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Topic 1: Meaning and Definition of Accounting

Accounting is the process of identifying, measuring, recording , Classifying , summarizing ,

analysing and communicating the required information relating to the economic transactions
and events of an organisation to the interested users Accounting plays important role in
providing quantitative information, primarily financial in nature, about economic entities, that
is intended to be useful in making economic decisions.

Definition of Accounting:
“Accounting is the process of identifying, measuring and communicating economic
information to permit informed judgments and decisions by users of the information.”
-- (Year 1966) American Accounting Association (AAA)

Topic 2: Functions of Accounting

1. Identification : The first step in accounting is to determine what to record, i.e., to idenfity
the financial events which are to be recorded in the books of accounts. It involves observing
all business activities and selecting those events or transactions which can be considered as
financial transactions.
2. Measurement : In Accounting we record only those transactions which can be measured
in terms of money or which are of financial nature. If a transactions or event cannot be
measured in monetary terms, it is not considered for recording in financial accounts.
3. Recording : Once the economic events are identified and measured in financial terms,
these are recorded in books of account in monetary terms and in a chronological order.
Recording should be done in a systematic manner so that the information can be made available
when required. Journalizing of transactions and events is done under this step.

3. Classifying : Once the financial transactions are recorded in journal or subsidiary books,
all the financial transactions are classified by grouping the transactions of one nature at one
place in a separate account. This is known as preparation of Ledger.

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4. Summarising : It is concerned with presentation of data and it begins with balance of
ledger accounts and the preparation of trial balance with the help of such balances. Trial balance
is required to prepare the financial statements i.e. Trading Account, Profit & Loss Account and
Balance Sheet.
5. Analyzing: As we know that absolute figures conveys nothing until they are not compared
with some relative figure. Thus in order to make accounting figures meaningful, they are
compared with others, eg use of ratio analysis.
6. Communication : The main purpose of accounting is to communicate the financial
information the users who analyse them as per their individual requirements. Providing
financial information to its users is a regular process.

Topic 3: Objectives of Accounting

1. To keep systematic and complete records of financial transactions in the books of
accounts according to specified principles and rules to avoid the possibility of omission
and fraud.
2. To ascertain the profit earned or loss incurred during a particular accounting period which
further help in knowing the financial performance of a business.
3. To ascertain the financial position of the business by the means of financial statement i.e.
balance sheet which shows assets on one side and Capital & Liabilities on the other side.
4. To provide useful accounting information to users like owners, investors, creditors,
banks, employees and government authorities etc who analyze them as per their
requirements.
5. To provide financial information to the management which help in decision making,
budgeting and forecasting.
6. To prevent frauds by maintaining regular and systematic accounting records.

Topic 4: Advantages of Accounting

1. It provides information which is useful to management for making economic decisions.
2. It help owners to compare one year’s results with those of other years to locate the factors
which leads to changes.
3. It provide information about the financial position of the business by means of balance
sheet which shows assets on one side and Capital & Liabilities on the other side.
4. It help in keeping systematic and complete records of business transactions in the books
of accounts according to specified principles and rules, which is accepted by the Courts
as evidence.

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 5. It help a firm in the assessment of its correct tax Liabilities such as income tax, GST,
excise duty etc.
6. Properly maintained accounts help a business entity in determining its proper purchase
price.

Topic5: Limitations of Accounting

1. It is historical in nature; it does not reflect the current worth of a business.
Moreover, the figures given in financial statements ignore the effects of changes in price
level.
2. It contains only those informations which can be expressed in terms of money. It ignores
qualitative elements such as efficiency of management, quality of staff, customers
satisfactions etc.
3. It may be affected by window dressing i.e. manipulation in accounts to present a more
favorable position of a business firm than its actual position.
4. It is not free from personal bias and personal judgment of the people dealing with it. For
example different people have different opinions regarding life of asset for calculating
depreciation, provision for doubtful debts etc.
5. It is based on various concepts and conventions which may hamper the disclosure of
realistic financial position of a business firm. For example assets in balance sheet are
shown at their cost and not at their market value which could be realised on their sale.

Topic6: Book Keeping – The Basis of Accounting

Book keeping is the record-making phase of accounting which is concerned with the recording
of financial transactions and events relating to business in a significant and orderly manner.
Book Keeping should not be confused with accounting.Book keeping is the recording phase
while accounting is concerned with the summarizing phase of an accounting system.

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The distinction between the two are as under.
Book keeping Accounting
1. It is the recording phase of an accounting 1. It is the summarizing phase of an
system. accounting system.
2. It is a Secondary Stage which begins
2. It is a primary stage and basis for accounting.
where the Book keeping process ends.
3. It is routine in nature and does not require 3. It is analytical in nature and required
any special skill or knowledge special skill or knowledge.
4. It is done by senior staff called
4. It is done by junior staff called book-keepers
accountants.
5. It does not give the complete picture of the 5. It gives the complete picture of the
financial conditions of the business unit. financial conditions of the business unit.

Topic 7: Types of accounting information

Accounting information can be categorized into following:

1. Information relating to profit or loss i.e. income statement, shows the net profit of
business operations of a firm during a particular accounting period.
2. Information relating to Financial position i.e. Balance Sheet. It shows assets on one side
and Capital & Liabilities on the other side.
3. Schedules and notes forming part of balance sheet and income statement to give details
of various items shown in both of them.

Topic 8: Subfields/Branches of Accounting

1. Financial Accounting:- It is that subfield/Branch of accounting which is concerned with
recording of business transactions of financial nature in a systematic manner, to ascertain
the profit or loss of the accounting period and to present the financial position of the
business.
2. Cost Accounting:- It is that Subfield/Branch of accounting which is concerned with
ascertainment of total cost and per unit cost of goods or services produced/ provided by
a business firm.
3. Management Accounting:- It is that subfield/Branch of accounting which is concerned
with presenting the accounting information in such a manner that help the management
in planning and controlling the operations of a business and in better decision making.

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Topic 9: Interested users/parties of Accountings
information’s and their Needs
There are number of users interested in knowing about the financial soundness and the
profitability of the business.
Users Classification Information the user want
Return on their investment, financial health of their
1. Owner
Internal company/business.
2. Management To evaluate the performance to take various decisions.
1. Investors and
Safety and growth of their investments, future of the business.
potential investors
Assessing the financial capability, ability of the business to
2. Creditors
pay its debts.
3. Lenders Repaying capacity, credit worthiness.
External Assessment of due taxes, true and fair disclosure of
4. Tax Authorities
accounting information.
Profitability to claim higher wages and bonus, whether their
5. Employees
dues (PF, ESI, etc.) deposited regularly.
Customers, Researchers etc., may seek different in-formation
6. Others
for different reasons.

Topic 10: Qualitative Characteristics of Accounting

Information
Accounting information is useful for interested users only if it posses the following
characteristics:
1. Reliability: Means the information must be based on facts and be verified through
source documents by anyone. It is believed that reliable information should be free from
error and bias and faithfully represents what it is meant to represent.

2. Relevance: The second qualitative characteristic of accounting information is relevance.

It is believed that a relevant information must be available in time, must help in prediction
and feedback and must influence the decisions of users in a positive manner.

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 3. Understandability: The information should be presented in such a manner that users can
understand it well. Understandability means decision-makers must interpret accounting
information in the same sense as it is prepared and conveyed to them.

4. Comparability: The information should be disclosed in such a manner that it can be

compared with previous year’s figures of business itself and other firm’s data.

Topic 11: Basic accounting terms

1. Business Transaction: An Economic activity that affects financial position of the
business and can be measured in terms of money e.g., purchase of goods for use in business.

2. Account: Account refers to a summarized record of relevant transactions of particular head

at one place. All accounts are divided into two sides. The left side of an account is called debit
side and the right side of an account is called credit side.

3. Capital: Amount invested by the owner in the firm is known as capital. It may be brought
in the form of cash or assets by the owner.

4. Drawings: Any thing (whether money or kind) withdrawn by owner from business for
personal use, is known as drawings. Example: Purchase of car for for personal use by
withdrawing money from business.

5. Assets: Assets are economic resources controlled by an enterprise having the future
economic benefit. Assets can be broadly classified as:

1. Current Assets: Current Assets are those assets which are held for short period and can
be converted into cash within one year. For example: Debtors, stock etc.
2. Non-Current Assets: Non-Current Assets are those assets which are hold for long
period and used for normal business operation. For example: Land, Building,
Machinery etc.
They are further classified into:
1. Tangible Assets: Tangible Assets are those assets which have physical existence
and can be seen and touched. For Example: Furniture, Machinery etc.

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 2. Intangible Assets: Intangible Assets are those assets which have no physical
existence and can be felt by operation. For example: Goodwill, Patent, Trade
mark etc.

6. Liabilities: Liabilities are obligations or debts that an enterprise has to pay after some time
in the future.
Liabilities can be classified as:

1. Current Liabilities: Current Liabilities are obligations or debts that are payable within
a period of one year. For Example: Creditors, Bill Payable etc.
2. Non-Current Liabilities: Non-Current Liabilities are those obligations or debts that are
payable after a period of one year. Example: Bank Loan, Debentures etc.

7. Receipts:

1. Revenue Receipts: Revenue Receipts are those receipts which are occurred by normal
operation of business like money received by sale of business products.
2. Capital Receipts: Capital Receipts are those receipts which are occurred by other than
business operations like money received by sale of fixed assets.

8. Expenses: Costs incurred by a business for earning revenue are known as expenses. For
example: Rent, Wages, Salaries, Interest etc.

9. Expenditure: Spending money or incurring a liability for acquiring assets, goods or

services is called expenditure. The expenditure is classified as :

1. Revenue Expenditure: If the benefit of expenditure is received within a year, it is called

revenue expenditure. In other words we can say , that Revenue expenditures are those
expenditures which are made in order to boost the sales. For Example: rent, Interest etc.
2. Capital Expenditure: The expenditure made which results to the occurring of fixed asset
are known as capital expenditures If benefit of expenditure is received for more than one
year, it is called capital expenditure. Example: Purchase of Machinery.
3. Deferred Revenue Expenditure: There are certain expenditures which are revenue in
nature but benefit of which is derived over number of years. For Example: Huge
Advertisement Expenditure, Preliminary expenses, Research and Development expenses.

10. Profit: The excess of revenues over its related expenses during an accounting year is
profit.
Profit = Revenue – Expenses
11. Gain: A non-recurring profit from events or transactions incidental to business such as
sale of fixed assets, appreciation in the value of an asset etc.

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 12. Loss: The excess of expenses of a period over its related revenues is termed as loss.
Loss = Expenses – Revenue
13. Goods: The products in which the business deal in, the items that are purchased for the
purpose of resale and not for use in the business are called goods.
14. Purchases: The term purchases is used only for the goods procured by a business for
resale. In case of trading concerns it is purchase of final goods and in manufacturing concern
it is purchase of raw materials. Purchases may be cash purchases or credit purchases.
15. Purchase Return: When purchased goods are returned to the suppliers, these are known
as purchase return.
16. Sales: Sales are total revenues from goods sold or services provided to customers. Sales
may be cash sales or credit sales.
17. Sales Return: When sold goods are returned from customer due to any reason is known
as sales return.
18. Debtors: Debtors are persons and/or other entities to whom business has sold goods and
services on credit and amount has not received yet. These are assets of the business.
19. Creditors: If the business buys goods/services on credit and amount is still to be paid to
the persons and/or other entities, these are called creditors. These are liabilities for the
business.
20. Bill Receivable: Bill Receivable is an accounting term of Bill of Exchange. A Bill of
Exchange is Bill Receivable for seller at time of credit sale.
21. Bill Payable: Bill Payable is also an accounting term of Bill of Exchange. A Bill of
Exchange is Bill Payable for purchaser at time of credit purchase.
22. Discount: Discount is the rebate given by the seller to the buyer. It can be classified as :

1. Trade Discount: The purpose of this discount is to persuade the buyer to buy more
goods. It is offered at an agreed percentage of list price at the time of selling goods.
This discount is not recorded in the accounting books as it is deducted in the
invoice/cash memo.
2. Cash Discount: The objective of providing cash discount is to encourage the debtors to
pay the dues promptly. This discount is recorded in the accounting books.

23. Account : Account refers to a summarised record of relevant transaction of particular

head at one place.
24. Income: Income is a wider term, which includes profit also. Income means increase in the
wealth of the enterprise over a period of time.
25. Stock : The goods available with the business for sale on a particular date is known as
stock.
26. Cost : Cost refers to expenditures incurred in acquiring , manufacturing or processing
goods and / or services to make it saleable.
27. Voucher: The documentary evidence in support of a transaction is known as voucher. For
example, if we buy goods for cash we get cash memo, if we buy goods on credit, we get an

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invoice, when we make a payment we get a receipt.
28. Goods and Service Tax (GST) : GST is an indirect tax which is levied on the supply of
goods and service.
29 Cash Memo : Cash Memo is A bill of sale, it is a written document by a 'seller' to a
purchaser, reporting that on a specific date, a particular sum of money or other "value received",
30 Invoice or Bill : When goods are sold on credit, An invoice or bill is issued on the name of
the buyer, indicating the products, quantities, and agreed prices for products or services, the
seller has provided the buyer.
31 Receipt : A receipt is a written acknowledgment that a specified a sum of money has been
received from the customer as an exchange for goods or services. The receipt is evidence of
purchase of the goods or service.
32 Pay-in-Slip : Pay in slip is a form that is filled when the money is deposited by a customer
in to his bank account.
33. Cheque : A cheque is a document (usually a piece of paper) that orders a payment of money.
The person writing the cheque, the drawer, usually has a account where the money is deposited.

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 UNIT 2

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Topic12: Concept of Accounting Principles:
Financial Accounting both practical and theory-based is built on some accounting principles. As
the objective of accounting is to provide appropriate, useful and reliable information about the
financial performance and position of the business to its various users to enable them to make
judicious decisions. This objective can be achieved only when accounting records are
maintained on the basis of uniform rules and principles.
Accounting principles, concepts and conventions are commonly known as Generally
Accepted Accounting Principles (GAAP). These principles are the base of Accounting.
Generally Accepted Accounting Principles (GAAP) refer to the rules or guidelines adopted for
recording and reporting of business transactions, in order to bring uniformity and consistency
in the preparation and the presentation of financial statements.

Topic13 : Fundamental Accounting Assumptions

• Going concern concept/assumption According to this concept, it is assumed that the
business firm would continue its operations indefinitely, i.e. for a fairly long period
of time and would not be liquidated in the foreseeable future. Thus busniness has nor
necessity nor intention to close its business in the fore seeable future.
• Consistency concept: According the consistency concept, accounting practice once
chosen and followed should be consistently over the years. It directly helps to
financial statement to be more understand and comparable. This concept is particular
important when alternative accounting practice are equally acceptable.
• Accrual concept: According to the concept, a transaction is recorded at the time
takes place and not at the time when settlement done. In other words, revenue is
recorded which sales are made or services are rendered and irrelevant as to when
cash is received against the sales.
Similarly, expenses are recorded at the time when are incurred and it is irrelevant as
to when payable.

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Topic 14: Accounting Principles
The various accounting principles are discussed as below:

(i) Business entity or accounting entity (separate entity) principle : This

accounting concept separates the business from its owner. As far as accounting is
concerned the owner and the business are two separate entities. This will help the
accountant identify the business transactions from the personal ones.

(ii) Money measurement principle : This accounting concept states that only financial
transactions will find a place in accounting. So only those business activities that can be expressed
in monetary terms will be recorded in accounting. Any other transaction, no matter how
significant, will not find a place in the financial accounts.

(iii) Accounting Period principle accounting period refers to the span of time at the end
of which the financial statements of an enterprise are prepared, to know whether it has earned
profits or incurred losses during that period and what exactly is the position of its assets and
liabilities at the end of that period. It is also known as periodicity principle or time period
principle. So the indefinite life of an organization is divided into shorter, generally equal time
period.

(iv) Full disclosure principle : According to this principle, there should be reporting of all the
significant information relating to the economic affairs of the business and it should be
complete and understandable. According to GAAP, the full disclosure principle ensures
that the readers and users of a business’s financial information are not mislead by any
lack of information.

(v) Materiality principle : materiality principles states that only that item should be disclosed
separately , if it is of material importance ie, if it has the ability to influence or affect the
decision-making of various parties interested .

(vi) Prudence or conservation principle : This concept states that organization should
anticipate for no profits but provide for all possible losses . In other words, we should make
provisions for probable future expenses and ignore any future probable gain until it actually
accrues. Thus , it is based on the policy of playing safe.

(vii) Cost concept or historical cost principle according to this principle, assets are
recorded in the books at the price paid to acquire it. Assets are recorded in the books of

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accounts at their cost price which includes cost of acquisition, transportation, installation and
making the asset ready for use and this cost is the basis for all subsequent accounting of such
assets.

(viii) Matching cost or matching principle according to this principle, expenses incurred in
an accounting period should be matched with revenues during that period, i.e. when a revenue
is recognized in a period, then the cost related to that revenue also needs to be recognized in
that period to enable calculation of correct profits of the business.

The matching concept thus, states that all revenues earned during an accounting year, whether
received during that year or not and all costs incurred whether paid during the year or not
should be taken into account while ascertaining profit or loss for that year.

(ix) Dual aspect or duality principle dual aspect is the foundation or basic principle of
accounting. According to this principle, every transaction entered by a business has two
aspects, i.e. debit and credit. There may be more than one credit. However, the total of all
debits and total of all credits will always be equal words, we can say that for every debit,
there is always an equal credit.

(x) Revenue recognition principle (realization principle) : The concept of revenue

recognition requires that the revenue for a business transaction should be included in the
accounting records only when it is realized. Revenue is assumed to be realized when a legal
right to receive it arises, i.e. the point of time when goods have been sold or service has been
rendered.

(xi)Verifiable objective concept/objectivity concept (objective by principle) :According to

this principle, accounting information should be verifiable and should be free from personal
bias. Every transaction should be based on source documents such as evidences should be
objective which means that they should state the facts as they are, without any bias towards
either side.

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Topic 15: System of Accounting
The systems of recording transactions in the books of accounts are generally classified into two
types:

• Double entry system is based on the principle of ‘dual aspect’ which states that every
transaction has two aspects, i.e. debit and credit. The basic principle followed is that
every debit must have a corresponding credit. Thus, one account is debited and the
other is credited.
• Single entry system this system is not a complete system of maintaining records of
financial transactions. It does not record two field effect of each and every transaction.
Only personal accounts and cash book are maintained under this system instead of
maintaining all the accounts. No uniformity is maintained under this system while
recording transactions. The single entry system is also known as accounts from
incomplete records.

Topic 16: Basis of Accounting

1. Cash basis of accounting : under the cash basis of accounting, entries in the books of
accounts are made, when cash is received or paid and not when the receipts or payment
becomes due. All transactions related to revenues, costs, assets, and liabilities are reflected in the
accounts for the period in which actual receipts or actual payments are made. Cash basis of
accounting does not recognize accounts receivable or accounts payable.

2. Accrual basis of accounting : As per accrual basis, revenues and expenses are recorded
when they accrue, regardless of the actual receipt or payment of the amount. This basis is more
commonly in use than the cash basis. Accrual basis of accounting is based on realization and
matching principle

The downside of this method is that accrual accounting does not give any awareness of cash flow.
An enterprise can appear to be more profitable while in reality, it has no balances
in bank accounts.

3. Hybrid or Mixed Basis: Under the hybrid system of accounting, incomes are recognized
similar as in Cash Basis Accounting i.e. when income is received in cash and expenses are
recognized similar as in accrual basis i.e. during the accounting period in which expenses arise
irrespective of when they are paid.

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Topic 17: Difference between cash and accrual basis of
Accounting:

Topic18: Meaning of Accounting Standards :

Accounting standards are the rules that ensure the uniformity of Accounting practices , and
provide guidance for the preparation, presentation and reporting of accounting information.
Accounting standards are the written statements consisting of uniform accounting rules and
guidelines issued by the accounting body of the country (such as institute of Chartered
Accountants of India) that are to be followed in the preparation and presentation of financial
statements. However, the accounting standards cannot override that provision of applicable
laws, customs, usages and business environment in the country.

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Features/Characteristics/Nature of Accounting Standards / Utility of AS:
a) Helpful in bringing the uniformity.

b) Helpful in improving the reliability of financial statements .

c) Helpful in resolving the conflicts among the users of financial information.

d) Basis of preparing financial statements

e) Uniformity in accounting methods

f) Sense of confidence to various users

g) Simplifying accounting information

Topic 19: Meaning of IFRS

IFRS or International Financial Reporting Standards refers to a globally-accepted set of
accounting and financial reporting guidelines for preparing and presenting financial statements.
It ensures uniformity in accounting practice that makes financial records comparable across
different reporting entities worldwide.
Over the years, it has emerged as the new world standard in accounting. These are
issued by International Accounting System Board (IASB). IASB replaced International
Accounting Standard Committee (IASC) in 2001.

Topic 20: Uses/ Features/ Objectives of IFRS

1 Financial Tool: The International Financial Reporting Standards bring efficiency,
accuracy, and data transparency to serve public interests for growth, trust, and sustainability
of the world economy.

2- Create a Common Law: One of its key objectives is to ensure that common law is
introduced and adopted by as many jurisdictions and countries as possible to bring everyone
on the same page.

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3 Assist in preparation of reliable financial records: By following International
Financial Reporting Standards, the data presented in the books of accounts are likely to be
accurate, reliable, uniform, and appropriate within the bounds of its rules.

4 Ensure comparability, transparency, and flexibility in reporting: The

consistency in reporting accounting practices enables easy comparison of the financial
records of compare companies across nations. Such comparisons allow investors to identify
risks and opportunities before investing.

PART B

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Topic: Meaning of Financial Statements
Financial statement are those statement that show the profitability (Income statement) and the
financial position (Balance Sheet) of the business at the end of accounting period.

In the word of John N. Myer “The financial statement provide a summary of the accounts of
a business enterprise, the balance sheet reflecting the assets, liabilities and capital as on a
certain date and the income statement showing the result of operation during a certain period”

Financial statements include the following statements:

1. Income statement (Trading and Profit and Loss Account) – prepared to ascertain
gross profit/loss and net profit/loss during an accounting period.
2. Statement of Financial Position (Balance Sheet) – prepared to ascertain position
(assets, liabilities and capital) of an enterprise at a particular point of time.
3. Schedules and notes forming part of Balance sheet and Income statement – to give
details of various items shown in both the statements.

These two Financial Statements (Income Statement and Statement of Financial Position) are
termed as ‘Final Accounts’.

Topic: Objective of Preparing Financial Statements.

1. To present a true and fair view of the financial performance (Profit/Loss) of the business.
2. To present a true and fair view of the financial position (Assets/Liabilities) of the
business.
3. To provide useful information to the management of an organisation for the purpose
of planning, controlling, analysing, and decision making.
4. To provide information to prospective investors to attract them, so that they can take
rational decisions regarding their investment based on the reports.
5 To demonstrate a company’s creditworthiness to lenders and creditors, as financial
reports help them in evaluating the ability of a company in repaying their money.
6 To provide information to the shareholders and public at large about the various
aspects of the entity.

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7. To disclose how an organisation is procuring and using various resources.
8.To facilitate the statutory audit to abide by different legal and governmental regulations.
9. To disclose information about the economic resources of an entity claims to these
resources(liability and owner’s equity), and to show how these resources and claims have
undergone changes over a period of time.
10 To supply details on the cash flows that a business is exposed to, including their
timeliness and volatility.
11. To determine the liquidity position of an organisation, which in turn can be used to
evaluate whether an organisation can continue as a going concern

Topic: Capital Expenditure and Revenue expenditure.

1. Capital Expenditure:
The non-recurring expenditure whose benefit is derived by the business for more than a year
is called Capital Expenditure.
It includes the amount spent or liabilities incurred to acquire or improve any fixed asset or
acquiring any legal rights or first-time expenses incurred to make fixed assets workable e.g.
purchase of machinery/building/furniture etc., expenses incurred to acquire Patents, Trade-
marks etc. and expenditure incurred for making an asset ready to use (like installation exp.,
carriage, first time expenses incurred on second hand fixed asset for making it ready to use).
Capital expenditures are recorded on the assets side of the Balance sheet.
2. Revenue Expenditure
The recurring and routine nature expenditures which are incurred for operating the business
smoothly and which help to maintain business’s earning capacity, are called Revenue
expenditures e.g. expenses incurred for producing finished goods such as direct expenses,
purchase of raw material and other expenses as rent, salary, repairs etc.
The benefit of these expenses last up to one year (give benefit up to one year). These
expenses are shown on Debit side of the income statement (trading and profit and loss
account).
3. Deferred Revenue Expenditure
The expenditure which is revenue in nature, but the heavy amount spent and benefit likely to
be derived over a number of years called deferred revenue expenditure e.g. heavy expenses
on advertising on launching of a new product and hence it is capitalized like any fixed asset.

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Topic: Accounting treatment of Deferred Revenue Expenditure
As per matching principle, expenses incurred in an accounting period are matched with the
revenue recognized in that accounting period. So the whole deferred revenue expenditure
should be spread over the number of years over which the benefit is likely to be derived.
During the current accounting year:
(a) Only that portion of the expenditure should be charged to the profit and loss account
which has facilitated the enterprise to earn revenue during current year.
(b) Remaining amount of expenditure should be carried forward to the next year and shown
on the assets side of the balance sheet.

Topic: Revenue Receipt and Capital Receipt

1. Capital Receipt
Capital receipts are those irregular receipts that don’t affect profit or loss of the business; it
either increases the liabilities (raising of loans) or reduces the fixed assets (sale of fixed
assets), so they will be shown in the balance sheet.
Capital receipts are not made available for distribution as profit to the owner.

2. Revenue Receipt
Revenue receipts are received in the normal and regular course of business like Receipts from
sale of goods and rendering services to customers. Income from non-operating business
activities like income from investment i.e. interest and dividend received and rent received,
Commission and other fees received for non-operating business etc. These receipts increases
profit and are shown on the credit side of the Trading and Profit and Loss account.

Topic Types of Expenses

1. Direct Expenses: Those expenses which are incurred on purchasing of goods and for
converting the raw materials into the finished goods e.g. Manufacturing wages, Expenses on
purchases (including all duties and taxes paid on purchases), Carriage/Freight/Cartage
inwards, Production expenses (such as power and fuel, water etc.), factory expenses (e.g.
lighting, rent and rates), Royalty based on Production etc.
Note: All direct expenses are debited to Trading account.

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Indirect Expenses: Those expenses which are not directly related to production or purchase
of the goods are called indirect expenses. It includes those expenses which are related to
office and administration, selling and distribution of goods and financial expenses etc.
These expenses are shown on the debit side of the Profit and Loss A/c.

Topic: Calculation of Gross Profit

Gross Profit = Net Sales – Cost of Goods Sold
Net Sale = Total Sale – Sale Return
Cost of goods sold = Opening Stock + Net Purchases + Direct Expenses (Wages, Expenses
on Purchases, Carriage inward etc.) – Closing Stock.
Net Purchases = Total Purchases – Purchases Return

Topic: Calculation of Operating Profit:

Operating profit = Net sales – Operating cost

OR
= Gross Profit – (Office and Administrative Expenses + Selling and distribution exp.)

Operating Cost = Cost of Goods Sold + Office and Administrative Expenses + Selling and
distribution exp.

Net Profit = Operating Profit + Non-operating Income – Non-operating expenses.

Operating expenses: The expenses which are related to the main or normal activities of the
business e.g. office and Administrative expenses, selling and distribution expenses. Operating
profit is also called EBIT (Earnings before interest and taxes).

Topic: Income Statement

It is divided into two parts:

1. Trading Account which shows the gross profit or gross loss.

2. Profit and Loss Account which shows the net profit or net loss.

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Format of Trading Account
Name of Business Firm
Trading Account
Dr. Cr.
Particulars Rs. Particulars Rs.
To Opening Stock ____ By Sales __
Less: Returns Inward/Sales
To Purchases __ __
Returns
Less: Purchases Returns/ Returns
__ ____ By Scrap sales ___
outwards
To All Direct Expenses ____ By Closing Stock ___
To Wages ____
To Wages & Salaries
To Carriage of Carriage Inwards
____
Carriage on purchases
To Direct Expenses ____
To Gas, Fuel and power ____
To Freight, octroi and cartage ____
To Manufacturing Expenses or
____
Productive expenses
To Custom or import duty ____
To Dock and clearing charge ____
To Excise duty ____
To Factory rent and lighting ____
To other direct charges ____
To Royalty ____
To Gross Profit transferred to Profit & By Gross Loss transferred to Profit
(Balance
Loss A/c) ____ & Loss A/c)
figure)
(Balance figure) (Balance figure)

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Formal of Profit & Loss Account
Profit & Loss A/c
for the Year Ended……
Dr Cr
Particulars Rs. Particulars Rs.
To Gross Loss By Gross Profit
(Transferred from Trading A/c) (Transferred from Trading A/c)
To Office & Admin. Expenses By Rent Received
To Salaries By Rent (Cr.)
To Rent Rates Taxes By Discount Received
To Printing and Stationery By Discount (Cr.)
To Salaries & Wages By Rebates
To Postages and Telephones By Commission Received
To Office Lighting By Interest Received
To Insurance Premium By Dividend Received
To Legal Expenses By Bad Debts Recovered
To Establishment Expenses By Apprentice fees or premium
To Audit Fees By Gain on Sale of Fixed Asset
To Trade Expenses By Miscellaneous Receipts
By Net Loss (If Dr. side > Cr. side)
To Travelling Expenses
(Transferred to capital Account)
To General Expenses
To Selling & Distribution Exp.
To Carriage and Freight Outwards
To Commission
To Brokerage
To Advertisement
To Publicity
To Bad Debts
To Export Duty
To Packing Expenses
To Salaries of Salesman
To Delivery Van Expenses
To Financial Exp.
To Interest paid on loans
To Interest (Dr.)
To Discounts (Dr.)

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To Rebate Allowed
To Bank Charges
To Miscellaneous Exp.
To Repairs
To Depreciation on Fixed Assets
To Conveyance Expenses
To Entertainment Expenses
To Donations & Charity
To Loss on Sale of Fixed Assets
To Stable Expenses
To Loss by Fire
To Loss by theft
To Unproductive Expenses
To Net Profit Transferred to Capital Account
(If Cr. side > Dr, side)

• The words ‘To’ and ‘By’ are generally not used these days.
• The name of Business Firm is stated on the top of trading & P & L A/c.

Topic: Meaning of Balance Sheet

Balance sheet is a summarised statement of assets and liabilities, prepared generally at the
end of financial year to show the financial position of the business. All liabilities are put on
the lef hand side of balance sheet where all assets are shown on its right hand side.
Grouping and Marshalling of Assets and Liabilities
Grouping: The term ‘Grouping’ means putting together items of a similar nature under a
common heading. For example, under the heading ‘trade Creditors’ the balances of the ledger
accounts of all the suppliers from whom goods have been purchased on credit, will be shown.
Marshalling: It refers to the order in which the various assets and liabilities are shown in the
Balance Sheet. The assets and liabilities can be shown either in the order of liquidity or in the
order of permanence.

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 1. A general format of a Balance Sheet in order of liquidity is shown below:

A general format of a Balance Sheet in the order of performance is shown below:

Balance Sheet of …………
As at………….

Liabilities Rs. Assets Rs.

Capital: Fixed Assets:
Opening Balance XX Good will
Add: Net Profit XX Land
(Less: Net Loss) Building
Less: Drawings XX XXX Plant & Machinery
Long-term Liabilities: Furniture & Fixtures
Long term loan Investment: (long term)
Current liabilities: Current Assets:
Income received-in-advance Closing stock
Outstanding Expenses Accrued income
Sundry Creditors Prepaid expenses
Bills Payable Sundry Debtors
Bank Overdraft Bills Receivable
Cash at Bank
Cash in Hand
Adjustment in preparation of financial statements of Sole-proprietor
Meaning of Adjustment entries: Those entries which need to be passed at the end of the
accounting year to show the accurate profit or loss and fair financial position of the business.
Need of Adjustment: There are number of transactions that may not find the place in the
Trial Balance due to any reason such as Closing Stock (because it is valued at the end of the
year), Manager’s Commission based on Net profits (because its calculation requires
preparation of Income Statement first). These transactions can only be taken into account by
passing Adjustment entries so that their impact on the profitability and financial position can
be shown.
Closing Stock: the closing stock represents the cost of unsold goods lying in the stores at the
end of the accounting period.
Outstanding Expenses: When expenses of an accounting period remain unpaid at the end of
an accounting period, they are termed as outstanding expenses.
As they relate to the earning of revenue during the current accounting year, it is logical that
they should be duly charged against the revenue for computation of the correct amount of
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profit or loss.
Prepaid Expenses: At the end of the accounting year, it is found that the benefits of some
expenses have not yet been fully received; a portion of its benefit would be received in the
next accounting year. This portion of expenses, is carried forward to the next year and is
termed as prepaid expenses.
Accrued Income: It may sometime happen that certain items of income such as a interest on
loan, commission, rent, etc. are earned during the current accounting year but have not been
actually received by the end of the same year. Such incomes are known as accrued income. .
Income Received in Advance: Sometimes, a certain income is received but the whole
amount of it does not belong to the current period. The portion of the income which belongs
to the next accounting period is termed as income received in advance or an Unearned
Income.
Depreciation: It is the decline in the value of assets on account of wear and tear and passage
of time. It is treated as a business expense and is debited to profit and loss account.
This, in effect, amounts to writing-off a portion of the cost of an asset which has been used in
the business for the purpose of earning profits.
Closing Stock
Dr. (i) Credit side of Trading A/c.
A/c
Closing Stock
(ii) Show on the assets side of
To Trading A/c
BALANCE SHEET.
(i) Add to the concerned item on the
Expenses A/c Dr. Debit side of Trading/Profit & Loss
Outstanding/Unpaid Expenses A/c.
Outstanding (ii) Shown on the liabilities side of
Expenses A/c BALANCE SHEET.
(i) Deduct from the concerned
Prepaid Expenses
Dr. expenses on the debit side of Profit &
Prepaid expenses/Unexpired A/c
Loss A/c
expenses
(ii) Show on the assets side of
To Expenses A/c
BALANCE SHEET.
Accrued Income (i) Add to the concerned income on
Dr.
Accrued income/ Income due A/c Credit side of Profit and Loss A/c
but not received (ii) Show on the assets side of
To Income A/c
BALANCE SHEET.
(i) Deduct from the concerned income
Income A/c Dr.
Unearned income/Income on the credit side of Profit & Loss A/c
received in Advance To Unearned (ii) Show on the liabilities side of
Income A/c Balance Sheet.

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 (i) Show on the debit side of Profit
Depreciation A/c Dr.
Loss A/c
Depreciation
(ii) Deduct from the concerned asset
To Asset A/c
in the Balance Sheet.
Bad Debts : The debtors from whom amounts cannot be recovered are treated in the books of
accounts as bad and are termed as bad debts.
Further Bad Debts : These Bad debts is a loss that occurred after reparation of Trial
Balance. Further bad debts be added in the bad debts already appearing in the Profit and Loss
Ae and Debtors would be reduced with the same amount.
Provision for Bad Debts : In the balance sheet, debtors appears on the assets side of the
Balance Sheet, which is their estimated realisable value during next year. It is quite possible
that the whole of the amount may not be realized in future. However it is not possible to
accurately know the amount of such bad debts.
Hence, a reasonable estimate of such loss is provided in the book. Such provision is called
provision for bad debts. Provision for doubtful debts is shown as a deduction from the debtors
on the asset side of the balance sheet.
Note : The provision for doubtful debts brought forward from the previous year is called the
opening provision or old provision. When such a provision already exists, the loss due to bad
debts during the current year are adjusted against the same and while making provision for
doubtful debts required at the end of the current year is called new provision. The balance of
old provision as given in trial balance should also be taken into account.
Provision for discount on Debtors : Discount is allowed to customers to encourage them to
make prompt payment. The discount likely to be allowed to customers in an accounting year
can be estimated and provided for by creating a provision for Discount on debtors.
Provision for discount on debtors is made on good debtors which are arrived at by deducting
further bad debts and provision for bad debts out of Debtors shown in the Balance sheet.
Bad Debts A/c Dr. (i) Debit side of P&L A/c.
To write off bad debts (ii) Deduct from debtors on the as-
To Debtors
sets side of Balance Sheet.
Provision for Doubtful Debts
Dr. (i) Debit side of P & L A/c.
Provision for bad and A/c
doubtful debts (ii) Deduct from debtors on the
To Debtors A/c
assets side of Balance Sheet.
P & L A/c Dr. (i) Debit side of P & L A/c.
Provision for discount
To Provision for Discount on (ii) Deduct from debtors on the
on debtors
Debtors Debtors A/c assets side of Balance Sheet.
Manager’s Commission
The manager of the business is sometimes given the commission on the net profit of the
company. The percentage of the commission is applied on the profit either before charging
such commission or after charging such commission. In the absence of any such information,
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it is assumed that commission is allowed as a percentage of the net profit before charging
such commission.
1. Commission on net profits before charging such commission
Commission =Net profit before commission×Rate of Commission100=Net profit before
commission×Rate of Commission100
2. Commission on net profits after charging such commission
Commission =Net profit before commission×Rate of Commission 100+Rate of
Commission =Net profit before commission×Rate of Commission 100+Rate of Commission
Interest on Capital A/c Dr. (i) Debit side of P & L A/c.
Interest on Capital (ii) Add to capital on the liabilities
To Capital A/c
side of Balance Sheet.
Capital/Drawings A/c Dr. (i) Credit side of P & L A/c.
Interest on drawings To Interest on Drawings (ii) Deduct from capital on the
A/c liabilities side of Balance Sheet.
Interest on Loan A/c Dr. (i) Debit side of P & L A/c.
Interest payable on loan
(ii) Add to loan on the liabilities side
(borrowed) To Loan A/c
of Balance Sheet.
P& L A/c Dr. (i) Debit side of P & L A/c.
Commission payable to
To Comm. Payable to (ii) Show on the liabilities side of
manager
manager A/c Balance Sheet.
Adjustment in Respect of Goods
Abnormal Loss : Sometimes losses occur due to some abnormal circumstances such as
accident, fire, flood, earhquakes etc. Such losses are called Abnormal losses. These may be
divided into two categories :-
(A) Loss of Goods (B) Loss of fixed assets
Good taken for personal use {Drawings in goods) : When the goods are withdrawn by
proprietor for personal use the cost of such goods deduct from purchases and the amount
should be deduct from capital in Balance Sheet.
Goods distributed as free samples : Sometime goods are distributed as free sample by the
businessman for the purpose of advertisement. The cost of free sample deduct from purchase
and shown in Debit side of profit and loss account.
Abnormal loss of goods by fire, theft, accident, etc.
Treatment in
Adjustment Treatment in Balance Sheet
Trading & P & L A/c
1) Loss of … A/c Dr.
(i) Gross Loss: Deduct from
1) Loss of Goods (By accident, To Trading A/c
Purchases or show on the credit side
Fire, Theft) (or)
of Trading A/c.
To Purchases A/c
If goods were note insured 2) P & L A/c Dr.

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 To Loss by …… (ii) Net Loss: Debit side of P & L
A/c A/c.
If goods were insured and full 2) Insurance
Dr. (iii) Insurance claim: Assets side of
claim accepted by insurance company A/c
Balance Sheet.
company To Loss by … A/c
2) Insurance
Dr.
If full claim not accepted by Company A/c
Insurance Company Profit & Loss A/c Dr.
To Loss By …. A/c
(i) Deduct the amount of goods from
Drawings A/c Dr.
the purchases in Trading A/c.
2) Goods taken by the proprietor
(ii) Deduct the amount from the
for his personal use
To Purchases A/c capital on the liabilities side of
Balance Sheet.
(i) Deduct the amount of goods from
Advertising A/c Dr.
3) Goods distributed as free the purchases in Trading A/c.
samples (ii) Show on the debit side of P & L
To Purchases A/c
A/c.
(i) Deduct the amount from the
Charity A/c purchases on the debit side of
4) Goods given as charity Trading A/c.
(ii) Show on the debit side of P & L
To Purchases a/c
A/c.
Key Points:

1. If closing stock is shown in Trial Balance then it will be shown in balance sheet only.
It is assumed that purchases amount already gets adjusted in trial balance.
2. Salary and wages will be shown in profit and loss A/c debit side (assuming that salary
is prominent) while wages and salary will be shown in trading A/c debit side, (wages
are prominent).
3. Freight, carriage, cartage will be shown in Dr. side of trading A/c. if inward word
attached with these then it also debited to trading A/c, if outward word attached with
these item then it will be debited to profit and loss account.
4. Any expenses related to factory are debited to trading account like factory lighting,
factory rent if factory word is not given then lighting and rent will be debited to profit
and loss account.
5. Trade expenses always debited to profit and loss A/c not as name indicate trading A/c.
6. Packaging material: cost of packaging material used in product are direct expenses as
it refers to small containers which form part sold, it will debited to trading A/c.

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 7. Packing: the packing refers to the big containers that are used for transporting the
goods and regarded as indirect expenses and debited to profit and loss account.
8. Adjusted purchases mean the amount of purchases is adjusted by way of adding
opening stock and reduced by the amount of closing stock, e.g., purchases Rs.
1,00,000; opening stock Rs. 12,000, closing stock Rs. 8,000. Calculate adjusted
purchases.
Adjusted purchases = purchases + opening stock – closing stock
= Rs. 1,00,000 + Rs. 12,000 – Rs. 8,000 = Rs. 1,04,000
When adjusted purchases is given in trail balance, then there is no need of debiting
opening stock and crediting closing stock in trading A/c.
In this case closing stock will be shown in balance sheet only.

Remember
While preparing Final Accounts the items which are given inside the Trial Balance are
written only once either in Income Statement or in the Balance Sheet. (Assuming that they
have been already adjusted in the respective account). On the other hand, the items which are
given outside the Trial Balance (known as adjustment) are to be written twice because the
double entry in respect of all adjustments is to be completed in the final accounts itself.

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