SAI SUDHIR DEGREE & PG COLLEGE

FIRST YEAR FIRST SEMESTER

Teacher: MRS. Shivani

MCA
MANAGERIAL
ECONOMICS &
ACCOUNTING
___

Unit 3: THEORY OF PRODUCTION AND MARKETS

THEORY OF PRODUCTION

Production is the process by which different inputs, including capital, labor,

and land, are used to create outputs in the form of products or services.
Production is not only concerned with the tangible aspect. Rather
production also includes any service that can satisfy the wants of people.
According to James Bates and J.R. Parkinson "Production is the organized
activity of transforming resources into finished products in the form of
goods and services, and the objective of production is to satisfy the
demand of such transformed resources".

PRODUCTION FUNCTION

Production is a process that business uses to convert inputs into outputs.

Production involves a series of activities that convert the inputs into outputs
that people can use for the fulfillment of their needs. Production is basically
the transformation of inputs into output. Input is anything that is utilized in
the creation of a commodity and Output is something that gets produced at
the end of the production process. The relationship between inputs and
outputs is defined using the Production Function.

The factors of production

1. Land: Natural resources

2. Labor : Human skill and effort

3. Capital: Equipment and materials

4. Enterprise: Organisation and undertaking production

Algebraic Representation of Production Function

It offers a mathematical representation of this connection and plays a vital

role in comprehending and enhancing production, The general structure of
the production function can be articulated as follows:

Q = f(L, K, T, 0)

Where:

Q represents the volume of output generated.

L signifies the amount of labour engaged.

K denotes the quantity of capital (e.g., machinery, structures, equipment)

utilized.

T represents technology, which can augment or diminish production

efficiency.
O stands for other factors influencing production, including natural
resources, managerial expertise, and organizational structure.

Short Run and Long Run Production Function

Production functions are based on the period can be divided into two
categories: Short Run Production Function and Long Run Production
Function. In these production functions, the combination and behavior of
variable factors and fixed factors are different.

1. Short Run Production Function:

Short Run is a period of time where output can only be changed by

changing the level of variable inputs. In the short run, some factors are
variable and some are fixed. Fixed factors remain constant in the short run
like land, capital, plant, machinery, etc. Production can be raised by only
increasing the level of variable inputs like labour. Therefore, the situation
where the output is increased by only increasing the variable factors of
input and keeping the fixed factors constant is termed a Short Run
Production Function. This relationship is explained by the 'Law of Variable
Proportions'.

2. Long Run Production Function:

Long Run is a period where the output can be increased by increasing all
the factors of production whether it is fixed (land, capital, plant, machinery,
etc.) or variable (labour). In the long run, is enough time to alter all the
factors of production. All factors are said to be variable in the long run.
Therefore, the situation where the output is increased by increasing all the
inputs simultaneously and in the same proportion is termed Long-Run
Production Function. This relationship is explained by the 'Law of Returns
to Scale.'
LAW OF VARIABLE PROPORTION

The law of variable proportion is an economic theory that states that

increasing the quantity of one factor of production while keeping the others
constant will result in a decline in the marginal product of that factor. It's
also known as the law of proportionality.

The law of variable proportion is used in short-run production functions,

where one factor varies while the others remain the same. It's applicable to
all fields of production, such as industry and agriculture.

Stages of the Law of Variable Proportion

There are three stages which describe the law of variable proportion. These
three stages Depict the variable conditions and factors Positioning with
their impacts. These three stages of the law of variable proportion are
discussed below.

Stage 1

Under stage 1, the TPP increases at an increasing rate, and the MPP also
increases. Due to the increase in the units of variable factor, MPP
increases. This stage is also called the stage of increasing returns.
Generally, in stage one, the producer does not operate. The marginal
product increases in this stage. So that the producer can employ more units
and make the proper utilization of resources.
Stage 2

Here the TPP increases at a diminishing rate. Though it increases at a

diminishing rate, It stays positive. The MPP decreases due to the increase
in the number of units of variables. This stage is called the stage of
diminishing Returns. The producers most likely prefer to operate on the
stage.
Stage 3

Here the TPP starts declining but stays positive, while MPP decreases and
becomes negative. This stage is also called the stage of negative returns.
Producers avoid operating in stage 1 as well as in stage 3. In this stage,
there is a decline in the total product. The marginal product also becomes
negative. In stage 3, the cost is higher, and the revenue decreases. This
leads to a reduction in profits.

Isoquants

Breaking the word isoquant into its individual components can easily
explain its meaning. Iso means equal and quant means quantity. Hence,
isoquant is a graphical representation of all the various combinations of
inputs which are equal in the eyes of the producer as they produce the
same level of output.

Isoquants are called equal-product or iso-product curves. Again, as all the

combinations yield the same level of output the producer tends to be
indifferent among them. Hence, isoquants are also known as producer
indifference curves. Further, isoquants share resemblances with the
indifference curves.

Economies of Scale:

Economies of scale can be described as the cost advantages that an

organization can attain over time by increasing production. Thus,
"Economies of Scale" refers to the benefits of large-scale expansion. The
cost advantage is realized via the reduced average cost per unit.

Effects of Economies of Scale on Production Costs:

1. The fixed cost per unit is decreased. More production implies that the
fixed cost is distributed over a larger output than it was previously.

2. It lowers variable costs per unit. This happens when the production
process becomes more efficient due to the increased scale of output.

Types of Economies of Scale:

The Economies of Scale may be divided into two categories-

1) Internal Economies

2) External Economies.

Internal Economies:

These are the actual economies that result from an organization's growth
internally. These economies are the outcome of the organization's own
expansion.Internal economies of scale occur when factors of production in
the firm can reduce the cost of production.

Types of Internal Economies of Scale:

1. Technical/Internal Economies of Scale:

Technical specialization: Larger companies can afford specialized

machinery and technology that smaller companies cannot, which results in
increased productivity and reduced unit costs.

Division of Labor: As businesses expand, they can assign specialized staff

to different activities, which boosts output and lowers expenses per unit.
Economies in manufacturing Processes: Through research and
development (R&D) or continuous improvement initiatives, larger
companies may create more effective manufacturing processes that reduce
costs.

2. Financial Economies of scale:

Reduced Cost of financial: Because of their size and stability, larger

companies are frequently able to negotiate cheaper interest rates on loans
and have better access to the financial markets.

Better Creditworthiness: Lenders view larger businesses as less risky,

which enables them to obtain funding on more advantageous conditions.

Internal Funding Options: Bigger businesses could be able to finance

investment or growth projects internally rather than primarily depending on
outside funding.

3. Managerial Economies of Scale:

Specialization in Management: Larger companies can afford to hire

specialized managers and departments (such as marketing, finance, and
HR), which enhances efficiency and coordination in decision-making.

Professional Management: As businesses expand, they may bring in more

skilled and seasoned managers who may boost strategic planning and
operational effectiveness.

4. Marketing Economies of Scale:

Advertising Economies: By distributing their advertising and promotional

spending over a higher output, larger businesses can lower their per- unit
marketing costs.
Brand Recognition: Compared to smaller competitors, larger companies
frequently enjoy the benefits of brand recognition and reputation, which
lowers the need for expensive promotional operations

5. Technological Economies of Scale:

R&D Benefits: bigger firms can afford to spend more on R&D, which results
in technological breakthroughs that lower costs and increase efficiency.

Patents and Intellectual Property: Larger firms might have a more robust
portfolio of intellectual property, which gives them a competitive edge and
lowering the expenses of innovation.

6. Risk Diversification Economies of Scale:

Benefits of Diversification: By distributing risks and reducing the effect of

downturns in particular industries or areas, larger companies can diversify
their product lines or geographic markets.

Economies in Risk Management: Larger companies are able to lower total

risk exposure by employing advanced risk management techniques and
insurance coverage.

External Economies:

External Economies are the economies that result from sources outside the
company. These economies lead to advancements in the primary
organization through higher-quality external elements such as improved
labor, infrastructure, transportation, etc. The organization's cost of
manufacturing per unit of an item drops as a result of these external factors
strengthening.
Definition: External economies of scale occur when factors outside of the
firm positively impact the firm's productivity, thereby increasing economies
of scale.

Types of External Economies of Scale:

1. Economies of infrastructure:

Transportation: By minimizing transportation costs and enhancing logistics,

improved transportation networks-such as highways, ports, or
airports-benefit several businesses.

Utilities: Businesses in the same location can save money and increase
dependability by sharing utilities including water, power, and
telecommunications infrastructure.

Technology Parks and Clusters: Groups of businesses together in

technology parks or clusters can promote common access to specialized
infrastructure and services, cooperation, and knowledge sharing.

2. Economies of knowledge and manpower pools:

Skilled Labor: Areas with a high concentration of skilled people can offer
businesses access to a wider pool of talent, which lowers recruitment costs
and boosts output through specialization and information sharing.

Research and Development: Being close to academic institutions, research

centers, or innovation hubs can help with cooperation, access to findings
from studies, and the development of new technologies that help a number
of businesses.

3. Economies of suppliers
Specialized Suppliers: By providing cost savings through bulk purchases,
just-in-time delivery, and reduced transaction costs, clusters of businesses
in similar industries may attract specialized suppliers and service providers.

Suppliers Competitiveness: In a highly competitive marketplace, rivalry

among suppliers can result in better service, more affordable costs, and
innovative goods and services.

4. Market-based economies:

Customer Proximity: By virtue of their proximity and market visibility,

businesses that concentrate in particular markets can draw in a wider range
of clients and so lower their marketing and distribution expenses.

Market understanding: Better market intelligence and strategic

decision-making for businesses may result from shared market
understanding and trends within a concentrated industry.

5. Financial Economies:

Access to Capital: Firms may find it easier to attract money, pay less for
borrowing, and have more investment prospects in areas with concentrated
financial markets or venture capital networks.

Diseconomies of Scale:

Diseconomies of scale occur when an additional production unit of output

increases marginal costs, which results in reduced profitability. Instead of
production costs declining as more units are produced (which is the case
with economies of scale), the opposite happens, and costs increase with
the production of each additional unit.

Types of Diseconomies of Scale:

1. Managerial Diseconomies:

Bureaucracy: Administrative overhead and bureaucratic complexity may

rise as businesses grow large. Decision-making procedures may become
slow as a result, and coordination and communication expenses may rise.

Coordination difficulties: Larger organizations may have difficulties

coordinating efforts among many divisions or departments, which can result
in disagreements, inefficiencies, and duplication of work.

2. Technical Diseconomies:

Complexity: manufacturing processes and logistics may become more

complicated in larger-scale operations. Increased costs for processing
larger inventory, maintaining equipment, and guaranteeing quality control
could be the outcome of this complexity.

Loss of Control: As a company expands in size, it may become more

difficult for it to retain operational control and uniform quality standards,
which can result in increasing production inefficiencies and defect rates.

3. Financial Diseconomies:

Cost of Capital: Due to increased perceptions of risk or higher borrowing

costs, larger businesses may have to pay more to raise money. This may
reduce the number of investment opportunities and raise the total cost of
funding operations and growth.

Financial Management Complexity: As businesses expand, managing their

financial resources gets more difficult, mandating the use of sophisticated
financial management techniques and tools. Ineffective financial
management can result in decreased profitability and increased expenses.

4. Marketing Diseconomies:
Customer Service Challenges: As they expand, larger businesses may find
it more difficult to provide individualized customer care, which will lower
customer satisfaction and retention. This may result in increased costs for
handling client complaints and maintaining client relationships.

Brand Dilution: Businesses run a risk of losing their unique identity and
competitive edge when they enter new product categories or marketplaces.
For the brand to remain competitive and well-known, additional resources
may need to be spent on marketing.

COST OF PRODUCTION

There are many types of costs of production, including:

1. Fixed costs: These costs are constant regardless of production levels

and include business equipment, rental spaces, and advertising. For
example, rent, insurance, and employee salaries are fixed costs.
2. Variable costs: These costs change with production levels and
include direct labor costs and sales commissions. For example,
utilities, raw materials, and commissions are variable costs.
3. Total cost: This is the sum of fixed and variable costs, and is the
overall cost of production.
4. Marginal cost: This is the cost to produce one additional unit of a
product. This is the cost of producing one additional unit of output.
5. Average cost: This is the cost to produce one unit of a product. This
is the total cost of production divided by the number of units
produced.
6. Direct costs: These costs are associated with the production cycle,
such as the cost of materials. These are costs that are directly linked
 to the manufacturing process, such as labor, raw materials,
machinery, and fuel.
7. Indirect costs: These costs keep the production cycle operating, such
as utilities, depreciation, and production supervisory wages. These
are costs that are not directly linked to the manufacturing process,
such as maintenance, marketing, administrative expenses, insurance,
and rent.
8. Short-run costs: These costs are affected by revenue and variable
expenses, and can be seen in real-time during production.
9. Long-run costs: These costs are accumulated when companies alter
production levels, and are mainly variable expenses.

OPPORTUNITY COST

Opportunity cost arises only in a world of scarcity. In other words, where the
means or resources available to satisfy wants are limited so that all wants
cannot be met, the problem of opportunity cost arises. It is obvious that in a
world of plenty where resources are limitless, all wants can be satisfied. So
in order to satisfy a want, no alternative or opportunity is sacrificed. It
means that the value of alternative sacrificed is zero. It has, therefore, been
said that the opportunity cost is like a ghost which vanishes when boldly
confronted. Destroy the opportunity, cost itself will vanish. But in the actual
world scarcity is a reality and the sacrifice of the alternative is also a reality.
So opportunity cost is positive.

Economists express costs in terms of foregone alternative. If some course

of action is adopted, there are typically many alternatives that might be
foregone. Suppose the government takes a decision to construct a road. In
order to do so it might cut expenditure on schools, on research laboratories
or on modernizing the communication system. To get a precise measure of
opportunity cost, economists count the sacrifice as that of the best available
alternative, i.e. the next best alternative.

CONCEPT OF REVENUE

A firm has to play the dual role of the producer and a seller. As a producer,
A firm to the costs of producing alin mahitis produce if decided by the
conditions that prevail in the product market and sale proceeds (revenue) it
expects to earn vis-a-vis the costs that it has incurred The equilibrium
output is that which gives it maximum profit.The sale proceeds that revenue
a firm gets from the sale of its product is called revenue.

The concept of revenue is different from the concept of profit. The following
equation shows the difference: Profit = Revenue - Costs Revenue =
Costs + Profits.

Total Average and Marginal Revenue

The revenue concept relates to Total Revenue, Average Revenue and

Marginal Revenue.

1. Total Revenue (TR): Total Revenue from the production and sale of a
product of a firm is the total quantity of the product produced and sold
multiplied by the price of the product.
Thus: TR = PxQ.

Where, TR is Total Revenue, P is price and Q is quantity of the product

produced and sold.

If a firm sells 100 units of a commodity at 10 per unit. Then the total
revenue of the firm will be:

QxP=TR

100×₹10=₹ 1,000.

2. Average Revenue (AR): Average Revenue is the revenue earned per

unit of output produced and sold.

In other words, Average Revenue refers to revenue per unit of output.

AR = TR / Q

Where, AR is Average Revenue, TR is Total Revenue , Q is quantity of the

product produced and sold.

Average Revenue (AR) is equal to price (AR = P) when a firm sells all units
of output produced at the same price (except in the case of discriminating
prices). Therefore, AR = TR / Q
or, AR = P x Q / Q

or, AR = Price

If, for example, a firm realizes Total Revenue₹ 1,000 by the sale of 100
units. It implies that the Average Revenue is ₹10 (1000/10) or the firm has
sold the commodity at a price of 10 per unit.

3. Marginal Revenue (MR): Marginal Revenue is defined as the extra

revenue carned by the producing and selling an extra unit of output.

Starting algebraically, marginal revenue is the difference between total

revenue earned by producing and selling 'n' units of a product instead of 'n
1 units.

Thus, MR = TRn - TRn-1

MR = Marginal Revenue

TRn = Total Revenue of 'n' units of output TRn-1 Total Revenue of 'n - 1'
units of output

COST-OUTPUT RELATIONSHIP

The cost-output relationship is the way a company's total production costs

change as the level of output changes. It's an important factor in
determining the best production level and helps with cost control, pricing,
profit prediction, and promotion.
 The cost-output relationship is different in the short run and the long run:

● Short run: In the short run, the size of the industry can't be expanded to
meet increased demand. Total fixed costs remain constant, while total
variable costs change with output.
● Long run : In the long run, the size of the industry can be expanded to
meet increased demand. All inputs are variable, and costs depend on
returns to scale.

The cost per unit is calculated by dividing the total production costs by the
number of units produced. The total production cost is the sum of the total
fixed cost and the total variable cost.

BREAK EVEN ANALYSIS

A break-even analysis is a financial calculation that determines when a
business will cover all its costs and start making a profit. It's a key
component of a business plan and is often required when seeking
investors or loans.

Importance of Break-Even Analysis

● Manages the size of units to be sold: With the help of break-even

analysis, the company or the owner comes to know how many units
need to be sold to cover the cost. The variable cost and the selling
price of an individual product and the total cost are required to
evaluate the break-even analysis.
● Budgeting and setting targets: Since the company or the owner
knows at which point a company can break-even, it is easy for them
to fix a goal and set a budget for the firm accordingly. This analysis
can also be practised in establishing a realistic target for a company.
● Manage the margin of safety: In a financial breakdown, the sales of a
company tend to decrease. The break-even analysis helps the
company to decide the least number of sales required to make
 profits. With the margin of safety reports, the management can
execute a high business decision.
● Monitors and controls cost: Companies’ profit margin can be affected
by the fixed and variable cost. Therefore, with break-even analysis,
the management can detect if any effects are changing the cost.
● Helps to design pricing strategy: The break-even point can be
affected if there is any change in the pricing of a product. For
example, if the selling price is raised, then the quantity of the product
to be sold to break-even will be reduced. Similarly, if the selling price
is reduced, then a company needs to sell extra to break-even.

​ How it's calculated: The formula for break-even analysis is as follows:

Break-Even Quantity = Fixed Costs / (Sales Price per Unit – Variable Cost
Per Unit)

where:

● Fixed Costs are costs that do not change with varying output (e.g.,
salary, rent, building machinery)
● Sales Price per Unit is the selling price per unit
● Variable Cost per Unit is the variable cost incurred to create a unit
It is also helpful to note that the sales price per unit minus variable cost per
unit is the contribution margin per unit. For example, if a book’s selling price
is rs100 and its variable costs are rs5 to make the book, rs95 is the
contribution margin per unit and contributes to offsetting the fixed costs.
PRICE - OUTPUT DETERMINATION UNDER PERFECT
COMPETITION AND MONOPOLY

PERFECT COMPETITION

Perfect competition is a theoretical market structure that describes a market

where many buyers and sellers interact to sell identical products. It's a model
that economists use to understand how supply and demand affect prices and
behavior in a market economy.

Characteristics of perfect competition:

● Identical products: All firms sell the same product.

● Price takers: Firms must accept the equilibrium price for their goods.
● Free entry and exit: Firms can enter or leave the market without restrictions or
high costs.
● Perfect information: Buyers and sellers have complete knowledge of prices
and products.
● No externalities: Costs or benefits of an activity don't affect third parties.
● Zero transaction costs: Buyers and sellers don't incur costs when exchanging
goods.
● Profit maximization: Firms sell where marginal costs meet marginal revenue.

In reality, perfect competition rarely occurs because some or all of these

characteristics are not present.

Examples of perfect competition:

 ● Farmers' markets: Small producers sell similar products at similar prices, and
it's easy to compare prices.
● Online marketplaces: Individuals can sell items to a large audience with access
to all the available information.
● Foreign exchange markets: There are many buyers and sellers, and
information is easy to access.

PRICE - OUTPUT DETERMINATION UNDER PERFECT COMPETITION :

Under perfect competition, the buyers and sellers cannot influence the market
price by increasing or decreasing their purchases or output, respectively. The
market price of products in perfect competition is determined by the industry.
This implies that in perfect competition, the market price of products is
determined by taking into account two market forces, namely market demand
and market supply.

MONOPOLY

A monopoly market is a market structure where a single seller or producer

controls the supply of a product or service, and there are no close substitutes
for it. In a monopoly market, the seller can: dictate prices, restrict output, and
enjoy super-normal profits.

Monopolies are discouraged in free-market economies because they can

lead to unfair consumer practices, such as limiting consumer choice and
exploiting customers. However, some monopolies, such as those in the utility
sector, are government regulated.

Some characteristics of a monopoly market include:

● Single producer: There is only one producer or seller of the product or service.
● No close substitutes: There are no other products or services that are similar
enough to compete with the monopoly's product or service.
 ● Barriers to entry: There are strict barriers to prevent new firms from entering the
market or producing similar products. These barriers can be economic, legal, or
technological.

Some examples of monopolies include:

● Microsoft (Windows) in the software market

● The United States Postal Service (USPS)

PRICE - OUTPUT DETERMINATION UNDER MONOPOLY MARKET : In a

monopoly market, the monopolist sets the price and earns a positive economic
profit. The monopolist has market power and can maintain supernormal profits in
the long run.

UNIT 5: ACCOUNTING

MEANING: Accounting is the process of recording financial transactions

pertaining to a business. The accounting process includes summarizing,
analyzing, and reporting these transactions to oversight agencies, regulators,
and tax collection entities. The financial statements used in accounting are a
concise summary of financial transactions over an accounting period,
summarizing a company's operations, financial position, and cash flows.
SIGNIFICANCE

1. Keeps a record of business transactions

Accounting is important as it keeps a record of the organization’s financial information.

Up-to-date records help users compare current financial information to historical data.
With full, consistent, and accurate records, it enables users to assess the performance
of a company over a period of time.

2. Facilitates decision-making for management

Accounting is especially important for internal users of the organization. Internal users
may include the people that plan, organize, and run the organization. The management
team needs accounting in making important decisions. Business decisions may range
from deciding to pursue geographical expansion to improving operational efficiency.

3. Communicates results

Accounting helps to communicate company results to various users. Investors, lenders,

and other creditors are the primary external users of accounting information. Investors
may be deciding to buy shares in the company, while lenders need to analyze their risk
in deciding to lend. It is important for companies to establish credibility with these
external users through relevant and reliable accounting information.

4. Meets legal requirements

Proper accounting helps organizations ensure accurate reporting of financial assets and
liabilities. Tax authorities, such as the U.S. Internal Revenue Service (IRS) and the
Canada Revenue Agency (CRA), use standardized accounting financial statements to
assess a company’s declared gross revenue and net income. The system of accounting
helps to ensure that a company’s financial statements are legally and accurately
reported.

PRINCIPLES OF DOUBLE ENTRY SYSTEM

MEANING

Double-entry is the first step of accounting. To understand any accounting entry, one should know
about this system. Each accounting transaction is recorded in a minimum of two accounts, one is a
debit account, and another is a credit account. Also, the transaction should be balanced, i.e., the
credit amount should be equal to the debit amount.

When a business engages in a transaction, it records both the debit and credit aspects of the
exchange in separate accounts. For instance, when a company makes a sale, it not only records the
increase in its cash or accounts receivable (debit) but also acknowledges the corresponding increase
in revenue (credit). This dual recording system serves several critical purposes.

Firstly, it helps prevent errors and fraud by necessitating a cross-verification of entries. If the books
are not in balance, it signals an inconsistency that requires investigation. Secondly, double entry
facilitates the creation of financial statements, enabling businesses to generate accurate reports
that reflect their financial performance and position.

Therefore, the double entry accounting is the cornerstone of reliable accounting, providing
transparency, accuracy, and a systematic approach to financial management, which is indispensable
for informed decision-making and regulatory compliance.

Features
● Two Parties: Two parties are involved, one is the receiver, and another is the giver. The
receiving party is debited, and another party is credited. For example, A purchases goods
from B, where A is a receiver party, and B is a giver party.
● Equal Effect: Each transaction should have an equal financial effect. The debit amount
should be equal to the credit amount.
● Separate Legal Entity: This accounting system records the transaction separately from its
owners.
● Debit and Credit: There are two aspects for recording any transaction, the Debit aspect,
and the Credit aspect.

Principle

Double entry accounting is based on a simple principle, that for every debit, must have equal and
opposite credit. There should be at least two accounts involved in any transaction.

Debit Side = Credit Side

The double entry is based on the debit and credit accounts of the transaction. So, we need to
understand what account kind of debits and what credits.
There are three different types of accounts, Real, Personal, and Nominal Accounts. Rules of
recording the transactions are decided based on the type of account.

1 - Real Accounts - Debit what comes in and Credit what goes out. Real accounts include Pant &
Machinery, Buildings, Furniture, or any other Asset account. So when we purchase Machinery, the
Machinery account is debited, and when we sell Machinery, the Machinery account is credited.

2 - Personal Accounts - Debit the Receiver and Credit the Giver. The personal account includes the
account of any person, such as an owner, debtor, creditor, etc. When we make payment to our
creditors, the receiver account is debited, and when we receive the payment, the giver account is
credited.

3 - Nominal Accounts - Debit all Expenses and Losses and Credit all Incomes and Gains. Nominal
accounts include all the Expenses, Income, Profit, and Loss accounts. For example, the Salary Paid
account is debited, and the rent received account is credited.

JOURNAL

An accounting journal is a detailed account of all the financial transactions of a

business. It’s also known as the book of original entry as it’s the first place where
transactions are recorded. The entries in an accounting journal are used to
create the general ledger which is then used to create the financial statements of
a business.

Before computerized bookkeeping and accounting, the transactions were entered

manually into a journal and then posted to the general ledger. Apart from the
general journal, accountants maintained various other journals including
purchases and sales journal, cash receipts journal and cash disbursements
journal. With accounting software, today you’re likely to find only a general
journal in which adjusting entries and unique financial transactions are entered.

How to Do Accounting Journal Entries?

To create an accounting journal, record the information about your financial
transactions. The details of financial transactions can be derived from invoices,
purchase orders, receipts, cash register tapes and other data sources.

Once you’ve analyzed the transactions, the information is documented in a

chronological order in the journal. Each transaction that is listed in the journal is
known as a journal entry. This information is then recorded in the ledgers.

The journal entries are usually recorded using the double entry method of
bookkeeping. Each transaction is recorded in two columns, debit and credit.

For example, if you purchase a piece of equipment with cash, the two
transactions are recorded in a journal entry. You will have to decrease the cash
account and the increase the asset account.

The rules of debit and credit, also known as the Golden Rules of accounting,
are:

● Debit what comes in, credit what goes out

● Debit all expenses and losses, credit all incomes and gains
● Debit the receiver, credit the giver

Debits are recorded on the left side of an account, while credits are recorded
on the right side. Debits increase assets and expenses, while credits increase
liabilities, equity, and revenue.

Ledger

The ledger is a group or set of accounts. In other words, ledger is a book in which various
accounts (of personal, real and nominal nature) are opened. Its source of information are the
books of original entry, called journals. Usually only one account is placed on each page of the
ledger. Ledger is the main or principal book of account. Business practice formerly favoured the
use of bound books for the ledger accounts, but the present tendency is to use loose-leaf forms
printed on paper or cards. The bound ledger is inflexible in that new accounts or additional
space for old accounts must be placed where blank pages are available. The increasingly
popular loose-leaf ledger is more flexible and permits rearrangement of the accounts, if
necessary. New accounts may be placed where desired and additional space may be given to
an account merely by inserting a new sheet along with the old.

Trial Balance
Meaning
When all the accounts of a concern are balanced off they are put in a list, debit balances on one
side and credit balances on the other side. The list so prepared is called trial balance. The total
of the debit side of trial balance must be equal to that of its credit side. This is based on the
principle that in double entry system, for every debit there must be a corresponding credit. The
preparation of a trial balance is an essential part of the process because if totals of both the
sides are the same then it is proved that books are at least arithmetically correct. It must be
remembered that equalising the two sides of a trial balance is not the sole and conclusive proof
of the complete correctness of books.

SUBSIDIARY BOOKS

Meaning
Journalising every transaction is a lengthy task especially when the size of a business is large.
The system of book-keeping should be easy, simple to follow and should be such as can allow
division and sub-division of duties and speedy working. If the size of the business is a small
one, then it is possible to enter each and every transaction in the journal, commonly known as
books of original record or primary record or subsidiary record. But when size of the business
grows, it is no longer possible to record all the transactions in one general journal, but the main
journal is split into a number of separate journals or Day Books. A separate Day Book is used
for each type of transaction. These transactions are usually numerous. For instance, separate
Day Books are kept in big-sized business for receipts and payment of cash, credit purchase and
sale of goods, returns of goods purchased and sold, bills receivable and bills payable. These
journals are prepared almost every day and are of specialized character as they include
transactions relating to one type of transactions. They are, therefore, known as special journals.
They may also be called special purpose Subsidiary books.

Types
(i) Cash Book.

(ii) Bills receivable journal.

(iii) Bills payable journal.

(iv) Sales journal.

(v) Purchases journal.

(vi) Sales return journal.

(vii) Purchases return journal

CASH BOOK

Meaning

Cash book may be defined as the record of transactions concerning cash receipts and cash
payments.

Necessity of cash book. It is common experience in any business that transactions affecting
cash occur very frequently. Cash sales, cash purchases, payment of expenses like salaries,
wages, cartage, carriage, commission, rent, electricity expenses, water bills, rates and taxes,
collection of cash from customers, payments to creditors are a few examples of transactions
affecting cash. In view of the above fact, the necessity of a separate book for recording cash
transactions cannot be overemphasized.

Single Column Cash Book

There is only one column, i.e, cash column. It is just like a cash account.

Two Columnar Cash Book

In this cash book, two columns are kept on both sides. One is for cash and second is for
discount. This cash book is also called as cash book with cash and discount columns. On the
left-hand side of the cash book, cash discount allowed to customers is shown in the discount
column while on the right hand side, cash discount received from suppliers or creditors is shown
in the discount column.

Three Columnar Cash Book

It is a very popular form of Cash Book. Where a business enterprise has a current account in a
bank, it would pay therein most of its cash receipts and cheques received from various
customers and others and would then make most of the payments by cheques drawn on such
bank account. Under such a situation, the form of cash book with only cash and discount
column on either side would not serve the purpose. A more elaborate cash book would have to
be designed so as to serve the combined purpose of a cash account and a bank account,
without in any way disturbing the double entry principles. The rulings would, in this situation,
consist of discount, cash and bank columns on both

the sides of the cash book. The three columns provided are as follows:
(a) the first column is for discount, which is a nominal account,
(b) the second column is for cash, which is a real account, and

(c) the third column is for a bank, which is a personal account.

Petty Cash Book

In every business, of whatever size, there are many payments which are of small amounts and
high frequency. Examples are payments for stationery, postage, telegrams, carriage, cleaning,
traveling. all these payments are recorded in the cash book, it will unnecessarily be
overburdened. In order to make the task of the cashier easy, a petty cashier is appointed and is
handed over a small sum which, from past experience, is found sufficient enough to meet the
requirements of a given period (say, one month). This small amount is called 'imprest' or 'float'.
The petty cashier makes the payment of petty expenses for which he is authorized and records
there in his cash book called "petty tty cash book". All these payments are supported

BANK RECONCILIATION STATEMENT

MEANING: Normally, at the end of each month, the entries in the cash book are compared with
entries in the pass book. The exact causes of differences between the balance as shown by the
cash book and the balance as shown by the pass book are scrutinized and then a reconciliation
statement is prepared, commonly called a Bank Reconciliation Statement.

Final accounts

Final accounts are financial statements that summarize a company's financial

performance and position at the end of an accounting period. They are also
known as financial statements.

Final accounts are made up of the following accounts:

● Balance sheet: Shows the company's financial position

● Profit and loss account: Details the company's revenues and expenses to show
profit or loss
 ● Trading account: Another component of final accounts

Final accounts are important for: assessing a business's financial health,

making informed decisions, meeting regulatory requirements, and strategic
planning and analysis.

The preparation of final accounts is the final stage of the accounting cycle.