of trial balance. So
these cannot be located in a trial balance. An accountant should invest his energy
to locate both types of errors and rectify them before preparing trading, profit and
loss account and balance sheet. Because if final accounts are prepared before
rectification these will not give us the correct and fair view of the state of affairs
as required by the IAS. The profit and loss and balance sheet disclosed through
this trial balance would not depict the correct amounts.
2.1.2.1 Examples
The procedure for rectification for such errors is explained with the help of
following examples:

239
i. Credit sales to Maheen of Rs. 10,000 were not recorded in the books of
accounts. This is an error of complete omission. Its affect is that Maheen’s
account has not been debited and Sales account has not been credited.
Accordingly, recording usual entry for credit sales will rectify the error.
Maheen’s A/c Dr. 10,000
To Sales A/c 10,000
ii. Credit sales to Maheen Rs. 10,000 were recorded as Rs. 1,000 in the books
of accounts. This is an error of commission. The effect of wrong recording
is shown below:
Wrong Entry
Maheen’s A/c Dr. 1,000
To Sales A/c 1,000
Correct Entry:
Maheen’s A/c Dr. 10,000
To Sales A/c 10,000
Now in order to correct the entry Maheen’s account has to be given a
further debit of Rs. 9,000 and sales account has to be credited with a further
amount of Rs. 9,000, rectification entry will be:
Rectifying Entry
Maheen’s A/c Dr. 9,000
To Sales A/c 9,000
Now both these entries together are equipment to the single correct entry as
mentioned above.
iii. Credit sales to Maheen Rs. 10,000 were recorded as Rs. 12,000. This is an
error of commission. The effect of wrong entry made has been:
Wrong Entry
Maheen’s A/c Dr. 12,000
To Sales A/c 12,000
Correct Entry
Maheen’s A/c Dr. 10,000
To Sales A/c 10,000
You can see that there is an excess debit of Rs. 2,000 in Maheen’s account
and excess credit of Rs. 2,000 in sales account. The, rectification entry will be
recorded as follows:
Rectifying Entry
Sales A/c Dr. 2,000
To Maheen‘s A/c 2,000
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iv. Credit sales to Maheen Rs. 10,000 was correctly recorded in the sales book
but was posted to Rabia’s account. This is an error of commission. The
effect of wrong posting has been:
Wrong Entry
Rabia’s A/c Dr. 10,000
To Sales A/c 10,000
Correct Entry
Maheen’s A/c Dr. 10,000
To Sales A/c 10,000
Notice that there is no error in sales account. But Rabia’s account has been
debited with Rs. 10,000 instead of Maheen’s account. Hence rectifying entry will
be:
Rectifying Entry
Maheen’s A/c Dr. 10,000
To Rabia’s A/c 10,000
v. Rent paid Rs. 2,000 was wrongly shown as payment to landlord in the
cashbook:
Wrong Entry
Landlord’s A/c Dr. 2,000
To Cash A/c 2,000
Correct Entry
Rent-Expenses A/c Dr. 2,000
To Cash A/c 2,000
Landlord’s account has been wrongly debited instead of expense (rent)
account. Hence, rectifying entry will be:
Rectifying Entry
Expense (rent) A/c Dr. 2,000
To Landlord’s A/c 2,000
In the next section types of errors and their respective rectification is
discussed in detail. Every type of error is explained with the help of an example.
2.2 Types of Errors
Following are four main types of accounting errors. All of them are
discussed one by one with the help of examples:
 Errors of Omission
 Errors of Principle
 Compensating Errors
 Errors of Commission
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2.2.1 Errors of Omission
Omission is a mistake resulting by neglect. This means that an event
occurred but we did not record it. The errors of omission may be committed at the
time of recording the transaction in the books of original entry or while posting to
the ledger. These can be of two types:
a. Error of complete omission
b. Error of partial omission
You know that transactions are recorded in chronological order in journal.
Sometimes a transaction is completely omitted from recording in the books of
original entry; it is an error of complete omission. For example, goods sold to Mr.
Ahmad Rs. 10,000 on credit but not entered in the books of accounts. It means we
omitted the transaction. Now a rectifying entry is required in journal and then
posted to ledger. The trial balance will be tallied in case of complete omission of
transaction because both the debit and credit effects are not shown.
When recording of transaction is partially omitted from the books, it is an
error of partial omission. If in the above example, credit sales had been duly
recorded in the journal but the posting from sales book to Ahmad’s account has
not been made, it would be an error of partial omission. Such errors happen as a
result of omission on the part of person responsible for the maintenance of books
of account. In case of such errors, the trial balance will not be tally because one
side of the transaction is shown while the other is missing in trial balance. The
following examples will help in understanding both types of errors of omission
and their respective rectifications.
Illustration No. 6
Following transactions were omitted hence escaped being recorded in the
books of original entry and this omission was detected at the end of the year.
Following adjusting entries were made to rectify the error of omission.
a) Sale of Rs.5000 to Messrs Bashir & Co. on credit;
b) Advance of Rs.500 to Mr. Burhan purchase manager by issuing a cheque
c) Stationary worth Rs.72 was purchased on 30-11-2013 on credit from Butt
Stationers;
d) Tools for Rs.600 were purchased on credit from Modern Equipment Co.
e) Purchased equipment worth Rs. 1,000
f) A sale of Rs 15,000 made to XYZ on April 15, was omitted by mistake.

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Solution
S. No Accounts L.F Debit Credit
a) Bashir & Co 5000
To Sales 5000
(Sales on credit now accounted for)
b)
Advance to Staff (Purchase Manager) 500
To Bank 500
c) (Advance paid through cheque)

d) Stationary 72
To Butt Stationers 72
(stationary purchased on credit)

e) Tools 600
To Modern Equipment & Co. 600
(Tools purchased on credit)

f) Asset a/c
To Cash a/c 1000
(Purchased an asset) 1000

XYZ Account 15,000

To Sales 15,000
Rectification of omission of recording sale to
XYZ on Apr 15.

Illustration No. 7
Following are the examples where the ledger accounts have been affected
by the error of partial omission.
a) The debit to purchases for Rs.5000 was omitted to be posted to the ledger
b) Receipt of Rs.672 from Ahmad & Co. could not be posted to its account
Rectification
a) Post Rs 5,000 on the debit side purchases account in the ledger.
b) Post Rs 672 on the credit side of Ahmad & Co’s ledger account.
By looking at the above illustrations we can conclude that a rectifying entry
should be passed in the case of error of complete omission because the transaction
243
was not recorded. No entry is required in the case of error of partial omission
because the transaction has earlier been duly recorded but omitted to be posted to
the ledger account. Therefore, only the ledger account is corrected by posting the
account on the correct side of the ledger.
2.2.2 Errors of Principle
Accounting entries are recorded by following principles of accounting.
These principals are issued by International Accounting Standard Board and
International Accounting Standard Committee. Accountants follow these
standards named as International Accounting Standards (IAS) and International
Financial Reporting Standards (IFRSs). If any of these principles are violated or
ignored, errors resulting from such violation are known as errors of principle. An
error of principle may occur due to entering a transaction in the wrong class of
account. Sometimes when a capital expenditure is mistakenly recorded as revenue
expenditure then an error of principle occurs.
For example, repairs to furniture have been wrongly debited to Furniture
A/c instead of debiting Repairs A/c. It means that a transaction instead of being
recorded in the right account has been recorded in wrong account of a different
class. Repair is revenue expenditure; hence it should be debited to Repairs A/c.
But it has been wrongly debited to Furniture A/c making it to be a capital
expenditure. Since repairs A/c and furniture A/c belong to two different classes
(Repairs A/c belongs to expenses A/c, while Furniture A/c belongs to Assets A/c),
so it is an error of principle. To further explain, amount of Rs 100 withdrawn by
the proprietor for his personal use has been debited to trade expenses a/c. For this
error, there is no mistake in the amount on any side of the trial balance. So the
trial balance will agree. This type of error will have an impact on financial
statements. It may lead to under/over stating of income or assets or liabilities, etc.
For example, amount spent on construction of additional store with the
factory building should be treated as capital expenditure and must be debited to
the asset account. Instead, if this amount is debited to maintenance and repairs
account, it means treated as a revenue expense, this is an error of principle.
Similarly, if a credit purchase of machinery is recorded in purchases book instead
of journal proper or rent paid to the landlord is recorded in the cashbook as
payment to landlord, these are errors of principle. These errors do not affect the
trial balance but contradict the accounting principles.
Illustration No. 8
A manufacturing machine for Rs. 5000 was purchased but was debited to
manufacturing expenses. Give necessary correcting entry.
244
Solution
Manufacturing machine is a fixed asset and should be recorded as an asset
instead of expense. The effect will be corrected by passing a reverse entry:
Sr. No Particulars Debit Credit
2013
Dec.31 Manufacturing Machine a/c 5000
To manufacturing Expenses 5000
(Charging Rs.5000 to correct head of Account)
2.2.3 Compensating Errors
These errors are a group of errors; the total effect is not reflected in the trial
balance. These errors are of neutralizing nature. One error is compensated by the
other error of an opposite nature therefore also called as offsetting errors. For
example, Saleem’s A/c is debited by Rs 2500 while it was to be debited by Rs
3500 and Maheen’s A/c is debited by Rs 3500 while the same was to be debited
by Rs 2500. Thus excess debit of Maheen’s A/c by Rs.1000 is compensated by
short credit of Saleem’s A/c by Rs.1000. As the debit amount and the credit
amount are equalized, such errors do not affect the agreement of trial balance, but
the fact remains that there is still an error. The rectifying entry for the above error
is:
Saleem a/c 1000
To Maheen a/c 1000
Another example to further simplify the nature of compensating error is
given below. In a credit sale transaction, the sales account is credited in excess by
say, Rs.5,000 and similarly the suppliers account in case of a credit purchase is
understated by Rs.5,000, this is a case of two errors compensating for each other’s
effect. It is to be noted that extra credit to the sales account is offset by lower
credit to the creditor's account, both being credit balance. Since, one plus is set off
by the other minus, the net effect of these two errors being of compensating
nature and do not affect the agreement of trial balance.
Illustration No. 9
While posting ledger accounts from the journal following debit and credit
entries escaped notice.
a) A debit of Rs.100 to stationery expense was not posted in the ledger.
b) A credit of Rs.100 to discount earned was also not posted in the legers.
Solution
No adjusting journal entry is required. Now post Rs.100 to debit of
stationary account and also to the credit of discount earned account.
245
2.2.4 Errors of Commission:
These errors are as a result of some positive act of commission on part of
the person responsible for maintenance of books of account. These errors by
definition are of clerical nature. These errors may be committed at the time of
recording and/or posting.
For example, an amount of Rs. 10,000 received from customer (Debtor) is
correctly recorded on the debit side of the cash book but while posting, the
customer's account is credited with Rs. 1,000. This is an error, which is
committed at the time of posting, by posting wrong amount to the account. This
will result in disagreement of trial balance, since, the credit total of the trail
balance will be short by Rs. 9,000. For example, if wrong amounts are entered
either in the journal or in the ledger, when totals are wrongly made, if posting is
done to wrong accounts, non-recording of balance of an account in the trial
balance, wrong balancing of accounts etc. The following are some of the
examples of error of commission and their details to explain the error and its
respective rectification with the help of illustrations.
2.2.4.1 Errors in Books of Original Entry
If a transaction has been wrongly recorded in journal, then its effect will be
reflected till final accounts preparation. For Example, Mr. Aslam sold goods to
Mr. Akram for Rs.200 but while journalizing the entry amount was entered in
books of account as Rs.2000. Since this error is an error of books of original
record so it will have no effect on trial balance.
Illustration No. 10
A machine was purchased for Rs.7980 but in the Journal amount was
wrongly recorded at Rs.7890. Give correcting entry.
Solution
In this case the actual purchase price was Rs.7980 but was originally
recorded as Rs.7890. It means that a less debit to machine A/c was given to the
extent of Rs. (7980-7890 = Rs.90) Debit to this extent would now be given to
machine account.
Sr. No Accounts L.F Debit Credit
2013 Machine A/c 90
Dec.31 To Bank A/c 90
(Less debit originally given to machine now
rectified)

246
2.2.4.2 Posting Wrong Amount
Transactions from the journal are posted to the respective accounts in the
ledger. Error may be committed while carrying out posting. It may take various
forms such as, posting to wrong account, to the wrong side of account or posted
twice to the same account, as a result the trial balance will not tally. For example,
goods purchased of Rs.5400 from Rani was posted to the debit of Rani’s account
or posted twice to her account or posted to the credit of Rani’s account. In the
above examples, only one account is affected because of the error therefore, trial
balance is also affected.
Illustration No. 11
Suppose the journal had following entry showing payment to M/S Nazir &
Co and retiring a liability.
A/c Payable-Nazir & Co. 8900
To Bank 8900
While posting in the ledger Nazir & Co. was incorrectly debited by 9800
but bank was correctly credited for Rs.8900. Make correcting entries.
Solution
No fresh journal entry is required. The journal entry is correct but as it is a
matter of wrong posting, excess debit has been given in the ledger for (Rs.9800-
8900) Rs.900.
2.2.4.3 Posting to Wrong Side of an Account:
Suppose we had to credit Modern Tailors for Rs.500 but we wrongly
debited the account for Rs.500. Now as a result;
a) The credit side is in short of Rs.500, while
b) The debit side is in excess of Rs.500
Now in order to rectify, we have to credit the account for Rs.500+500 = 1000
Illustration No. 12
Commission account was to be debited by Rs.750. However, the
accountant wrongly posted Rs.750 to the credit of commission account. Rectify
the error.
Solution
The error will be corrected by debiting commission account with Rs.750+750
i.e. Rs.1500.
2.2.4.4 Wrong Casting
Casting is an accounting term used for addition. There may be a mistake in
totaling books of accounts. The totaled amounts may be less than the actual
amount or more than the actual amount. First is a case of under casting and
247
second of overcastting. For example, the total of Purchases Book is written as Rs
44800 while actual total is Rs 44300, the total of Sales Day Book is written as
Rs.52500 while it is Rs.52900. It is a case of an error affecting one account hence
it affects trial balance.
Illustration No. 13
Purchases book is overcast for the month of July, 2009 by Rs 8000.
Solution
Accounts Affected
The total of the Purchase Book is posted to the debit of Purchase A/c.
Therefore Purchase A/c is affected.
Rectification
To nullify the effect of the error, the entry of Rs 8000 will be made on the
credit side of the Purchase A/c with the words written as “The amount of
Purchase Book is overcast for the month of July, 2009.”
Dr Purchase A/c Cr
Date Particulars Amount(Rs) Date Particulars Amount(Rs)
Amount as per
Purchase Book, for
the month of
July, 2009 8000
2.2.4.5 Wrong Balancing of Accounts
While closing the books of accounts at the end of the accounting period, the
ledger accounts are balanced. Balance is calculated of the totals of the two sides
of the account. It may be wrongly calculated. For example, the total of the debit
column of Maheen’s A/c is Rs.8600 and that of credit column is Rs.6800. The
balance calculated is Rs.1600 while the actual balance is Rs.1800. It has affected
one account only therefore, the trial balance gets affected.
For example, an amount of Rs.6,300 for credit purchases from Ali on
16.4.2010, correctly entered in the purchases journal, but while posting, his
account has been credited with Rs.3,600, thus under crediting his account by
Rs.2,700. In this case since the entry has been made correctly in the purchases
journal, posting to the purchases account may be assumed to be free of errors.
Therefore, the error is only in Ali’s account. This can be rectified by entering
additional credit of Rs.2,700 in his account with the comment in the particular
column as “Mistake in posting on 16.4.2010”.

248
2.2.4.6 Wrong Carry Forward of Balances or Totals
Totals or balances are carried forward to the next page. These may be
carried forward incorrectly. For, example the total of one page of the purchases
book is Rs.35,600 which is carried to next page as Rs.36500. Again the error
affects one account only. Therefore, trial balance gets affected. Such errors can be
rectified by giving an explanatory note.

2.3 Locating Errors

As final accounts are prepared with the help of trial balance and figures are being
picked up by trial balance, the trial balance must be correctly prepared so that the
chances of errors in the preparation of final accounts are eliminated. If the final
accounts are prepared from the wrong trial balance, it will show the wrong
financial position of the company. Even a small error can be of great importance;
therefore, it is of utmost importance that the trial balance must be prepared with
care and accuracy so that the financial statements depict the true and fair view of
the financial state of affairs of the business.
2.4 Stages of Correction of Accounting Errors
Errors may happen at any of the following stages of the accounting cycle.
A. At Recording Stage
 Errors of principle
 Errors of omission
 Errors of commission

B. At Posting Stage
 Error of omission
a) Complete
b) Partial
 Error of commission
a) Posting to wrong account
b) Posting on the wrong side
c) Posting of wrong amount
C. Balancing Stage
a) Wrong totaling
b) Wrong balancing
D. Preparation of Trial Balance
a) Error of Omission
b) Error of Commission
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2.5 Suspense Account
As stated earlier, that it is advisable to locate and rectify the errors before
preparing the final accounts for the year. But in certain cases when after
considerable search, the accountant fails to locate the errors and he is in a hurry to
prepare the final accounts of the business for filing the return for sales tax or
income tax purposes, he transfers the amount of difference of trial balance to a
newly opened 'Suspense Account'.
Opening of a Suspense Account is a temporary arrangement. Locating
errors is not an easy task and may require some time. Unless detected and located,
errors cannot be corrected. Books of accounts are closed at the end of accounting
year. Although efforts are made to avoid the errors but sometimes to avoid delays
in the preparation of financial statements, the amount of difference of the trial
balance is temporarily put in an account called “Suspense Account” so as to tally
the trial balance by putting the difference on the shorter side. When all errors are
located and rectified, the balance in suspense account would be zero and closed. If
any error is not located and rectified, some balance still remains in the suspense
account. In case of debit balance it will be shown on the asset side of balance
sheet and on the liabilities side in case of credit balance.
2.5.1 Examples
i. Ghulam’s Account was debited short by Rs.100. The error will be rectified
through Suspense A/c by debiting Ghulam A/c and crediting Suspense A/c
by Rs.100.
Rectifying Journal entry:
Ghulam Dr. 100
To Suspense A/c 100
(Ghulam’s A/c debited short is now corrected)
ii. Similarly, if the Sales Book for December, 2009 is under cast by Rs. 500.
The error will be rectified by debiting Suspense A/c and crediting Sales A/c.
Rectifying Journal entry:
Suspense A/c Dr 500
To Sales A/c 500
(Sales Book under cast is rectified)
In the next accounting period, as and when the errors are located these are
corrected with reference to suspense account. When all the errors are discovered
and rectified, the suspense account shall be closed automatically. We should not
forget here that only those errors which affect the totals of trial balance can be
250
corrected with the help of suspense account. Those errors which do not affect the
trial balance can't be corrected with the help of suspense account.
Illustration No. 14
Samina prepared a trial balance of her shop for the year ended on 31 st
March, 2009. The debit total of the trial balance was short by Rs.9,145. She
transferred the deficiency to a suspense account. In April 2009, after a close
examination, she found the following errors:
a) Purchases day book for September 2008 was under cast by Rs.500.
b) Sales day book of November 2008, was overcast by Rs.5,000
c) A second hand computer purchased for office use for Rs.4,050 was
recorded in the office equipment account as Rs.405.
d) A bill drawn by her for Rs.20,000 was not entered in the bills receivable
book.
e) A machinery purchased for Rs.50,000 was entered in the Purchases day
book.
Pass the necessary journal entries to rectify the above errors to help Samina in
finalizing the trial balance.
Solution:
Books of Samina Journal
Debit Credit
Date Particulars
Amount Rs. Amount Rs.
2009 Purchases A/c 500
April Suspense A/c 500
1 (being Purchases Day Book total under cast
by Rs.500, now rectified)
Sales A/c 5,000
Suspense A/c 5,000
(Sales Day Book, total overcast by Rs.5,000,
now rectified)
Office Equipment A/c 3,645
Suspense A/c 3,645
(Office equipment was under debited by
Rs.3,645, now rectified)
Bills Receivable A/c 20,000
Sundry Debtors A/c 20,000
(Bill drawn completely omitted in the books,
now recorded)
251
 Machinery A/c 50,000
Purchases A/c 50,000
(Purchases account wrongly debited instead
of machinery account, now rectified)
TOTAL 79,145 79,145
Dr. Account Cr.
Date Particulars Amount(Rs) Date Particulars Amount(Rs)
March Balance 9,145 April 1, Purchases 500
31, b/f(balancing figure 2009 A/c 5,000
2009 in the trial balance) Sales 3,645
Office
equipment
9,145 9,145
Illustration No. 15
Following are some accounting errors. Rectify the same through Suspense A/c.
a) Purchases Book has been overcast by Rs.200
b) Goods purchased from Munawar of Rs.2500 have been posted to the debit
of his account.
c) Discount Rs.100 allowed to Abdullah was not debited to discount account.
Solution
a) Accounting effect: Purchase A/c has been debited in excess by
Rs.200
Rectification: Purchase A/c is credited by Rs.200 and
Suspense A/c is debited by Rs.200.
Journal entry:
Suspense A/c Dr 200
To Purchases A/c 200
(Purchase Book overcast is now corrected)

b) Accounting effect: Munawar A/c has been debited by Rs.2500

instead of it being credited by the same amount.
Rectification: Munawar A/c is credited by Rs.5000
Journal Entry:
Suspense A/c Dr 5000
To Munawar A/c 5000
(Goods purchased from Munawar debited to his account is now corrected)

252
c) Accounting effect: Discount A/c is omitted to be debited by Rs.100.
Rectification: This account is debited and Suspense A/c is
credited.
Journal Entry:
Discount A/c Dr 100
To Suspense A/c 100
(Discount allowed is not debited to discount A/c.)
Illustration No. 16
Trial balance of Rahim did not agree. Rahim put the difference to suspense
account. Subsequently, he located the following errors:
a) Wages paid for installation of Machinery Rs. 600 was posted to wages
account.
b) Repairs to Machinery Rs. 400 debited to Machinery account.
c) Repairs paid for the overhauling of second hand machinery purchased Rs.
1,000 was debited to Repairs account.
d) Own business material Rs. 8,000 and wages Rs. 2,000 were used for
construction of building. No adjustment was made in the books.
e) Furniture purchased for Rs. 5,000 was posted to purchase account as Rs.
500.
f) Old machinery sold to Karim at its book value of Rs. 2,000 was recorded
through sales book.
g) Total of sales returns book Rs. 3,000 was not posted to the ledger.
Rectify the above errors and prepare suspense account to ascertain the original
difference in trial balance.
a) Machinery A/c Dr. 600
To Wages A/c 600
(Wages paid for installation of machinery wrongly debited to wages account, now
rectified)
b) Repairs A/c Dr. 400
To Machinery A/c 400
(Repairs paid wrongly debited to machinery account now rectified)
c) Machinery A/c Dr. 1,000
To Repairs A/c 1,000
(Repairs for overhauling of second hand machinery purchased, wrongly debited
to repairs account, now rectified).

253
d) Building A/c Dr. 10,000
To Purchases A/c 8,000
To Wages A/c 2,000
(Material and wages used for construction of building, not debited to building
account).
e) Furniture A/c Dr. 5,000
To Purchases A/c 500
To Suspense A/c 4,500
(Furniture purchased for Rs. 5,000 wrongly debited to purchases account as Rs.
500, now rectified).
f) Sales A/c Dr. 2,000
To Machinery 2,000
(Sale of machinery wrongly recorded in sales book, now rectified).
g) Sales Return A/c Dr. 3,000
To Suspense A/c 3,000
(Total of sales returns book not posted to ledger, now rectified).
Dr. Suspense Account Cr.
Amount
Date Particulars Date Particulars Amount Rs.
Rs.
Difference as per 7,500 Furniture a/c 4,500
trial balance _____ Sales return a/c 3,000
7,500 7,500
Hence, original difference in Trial Balance was Rs. 7,500 excess credited.
3. SELF-ASSESSMENT QUESTIONS
3.1 Fill in the Blanks:
i. Amount spent on acquiring a copy right is an example for _________.
ii. Expenditure incurred for replacing an old asset with a new asset is
__________ expenditure.
iii. Amount spent on purchase of goods for sale is _______________
expenditure.
iv. Depreciation on fixed asset is_________ expenditure.
v. Expenses on research and development will be classified under _________.
vi. Amount spent on purchase of fixed assets is _______________ expenditure.
vii. An expenditure of revenue in nature whose benefits are availed over a
number of years is ___________ expenditure.
viii. If a transaction has not been recorded then it is called as error of
_______________.
254
ix. ______________ can be affected by error of commission.
x. Wrongly computing the balance of accounts is _______________ error.
xi. If the trial balance does not ___________ it indicates that some
___________ have been committed.
xii. A Suspense Account facilitates the ____________ of financial statements
even when the ___________ has not tallied.
3.2 Classify the Following as True or False:
i. In a quality business there is no distinction between revenue and capital
expenditure. (True/False)
ii. The benefit of capital expenditure is for less than a year. (True/False)
iii. The expenditures whose benefit is for one year are known as revenue
expenditures. (True/False)
iv. Sometimes it is difficult to distinguish between capital expenditures and
revenue expenditures. (True/False)
v. Preliminary expenses to execute a business are treated as capital
expenditures. (True/False)
vi. Such expenditures which increase the value of fixed assets are termed as
revenue expenditures. (True/False)
vii. Capital expenditure is non-recurring in nature. (True/False)
viii. Expenditures on repair of machinery are treated as revenue expenditures.
(True/False)
ix. Revenue expenditure is non-recurring in nature. (True/False)
x. The purpose of revenue expenditure is to maintain a business. (True/False)
xi. A trial balance being balanced does not guarantee the absence of accounting
errors (True/False)
xii. The wrong entry of transaction can lead to erroneous trial balance.
(True/False)
xiii. Error of omission effect the trial balance. (True/False)
xiv. If capital expenditure is considered as revenue expenditure then a balanced
trial balance will show the correct entry of transactions. (True/False)
xv. There is no importance of errors in books of original entry. (True/False)
xvi. Both sides of an account are equal if compensating error takes place.
(True/False)
xvii. Error of commission creates problems in the preparation of final accounts.
(True/False)
xviii. Error of commission cannot be rectified. (True/False)
xix. Trial balance is affected by error of commission. (True/False)
255
xx. Error of non-posting of an account affects only one account. (True/False)
xxi. Trial balance provides a basis for final accounts. (True/False)
3.3 Complete the following sentences:
i. Such expenditures are capital expenditures
a. which are used to purchase fixed assets.
b. which yield benefit for more than one year.
c. which is used to increase the earning capacity of business.
d. a, b and c.
ii. Such expenditures are revenue expenditures
a. which increases the value of assets.
b. whose benefit is for one year.
c. which is used for the installation of fixed assets.
d. which does not depreciates the machinery.
3.4 Choose the correct answer:
i. Transaction which provide benefit to the business for more than one year is
called as;
a) Capital transaction
b) Revenue transaction
c) Neither of the two.
ii. Amount spent on remodeling an old car is an example of;
a) Deferred revenue expenditure
b) Revenue expenditure
c) Capital expenditure
iii. Mr. Arif introduced Rs.50,000 as additional capital in the business. This
amount will be considered as __________.
a) Capital receipt
b) Revenue receipt
c) Both
iv. Revenue receipts are ___________ in the business.
a) Non-recurring
b) Recurring
c) Neither of the above.
v. Mr. Arif purchases goods worth Rs.80,000 for the purpose of selling. This
amount will be treated as
a) Capital expenditure
b) Revenue expenditure
c) Deferred revenue expenditure
256
vi. Expenses on advertisement will be classified under
a) Capital expenditure
b) Revenue expenditure
c) Deferred revenue expenditure
vii. A plant worth Rs.8, 000 is sold for 8,500 the capital receipt amounts to
a) Rs. 8,000
b) Rs. 8,500
c) Rs. 500
viii. Revenue expenditure is intended to benefit.
a) Subsequent year
b) Previous year
c) Current year
ix. An asset worth Rs.1, 00,000 is sold for Rs.85, 000 the capital loss amounts to
a) Rs. 85,000
b) Rs. 100,000
c) Rs. 15,000
x. The net loss which arises in a business is an example of
a) Revenue loss
b) Capital loss
c) Neither of the two
xi. Which of the following errors is an error of omission?
a) Sale of Rs.500 was written in the purchases journal
b) Wages paid to M have been debited to his account.
c) The total of the sales journal has not been posted to the Sales
Account
d) None of the above
xii. The preparation of a trial balance helps in:
a) Locating errors of complete omission
b) Locating errors of principle
c) Locating errors of commission
d) None of the above
xiii. Which of the following errors is an error of omission?
a) Sale of Rs.500 was written in the purchases journal
b) Wages paid to Mohan have been debited to his account.
c) The total of the sales journal has not been posted to the Sales
Account
d) None of the above
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Answer
Fill in the Blanks
i. Capital ii. Capital iii. Revenue iv. Revenue
expenditure expenditure
v. Deferred vi. Capital vii. Deferred viii. Omission
Revenue
expenditure
ix. Trial balance x. Commission xi. Agree/balan xii. Trial balance
ce, errors
Classify the Following as True or False:
i. False ii. False iii. True iv. True v. False
vi. False vii. True viii. True ix. False x. True
xi. True xii. True xiii. False xiv. True xv. False
xvi. True xvii. True xviii. xix. True xx. True
xxi. True
Choose the correct answer:
i. a ii. c iii. a iv. b v. b
vi. c vii. b viii. c ix. c x. a
xi. c xii. c
4. PROBLEMS
Problem 01
Classify the following into capital and revenue and give reasons.
a) Legal expenses incurred for raising a loan Rs 100.
b) Paid expenses Rs 50/- or repairing the machinery.
c) Rs 1000/- spent on the repair of machinery newly purchased.
d) Sold an old equipment costing Rs 5000/- accumulated depreciation Rs 400/-
and selling price received is Rs 4500/-.
e) Purchased land for Rs 90000/- and partial payment of Rs 40000/-.
f) A part of the land purchased for Rs 10000/- was sold for Rs 12000/-.
g) Legal expenses Rs 100/- was paid on an income tax case.
h) Preliminary expenses in the formation of a company.
i) Compensation paid to a director for loss of office.
j) Intensive advertising undertaken by a company to popularize a new product.
Problem 02
a) Carriage paid on installation and erection of new machinery.
b) Premium paid on the redemption of debentures.
c) Repair to second hand car purchased.
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d) Repair to furniture which is used in the business.
e) Acquired land for an agricultural farm at an annual rent of Rs 1500/-.
f) Outdated machinery sold for Rs 6000/- and cash received.
g) Cost of overhauling and painting a second hand tractor newly bought.
h) Cost of annual taxes and insurance paid Rs 500.
i) Legal expenses incurred in an action for infringement of its trade mark.
j) Wages paid to farmers for cultivation Rs 1500 and for digging well Rs 500.
k) Amount realized from the sale of rice 20000/-.
Problem 03
Do the following errors affect the trial balance or not? Write ‘Yes’ if it affects and
‘No’ if it does not.
a) Sold goods of Rs.3200 to Ansari, but are not entered in the Sales Book.
b) Purchased goods of Rs.2400 from Ali and is correctly entered in the Purchases
Book but posted to the credit of her account in the ledger as Rs.3400.
c) Total of the Purchases Book is incorrect.
d) Amount of repair to building is debited to Building Account.
Problem 04
Following are the accounting errors. Write against each error the type i.e. error of
omission, error of principle, compensatory error and error of commission as per
the nature of error:
a) Purchase of Furniture is entered in the Purchase Book (Error of
…………….......)
b) Repairs of building is debited to Building A/c. (Error of
......................................)
c) Sales Book is totaled Rs. 15000 instead of its 14600. (Error of
……………........)
d) Faraz’s A/c was to be debited by Rs 4500 and Saleem A/c was to be debited
by Rs. 5500 while Faraz’s A/c was debited by Rs. 5500 and that of
Saleem’s A/c by Rs. 4500. (Error of ............)
Problem 05
Rectify the following errors:
a) Rs. 1,000 paid as rent to the landlord was debited to the landlord’s Account.
b) Materials from the store for Rs.1,000 and wages of Rs.400 had been used in
making tools and implements for use in the factory but no adjustments were
made in the books.
c) The purchases book was overcast by Rs.100.
d) A sale of Rs.500 to Ali & Co. was credited to its account.
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Problem 06
Rectify the following errors.
a) Rs 100 paid for rent was debited to landlord A/c.
b) Salary Rs 125 paid to clerk due to him has been debited to his personal
account.
c) Rs 100 received from Shah & Co. has been wrongly entered as from Shaw
& Co.
d) Rs 700 paid in cash for a typewriter was charged to office expenses
account.
Problem 07
Trial balance of Waseem did not agree. It showed an excess credit Rs. 10,000.
Waseem put the difference to suspense account. He located the following errors:
a) Sales return book over cast by Rs. 1,000.
b) Purchases book was under cast by Rs. 600.
c) In the sales book total of page No. 4 was carried forward to page 5 as Rs.
1,000 instead of Rs. 1,200 and total of page 8 was carried forward to page 9
as Rs. 5,600 instead of Rs.5,000.
d) Goods returned to Hanif Rs. 1,000 were recorded through sales book.
e) Credit purchases from M & Co. Rs. 8,000 were recorded through sales
book.
f) Credit purchases from S & Co. Rs. 5,000 were recorded through sales book.
However, S & Co. were correctly credited.
g) Salary paid Rs. 2,000 was debited to employee’s personal account.
Problem 08
The trial balance of Aslam Dealers prepared on 31st December, 2000 did not tally.
The difference was placed in the suspense account on the debit side Rs. 39,180. A
detailed examination of his books revealed the following mistakes:
a) A payment of Rs.20,000 to John was posted to the credit of his account.
b) Goods returned by Aleena a regular customer for Rs.5,800 was posted to
the credit of sales account
c) Charges on renovation to the show windows of the shop of Rs.23,640 was
debited to the furniture and fixtures account as Rs.32,460.
d) A payment received from Saleem for Rs.49,240 was credited to Haleem’s
account.
e) Glass purchased for show windows from Aftab suppliers on a credit for
Rs.38,450 was recorded in the purchases day book. At the time of posting,
their account was credited with Rs.34,850.
260
You are required to correct the above mistakes by passing the necessary
rectifying errors in the General journal and find out amount that was
transferred to suspense account where the trial balance did not tally.
Problem 09
Rectify the following accounting errors through Suspense Account by making journal
entries
a) Purchase of goods from Maleeha for Rs2500 was entered in the sales book;
however Maleeha’s Account was correctly credited.
b) Cash received from Anila a debtor Rs3200 was correctly entered in the cash
book but was omitted to be posted to his account.
c) Sales Book was overcast by Rs1500.
d) Cash of Rs4000 paid to Hanif was credited to Rafique A/c as Rs1400.
e) The total of Purchase Returns Book of Rs3150 was carried forward as
Rs1530.
f) Namita was paid cash Rs6500 but Sumita was debited by Rs6000.
Problem 10
State with reasons whether the following items are capital or revenue
a) Loan taken from a Bank Rs. 40,000.
b) Old building was demolished for Rs. 600 in order to construct it.
c) Amount received from Accounts Receivable whose account was previously
written off as bad debts.
d) Company issues shares at premium.
e) Additional accessories purchase Rs. 4,000
f) Designed expenses for building paid.
Problem 11
Identify the following as capital and revenue expenditures:
a) Purchased a delivery van at the cost of Rs. 25,000.
b) Spent Rs. 1,000 on registration and Rs. 600 on painting of delivery van.
c) Constructed a Car park at the cost of Rs. 12,500 in building of office.
d) Purchased uniform for delivery Rs. 500.
e) Purchased a new battery for Rs. 400 after one year use of delivery van.
f) Spent Rs. 1,000 on the repainting of the delivery van after two years.
g) Overhauling expenses of the van after use of 10 years Rs. 4,000.
Problem 12
State with reasons whether following items are capital or revenue:
a) Rs. 2,000 realized for sale of furniture
b) Office of General Manager was air-conditioned at a cost of Rs. 15,000
261
c) Rs. 500 paid as damages for infringement of a patent
d) Rs. 1,500 paid for transportation of stock from old premises to new
premises
e) Rs. 2,000 received from debtor whose account was previously written off as
bad
f) Rs. 3,000 paid as a fee to an Attorney to raise a debenture loan.
5. SUMMARY
a) Capital Expenditure: Expenditure incurred on procurement of fixed assets or
related to his procurement is called capital expenditure and is shown in balance
sheet.
b) Revenue Expenditure: Expenditure incurred to run the day to day
business, such as purchase of goods, salaries, office rent, entertainment and
telephone is revenue expenditure and is ultimately accounted for the trading
and profit and loss account.
c) Capital Receipts: Receipts resulting from sale of fixed assets are capital
receipts.
d) Additional investment made by the proprietor to increase his capital is
acknowledged as capital receipts.
e) Deferred Revenue Expenditure: A heavy revenue expenditure, the benefit
of which may be extended over a number of years, and not for the current
year alone is called deferred revenue expenditure.
f) Capital Profit/Loss: Capital profit/loss is the profit/loss which arises not
from the normal course of the business. Profit/loss on sale of fixed asset is
an example for capital profit/loss.
g) Revenue Profit/Loss: Revenue profits/losses arise from the normal course
of the business. In other words, ‘net profit/loss’.
h) Trial Balance is a statement which shows the extract of the balances, either
credit or debit of various accounts in the ledger. The objective of preparing
trial balance is to check the arithmetical accuracy of the ledger accounts and
to help in locating errors. It also provide basis for the preparation of
financial statements.
i) Types of errors: There are four types of errors.
 Errors of Omission
Errors caused due to omission of recording a transaction either
fully or partially in the books of accounts.

262
  Errors of Principle
Errors caused due to ignoring the accounting principles which may
lead to wrong classification or identification of receipts and
payments between revenue and capital receipts and revenue
expense and capital expenditure.
 Compensating Errors
Two or more errors committed in such a way that they nullify the
effect of each other on the debits and credits.
 Errors of Commission
Errors caused due to wrong recording of a transaction, wrong
posting, wrong totaling, wrong balancing, etc.
j) Suspense Account: The account in which trial balance difference is put
temporarily till such time that errors are located and rectified is called as
suspense account. It facilitates the preparation of provisional financial
statements even when the trial balance does not tally.
k) Disposal of Suspense Account: When all the errors are located and
rectified by passing the necessary journal entries, the suspense account is
automatically closed.
BIBLIOGRAPHY
Ahmad, M. M., Khan, S. A., Arshad, M., & Shah, S. M. (2013). Advanced
Financial Accounting. Islamabad: National Book Foundation Islamabad.
Dupree, D., & Marder, M. (1984). Principles of Accounting. Addison-Wesley.
Farooq, U., & Amir, S. M. (2008). Principles of Accounting. Islamabad: Allama
Iqbal Open University.
Hussain, K., Buttar, Z. U., Pirach, M. A., & Chaudhry, M. I. (1996). Accounting
Principles. Lahore: Orient Publishers Urdu Bazaar Lahore.
Mukherjee, A., & Hanif, M. (2003). Modern Accountancy I. Tata McGraw-Hill
Education.
Randall, H. (2005). Accounting. Cambridge University Press.
Wood, F., & Sangster, A. (2008). Business Accounting I. Pearson Education.

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Unit–9

ACCOUNTING FOR
BILL OF EXCHANGE

Written by: Syeda Faiza Urooj

Reviewed by: Muhammad Munir Ahmad
Asia Batool

264
 CONTENTS
INTRODUCTION
OBJECTIVES
1. INTRODUCLTION
1.1 Bill of Exchange
1.2 Definition
1.3 Parties to Bill of Exchange
2. TYPES OF BILL OF EXCHANGE
2.1 Inland Bill of Exchange
2.2 Foreign Bill of Exchange
2.3 Time Bill of Exchange
2.4 Sight Bill of Exchange
2.5 Specimen of Inland Bill of Exchange
2.6 Specimen of Foreign Bill of Exchange
2.7 Accommodation Bill
2.8 Features of the Bill
2.9 Days of Grace
2.10 Acceptance for Honour
2.11 Discounting of Bill
2.12 Dishonour of the Bill
2.13 Noting Charges
2.14 Retirement of the Bill
2.15 Renewal of the Bill
3. ACCOUNTING OF BILL OF EXCHANGE
3.1 Maturity of bill of Exchange
3.1.1 Payment on Due Date
3.1.2 Endorsement to Creditor
3.1.3 Discounting of the Bill
3.1.4 Deposit in the Bank
3.1.5 Bills Receivable Book
3.1.6 Bills Payable Book
265
 3.2 Entries in the Journal
3.3 Dishonour of the bill of Exchange
3.4 Journal Entries on the Dishonour of the Bill of Exchange
4. SELF-ASSESSMENT QUESTIONS
4.1 Choose the Best Answer from the Given Options
4.2 Give the Short Answers of the Following Questions
5. PROBLEMS
6. SUMMARY
REFERENCES/BIBLIOGRAPHY

266
INTRODUCTION
Now-a-days it has become very necessary for every business to sell its
goods or provide services on credit basis in order to increase the sales, profit and
meet competition. With the increase in credit sales, the risk of bad debts is also
increases. To ensure the recovery of debts, a document known as bill of exchange
has got popularity in business world. This unit describes the introduction of bill of
exchange, its various types and accounting procedures. At the end of the unit self-
assessment questions and various problems are discussed for well comprehension
of the topics covered in this unit.

OBJECTIVES
After studying this unit, you will be able to:
1. Know about the importance of bill of exchange in the business world
2. Understand its various types
3. Differentiate between trade bill and accommodation bill
4. Journalize the transactions related to bills of exchange
5. Know the role of banks and notary public in respect of bills of exchange

267
1. INTRODUCTION
In previous units, we learned that we use cash and bank cheque for
payments and receipts in the business. But we know that most of the businesses
are carried on through credit. But in fact, a business man cannot stop his business
he needs finance to run his business in order to overcome this problem. He uses a
document named as bill of exchange.
Bills of exchange developed during the middle ages as a means of
transferring funds and making payments over long distances without physically
moving bulky quantities of precious metals. In the hands of thirteenth-century
Italian merchants, bankers, and foreign exchange dealers, the bill of exchange
evolved into a powerful financial tool, accommodating short-term credit
transactions as well as facilitating foreign exchange transactions.
Generally bills of exchange are used to get for loan from bank. The person
seeking loan keep bills with the bank and gets loan from the bank. The loan value
(varies from 80-95% of bills amount) depends on various things like maturity
date, risk, interest etc. Bank recovers the loan amount against the customer
payments. Bank also charge some amount for bills of exchange, so banks get
benefit from it and company will get liquidity so company can be able to do its
business smoothly and to have more profits.
1.1 Bill of Exchange
A bill of exchange is an instrument in writing containing an unconditional
order, signed by the maker, directing a certain person to pay a certain sum of
money only to or to the order of a certain person or to the bearer of instrument.
It is a negotiable instrument, similar to a post-dated cheque, which is
usually sold at a discount. The person holding it has proof of debt. A bill is an
unconditional order in writing, addressed by the drawer to the drawee, requiring
the drawee to pay a sum of money on demand or at a specified future time to
the payee (who might be the drawer or another party) or to the bearer. If the
drawee accepts the bill, by writing on it and signing it, he becomes
the acceptor and therefore primarily liable to pay the bill when it becomes due. If
the acceptor fails to pay, the drawer or an endorser must compensate the holder.
1.2 Definition
The formal definition of a bill of exchange under the Bills of Exchange Act
1909 - 1973 is: “An unconditional order in writing, addressed by one person to
another, signed by the person giving it, requiring the person to whom it is
addressed to pay on demand, or at a fixed and determinable future time, a sum
certain in money to the order of a specified person, or to bearer.”
268
 Assume that a merchant in France sold goods to a Pakistani merchant and
accepted in payment a bill of exchange drawn on the Pakistani merchant
promising to pay an agent of the French merchant in France at a certain date in the
future, and in a certain currency. The bill of exchange allowed the Pakistani
merchant to accept delivery on the goods from France, sell them, and take the
proceeds to redeem the bill of exchange in Pakistan, probably in Pakistani
currency.
1.3 Parties to Bill of Exchange
Initially there are three parties to a bill of exchange.
(b) Drawer: The person who writes the bill is called the drawer. He gives the
order to pay money to third party.
(c) Drawee: The party upon whom the bill is drawn is called the drawee. He is
the person to whom the bill is addressed and who is ordered to pay. He
becomes an acceptor when he indicates his willingness to pay the bill.
(d) The payee: the person to whom the money is payable.
2. TYPES OF BILL OF EXCHANGE
Following are types of bills of exchange:
2.1 Inland Bill of Exchange
An inland bill is one which is (i) drawn and payable in same country or (ii)
drawn in one country upon some person resident in same country even though it is
made payable in a foreign country. Thus in an inland bill of exchange, both
drawer and drawee belong to the same country.
2.2 Foreign Bill of Exchange
A foreign bill is one which is drawn in one country and payable in another
country. Foreign bills are drawn in a set of three and each part of the set called a
via contains a reference to the other parts. This is done to avoid delay or loss
or miscarriage during the transit.
2.3 Time Bill of Exchange
When a bill of exchange is payable on a specified period of time, it is called
time bill of exchange.
2.4 Sight Bill of Exchange
A bill of exchange payable on bearing it or at sight is called sight bill of
exchange. For example cheque etc.
2.5 Specimen of Inland bill of Exchange
Drawee after accepting the bill sends back to the drawer and drawer can use
it for purchases etc.
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 Stamp Rs. 5000 20, Murree Road,
Rawalpindi.
5th Jan 2018.

Three months after date, pay to Mr. M. A. Khan or order the sum of Rs. Five Thousand
only for value received.

To,
Sardar & Co.
Karachi. H.Q. Sons

2.6 Specimen of Foreign Bill of Exchange

Stamp Exchange for $ 250 Lahore,

1st December, 2018

At sixty days after sight of this First of Exchange (second unpaid) pay to
ourselves or order two Hundred and Fifty Dollars value received..

To,
Messrs. McDonald & Evans Ltd.
8 John Street,
London W.C.I
2.7 Accommodation Bill
Accommodation bill is drawn by the drawer on drawee in order to provide
financial help to each other. Such bill is discounted through bank to overcome
financial problems.
2.8 Features of the Bill
a. ”Bill of Exchange” included in the current text
b. Drawer´s name = Name and address of the issuer of the Bill of Exchange
i.e. the Seller.
c. Drawee’s name = Name and address of the paying part.
d. The amount expressed in letters.
e. The amount expressed in figures.
f. Date of issue = the date of the issuance of the Bill of Exchange.

270
g. Maturity = The maturity date of the Bill of Exchange. Upon immediate
payment, write “At sight”. Upon payment at a pre-determined date, write
maturity yyyy-mm-dd at a pre-determined date after shipment . When a Bill
of Exchange matures at a pre-determined period after acceptance, e.g. 60
days sight the acceptance shall include maturity date.
h. Payee = the party receiving payment at maturity. In this field usually is
written ”ourselves” and the issuer of the Bill of Exchange makes an
endorsement on the reverse of the Bill of Exchange. The endorsement is
consisting of the firm’s stamp at the company’s written name plus a
signature of the person authorized to sign the Bill of Exchange.
i. Field for additional information if applicable, e.g. Letter of Credit No.
j. Drawer´s signature = The Seller’s firm stamp + signature alt. the company’s
written name plus the signature of the person authorized to sign the Bill of
Exchange.
k. When the drawee has accepted the Bill of Exchange, he is called acceptor.
l. It could be payable at a the domicile of a third party, e.g. a bank, whose
address should be stated.
m. Place of payment is the domicile of the drawee provided that he is not
evidencing otherwise.
2.9 Days of Grace
Usually bill of exchange is payable on a specified date but due to some
reasons the drawee fails to pay therefore, a few days more are given as extra time
to pay off the bill. These extra time usually of three days and are called days of
grace. But such days of grace are not given in case of demand or sight bills.
2.10 Acceptance for Honour
Sometimes a bill of exchange is dishonored due to any reason at that time
who accepts the responsibility for its payment on behalf of drawer or drawee is
called acceptance for honour.
2.11 Discounting of Bill
A bill of exchange is a document which can be discounted through bank. A
proprietor does not wait till its maturity date and discount it from a bank. Bills of
exchange can be discounted on rebate before its due date. The rebate or discount
is earning of the bank. The bills of exchange usually mature within 90 days. In
case a bill, say of rupees 2000 due 90 days hence is discounted today at
20 percent per annum, the borrower is paid rupees 1900. The bank however
collects the full amount of rupees 2000 of the bill from drawer on maturity. The
drawer or maker of the bill is expected to pay the bill on maturity.
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The bank by discounting the clean or documentary bill advances the amount to
the payee. On maturity of the bill the amount is collected from the drawer. The
discount is the safe earning of the bank because the bill of exchange is a
negotiable instrument. If at any time the bill is dishonoured the payee is
responsible to make the full payment of the bill to the bank. On the maturity of
the bill there is certainly of payment to the bank. It is thus a short term advance
with certainly of payment. As the date of payment to the bank is sure the short
term advance is quite liquid.
2.12 Dishonour of the Bill
When the holder of the bill presents it to the drawee for payment on due
date and drawee fails to make payment the bill is said to be dishonoured i-e bill
will not be paid. If the bill is dishonoured , the bill become useless and the party
from whom the bill was received will be liable to pay the amount as some
expenses has been incurred by the party.
2.13 Noting Charges
When a bill of exchange is dishonoured, the holder can get such fact noted
on the bill by a notary public. The advantages of noting is that the evidence of
dishonoured is secured. The noting is done by recording the fact of dishonoured,
the date of dishonour, the reason of dishonour, if any. For doing all this,
the notary public charges his fees which is called noting charges.
2.14 Retirement of the Bill
Sometimes the drawee pays the bill before the agreed date enjoying the
rebate which is provided to him for pre-payment of the bill. This is known as
retirement of the bill. The amount of the rebate depends upon the time left for
payment and the amount for which the bill is drawn.
When acceptor of the bill has spare funds to pay it back before the maturity,
it approaches the payee of the bill of exchange and ask him whether he is
prepared to accept cash before maturity? In such case rebate given becomes the
income of acceptor and expense of payee.
2.15 Renewal of the Bill
When the drawee of the bill after accepting it, has some apprehension in his
mind that his mind that he may not be able to honour the bill on due date, may
request the drawer of the bill to cancel the original bill and to draw a fresh bill on
him for a further period of time this is called renewal of the bill.
Sometimes the drawee of the bill is unable to pay the bill on its agreed date
or time. In such a situation the drawee can apply to issue a new bill subject to
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certain conditions after the agreement of the drawer. After the issuance of the bill
the former is considered to be cancelled. But if the drawee again unable to pay the
newly issued bill, the first bill with all its farmer conditions becomes payable and
valid.
2.16 Benefits of Bill of Exchange
i. Bill of exchange is helpful in international payments.
ii. In case of dishonor of the bill it is legally protected.
iii. It is a legal document convertible into cash.
iv. Helpful in making payments to the creditors.
3. ACCOUNTING FOR BILL OF EXCHANGE
3.1 Maturity of Bill of Exchange
Bill of exchange matures in the following manners.
3.1.1 Payment on Due Date
The bill matures on payment on due date by the drawee to the payee
3.1.2 Endorsement to Creditor
After accepting the bill by the drawee, the drawer can endorse it to anyone
of his creditors.
3.1.3 Discounting of the Bill
A bill of exchange is a document which can be discounted through bank. A
proprietor does not wait till its maturity date and discount it from a bank.
3.1.4 Deposit in the Bank
Sometimes the drawer deposit the bill with its dealing bank and bank on
maturity of the bill collects the amount and deposit in the drawer's account.
3.1.5 Bills Receivable Book
In bills receivable book the proprietor records all those bills receivables
which are to be received. All matters relating to bills receivables are recorded in
this book.
3.1.6 Bills Payable Book
In bills payable book the proprietor records all those bills payables which
will be paid in future. All matters relating to bills payables are recorded in this
book.
3.2 Entries in the Journal
Illustration No.1
Rahim sold goods worth Rs.5000 to Akram. Akram cannot pay cash. He
accepted a bill of exchange for Rs.5000 payable after one month and returns it to
Rahim. Show entries in Rahim's book and also Akram's Book.

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Journal Entries in Rahim’s Book
Sr. No Particulars L.F Debit Credit
May 5 Akram 5000
Sales 5000
(On sale of goods of Akram)
May 10 Bills Receivable 5000
Akram 5000
(Akram's account credited on receipt of
Bill from him).
Journal Entries in the Akram’s Book
Sr. No Particulars L.F Debit Credit
May 5 Purchases 5000
Rahim 5000
(Purchases from Rahim)
May 10 Rahim 5000
Bills Payable 5000
(Rahim debited for issue of accepted bill
sent to him in lieu of cheque or cash).
Illustration No. 02
On June 13, Akram honors the bill and on presentation his banker U.B.L
Gulberg Lahore pays Rs.5000 to Rahim.
Entries in Rahim’s Journal
June 13 Bank 50,000
Bills Receivable 50,000
(Bill is sent to bank which makes
collection)
Entries in Akram’s Journal
June 13 Bills Payable 50,000
Bank UBL a/c No 50,000
(Bill paid through bank)
Illustration No. 03
Suppose Rahim wants the money urgently and discounts the bill after 15
days instead of waiting for full period. His bankers pay him the amount but
deduct discount at 10%. The deduction would be 5,000*10/2*12*100 = Rs. 21
and he would get Rs.5, 000-21 = Rs. 4,979.
Required: Record entry in Rahim's Journal

274
Journal Entries in the Rahim’s Book
June 28 Cash 4,979
Discount expense 21
Bills Receivable 5,000
(Discounting of bill receivable)
Illustration No. 04
Suppose Akram is unable to pay Rs. 5000 on due date and the bill is
dishonored. Rahim issues notice to him and incurs Rs.25 expenses on this
account. You are required to record entries in Rahim's Journal.
June 28 Akram 5,025
Bills Receivable 5,000
Cash 25
(Amount of the bill and expenses incurred
debited to Akram's A/c)
Illustration No. 05
Rahim makes purchases of Rs.8,000 from Amjad. He pays cash Rs.3,000
and endorses bill receivable in favour of Amjad for the balance.
Journal Entries in the Rahim’s Book
June 1 Purchases 8,000
Cash 3,000
Bills Receivable 5,000
(Purchases partly paid in cash and partly
by bill receivable)
Journal Entries in Amjad’s Book
June 1 Rahim 8,000

Sales 8,000
(Goods sales on credit)

Cash 3,000
“ Bill Receivable 5,000

Rahim 8,000
(Received cash and drew a bill for the
balancing amount)

275
Illustration No. 06
A draw's bill on B due after 3 months for Rs. 1,500 and B accepts it. Draft
journal entries and open the necessary ledger accounts in each of the following
cases in the books of both parties.
i. When A receives the bill
ii. When A discounts it and receives Rs.1,475.
iii. When A endorses it to C in payment of his debt
iv. When A keeps it with him till maturity and gets the money on due date
A’ Books
S. No Particulars L.F Debit Credit
i. Bills Receivable 1,500
To B's A/c 1,500
(Bill accepted by B)

ii. Cash 1,475

Discount 25
To Bill Receivable A/c 1,500
(bill discounted for Rs.1475)

iii. C' 1,500

To Bills Receivable A/c 1,500
(bill endorsed over to C)

iv. Cash 1,500 1,500

To Bills Receivable A/c
(amount received on the maturity of the
bill)
3.3 Dishonor of the Bill of Exchange
A bill of exchange is said to be dishonored when the drawee refuses to
accept or make payment on the bill. A bill may be dishonored by non-acceptance
or non-payment.
a) If the drawee refuses to accept the bill when it is presented before him for
acceptance, it is called dishonour by non-acceptance. When a bill is
dishonored by non-acceptance, an immediate right of recourse against the
drawer and endorser accrues to the holder. In this case, presentment for
payment is not necessary.
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b) If the drawer has accepted the bill, but on the due date, he refuses to
make payment of the bill, it is called dishonour by non-payment. In this
case the holder has immediate right of recourse against each party to the
bill.
3.4 Journal entries on the dishonour of the bill of exchange:
3.4.1 Creditor’s Books:
At the time a bill is dishonoured, it may be either with the drawer or with
his banker with whom he has discounted it or with a creditor of whose favor he
may have endorsed it:

(a) When the bill of exchange is still in the drawer's possession:

Acceptor's personal account [Dr.]
(full value of the bill and noting charges)
To Bills receivable account [Cr.]
To Cash account (noting charges) [Cr.]

(b) When the bill of exchange has been discounted with the bank:
Acceptor's personal account [Dr.]
To Bank [Cr.]

Note: The amount will include the noting charges. No separate entry will be
passed for noting charges as in case (a) above
(c) When the bill of exchange has been sent for collection:
Acceptor's personal account [Dr.]
To Bank for collection account [Cr.]

(d) When the bill of exchange has been sent for collection:
Acceptor's personal account [Dr.]
To Personal account of creditor [Cr.]
It may be noted that in all four cases the drawer debits the acceptor's credits
that party's account who presents the bill for payment.
3.4.2 Debtor's Books
When the bills payable is dishonoured, the debtor has to pass the same
journal entry in all the cases. The journal entry is:
Bill payable account (full value of the bill) [Dr.]
Trade expenses account (noting charges) [Dr.]
To personal account of drawer [Cr.]
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Illustration No. 06
P draws a bill on Q for $2,000 who accepts and returns it to P on the same
date. The bill is dishonored by Q on the due date. P pays $30 as noting charges.
Record the above transactions in the books of P and Q.
Solution
Journal Entries in the Books of P
Bills receivable account 2,000
To Q 2,000
(Acceptance received)

Q 2,030
To Bills receivable account 2,000
To Cash account 30
(Bill endorsed)

Journal Entries in the Books of Q

P 2,000
To Bills payable account 2,000
(Acceptance given)

Bills payable account 2,000

Trade expense account 30
To P 2,030
(Acceptance dishonoured and noting
charges paid)

Journal Entries in the Books of R

Bill receivable account 2,000
To P 2,000
(Bill received from a debtor - Q)

Cash account 2,000

To Bill receivable account 2,000
(Amount of the bill received)

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Illustration No. 07
On 1st January, 2013 P draws on Q a three months bill for Rs. 2,000 who
accepts and return it to P on the same date. On 4th January P discounts it with his
bank at 6% per annum. The acceptance is dishonoured in the due date, and bank
pays Rs. 30 as noting charges.
How these transactions should be recorded in the journal of P & Q.
Solution
Journal Entries in the Books of P
2013
Jan. 1 Bills receivable 2,000
To Q 2,000
(Acceptance received)

Jan. 4 Bank account 1,970

Discount account 30
To Bills receivable account 2,000
(bill discounted)

April 4Q 2,030
To Bank account 2,030
(Q's acceptance dishonoured)
Journal Entries in Books of Q
2013
Jan. 1 P 2,000
To Bills payable account 2,000
(Acceptance given)

April 4 Bills payable account

Trade expense
To P
(Bill dishonoured, noting charges paid.)
Illustration No. 08
P draws a bill for Rs. 2,000 on Q who accepts and returns it to P on the
same date. P sent the bill to his banker for collection. On the due date, the bill is
dishonoured by Q. Give journal entries in the books of P.

279
Solution
Bills receivable account 2,000
To Q 2,000
(Acceptance received)

Bank for collection account 2,000

To Bills receivable account 2,000
(Bill sent for collection)

Q
To Bank for collection account

(Bill dishonoured)

4. SELF-ASSESSMENT QUESTIONS
4.1 Choose the best answer from the given options:
i. A bill of exchange is defined under Bills of Exchange Act:
a) 1882
b) 1906
c) 1982
d) 1932
ii. A person who writes the bills of exchange is called:
a) Acceptor
b) Payee
c) Drawer
d) Drawee
iii. A person who accepts the bills of exchange is called:
a) Creditor
b) Drawer
c) Endorser
d) Drawee
iv. The person to whom bill is transferred will become
a) Endorsee
b) Endorser
c) Creditor
d) Payer
v. Extra days given to payer are known as:
a) Days of bill receivable
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 b) Days of bill payables
c) Days of Grace
d) Discount period
Answer
i. a ii. c iii. d iv. a v. c
4.2 Give the short answers of the following questions:
i. Who is drawer and drawee?
ii. What do you know about days of grace?
iii. Define the term accommodation bill of exchange
iv. What is meant by maturity of bills of exchange?
v. Differentiate between inland and foreign bill.
vi. Who is endorsee?
vii. What do you mean by discounting of bill?
viii. Explain the noting charges.
ix. What is the role of notary public?
x. What is meant by dishonor of bill?
5. PROBLEMS
Problem 01
Bilal owes Kalim Rs.8000. Kalim then draws a bill for Rs. 8000 on Bilal for
a period of three months. Bilal accepts and return it to Kalim. Kalim discounted
the bill with his bank at 12 % p.a. On due date, the bill was dishonoured noting
charges amount to Rs. 30. Kalim then draws a bill for the balance plus interest of
Rs. 170. Before the due date of this bill Bilal pays the amount at a discount of Rs.
40 to retire the bill. Pass Journal Entries in the books of Kalim.
Problem 02
Irum accepted a bill for Rs. 2,000/- drawn by Diya at three months. Diya
got the bill discounted with her bank for Rs. 1,900. Before the due date Irum
approached Diya for renewal of the bill. Diya agreed on the condition that Rs.
1,000/- be paid immediately together with interest on the remaining amount at 6%
p.a. For balance Irum should accept a new bill for three months. These
arrangements were carried through but afterwards, Irum become insolvent and
only 40 % of the amount could be recovered from her estate. Give journal entries
in the books of Diya.
Problem 03
Ali sold goods to Dawood for Rs. 3,000. On the same date Dawood
accepted a bill for 2 months. Ali endorsed the bill to Ishwar. On the due date of
the bill, Ishwar informed that the bill is dishonoured and the noting Charges were
281
Rs. 20. Ali drew a new bill on Dawood for the amount due including noting
charges and an interest of Rs. 130. Before the due date of the second bill Dawood
become bankrupt and 20 paisa in a rupee was received from his estate as first and
final dividend. Pass the necessary journal entries in the books of Ali.
Problem 04
On 1st March, Kashif sold goods to Aman worth Rs. 8,000/- and Aman
accepted the Bill for Rs. 8,000/- at 3 months drawn by Kashif. Kashif discounted
the bill with his bank @ 6% p.a. On due date the bill was dishonoured and Aman
requested Kashif to accept Rs. 4,000/- immediately and draw upon him a new bill
for the remaining amount at 3 months together with an interest at 10% p.a. Kashif
agreed. The second Bill was duly honoured. Give Journal entries in the books of
Aman.
Problem 05
Arsheen purchased goods from Bilal on Credit for Rs. 10,000 and
accepted a bill drawn by Bilal for four months. Bilal discounted the bill with
her bank for Rs. 9600/- Before the due date Arsheen approached Bilal with a
request to renew the Bill Bilal agreed with the condition that Arsheen should pay
Rs. 6000 with interest of Rs. 120 and accept a new bill for the balance. The
arrangement was duly carried out. New bill is met on the due date. Pass journal
entries in the books of Arsheen.
Problem 06
Anita brought goods worth Rs. 4,500 from Saman on August 1, 2018. On
the same day, Anita accepted the bill for Rs. 4,500 at 3 months drawn by Saman.
Saman got the bill discounted with his bank at 6%. Before the due date, Anita
informed Saman about his inability to pay the amount of bill. He further requested
him to accept Rs. 2,500 in cash and immediately draw upon him a new bill for the
remaining amount at 2 months together with interest at 8 % p.a. Saman agreed.
The second bill was duly paid on maturity. Give journal entries in the books of
Anita.
6. SUMMARY
Bill of Exchange
“A bill of exchange is an unconditional order in writing addressed by one
person to another, signed by the person giving it, requiring the person to whom it
is addressed to pay on demand or at a fixed or determinable future time a
specified amount to the order of a specified person or to bearer”

282
 Journal Entries
In the books of drawer
Sr. Transaction Accounts Dr. Cr.
No
1. A sells goods for 1000 to B and draws B’s A/c 1000
a bill upon him, B accepts the bill Sale A/c 1000
payable after 3 months Bill receivable 1000
A/c 1000
B’s A/c
2. A discounts the bill after one month 990
for Rs. 990 Cash 10
Discount 1000
Bill
3. A holds the bill till maturity and then receivable 1000
the bill is duly honored.
Cash 1000

4. On maturity the bill is dishonored. A Bill receivable 1050

incurs Rs.50 as legal expenses for 1000
giving notice to B. B’s account 50
Bill receivable
B renews the bill for Rs.1100 Cash 1100
5. 1050
Bill receivable 50
B’s account
Interest A/c
In the books of Drawee
Sr. Transaction Accounts Dr. Cr.
No
1. B purchases goods from A for Purchases 1000
Rs.1000 and accepts a bill for 3 To A’s a/c 1000
months. A's account 1000
To B/P a/c 1000
2.
A discounts the bill after one month. No entry shall
be made in B’s
book which
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 drawer
3. discounts the
B honors and pays the bill on due bill before due 1000
date. date.
4. 1000
Bills Payable a/c
On maturity B cannot pay the bill. A 1000
sends notice for Rs.1000 as bill Cash / 50
5. amount and Rs.50 as other charges in Bank
serving the notice 1050
Bills Payable a/c
B renews the bill for Rs.1100 Interest or Misc. 1050
Exp 50
1100
A’s A/c

A’s A/c
Interest
expenses
Bills payable
BIBLIOGRAPHY
Ahmad, M. M., Khan, S. A., Arshad, M., & Shah, S. M. (2013). Advanced
Financial Accounting. Islamabad: National Book Foundation Islamabad.
Dupree, D., & Marder, M. (1984). Principles of Accounting. Addison-Wesley.
Farooq, U., & Amir, S. M. (2008). Principles of Accounting. Islamabad: Allama
Iqbal Open University.
Hussain, K., Buttar, Z. U., Pirach, M. A., & Chaudhry, M. I. (1996). Accounting
Principles. Lahore: Orient Publishers Urdu Bazar Lahore.
Mukherjee, A., & Hanif, M. (2003). Modern Accountancy I. Tata McGraw-Hill
Education.
Randall, H. (2005). Accounting. Cambridge University Press.
Wood, F., & Sangster, A. (2008). Business Accounting I. Pearson Education.

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 GLOSSARY

Accounting
Accounting is the art of recording, classifying and summarizing in a
significant manner and in terms of money, transactions and events, which are in
part at least, of financial character, and interpreting the result thereof.”
Accounting System
Accounting system consists of personnel, procedures, devices and records
used by an organization to develop and to communicate accounting information to
decision makers.
Profession
All those economic activities other than the business aimed to earn profit
are called profession. Before adopting any profession it is essential to acquire the
basic knowledge and skills. The people who earn money through profession are
called professionals.
Transaction
Accounting transaction is an economic activity that can be objectively
measured in terms of money and effect the assets and/or equities of the enterprise.
Drawings
When the owner of the business withdraws the cash he invested or the
goods of the business for his personal use the value of such goods is called the
drawings. Drawings reduce the capital of owner while net income and further
investment increases the capital of the owner.
Goods
The commodities purchased by the business with a view to earn profit by
resale of these commodities without changing their physical characteristics are
called goods or merchandise.
Purchases
Purchase means the process of buying commodities either for resale at
higher price or to use in the manufacturing of the finished goods. There are two
types of purchase cash purchase and credit purchase. If the cash is paid at the time
of purchase it is called cash purchase but if payment is promised at some future
date then it would be credit purchase.
Sales
When the business provides goods to the customers for a price to earn profit
it is called sale. Again there are two types of sale cash sale and credit sale. In cash

285
sale the price is charged in cash at the time of sale. But if the payment is promised
by the customer on some future date it is called credit sale.
Service Revenue
Service revenue is the reward of professional that he earns by providing the
services to the clients. If the services are provided and the payment is made
immediately it is called the service revenue earned but if the payment is promised
in some future date it is called the service revenue receivable and if the client paid
in advance prior to providing the services then it will be the unearned service
revenue for service provider.
Purchase Return and Allowance
Some time the buyer returns purchased goods to the supplier for certain
reasons this is called the purchase return. The goods are returned or the allowance
claimed in the following situations.
a. If the goods are damaged or are not according to the quality agreed.
b. If goods are excess in quantity than demanded.
Sales Return and Allowance
When the buyer returns the goods sold it is sales return for the seller. It is
also called return inward. The reasons are same as in case of purchase return.
Debtor
The person who borrows some goods or cash from another person the
borrower is known as debtor in accounting. He remains debtor until he finally
makes payment and settled the account. Debtors are the asset of the business.
Creditor
Creditor is the person who lends the goods, services or cash to another
person. He remains creditor until he collects the amount from the borrower.
Creditors are the liability for the business.
Cash Discount
When the debtor pays cash before the due date the creditor may grant him
some concession on this early payment to encourage this tendency. This
concession is known as the cash discount.
Trade Discount
Trade discount is the concession that seller grants to the buyer on the list
price of the goods. This is the part of the list price.
Cash Transaction
Cash transactions are those transactions in which payment is made
immediately in cash. In these transactions neither credit nor any other
consideration is involved.
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Credit Transaction
It means the trade or business on credit in which cash is not involved and
the payment is promised in some future date.
Bad Debts
Now a day’s mostly business is on credit. If the creditor cannot recovered
the whole or a part of the debt this un-recovered debt is called bad debt in
accounting. It is the expense of the business. Businessman uses many tactics to
reduce these unwanted expenses.
Assets
Assets are economic resources owned by a business that are expected to
benefit future operations. In other words assets are probable future economic
benefits obtained or controlled by a particular entity as a result of past
transactions or events.
Liabilities
Liabilities are the claims against the assets of the business. These claims are
both internal and external. Internal claims means the claims by the owners of the
business who provide initial finance to the business technically called capital or
owner’s equity. External claims are the obligations of the business toward the
outsiders who provide finance to the business for example financial institutions,
suppliers, employees etc.
Total Sale
It means all the sale of a particular period including cash and credit sale.
Voucher
The written evidence of a transaction is called voucher. In accounting all
transactions must be supported by the vouchers. No transaction can be recorded in
the books of accounts until supported by a documentary proof. This proof may be
bills, invoices, and receipts.
Account
Account means a classified record of a particular person or a thing in black
and white. Each account has a unique title and all the transactions relevant to that
thing or person is recorded under this title. This is the classification process in the
accounting.
Sundry Expenses
The day to day petty expenses of small amounts are recorded in a single
account called sundry expense or miscellaneous expenses to save the wastage of
stationery, energies and time.

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Accounting Period
The owner can know the profit and loss of the business at any time from the
books of accounts but for ease and to comply with the instructions of the
government institutions the owners have to decide the period for which the
financial statements are prepared. Normally this period is one year but the
organization may prepare the financial statements during the year at any time
these statements are called interim financial statements.
Book-Keeping
Book keeping means to write the business transactions in the books of
accounts. The person who performs this duty is called book-keeper or accounts
clerk. Higher education in accounting is not necessary for the book-keeper
because he works under an accountant who directly supervises the book keeper.
The work of book keeper is clerical nature he produces the records in routine he
has not to apply the complex techniques.
Double Entry System of Book-Keeping
Double entry system of book keeping is the complete and comprehensive
system in which the complete information regarding the transaction is brought
into the records in a very result oriented manner.
Accounting Cycle
The Process through which accounting works flows is known as the
Accounting Cycle. It consists of the seven steps.
Journal
The journal is a permanent chronological record of debits and the credits
resulting from transactions, together with all necessary explanations of the
transaction.
Ledger
It is a book of final entry summarizing all of a company's financial
transactions under their respective heads, through offsetting debit and credit
accounts.
Trial Balance
It is a list of all ending or closing balances of accounts, which is prepared
on particular date to check the arithmetical accuracy of accounts
Adjustments
Once bookkeeping procedures have been completed, the accountant
prepares adjustments for the transactions involve more than one accounting
period. The following are the most common circumstances that require
adjustments: accrued revenue (for example, interest earned but not yet received);
288
accrued expense (wage cost incurred but not yet paid); unearned revenue (earning
subscription revenue that had been collected in advance); prepaid expense
(expiration of a prepaid insurance premium); depreciation (recognizing the cost of
a machine as expense spread over its useful economic life); inventory (recording
the cost of goods sold on the basis of a period's purchases and the change between
beginning and ending inventory balances); and receivables (recognizing bad-debt
expenses on the basis of expected uncollected amounts).
Adjusted Trial Balance
Once the adjustments are calculated and entered in the ledger, the
accountant prepares an adjusted trial balance—one that combines the original trial
balance with the effects of the adjustments.
Financial Statements
Final accounts or financial statements are the end product of an accounting
cycle. There are four types of financial statements Income statement, Balance
Sheet, Statement of changes in owner’s equity and Cash Flow Statement. The
income statement shows the profitability of the business. The balance sheet shows
the financial position of the business. Statement of changes in owner’s equity
shows the changes in the capital of the owners and cash flow statement shows the
cash position of the business it clearly states that what are the sources of cash and
what are the uses of cash.
Closing Entries
The final step is to close non-cumulative accounts. This procedure involves
a series of bookkeeping debits and credits to transfer sums from income-statement
accounts into owners' equity accounts. Such transfers reduce to zero the balances
of non-cumulative accounts so that these accounts can receive new debit and
credit amounts that relate to the activity of the next business period.
Accounting Equation
Financial position of an entity may be presented as:
Assets = Liabilities + Owner’s equity
This is also known as accounting equation. It is the foundation of double
entry system. All the accounting systems either they are very simple or highly
sophisticated based on this equation.
Personal Account
Personal Account is the account which is in respect of a person, firm or a
company. Personal accounts are of two types the accounts receivable or accounts
payable.

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Impersonal Account
Impersonal Accounts are those other then personal accounts. These
accounts include all expenses, incomes, assets and liabilities. Impersonal accounts
are further classified under the following two categories.
Real Accounts
All assets, liabilities and capital accounts are permanent accounts. All
permanent accounts are real accounts. Real accounts are balanced and carried
forward to the next accounting period. These accounts are accounts of assets and
properties such as land, building, plant, machinery, patent, cash, investment,
inventory, etc.
Nominal Accounts
These accounts are closed at the end of the financial year. The balances of
these accounts are not transferred to the next year for example wages paid,
discount allowed or received, purchases, sales, etc. These accounts generally
accumulate the data required for the preparation of Trading and Profit and Loss
Account.
Bill
It is the document prepared by the sales section at the time of credit sale.
Normally three copies of bill are prepared one copy is sent to the buyer with the
consignment second is sent to the accounts section and third is kept in the sales
section for record and future correspondence.
Cash Memo
In case of cash transaction (sale) Cash memo is prepared instead of bill. Its
three copies are prepared like bill and sent to the concerned departments.
Cheque
According to the nature, cheques are of two types first the businessman
issued for the payment and second those collected by the businessman as
collection of debt. He received voucher from the creditors for payment and sent
vouchers to his debtors for receipt of the payment.
Bank Advice
Through this document bank informed its clients about the status of their
accounts. This document is initiated either on the request of the client or at any
unusual event like the dishonor of cheque.

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Credit Note
When any customer returned goods the vendor sent a credit note to that
customer to inform that the specific amount is credited from his account and the
account is updated accordingly.
Debit Note
When the businessman returned goods to supplier he also send a debit note
along with goods to inform him that the value of the goods is debited in his
account and he is no more liable for this amount.
Pay-in-slip book
To make deposit with a bank it is necessary to use certain forms prescribed
by that bank. A printed form with a detailed listing of items being deposited is
called pay-in-slip. Banks provides these forms to depositors free of cost. This
book contains ten, fifty or hundred leaves or forms.
Cheque Book
A piece of commercial paper drawn on funds in a bank account and payable
on demand is called cheque. Cheque involves three parties (1) the drawer who
order the bank to a pay certain amount of money (2) the bank which the drawer
has a deposit (3) the person directed to receive the money known as the payee.
Bank Statement
A statement of account issued to each depositor at least once a year by a
bank. Bank statement reflects the details of the transactions recorded in the
account of the customer by bank.
Contra Entries
Those entries which are recorded on the both sides of the cash book are
known as contra entries. Both the cash and bank accounts are involved in this type
of transactions.
Un-presented Cheques
Cheques issued but not presented at the counter of payment is known as the
un-presented cheques
Un-Credited Cheques
Cheques deposited but not yet collected by the bank
Standing Order
A standing order is an instruction to a bank by a customer to make a fixed
payment regularly on stated days to some third party.

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Petty Cash
Petty cash book is used to record the small payments or expenditures of the
business, which are maintained by the petty cashier
Bank Reconciliation Statement
To reconcile the balances of cash book and pass book a statement is
prepared, that is known as Bank Reconciliation Statement
Final Accounts
Final accounts are those accounts which are prepared at the end of each
accounting period to ascertain the profit or loss and the financial position of an
entity
Revenue
The entire amount received or to be received from selling of goods or by
performing services are categorized under the head of the Revenue Account.
Direct Revenue
The revenue earned from the Primary operation of business or normal
business activities is called direct revenue or major revenue.
Indirect Revenue
Any type of revenue earned from other than primary operation of business
or normal business activities is named as indirect revenue.
Expenses
The economic costs which a business incurred through its operation to earn
the revenue are termed as expenses. For example, purchase of goods, freight in,
rent expenses, salaries expenses and selling expenses etc.
Direct expenses
The expenses directly attributable to purchase or manufacturing of goods
are categorized as direct expenses. These are the expenses which are incurred on
the goods up till the goods are ready for sale.
Indirect expenses
All those expenses which are incurred in the operation of business other
than the direct expenses are categorized under the head of indirect expenses. The
main categories of indirect expenses are Selling and Administrative expenses.
Assets
Assets are the resources owned and controlled by the business such as plant
and machinery, building, office equipment, stock and cash etc.
Fixed Assets
All those assets which provide the benefits to business more than one
accounting year are called fixed assets.
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Tangible fixed assets
These have the physical appearance, they can be touched or seen, such as
Office / Factory building, Office Equipment, Plant & Machinery, Furniture and
Fixture etc.
Intangible fixed assets
Those fixed assets which don’t have any physical appearance, nor can be
touched or seen but provide the benefits to business for more than one accounting
period are known as Intangible fixed Assets. For example, Goodwill, Patents,
Copy rights etc.
Current Assets
Those assets which are in the form of cash or equivalent to cash or can be
converted into cash or can be consumed or expired within one accounting year are
classified as current assets, such as cash in hand or at bank, Account Receivable,
Prepaid Insurance, Stock, Accrued Revenue etc.
Liabilities
Amounts payable by business to others are the liabilities of business. For
example, bank loan, note payable etc.
Long Term Liabilities
Liabilities which are payable by business in more than one accounting
period are called Long Term Liabilities or Fixed Liabilities, i.e. Bank Loan,
Debentures, Bond Payable etc.
Short Term Liabilities
Short term Liabilities are usually payable within one accounting period,
that’s why these are called short term or current liabilities, i.e., Account Payable,
Unearned Revenue, and Expenses Due etc.
Owner’s Equity
It is claim against the assets of the business by its owner. Generally it is the
amount invested into the business by its owner plus the accumulated profit or
Reserves etc. Owner’s Equity may also be called as the Internal Equities or
Liabilities, because this debt is claimed by the owner of the business and is
payable on the liquidation of the business.
Manufacturing Account
Manufacturing Account is prepared by those organizations which are
engaged in Manufacturing or production businesses to ascertain to gross profit or
loss resulted in manufacturing process.

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Trading Account
Trading account is prepared by those organizations which are engaged in
purchasing goods in bulk quantity and sell them into small quantity with some
profit margin. Like the manufacturing account, trading account is prepared to
ascertain the gross profit or loss resulting in trading business.
Sales
All those items which are manufactured or produced by the business for the
purpose of sale are categorized under the head of goods. Sales include all goods
sold on cash or credit during a particular period of the business. Sales will be
shown on the credit side of the manufacturing or trading account.
Returns Outward
All those goods which are sold to customer and returned back due to any
reason are known as Sales returns or returns outward. In manufacturing account,
sales returns will be deducted from the total gross sales
Sales Discount
Discount on Sales will be deducted from the gross sales and net sales will
be shown in manufacturing account.
Closing Stock
Goods remain unsold at the end of the accounting period will be written on
the credit side of the manufacturing account.
Opening Stock
Goods remaining unsold in the last accounting period will become the
opining stock for the next period or those goods which a business has at the
beginning of the accounting period is called the opening stock and will be shown
on the debit side of the manufacturing/trading account.
Purchases
All those items which are manufactured or bought for the purpose of sale,
are called the goods, and when the goods are purchased in finished form or raw
form these are categorized as purchases.
All the purchases either on cash or on credit will be recorded on the debit
side of the manufacturing or trading account.
Return Outwards
Goods purchased and returned back to supplier are called return outwards or
purchases return. These will be deducted from the gross purchases in the
manufacturing or trading account.

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Purchase Discount
Discount received on purchases will be deducted from the purchases and net
purchases will be shown on the trading/manufacturing account.
Freight In
The sum paid for conveyance of goods by sea is known as Freight in. It is
direct expenses and will be shown on the debit side of the account.
Carriage In
Carriage expenses paid for carrying goods by land, carriage in expenses are
paid usually to bring goods to warehouse.
Transportation In
Transportation in is also categorized as direct expenses and will be shown
on the debit side of the account. These expenses also paid for carrying goods by
road.
Wages
The remuneration paid to factory workers on the basis of hourly, daily or
piece work are called the productive wages and would be classified as direct
expenses.
Insurance in Transit
When goods or raw material is purchased from outside, there may be
chances of loss of goods due to theft, accident, or fire. Such type of loss may be
insured against to insurance that goods may reach safely to warehouse. The
premium paid for that type of insurance will be charged to trading account.
Import Duty
Import/Custom duty is paid when goods are imported from abroad. These
expenses are treated as direct expense and will be charged to Trading account.
Clearing Charges
If clearing agent is appointed to get delivery of the goods from the customs,
then the importer has to pay some amount to clearing agent for his services. This
amount is called clearing charges and would be recorded on the debit side of the
trading account.
Dock Charges
These amount are levied on ships and their cargoes when entering or
leaving docks. Dock charges paid for the purchase of goods would be recorded on
the debit side of the trading account.
Excise Duty
Excise duty is imposed on goods produced or manufactured or consumed in
the country. This duty is charged by the government.
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Manufacturing Expenses
All those expenditures which are incurred in factory to convert the raw
material into finished or semi finished goods would be categorized as
manufacturing expenses and would be charged to manufacturing account.
Factory insurance
Premium paid for the insurance of plant and machinery and factory
premises, where goods are produced or converted into finished or semi finished
goods, is direct expense and would be charged to manufacturing or trading
account.
Factory Rent
Rent paid for factory is also direct expenses and recorded in debit side of
the manufacturing account.
Store Consumed
These are the items which are used to keep the plant and machinery in
working condition, i.e. oil grease, cotton waste, soap or engine oil etc. such type
of all expenses will be charged to manufacturing/ trading account.
Factory Labour
All type of remuneration paid to factory worker, who are engaged in
manufacturing process, is categorized as direct expenses.
Royalty
Amount paid for use of rights to produce or manufacture of goods is known
as royalty. This amount is charged to manufacturing or trading a/c.
Motive Power
Any type of energy consumed to run the plant and machinery in the factory
is called Motive Power or Power, i.e. gas, electricity, steam, coal or coke etc.
Profit And Loss Account
Profit and Loss account is an account which is prepared to know that
whether the business earned net profit or suffered in loss from the operation
during a particular period.
Accounting Period
The span of time covered by an income statements or Profit & Loss A/c is
known as accounting period of an entity
Adjustments
Adjustments may be defined as:
To make a correct record of a transaction which has not been entered or which has
been entered only in an incomplete or wrong way.
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Adjusting Entries
Those entries which are passed at the end of each accounting period to
update the balances of accounts are known as adjusting entries.
Accounting System
The system through which profit or loss of the business is ascertained is
known as accounting system. There are two main types of accounting system (a)
cash system (b) accrual system
Cash Basis Accounting System
The system under which profit or loss of the business is calculated on the
basis of only the items of revenue received in cash and the items of expenses paid
in cash whether they relate to the current accounting period or not is known as
cash basis accounting system.
Accrual Basis Accounting System
The system under which profit or loss of the business is ascertained by
considering all items of revenues either cash received or not and all items of
expenses either cash paid or not which relate to current accounting period.
Closing Stock
Stock remained unsold at the end of the accounting period is known as
closing stock. Every business prepares a list of unsold inventory at the end of the
accounting period and puts value against it. Stock may be valued at cost or market
price, whichever is less
Accrued Expenses
Those expenses which have been incurred during the current period but not
paid and recorded in the books of accounts till the end of accounting period are
known as accrued expenses, outstanding expenses, expenses due or expenses
payable etc. In other words, services or benefits from these expenses have been
received but payments have not been made till the end of period.
Accrued Revenue
Those revenues which have been earned but not received and recorded in
the books of accounts till the end of accounting period are known as accrued
revenues, or revenue receivable etc. In other words, services rendered by a
business or properties of the business used by someone, but the remunerations for
services rendered or return of the property used is not received during the current
period, will be considered as accrued revenue.
Prepaid Expenses
The expenses which have been paid during the current accounting period
but the services or benefits from those expenses have not been received till the

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end of period in which these expenses are paid and the benefits from these
expenses will be received in next accounting period are known as Prepaid
expenses, expense paid in advance or unexpired expenses. In other words,
expenses of next period paid in current accounting period are considered as
prepaid expenses.
Unearned Revenue
That amount of revenue which has been received in advance but the
services have not been provided fully or partly against that revenue till the end of
accounting period is known as unearned revenue or revenue received in advance.
Depreciation
Depreciation may be defined as; The process of allocating the cost of Fixed
Assets to expenses throughout the accounting periods benefiting its use.
Interest on Capital
Amount of interest charged by the owner on the amount invested into the
business, would be considered as interest on capital
Interest on Drawings
Interest paid by the owner to the business on the amount of cash or goods
drawn for personal use.
Good Debts
That portion of debts which has been recovered fully by the business from
the debtor is classified as Good Debts and the concerned debtor is called Good
Debtors
Bad Debts
That portion of debts which are irrecoverable or cannot be realized in future
also from the debtors is classified as Bad debts or Uncollectible and the debtor
from whom the business fails to recover the debt is known as Bad Debtors.
Doubtful Debts
The debts, whose recovery is uncertain or doubtful, are termed as “Doubtful
Debts”. These debts may or may not become the loss for the business.
Provision for Doubtful Debts
Amount set aside out of profit for the expected loss or liability, whose
amount cannot be determined exactly, is termed as Provision
Capital Expenditures
Capital expenditure consists of expenditure, the benefit of which is not fully
enjoyed in one accounting period but spread over several accounting periods.
Revenue Expenditures
Revenue expenditure consists of expenditure incurred in one period of the
accounting, the full benefit of which is enjoyed in that period only
Capitalized or Deferred Expenditures
Deferred Revenue Expenditures are those expenditures which have been
incurred in an accounting period and they do not create any assets but their benefit is
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spread in more than one accounting period such as heavy expenditure on advertising
a new product. The benefit of advertising cost will last quite a few years.
Capital Receipts
The receipts which do not arise out of normal course of business are known
as Capital Receipts.
Revenue Receipts
The receipts which arise out of normal course of business are known as
revenue receipts.
Capital Profit
Capital profit is the profit which arises not from the normal course of the
business. Profit on sale of fixed asset is an example of capital profit.
Revenue Profit
Revenue profit is the profit which arises from the normal course of the
business. i.e., Net Profit – the excess of revenue receipts over revenue
expenditures.
Capital and Revenue Losses
In order to ascertain the loss incurred by a firm it is important to distinguish
between capital losses and revenue losses.
Capital Losses
Capital losses are the losses which arise not from the normal course of
business. Loss on sale of fixed asset is an example of capital loss.
Revenue Losses
Revenue losses are the losses that arise from the normal course of the
business. In other words, ‘net loss’ – i.e., excess of revenue expenditures over
revenue receipts.
Errors of Omission
Omission is a mistake resulting by neglect. This means that an event occurred
but we did not record it. The errors of omission may be committed at the time of
recording the transaction in the books of original entry or while posting to the ledger.
Errors of Principle
Accounting entries are recorded by following principles of accounting.
These principals are issued by International Accounting Standard Board and
International Accounting Standard Committee. Accountants follow these
standards named as International Accounting Standards (IAS) and International
Financial Reporting Standards (IFRSs). If any of these principles are violated or
ignored, errors resulting from such violation are known as errors of principle.
Compensating Errors
These errors are a group of errors; the total effect is not reflected in the trial
balance. These errors are of neutralizing nature. One error is compensated by the
other error of an opposite nature therefore also called as offsetting errors.

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Errors of Commission
These errors are as a result of some positive act of commission on part of
the person responsible for maintenance of books of account. These errors by
definition are of clerical nature. These errors may be committed at the time of
recording and/or posting.
Suspense Account
An account in the books of an organization in which items are entered
temporarily before allocation to the correct or final account.
Bill of Exchange
A bill of exchange is an instrument in writing containing an unconditional
order, signed by the maker, directing a certain person to pay a certain sum of money
only to or to the order of a certain person or to the bearer of the instrument.
Drawer
The person who writes the bill is called the drawer. He gives the order to
pay money to third party.
Drawee
The party upon whom the bill is drawn is called the drawee. He is the
person to whom the bill is addressed and who is ordered to pay. He becomes an
acceptor when he indicates his willingness to pay the bill.
The Payee
The person to whom the money is payable.
Inland Bill of Exchange
An inland bill is one which is (i) drawn and payable in same country or (ii)
drawn in one country upon some person resident in same country even though it is
made payable in a foreign country. Thus in an inland bill of exchange both drawer
and drawee belong to the same country.
Foreign Bill of Exchange
A foreign bill is one which is drawn in one country and payable in another
country. Foreign bills are drawn in a set of three and each part of the set called a
via contains a reference to the other parts. This is done to avoid delay or loss
or miscarriage during the transit.
Time Bill of Exchange
When a bill of exchange is payable on a specified period of time it is called
time bill of exchange.

Sight Bill of Exchange

A bill of exchange payable on bearing it or at sight is called sight bill of
exchange. i.e. cheque etc.

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 Accommodation Bill
Accommodation bill is drawn by the drawer on drawee in order to provide
financial help to each other. Such bill is discounted through bank to overcome
financial problems.
Days of Grace
Usually bill of exchange is payable on a specified date but due to some
reasons the drawee fails to pay therefore, a few days more are given as extra time
to pay off the bill. These extra time usually of three days and are called days of
grace. But such days of grace are not given in case of demand or sight bills.
Acceptance for Honour
Sometimes a bill of exchange is dishonored due to any reason, at that time
who accepts the responsibility for its payment on behalf of drawer or drawee is
called acceptance for honor.
Discounting of Bill
A bill of exchange is a document which can be discounted through bank. A
proprietor does not wait till its maturity date and discount it from a bank. Bills of
exchange can be discounted on rebate before its due date. The rebate or discount
is earning of the bank
Dishonor of the Bill
When the holder of the bill presents it to the drawee for payment on due
date and drawee fails to make payment the bill is said to be dishonored i-e bill
will not be paid. If the bill is dishonoured , the bill become useless and the patty
from whom the bill was received will be liable to pay the amount as some
expenses has been incurred by the party.
Noting Charges
When a bill of exchange is dishonoured, the holder can get such fact noted
on the bill by a notary public. The advantages of noting is that the evidence of
dishonoured is secured. The noting is done by recording the fact of dishonoured,
the date of dishonour, the reason of dishonour, if any. For doing all this the notary
public charges his fees which is called noting charges.
Retirement of the Bill
Sometimes the drawee pays the bill before the agreed date enjoying the
rebate which is provided to him for prepayment of the bill. This is known as
retirement of the bill. The amount of the rebate depends upon the time left for
payment and the amount for which the bill is drawn.
Renewal of the Bill
When the drawee of the bill after accepting it, has some apprehension in his
mind that his mind that he may not be able to honor the bill on due date, may
request the drawer of the bill to cancel the original bill and to draw a fresh bill on
him for a further period of time this is called renewal of the bill.

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