PRINCIPLES OF

ACCOUNTING
(Revised Edition)

(B.COM / B.A / ADC / BS)

Units: 1-9 Code: 438/5401

Department of Commerce
Faculty of Social Sciencs & Humanities
ALLAMA IQBAL OPEN UNIVERSITY
PRINCIPLES OF ACCOUNTING
(Revised Edition)

(B.COM / B.A / ADC / BS)

UNITS: 1-9 Code: 438/5401

DEPARTMENT OF COMMERCE
FACULTY OF SOCIAL SCIENCES & HUMANITIES

ALLAMA IQBAL OPEN UNIVERSIT ISLAMABAD

i
 (All Rights Reserved with the Publisher)

Year of Printing ........................ 2025

Quantity ...................................

Layout Setting .......................... Muhammad Zia Ullah

Incharge Printing ..................... Dr. Sarmad Iqbal

Printer ................................... Allama Iqbal Open University

Publisher ................................... Allama Iqbal Open University,

Islamabad Islamabad

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 COURSE TEAM

Chairman:
Dr. Syed Muhammad Amir Shah
Chairman Department of Commerce

Course Development Coordinator:

Asia Batool

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

2. Syed Umer Farooq
3. Jawaid Aamin
4. Muhammad Munir Ahmad
5. Asia Batool

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

2. Talat Mehmood
3. Prof. Muhammad Irshad
4. Sohail Amjed
5. Muhammad Munir Ahmad
6. Asia Batool

Editor: Fazal Karim

Layout Design: Muhammad Zia Ullah

iii
 CONTENTS

Page No.

Preface V

Course Introduction vi

Course Objectives vii

Unit 1 The Basic Accounting Model 1

Unit 2 Completion of the Accounting Cycle 27

Unit 3 Accounting for Merchandising Operations 51

Unit 4 Fixed Assets and Depreciation 63

Unit 5 Capital & Revenue etc. Correction of Error and 85

Accounting From Incomplete Records

Unit 6 Cash & Bank Transactions 111

Unit 7 Accounts for Non-Profit Making Organizations 145

Unit 8 Partnership – I 161

Unit 9 Partnership – II 197

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 PREFACE
Commerce is one of the most significant fields that made its own pathways
during the twentieth century and now it is being modified as per the needs of the
new millennium. A course in the field of accounting is not only important for the
students of accounting but it is also one of the basic requirements to understand
multiple perspectives, theories, and models of commerce. The courses at AIOU
are regularly revised and updated to fulfill the current needs of learners. It is a
matter of immense pleasure that the Department of Commerce of AIOU is
offering the revised and improved “Principles of Accounting (438/5401)” for
B.Com/Bachelors students.

AIOU books are developed in the mode of self-learning. A learner at the

level of B.Com/Bachelors can easily understand the language used in this book.
The course developers put their best efforts into making the materials self-
explanatory. The text speaks to the learner. This book is especially written for
non-formal and distance learners but is equally helpful for the students of the
formal education system. The book is recommended as a book for Principles of
Accounting for B. Com/bachelor’s students at AIOU.

Learning in the twenty-first century, which is the era of the knowledge

economy, must not be restricted to one book or specified learning materials. All
teachers and learners of this course are advised to go beyond the limits of one-
course book. The sky is the limit when you go in search of knowledge. I wish all
the readers of this book an enlightening journey of education ahead.

(Prof. Dr. Shahid Siddiqui)

Vice-Chancellor

v
 INTRODUCTION
Accounting and Finance are highly demanded professions globally, as every
organization requires budgeting and accounting services. Recognizing this
importance, the Department of Commerce introduced Accounting in the early 1980s.

Accounting, often called the "language of business," has two main branches:
financial accounting and management accounting. Financial accounting focuses
on financial statements such as the balance sheet, income statement, and cash
flow statement, while management accounting provides internal information for
decision-making and performance evaluation.

The department continuously updates the accounting curriculum with rapid

technological advancements to meet market demands. The revised course for B. Com
students simplifies and enhances understanding of accounting principles. It covers
nine key units, including accounting concepts, the accounting cycle, fixed assets and
depreciation, capital and revenue, error correction, incomplete records, cash and
banking transactions, non-profit organizations, and partnership accounting.

Designed for both distance learners and formal students, the course includes
practical exercises, self-assessment questions, and structured exercises to
reinforce learning. Each unit concludes with a summary to aid revision.
The course aims to provide a comprehensive, student-friendly learning
experience. Special thanks are extended to Mr. Muhammad Munir Ahmad for his
contributions. This book is expected to serve as an essential resource for
accounting students, helping them build a strong foundation in accounting
principles.

Finally, I am grateful to Prof. Dr. Syed Muhammad Amir Shah, Chairman

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

Comments from users are welcome.

Asia Batool
Course Development Coordinator
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 OBJECTIVES

Principles of Accounting is a comprehensive first course in accounting for

students who have no previous training in accounting or business.

The objectives of this course can be enumerated as follows:

1. It is designed for the student’s first exposure to accounting. We have

carefully planned the timing of new concepts and techniques to facilitate
learning. The pace enables the student to grasp and retain the material.
2. This book present accounting as it is practiced, but, the concepts
underlying each accounting practice are also carefully explained. So we
have tried to present an authoritative and practical basis of accounting.
3. The topic coverage is up-to-date and responsive to current trends in
business and accounting. The contemporary topics have been emphasized.
4. Another objective has been to present the updated accounting material in a
clear, concise and easy to understand manner. Accounting is treated as an
information system that helps management; investors and creditors to
make economic decisions. Every effort has been made to adopt a
systematic step-by-step approach in presenting the material.
5. It provides a complete and flexible learning system. The organization of
the book in two parts, each comprised of 9 units, is designed for students
taking this course with another Half Credit course in a semester. Action
oriented objectives at the beginning of each unit indicate in precise terms
what the student should be able to do when they complete the unit. A
unique feature of each unit is a special review section called "the
Summary" which summarizes the main theme of each unit. Moreover,
self-assessment questions illustrated examples and discussion questions in
each unit focus for the most part, on major concepts and terms.
I do hope that the student and reader of this book will find it easy to
comprehend along-with the application of its contents in real life situation.

vii
viii
UNIT – 1

THE BASIC
ACCOUNTING MODEL

Written by:
Syed Umar Farooq
Reviewed by:
Asia Batool
S.M. Aamir Shah
Sohail Amjed
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 CONTENTS
Sr. No. Subject Page No.

Introduction 3
Objectives 3
1. THE AREA OF ACCOUNTING 4
1.1 Evolution of Accounting 4
1.2 Quran and Accounting 4
1.3 Why Accounting is Necessary 4
1.4 Definition of Accounting 4
1.5 User of Accounting 5
1.6 Difference between Book-Keeping & 5
Accounting
1.7 Glossary of Common Terms 5
1.8 Abbreviations 7
2. DOUBLE ENTRY SYSTEM 7
2.1 Quranic Concept of Two Sides of an Account 7
2.2 Double Effect of Business Transactions 7
2.3 Debits and Credits 8
2.4 Rules for Debit and Credit 8
2.5 Journalizing 10
2.6 Special Journals 13
2.7 Advantages of Using Journals 17
3. THE LEDGER 17
3.1 Concept of Ledger in the Holy Quran 17
3.2 Process of Posting 18
3.3 Subsidiary Ledger and Control Accounts 18
4.1 Trial Balance Illustrated 23
4.2 Steps in Preparing Trial Balance 24
4.3 Errors and Their Correction 24
5. SUMMARY 26

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 INTRODUCTION
In this unit, you are introduced to the subject of accounting. For this purpose,
the general terms used in the area of accounting have been defined. Thereafter
various steps in the accounting process; viz, journalizing based on a double entry
system, accounting books usually maintained by business organizations viz. ledger,
'cash books, and subsidiary ledgers have been described and illustrated. The
discussion finally leads to the preparation of the trial balance.

OBJECTIVES
The main objective of this unit is to introduce and acquaint you, for the first
time, to the subject of accountancy and its basic (fundamental) principles. The study
of this unit will therefore enable you to understand:
• Definition of accounting and its objectives and double entry system of
accounting.
• Basic rules of journalizing, maintenance of accounting records in the form of
subsidiary books (journals, cash books, etc.) and ledgers.
• Day-to-day accounting routine for business transactions and the preparation
of trial balance.

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1. THE AREA OF ACCOUNTING
1.1 Evolution of Accounting
Accounting emerged to meet society's economic needs, evolving with business complexity.
Ancient civilizations like Babylon and Egypt recorded financial transactions, but
systematic accounting began with Luca Pacioli's double-entry system in 1494. The
Industrial and commercial revolutions further advanced accounting practices.
In Pakistan, accounting plays a crucial role in economic growth, particularly in
industries like textile, banking, and manufacturing. Companies follow International
Financial Reporting Standards (IFRS) to maintain transparency, aiding decision-making
for businesses and investors.

1.2 Quran and Accounting

As a Muslim, it is our faith that the Holy Quran is a comprehensive code of life and is a
source of guidance to us in conduct of all our worldly affairs. It meets the challenge of
changing times.

The Holy Quran lays great stress on "Kitabat" (recording in black and white),
particularly writing down of financial and business transactions. The contents of Verses
282 and 283 of Sura Al-Baqarah, inter-alia stipulates that: -
The Quran emphasizes the importance of maintaining accurate financial records for all
transactions, regardless of size. Ethical guidelines require bookkeepers to record transactions
truthfully, without omissions or alterations, and external influence. The responsibility of
recording financial dealings is seen as a duty given by Allah, reinforcing accountability and
integrity. These principles form the foundation of bookkeeping and accounting, stressing
periodicity, transparency, and professional ethics in financial transactions.

1.3 Why is accounting Necessary?

Accounting helps businesses track performance and maximize profits by systematically
recording transactions. It enables owners to assess expenses, income, assets, and liabilities
in real time. Instead of waiting until business ends to determine financial success,
accounting organizes data for informed decision-making. Ultimately, it provides essential
information for optimizing resource allocation and improving profitability.

1.4 Definition of Accounting

Accounting is essential for individuals, businesses, and organizations to make informed
economic decisions. Investors assess financial stability before investing, managers analyze
profitability to optimize products, and governments rely on financial data for taxation.
Non-profits also need accounting for planning and resource allocation.
As an information system, accounting processes business transactions into reports and
analyses, helping stakeholders make sound financial choices. It is broadly defined as identifying,
measuring, and communicating economic data to support informed decision-making.
Accounting is the process of identifying, recording, classifying,
summarizing, and interpreting financial transactions to

4
 provide meaningful financial information. According to the
International Financial Reporting Standards (IFRS) and
Generally Accepted Accounting Principles (GAAP),
accounting ensures transparency, accuracy, and compliance in
financial reporting for informed decision-making.

1.5 Users of Accounting

Accounting emerged to meet society's economic needs, evolving with business complexity.
Ancient civilizations like Babylon and Egypt recorded financial transactions, but
systematic accounting began with Luca Pacioli's double-entry system in 1494. The
Industrial and commercial revolutions further advanced accounting practices.
In Pakistan, accounting plays a crucial role in economic growth, particularly in
industries like textile, banking, and manufacturing. Companies follow International
Financial Reporting Standards (IFRS) to maintain transparency, aiding decision-making
for businesses and investors.

1.6 Difference between Book-Keeping & Accounting

Bookkeeping involves recording business transactions systematically, while accounting
encompasses a broader scope, including financial analysis, reporting, and decision-making.
Bookkeepers handle routine clerical tasks, often assisted by automation, whereas accountants
design financial systems, interpret data, and support management decisions. Accounting
includes budgeting, auditing, cost analysis, and tax planning, forming the foundation of
commerce and industry. While bookkeepers record data, accountants review, analyze, and
control financial information, requiring deeper knowledge and analytical skills.
1.7 Glossary of Common Terms
Before introducing you to the subject of accountancy, it will be advisable to define some
of the elementary terms used again and again in accounting. These terms may be referred
to while studying this as well as other units of this book.

Account
It is a date-wise summarized record of business transactions relating either to a person or a
thing or any item of income or expenditure. For example accounts of Ahmad and Co., of
machines, of wages and salaries, or of sales income.

Accounting Equation
The equation of financial position, i.e.,
Assets = Liabilities plus owner's equity
Assets: These are things having value, which are in possession of a trader or business, e.g.,
cash, stock, machines, vehicles, buildings etc. These items are owned by the business.
Business
It is an activity, which is undertaken for earning profit. Examples are export business,
banking, insurance, cloth merchandise, etc.

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Capital
It is an amount of cash or other property that a man or group of persons invests in business in the
form of cash and other assets like buildings, machinery, vehicles etc. It is also called Equity.
Credit
It denotes a transaction where cash or other payment is not made immediately in a business
transaction. The amount in such a case is payable at some future date. An example is the
purchase of goods on credit.
Creditor
He is a person or a party to whom payment is to be made at some future date. It is the
opposite of 'Debtor. Briefly creditor is written as 'Cr'.
Debtor
He is a person or a party who has to pay for goods or services or some benefit received on
credit. It is opposite of 'Creditor'. Briefly 'Debtor' is written as 'Dr'.
Discount
It is a rebate or allowance given in either price or a bill. It may be cash discount (where
payment is made immediately) or a 'trade discount' (granted by a Seller to a bulk-buyer).
Drawings
If cash or goods are taken away by the businessman or the owner for his personal use, the
amount or value of goods is called drawings.
Expenditure or Expenses
It means spending of money or incurring expenditure to secure some benefit:
Folio
It is a page of an accounting record such as a ledger or register. For Example ledger folio
15 means page 15 of the ledger.
Income
The earnings of a business resulting in a gross increase in capital or equity.
Journalizing
It is the act of debiting one account and crediting the other account simultaneously.
Ledger
The ledger is a register in which classified record of all the transaction of the business is
posted from the journal.
Liabilities
These are balances, which a business has to pay either to various parties for loans or supply
of goods and services on credit. For example bank loan, bank overdraft, salaries and wages
payable and other creditors.

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Transaction
Transaction is an economic event that can be objectively measured in terms of money and
effect the assets and/or equities of the enterprise.
Trial Balance
It is a list of all debit and credit balances of the ledger accounts and cashbook at a particular date.
Voucher I: It is a document serving as written evidence in support of a business, transaction
to be recorded in the journal, cashbook or the ledger. For example; cash memo, bills, salary
sheets, cash receipts, cheques, etc. serve as vouchers.
1.8 Abbreviations
In account books as well as in various units of this book certain abbreviations (or brief words) are
used again and again. For the convenience of the student these are clarified as under: -
i) Carry Forward (c.f. or c/f)
Where the totals of one page are transferred to next or any other page of the ledger or
other document, at the end of the former page (C/F) is written to denote that the total
amount has been transferred to the specified page. For example C/F page 15 means
that the total has been carried forward to page 15.
ii) Carried Down (c/d)
It is written where the total or balance of one section of an account is transferred or
taken to the next section of the same account. For example gross profit in the Trading
Account is carried down (C/D) to the Profit and Loss Section.
iii) Brought Forward & Brought Down
It is the opposite of the above processes, at (ii) above. Briefly these are written as
B/F or B/D.

2. DOUBLE ENTRY SYSTEM

2.1 Quranic Concept of Two Sides of an Account

2.2 Double Effect of Business Transactions

The double effect of each transaction when recorded in the books of accounts is known as
the double entry system. As every business transaction affects two or more account; one
must be debited and the other must be credited for a like amount. This means that when

7
one account (or accounts) is debited for Rs. 100/-, another account (or accounts) must be
credited for a total of Rs. 100/-. The requirement that each transaction results in
simultaneous debit and credit is called the double-entry procedure. This double-entry
procedure keeps the accounting equation in balance.
Example-1: Let us take an example. Suppose Mr. Shahid purchased a car for cash value
of Rs. 75000/-. In the books of Shahid, this transaction would be recorded as:
Dr. Cr.
Car Account (Debit) 75000/-
Cash Account (Credit) 75000/-
The double-entry system records transactions with equal debits and credits, ensuring
balance in accounts. Originating during the European Renaissance, it was introduced by
Italian mathematician Pacioli, influenced by Islamic knowledge. This system
revolutionized accounting by maintaining equilibrium in financial records. Goethe praised
it as a remarkable human invention essential for business.
2.3 Debits and Credits
Debit (Dr.) simply means making entry on left side of an account. Credit (Cr.) means
recording the entry on right side of an account. Thus, for any account, the left side is debit
side and the right side is the credit side as shown below:
Any Account
Left or debit side Right or credit side

2.4 Rules for Debit and Credit

The basis of double-entry bookkeeping is that every transaction affects at least two accounts.
In other words, there must be one or more accounts debited and one or more accounts credited,
and the total debits must equal the total credits. In equation form:
Assets = liabilities + owner's equity
We can see that if a debit increases assets, then a credit must be used to increase liabilities
or owner's equity. On the other hand, if a credit decreases assets, then a debit must be used
to show a decrease in liabilities or owner's equity. These are the rules because assets are on
the opposite side of the equation from liabilities and owner's equity. These rules can be
expressed as follows:

Assets = Liabilities + Owner’s Equity

Debit for Credit for Debit for Credit for Debit for Credit for
Increase Decrease Decrease Increase decrease Increase

To summaries:
a. Assets are increased by debits on the left side of the account and decreased by
credits on the right side of the account.

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b. Liabilities and owner's equity are decreased by debits on the left side of the
account and increased by credits on the right side of the account.
The application of these two rules keeps the accounting equation in balance. Now, we will
apply these debit and credit rules for assets, liabilities, and owner's equity to actual business
transactions.
Example-2: Let us suppose that Mr. Shahid went to the bank and borrows Rs.5000/- on a
promissory note.
Let us apply the correct double-entry rule. Increase in assets (cash) is recorded by
debits. Increases in liabilities (Note payable-bank) are recorded by credits.
Cash Account (Dr) Rs. 5000/_
Notes payable (Cr) Rs. 5000/-
Using account form, this entry would be as follows:

Cash Notes payable

5000 5000
The transaction involves an increase in the asset, cash, which is recorded on the left
side of the Cash Account, and an increase in the liabilities in the form of Note Payable,
which is recorded on the right side of the Notes Payable Account. (or bank account if an
overdraft is drawn from the bank). As the liabilities are a sort of equities, changes in them
are also recorded in the same manner.
In applying these rules, one should carefully consider the point that profits or
revenues always increase the owner's equity or capital whereas expenses or losses decrease
the owner's equity. Since owner's equity accounts decrease on the debit side, expense
accounts increase on the debit side, and since owner's equity accounts increase on the credit
side, revenue or profits increase on the credit side.
Debit and credit rules for expense and revenue therefore are:
a. Decreases in revenue or profit accounts are debit; increases are credits;
b. Increases in expense accounts are debits; decreases are credits.
One important point that should be carefully noted here is that assets, which seem to
be very good and useful for business, and expenses or losses which seem to be rather bad
things, both increase on the debit side, and liability and revenue accounts both increase on
the credit side. This highlights the fact that in accounting "debit" and "Credit" are only
denoting terms and should not be taken as basis for value judgments.
In another form rules of debit and credit may be stated as under: -
Nature of item or account Debit and credit rule Assets
Assets Assets, that come in or are purchased, are debited
Assets, which go out are credited
Liabilities Liabilities when increased are credited Liabilities when
decreased are debited
Capital Increases in capital are credited

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 Decreases in capital are debited
Expenses When expenses incurred, are debited
When expenses decrease or are transferred, are credited
Income/ Sales This account is credited
Sales Returns This account is debited
Losses This account is debited
Purchases Returns This account is credited

2.5 Journalizing
The act of debiting one account and crediting the other account is called Journalizing. Each
transaction is firstly recorded in a journal, which is an original entry book or starting
process in accounts. The journal contains chronological or date-wise records of business
transactions, the accounts debited and credited their respective amounts. Each entry is
recorded so that the duality or equilibrium or recording is maintained in equation form:
Assets = Liabilities + Owner's equity
and
Debits = Credits
Following are the steps involved in the process of journalizing a transaction:
a. Determine the titles of the accounts involved.
b. Understand the nature of the accounts.
c. Apply the rule of Debit & Credit described above.
d. And make the necessary journal entry.
Let's take an example:
Example-3: Bilal Ahmed invests Rs. 5000/- cash in the business. Let us analyze this
transaction.
a. Title of relevant accounts : Cash and Capital.
b. Nature of account : Assets and equity
c. Apply the rule : Cash Dr. and Capital Cr.
d. Journal entry : Cash Dr. and Capital Cr. 5000

Example-4: Let us record some other transactions in a general journal of Bilal Ahmed
i. He paid Rs. 500/- as rent.
ii. He purchased stationery worth Rs. 50/-
iii. Rs. 10/- is paid as conveyance expenses.
iv. Goods are purchased for Rs. 600/- from Shahid Majeed.
These transactions are journalized on the basis of rules described earlier:
Date GENERAL JOURNAL
Particulars L.F Amount
Dr. Rs. Cr. Rs.
Cash………………………………. 500
Capital………………… 500
(Cash in vested by Bilal Ahmed)

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 Rent Expense…………………….. 50
Cash…………………... 50
(Payment of rent)
Stationery…………………………. 50
Cash…………………… 50
(Cash purchase of stationery)
Conveyance expense……………... 10
Cash…………………… 10
(Conveyance expenses-petrol)
Purchases…………………………. 600
Shahid Majeed……… 600
(Good Purchased on Credit)
Notes- 1: Clarification within brackets is called `Narration'.
2: The aim of the Journal is to determine which account is to be debited
and which account is to be credited. On the basis of journal entries,
therefore, relevant accounts in the ledger are posted. The column "L.F"
(Ledger Folio) is used to record or enter page number of the ledger in
which the entry of debit or credit has been made from the journal.
Compound Journal Entries: Many business transactions may affect more than two
accounts. The journal entries for these transactions will involve more than one debit or
credit. Such entries are called compound or composite journal entries. You have got the
option of either debiting every account separately with corresponding credit or debiting
several accounts with their corresponding credits.
Example-5: Let us assume that on 15th March Bilal Ahmad spent a total amount of
Rs.560/- for the following expenses.
(a) Stationary Rs.60/-.
(b) Telephone Expenses Rs.300/-.
(c) Car Repair Rs.200/-.
Required: - Journalize these transactions.
Solution:
Date GENERAL JOURNAL
Particulars L.F Amount
Dr. Rs. Cr. Rs.
15-3-20-A Stationary 60
Telephone Expenses 300
Car Repair 200
Cash 560
(Expenses paid in cash)
Example 6: The following transactions relate to the first month's operation of Mr.
Khalil.
Jan.1.He invested a total amount of Rs.70000/- in the form of cash Rs.45000/- land valued
at Rs.5000/- and building valued at Rs.20000/

11
2. Deposited Rs.15000/-cash into the bank.
3. Purchased merchandise for cash Rs.3000/-.
4. Merchandise purchased on account from Minhaj and Company Rs.10000/-.
6. Purchase a Delivery Truck from Iqbal Autos Rs.20000/- and issued a Promissory note.
7. Cash sales Rs. 5,500/-
9. Sold merchandise to M/S Tariq & Co.Rs.7500/- on account.
12. Purchased two plots of land for cash Rs.15000/-
14. Purchased merchandise from M/S Faiz & Co. for Rs.15000/-.
15. Cash sales Rs.7500/-
16. Khalil withdrew merchandise-costing Rs.500/- for personal use
18. Made full payment to Minhaj & Co. by cheque for merchandise purchased on credit.
20. Paid through cheque Rs.1800/- for a television advertisement.
25. Khalil made an additional investment of Rs. 25000/-, which is deposited into Bank.
26. Received cheque of Rs.5000/- from M/S Tariq & Co. and deposited the same into
the bank.
27. Withdrew cash from the bank for office use Rs.5000/-.
28. Paid electricity bills for the month Rs.500/-
29. Issued a cheque of Rs.6000/- to M/S Faiz & Co.
30. Paid salaries to staff Rs. 3000/_
31. The owner withdrew from the bank Rs. 2500/- for personal use.
Required: Journalize the above transaction.
Solution: General Journal
Date Particulars LF Debit Credit
Jan. 1 Cash 11 45000
1985 Land 18 5000
Building 19 20000
Capital – Khalil 61
(To record investment) 70000
Jan. 2 Bank 12 15000
Cash 11 15000
(To record cash deposited into Bank)
Jan. 3 Purchases 51 3000
Cash 11 3000
(To record cash purchases)
Jan. 4 Purchases 50 10000
Minhaj & Co. 22 10000
(To record purchases on account)
Jan. 6 Delivery Truck 20 20000
Notes payable 20 20000
(to record purchase of delivery truck)
Jan. 7 Cash 11 5500
Sales 41 5500
(To record cash sales)
Jan. 9 Tariq & Co. 13 7500
Sales 41 7500

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 (To record purchase of land)
Jan. 12 Land 18 15000
Cash 11 15000
(To record purchase of land)
Jan. 14 Purchases 11 15000
M/S Faiz & Co. 41 15000
(To record cash sales)
Jan. 15 Cash 11 7500
Sales 14 7500
(To record cash sales)
Jan. 16 Drawing 51 500
Purchases 62 500
(To record drawing in from of goods)

Jan. 18 Minhaj & Co. 22 10000

Bank 12 10000
(To record payment to Minhaj & Co.
Jan. 20 Advertisement Expense 14 1800
Bank 61 1800
(To record payment of advertisement)
Jan. 25 Bank 12 25000
Capital – Khalil 61 25000
(To record additional investment)
Jan. 26 Bank 12 5000
Tariq & Co. 13 5000
(To record collection)
Jan. 27 Cash 11 5000
Bank 12 5000
(To record withdrawal for office use)
Jan. 28 Electricity Charges 31 500
Cash 11 500
(To record payment of electricity bills)
Jan. 29 M/S Faiz & Co. 23 6000
Bank 12 6000
(To record payment of liability)
Jan. 30 Salaries expense 32 3000
Cash 11 3000
(To record of payment of salaries)
Jan. 31 Drawings 2500
Bank 2500
(To record payment of Rs. 2500/- for personal
use)

2.6 Special Journals

Large businesses handle numerous daily transactions, so separate journals for cash, credit
purchases, and credit sales streamline recording and save time. Duties are assigned to
different staff for efficiency. The names of these journals commonly used in business firms
and companies are given below: -

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 Name of journal Object of this journal
Cash book To record receipt and payment of cash.
Purchases book To record transactions relating to credit purchases.
Sales book To record transactions relating to credit sales.

When goods are returned after purchase or sale, separate books—Purchases Return Book
and Sales Return Book—are maintained if such transactions are frequent. Students with
prior accounting knowledge will be familiar with these, while others should carefully study
their formats and usage. The use of these books is described as follows:
i. Cash book: The left side of the cashbook records receipts from various sources,
while the right side records payments under different heads. Receipts are based on
bank withdrawals and cash sales summaries, while payments are recorded from
vouchers, bills, and invoices. Entries are then posted to the ledger, with ledger page
numbers noted in the Ledger Folio column.
ii. Purchases journal
This journal is used to record credit purchases. From this journal postings are made to
relevant accounts. Individual amounts are posted to relevant creditor's account in the
creditor ledger. The total periodical amount is posted to the creditor's control account in
the main ledger. The corresponding debit entries are made to the following accounts:
a. Purchases account
b. Office supplies account in case of payments for items of office use.
Thus for every period credit entries must always be equal to the debit entries in
accordance with double entry bookkeeping.
iii. Sales journal: The journal may be closed weekly or monthly, with individual entries
posted to debtor accounts in the Debtors Ledger. The total amount is credited to the
sales income account and debited to the Debtors Account in the main ledger.

14
ANNEXURE-I ZARYAB TRADERS LIMITED
CASH BOOK

RECEIPTS PAYMENTS
Date Voucher Particulars Ledger Amount Date Voucher Particulars Ledger Amount
No. Folio Rs. No. Folio Rs.

December 1 Balance Brought 15 2,000 December 1 120 Salaries 18 4,000

Forward
= 1 Cash drawn from Bank 21 3,000 = 1 121 Stationery 20 500
Cheque No. 150705

= 1 12 Cash sales 50 1,200 = 2 122 Traveling 25 212

Expenditure
= 2 13 Cash Sales 50 800 = 4 123 Newspapers & 16 108
Periodicals
= 3 14 Cash sales 50 1,500 = 5 24 Telephone 24 300
Expenditure
= 4 15 Cash sales 50 1,000 = 5 25 Entertainment 12 80
= 5 16 Cash sales 50 1,200 = 5 26 Office Exp. 14 100
Balance Amount C/d 5,400
Rs. 10,700
December 7 Amount Balance B/d 5.400 Rs. 10,700

15
ANNEXURE-II PURCHASE JOURNAL (Used for purchases on credit)
Date Accounts credited Creditor ledger Credited Debited
folio
Creditors Purchases Office Miscellaneous
Supplies Account Amount
Rs. Rs. Rs. Rs.
May 1 Walid sons Individual 5000 5000
= 2 Butt Stationers amount posted in 800 800
= 3 Hay Brothers the creditors 2000 2000
= 4 Kalia and Co. ledger 3000 3000
= 4 Standard Type-writer 8000 Office 8000
Eqpt. equipment
= 5 Walid Sons 1000 1000
= 6 Kalia and Co. 2000 2000
21,8000 13,000 800 8000
Total posted Total posted Debited Posted to office Equipment
to creditors to Purchases office A/C in the main Ledger
A/C in the A/C in the Supplies A/C
main Ledger main Ledger in the
Ledger.

16
ANNEXURE-III
SALES JOURNAL
(used for credit sales)
Date Invoice No. Account Debitors Ledger Folio Amount Rs.
Rs.
May I 115 A B C Company 65 800
" 1 116 Karim Sons 66 200
" 3 117 Haji Sons 67 1000
" 3 118 Modern Traders 84 900
" 5 119 Iqbal Sons 69 1100
" 5 120 A B C Company 65 2000
Rs. 6000
Weekly posting in the
General Ledger as under
Debtors A/c Dr 6000
Sales A/c
Cr 6000

General Journal: The above-described three journals cover the bulk of business
transactions pertaining to cash, credit purchases and sales. For other miscellaneous items
not covered by these special journals, the general journal will be used. Its form and use has
already been described in detail in earlier paragraph 2.5.
2.7 Advantages of Using Journal
The functions and advantages of using a journal are summarized below:
The Journal
a. Records each transaction in chronological order.
b. Shows the classification of each transaction in terms of debit and credit.
c. Supply an explanation of each transaction whenever necessary.
d. Serves as a source for future reference to accounting transactions.
e. Removes lengthy explanations from the accounts.
f. Makes possible to post to the ledger at convenient intervals.
g. Assist in maintaining the ledger in balance and finally
Aids in tracing out errors.

3. THE LEDGER
3.1 Concept of Ledger in the Holy Quran
There appears to be no concept of a ledger in Ancient Times. It was for the first time that
this concept appeared in the Holy Quran The Holy Book mentions three ledgers maintained
by Almighty Allah:

i. Al-Aliyyeen The Ledger or Register containing account on record of

creditors or pious persons.

ii. As-suggeen the ledger or register containing accounts or records of the

sinners just like that of Debtors Ledger being maintained at present in business
organisations.

17
iii. Loh-e-Mahfooz or the General Ledger which is an overall record
(Master file) of everything, every book and every event in the universe (or universes
as per Holy Quran).
3.2 Process of Posting
After recording transactions in the journal, they are posted to the ledger, a complete
collection of accounts. Posting transfers journal entries to ledger accounts, typically done
periodically. Accounts are classified into balance sheet accounts (assets, liabilities, and
equity) and income statement accounts (revenues and expenses). Balance sheet accounts
are real accounts, while income statement accounts are nominal. Posting involves
transferring debits and credits from the journal to the respective ledger accounts, which
may be in physical or digital form. The conventional "T-account" format is commonly
used for ledger representation. (IFRS Reference: Conceptual Framework for Financial
Reporting)
(Dr.) Form of Ledger account (Cr.)
Date Particulars Ref. Amount Date Particular Ref. Amount

OR shortly, it can be drawn as:

(Dr.) (Cr.)
Left-hand side Right-hand side

(It is generally known as ‘T’ account)

3.3 Subsidiary Ledgers and Control Accounts
Subsidiary ledgers provide details supporting control accounts in the general ledger. For
example, an Accounts Receivable Control account summarizes all customer balances,
while a subsidiary ledger records individual customer transactions. Posting is done daily
for individual accounts and periodically for the control account. Subsidiary ledgers are also
used for cash, payables, fixed assets, revenues, and expenses. (IFRS: Financial Reporting,
Presentation & Disclosures)
Example 7
Bilal Traders completed the following transactions during October.
October I. Invested Cash Rs.20000 & Equipment Rs.3000 in the business.
October 3. Purchased supplies for cash Rs.700.
October 8. Purchased a Truck for Rs.34000 paying cash Rs. 10000 and a note payable for
the balance.
October 15. Purchased office equipment on account Rs.1500
Octobcr 18. Paid rent for October Rs.750
October 19. Received cash for job completed Rs.1200
October 22, Purchased supplies on account Rs.2600

18
October 23. Wages paid to employees Rs.4100
October 25. Paid premium on property insurance Rs.2960
October 26. Paid cash to the creditors Rs.2400
October 28. Received cash Rs.1400 for job completed.
October 29. Received an invoice for truck expenses, to be paid in November, Rs.410.
October 29. Paid miscellaneous expenses Rs.330
October 30. Paid wages to employees Rs.4300
October 3 I. Withdraw cash for personal use Rs.3000
Record the above transactions in a general journal, and also prepare relevant ledger
accounts. Journal
Date Particulars LF Debit Credit
Oct. 1 Cash 40000
Equipment 3000
Bilal Capital 43000
(Being initial investment)
Oct. 3 Supplies 700
Cash 700
(Being cash purchase)
Oct. 8 Truck 34000
Cash 10000
Note Payable 24000
(Being purchase of truck)
Oct. 15 Office equipment 1500
A/C Payable 1500
(Being purchase of equipment)
Oct. 18 Rent expense 750
Cash 750
(Being rent paid)
Oct. 19 Cash 1200
Service revenue 1200
(Being cash sales)
Oct. 22 Supplies 2600
A/C Payable 2600
(Being purchase of supplies)
Oct. 23 Wages expense 4100
Cash 4100
(Being wages paid)
Oct. 25 Prepaid Insurance 2960
Cash 2960
(Being Premium paid)
Oct. 26 A/C Payable 2400
Cash 2400
(Being creditors paid)
Oct. 28 Cash 1400
Service revenue 1400
(Being cash sales)
Oct. 29 Truck expenses 410
A/C Payable 410
(Being truck expenses)

19
Oct. 29 Miscellaneous expenses 330
Cash 330
(Being expenses paid)
Oct. 30 Wages expense 4300
Cash 4300
(Being wages paid)
Oct. 31 Bilal – Drawings 3000
Cash 3000
(Being cash withdrawn)
Ledger Accounts
Dr. Cash Account Cr.
Date Particulars PR Amount Date Particular PR Amount
Oct. 1 To Capital-Bilal 40000 Oct.3 By Supplies 700
-- 19 To Service revenue 1200 -- 8 By Truck 10000
-- 28 To Service revenue 1400 --18 By Rent Exp. 750
-- 23 By Wage Exp. 4100
-- 25 By Prepaid Insur 2960
-- 26 By A/Payable 2400
-- 29 By Misc. Exp. 330
-- 30 By Wage Exp. 4300
-- 31 By Drawing 3000
Balance 14060
Total 42600 Total 42600
Dr. Equipment Account Cr.
Date Particulars PR Amount Date Particular PR Amount
Oct. 1 To Capital-Bilal 3000 By balance 4500
-- 15 To A/C Payable 1500
4500 4500
Dr. Bilal Capital Account Cr.
Date Particulars PR Amount Date Particular PR Amount
Oct.31 To Balance 43000 Oct.1 By Cash 40000
-- By Equipment 3000
43000 43000
Dr. Supplies Account Cr.
Date Particulars PR Amount Date Particular PR Amount
Oct. 3 To cash 700 Oct.31 By Balance 3300
-- 22 To A/C Payable 2600
3300 3300
Dr. Truck Amount Cr.
Date Particulars PR Amount Date Particular PR Amount
Oct. 8 To Cash 10000 Oct.31 By Balance 34000
-- 8 To A/C Payable 24000

34000 34000

20
 Dr. A/C Payable Account Cr.
Date Particulars PR Amount Date Particular PR Amount
Oct.26 To Cash 2400 Oct.15 By Equipment 1500
Oct.31 To Balance 2110 -- 22 By Supplies 2600
-- 29 By Truck Exp. 410

4510 4510

Dr. Notes Payable Cr.

Date Particulars PR Amount Date Particular PR Amount
Oct.31 To Balance 24000 Oct.8 By Truck 24000

24000 24000

Dr. Rent Expense Account Cr.

Date Particulars PR Amount Date Particular PR Amount
Oct.18 To Cash 750 Oct.31 By balance 750

750 750

Dr. Service Revenue Cr.

Date Particulars PR Amount Date Particular PR Amount
Oct.31 To Balance 2600 Oct.19 By Cash 1200
-- 28 By Cash 1400
2600 2600

Dr. Wages Account Cr.

Date Particulars PR Amount Date Particular PR Amount
Oct.23 To Cash 4100 Oct.31 By Balance 8400
Oct.30 To cash 4300
8400 8400

Dr. Prepaid Insurance Account Cr.

Date Particulars PR Amount Date Particular PR Amount
Oct.25 To Cash 2960 Oct.31 By Balance 2960

2960 2960

Dr. Truck Expenses Account Cr.

Date Particulars PR Amount Date Particular PR Amount
Oct.29 To A/c Payable 410 Oct.31 By Balance 410

Total 410 Total 410

Dr. Misc. Expense Account Cr.

Date Particulars PR Amount Date Particular PR Amount
Oct.29 To Cash 330 Oct.31 By Balance 330

330 330

21
 Dr. Bilal Drawing Account Cr.
Date Particulars PR Amount Date Particular PR Amount
Oct.31 To Cash 3000 Oct.31 By balance 3000

3000 3000
Running Balance Ledgers: The modern ledger format includes three columns for debits,
credits, and balances. This design allows the balance to be updated after each transaction,
providing a clear and immediate view of account status.
Cash Account
Date Particulars PR Debit Credit Balance
Beginning Balance - - -
Oct. 1 To Capital 40000 - 40000 Dr.
Oct. 3 By Supplies - 700 39300 Dr.
Oct. 8 By Truck - 10000 29300 Dr.
Oct. 18 By rent - 750 28550 Dr.
Oct.19 By service revenue 1200 29750 Dr.
Oct. 23 By Wages - 4100 25650 Dr.
Oct. 25 By Prepaid Insurance - 2960 22690 Dr.
Oct. 26 By A.C Payable - 2400 20290 Dr.
Oct. 28 To Service revenue 1400 - 21690 Dr.
Oct. 29 By Misc. Expenses - 330 21360 Dr.
Oct. 30 By Wages Expenses - 4300 17060 Dr.
Oct. 31 By Drawings 3000 14060 Dr.

Equipment Account
Date Particulars PR Debit Credit Balance
Oct. 1 To Capital – Bilal 3000 3000 Dr.
Oct. 15 To A/C Payable 1500 4500 Dr.

Bilal Capital Account

Date Particulars PR Debit Credit Balance
Oct. 1 By Cash 20000 20000 Cr.
Oct. 1 By Equipment 3000 23000 Cr.

Supplies Account
Date Particulars PR Debit Credit Balance
Oct. 3 To Cash 700 70 Dr.
Oct. 15 To A/C Payable 2600 3300 Dr.

Truck Account
Date Particulars PR Debit Credit Balance
Oct. 8 To Cash 10000 10000 Dr.
Oct. 15 To A/C Payable 24000 34000 Dr.

Rent Expense Account

Date Particulars PR Debit Credit Balance
Oct. 18 To Cash 750 750 Dr.

22
 Service revenue Account
Date Particulars PR Debit Credit Balance
Oct. 19 By Cash 1200 1200 Cr.
Oct. 28 By Cash 1400 2600Cr.

Wages Account
Date Particulars PR Debit Credit Balance
Oct. 23 To Cash 4100 4100 Dr.
Oct. 30 To Cash 4300 8400 Dr.

Prepaid Insurance Account

Date Particulars PR Debit Credit Balance
Oct. 25 To Cash 2960 2960 Dr.

Truck Expense Account

Date Particulars PR Debit Credit Balance
Oct.29 A/c Payable 410 410 Dr.

Misc. Expenses Account

Date Particulars PR Debit Credit Balance
Oct. 29 To Cash 330 330 Dr.

Bilal – Drawing Account

Date Particulars PR Debit Credit Balance
Oct. 31 To Cash 3000 3000 Dr.

Notes Payable Account

Date Particulars PR Debit Credit Balance
Oct. 8 To Truck 24000 24000 Cr.

A/C Payable Account

Date Particulars PR Debit Credit Balance
Oct. 15 To Equipment 1500 1500 Cr.
Oct. 22 To Supplies 2600 4100 Cr.
Oct. 26 To Cash 2400 - 1700 Cr.
Oct. 29 To Truck 410 2110 Cr.

4. THE TRIAL BALANCE

4.1 Trail Balance Illustrated
The equality of debits and credits posted in the ledger should be verified at the end of each
accounting period, if not more often. Such a verification which is called a Trial Balance,
maybe in the form given below:- Bilal limited
S. No. Trial balance 31st October 2004
Debit Credit
1. Cash 14060
2. Equipment 4500
3. Capital – (Bilal) 43000

23
4. Supplies 3300
5. Truck 34000
6. A/C Payable 2110
7. Notes Payable 24000
8. Rent Expenses 750
9. Service revenue 2600
10. Wages 8400
11. Prepaid Insurance 2960
12. Truck expenses 410
13. Misc. Expenses 330
14. Drawing – Bilal 3000
TOTAL: 71710 71710

4.2 Steps in Preparing Trial Balance

The steps to follow in preparing a trial balance at a particular date are as follows: -
a. Determine the closing balance of each account in the ledger.
b. Put the debit balance of the ledger account in the debit column of the trial balance
and the credit balance of the ledger in the credit column of the trial balance.
c. Add each column.
d. Compare the totals of each column.
The usual balance for an account is known as the normal balance. Consequently, if
increases are recorded by debits the normal balance is a debit balance if increases are
recorded by credits, the normal balance is a credits balance. The table below indicates the
normal balance of the major account categories.
Accounts Category Way of Recording Normal balance
Increases
Assets Debits Debits
Liability Credits Credits
Owner's Equity Credits Credits
Capital Credits Credits
Drawings Debits Debit
Income or Revenues Credits Credit
Expenses Debits Debit

According to the above table, the ledger account for accounts payable will normally
have a credit balance and can be copied into the trial balance Column as a credit balance.
Once in a while, a transaction will cause an account to have a balance opposite from its
normal balance.
For example, when a customer overpays a bill or when a company overdraws its account
at the bank by writing a cheque for more money than it has in its balance. If this happens,
the abnormal balance should be copied into the trial balance Columns.
4.3 Errors and Their Correction
The significance of the trial balance is that it proves whether or not the ledger is in balance.
"In Balance" means that equal debits and credits have been recorded for all transactions.

24
If the debit and credit columns of the trial balance do not equal each it may be the result of
one or more of the following errors.
1. A debit was entered into an account as a credit or vice versa.
2. The balance of an account was incorrectly computed.
3. An error was made in carrying the account balance to the trial balance.
4. The trial balance was incorrectly totaled.
The trial balance proof does not mean that transactions were analyzed correctly
or recorded in the proper accounts. For example, there would be no way of determining
from the trial balance that a debit should have been made in the equipment account
rather than the office equipment account. Further, if a transaction that should have been
recorded is omitted, it will not be detected by a trial balance proof because equal credits
and debits will have been omitted. Also if an error of the same amount is made both as
a credit and as a debit, it will not be discovered through trial balance. The trial balance
proves only the arithmetical equality of the debit and credit in the accounts. Other than
simply totaling the columns wrongly, the two most common mistakes in preparing
a trial balance are:
l. Recording an account with a debit balance as a credit, or vice versa, and
2. Transposing two numbers in an amount when transferring it to the trial balance (for
example, transferring Rs.23459 as 23549). The first of these mistakes will cause the
trial balance to be out of balance by an amount divisible by 2. The second will cause
the trial balance to be out of balance by a number divisible by 9. Thus if a trial
balance is out of balance and the total has been verified, determine the amount by
which the trial balance is out of balance and divide it first by 2 and then by 9. If the
amount is divisible by 2, look in the trial balance for an equal amount to the quotient.
If such a number exists, this amount is likely in the wrong column. If the amount is
divisible by 9, trace each amount to the ledger amount balance, checking carefully
for a transposition error. If neither of these techniques identifies the error, it is
necessary to calculate again the balance of each account in the ledger and retrace
each posting from the journal to the ledger.

25
5. SUMMARY
Accounting has evolved to meet societal needs, similar to other sciences. While record-
keeping dates back to 4000 BC, the introduction of double-entry bookkeeping was a major
milestone. Accounting is defined as identifying, measuring, and communicating economic
information for informed decision-making. It is broader than bookkeeping, which focuses on
recording transactions, while accounting involves analysis and financial reporting.

The accounting process is based on the double-entry system, where debits equal
credits. Assets and expenses usually have debit balances, while liabilities, owner’s equity,
and revenues typically have credit balances. Transactions are first recorded in a journal
before being posted to the ledger. A trial balance is prepared to ensure the accuracy of
debits and credits. This foundational knowledge is essential for understanding accounting
principle

26
UNIT – 2

COMPLETION OF THE
ACCOUNTING CYCLE

Written by:
Syed Umar Farooq
Reviewed by:
Asia Batool
Talat Mahmood
Amjed Sohail
27
 CONTENTS
Sr. No. Subject Page No.
Introduction 29
Objectives 29
1. ADJUSTING THE ACCOUNTS 30
1.1 Necessity for Adjusting Entries 30
1.2 Cash vs. Accrual Basis Accounting 31
1.3 Types of Adjustments 31
1.4 Identifying the Basis for Adjustments 35
2. THE WORKSHEET 38
2.1 Definition 38
2.2 Specimen Format of Work Sheet 39
2.3 Step in Preparing the Work Sheet 39
3. THE FINANCIAL STATEMENTS 44
3.1 The Income Statement 44
3.2 Trading Account 45
3.3 Trading Account 45
3.4 Profit & Loss Account 45
3.5 Statement of Retained Earnings 48
3.6 Balance Sheet 48
3.7 Difference between Trial Balance & Balance Sheet 49
4. SUMMARY 50

28
 INTRODUCTION
First unit introduced the preliminary accounting process or cycle of analyzing;
classifying and summarizing business transactions and their posting into the ledger
accounts. This enabled you to learn how these transactions are entered into journal and
ledgers. The trial balance was shown as a way to test the arithmetical accuracy and equality
of debits and credits in the journalizing and posting process. The ultimate purpose of the
entire accounting process is to produce accurate financial statements for information of
different users.

In this unit, you will learn about the adjusting process, various adjusting entries and
their method of recording. The purpose of adjusting entries is to bring the accounts to their
proper balance before financial statements are prepared. You will also be introduced with
the topic of work sheet, which is used frequently as a useful step in the preparation of
financial statements. Using a work sheet lessen the possibility of ignoring an adjustment.

After completion of the work sheet, the preparations of financial statements have
been discussed. The income statement, (trading and profit and loss account) the retained
earnings statement and the balance sheet are illustrated showing how they are prepared
from the account titles and the data in the statement sections of the work-sheet.

OBJECTIVES
After studying this unit, you should be able to:
1. Identify the reasons why adjusting entries must be made, and sources of these entries.
2. Identify the classes and types of adjusting entries.
3. Prepare a work sheet and explain its uses.
4. Prepare an income statement, statement of retained earnings and balance sheet, on
the basis of information contained in a work sheet.
5. Recapitulation of the steps, in the accounting cycle and its completion.

29
l. ADJUSTING THE ACCOUNTS
1.1 The Necessity for Adjusting Entries
Accounting provides accurate and up-to-date financial information for decision-making.
The process includes recording transactions in journals and ledgers, followed by preparing
a trial balance to ensure debit-credit equality.
Need for Adjusting Entries:
Some transactions remain unrecorded or incomplete by the period-end, requiring
adjustments to reflect the correct financial position. These are called adjusting entries, not
just corrections, as they are a planned part of the accounting cycle.
Key Functions of Adjusting Entries:
➢ Ensuring Accuracy: Adjustments update accounts before financial statements,
preventing misstatements.
➢ Matching Principle (IFRS & GAAP): Expenses and revenues must be
recognized in the period they occur, not when cash is received or paid.
➢ Compliance with Accrual Accounting: Adjustments ensure adherence to
standards like IFRS 15 (Revenue Recognition) and IAS 1 (Financial Statement
Presentation).
➢ Reliable Financial Reporting: Adjustments help companies present true financial
health, aiding management, investors, and regulators.
For example, suppose accounts have to be prepared up-to 31st December of the year. The
salaries of the staff amounting to Rs.150,000/- are payable by 5th of the next month i.e. by the
5th January. Thus at the last day of December, the recorded expenditure of salaries will not be
inclusive of salaries for the month because these have not yet been paid but the amount of
Rs.150, 000/-actually relates to December. If accounts are prepared only based on amounts
recorded up to 31st December without taking unpaid December salaries into account, the profits
would naturally be overstated, and the financial statements would not reveal the true position
of the business.
Importance of Adjusting Entries in Financial Reporting (Aligned with IFRS &
GAAP)
Ensuring Comparability & Accuracy:
Adjusting entries ensures financial statements are comparable across periods by properly
recording accrued and prepaid expenses. Without adjustments, revenues and expenses may
be misstated, affecting profitability analysis and decision-making.
Key Adjustments Required:
Accrued Expenses (e.g., Salaries, Wages, Utility Bills) – Prevent overstatement of
income.
Prepaid Expenses (e.g., Rent, Insurance) – Allocate costs systematically over time.
Depreciation of Assets – Adjust based on asset usage (as per IAS 16 - Property, Plant &
Equipment).
Unearned Revenue – Recognized as income only when earned (IFRS 15 - Revenue
Recognition).

30
Matching Principle & Continuous Adjustments:
➢ Adjustments follow the matching principle, ensuring expenses are recorded in the
same period as the revenue they generate.
➢ Many expenses (e.g., prepaid insurance, depreciation) occur continuously,
requiring adjustments at month-end or year-end.
Legal & Reporting Requirements:
➢ Businesses must prepare to adjust entries at least annually for shareholder reports
and regulatory compliance.
➢ Entries should only transfer expired asset values to expenses, avoiding
misstatements.
1.2 Cash versus Accrual Basis Accounting
Accrual Accounting (Standard - IFRS & GAAP)
• Records revenues when earned and expenses when incurred, regardless of cash flow.
• Uses adjusting entries to reflect the true financial position.
• Ensures accurate financial statements by aligning revenue and expenses to the
correct period.
Cash Basis Accounting (Limited Use)
• Recognizes revenues only when cash is received and expenses when cash is paid.
• Can misstate financial performance due to timing mismatches.
• Generally unacceptable for financial reporting but used by small businesses for simplicity.
Accrual accounting provides a true financial picture, ensuring compliance with IFRS
& GAAP, while cash basis accounting is less accurate and not suitable for large enterprises.
1.3 Types of Adjustments
I. Accruals
At the end of the accounting period, accrued but unrecorded revenues and expenses are
recognized by means of adjusting entries. Accrual is simply the process of occurring, arising or
coming into existence. Some revenues and expenses accrue constantly with the passage of time.
Interest, for example, accumulates over the time that loaned (or borrowed) funds are used. Rent,
wages, insurance premiums and property taxes also accrue over time.
In accounting, the terms accrual is often interpreted broadly to include sales made or
services rendered but remained unbilled and purchased goods or services for which
invoices have not yet been received. Thus accrual adjustments involve increases in either
receivables or payables.
Example-1 Adjusting Journal Entries
Debit Credit
Date Particulars L.F
Rs. Rs.
20-A
Dec. 31
A/c Receivable 780
Services revenue. 780
(to recognize revenue earned during the last
December but which could not be billed to
customers until January)

31
 Dec. 31 Interest receivable 60
Interest revenue 60
(to record interest earned during December on
savings account kept with the Bank)

Revenue Accruals
To illustrate the accrual of revenues, let us consider the adjustments shown in the above
illustration. The first entry was needed to record December revenues for which bills were
not prepared and mailed until January, because of normal delays in billing procedures. The
second entry is to register savings account interest that accrued during December. You
should carefully note this point that revenue accruals involve the simultaneous recognition
of receivables and revenues and take the following form.
Asset (Receivable) Account Debited ............. xxx
Revenue or income Account Credited .......... xxx
Expense Accruals
The adjusting entries in the following illustration show the accrual of expenses at the end
of an accounting period. Study the entries carefully, particularly the explanations, to see
why the expense accruals were needed.
Expense Account Debited ................ xxx
Liability (payable) Account Credited ......... xxx
Example 2 Adjusting Journal Entries
Date Particulars L.F Debit Credit
Rs. Rs.

20-A Dec. 31 Wages expense 520

Wages payable 520
(To recognize December wages to be paid in
January)
Dec. 31 Interest expense 110
Interest payable 110
(To recognize accrued interest due on bank loan)
Dec. 31 Repair parts expense 75
Accounts payable 75
(To recognize repair parts purchased and used
during December, to be paid in January)
i. Deferrals
Deferred items involve adjusting previously recorded assets and liabilities into expenses
and revenues to reflect the correct accounting period.
Common Examples:
• Prepaid Expenses: Rent, insurance premiums, magazine subscriptions (recorded as
assets, later expensed).
• Unearned Revenue: Advance payments from customers (recorded as liabilities,
later recognized as revenue).
Accounting Treatment:
• Cash payments are often treated as immediate expenses for simplicity.

32
• If a portion of revenue or expense belongs to a future period, an adjusting entry is
made to defer the correct amount.
Adjusting entries ensures financial accuracy by properly allocating prepayments and
unearned revenues, aligning with accrual accounting principles (IFRS & GAAP).
ii. Deferred Revenue
Revenue received before they are earned are liabilities because they represent obligations
to customers. When a magazine company collects money in advance for subscriptions, it
has a liability to deliver magazine issues in the future; as magazines are delivered, portions
of the liability are earned as revenue. The adjusting entries in the following illustration
demonstrate the deferral of revenues that are as yet unearned at the end of the period.

Example 3 Adjusting journal entries

Date Particulars L.F Debit Credit
Rs. Rs.
20-A
Dec. 31 Rent revenue or rent income 800
Unearned rent income 800
(to defer January rent, which was received in
December & recorded at that time as revenue)
Dec. 31 Subscription revenue 1600
Unearned subscription revenue 1600
(to defer subscriptions revenue to magazines et to
be published)

Revenue deferral adjustments take the following form:

Revenue account debited ........ xxx
Unearned revenue (liability) account credited .........xxx
Deferred expenses
Adjustment entries that defer expenses to a future period are shown in the following
illustration:
Example 4
Date Particulars L.F Debit Credit
Rs. Rs.
20-A Un-expired insurance
Dec. 31 Insurance expense 480
(to defer insurance premiums that apply to future 480
periods)
Dec. 31 Prepaid rent 1350
Rent expense 1350
(to defer rent prepaid for the first quarter of the
coming year) Office supplies

33
Dec. 31 Office supplies 140
Supplies expense 140
(to recognize unused office supplies at year end
Adjustments to defer expenses take the following form.
Prepaid Expense (Asset) Account Debited ......... xxx
Expense Account Credited .............................. xxx
iii. Expirations
In a sense, all assets are deferred charges (debits) and all liabilities are deferred credits.
Assets and liabilities represent carryovers of cost and obligation into future accounting
periods. As assets are used up or depreciated in the process of earning revenues, portions
of their costs are written off (expired) to expenses; and liabilities in the form of deferred
revenues are shifted to revenue accounts as the revenues are earned.
Liability Expirations Revenue: As we saw earlier, some revenues may be collected in
advance before they are earned, in that case they should be treated as deferred liabilities.
The adjusting entries in the illustration given below recognize the portions of previously
deferred revenues that were earned during the month of January.
Liability expirations to revenue take the following form.
Unearned Revenue (liability) Account Dr.... xxx
Revenue Account Cr.. xxx
Example 5 Existing journal entries
Date Particulars L.F Debit Rs. Credit Rs.
20-A Unearned rent revenue 800
Dec. 31 Rent revenue
(to recognize rent revenue for January)
Jail. 31 Unearned subscriptions revenue 730
Subscriptions revenue 730
(to recognize revenue for magazines delivered
during the month)

Asset expirations to expense: As asset costs expire, they become expenses. Adjusting
entries are commonly made to recognize depreciation of productive or fixed assets such as
equipment, vehicles, or buildings. Assume, for example, that a motorcycle is purchased for
Rs. 19800/- and its expected life is 48 months, and at the end of its life its, expected salvage
or replacement value is Rs.600 and the motorcycle is expected to be equally useful
(productive) during each month of its life. Depreciation per month can be determined as
follows: -
Cost - Salvage value = Depreciation per month,
Expected life of motorcycle in months
or
Rs. 19800 -600 = Rs.400 per month.
48
Remember that depreciation of a long-lived productive asset is accumulated in an asset
contra account called Accumulated Depreciation. The adjusting entry to record the

34
motorcycle depreciation is shown in the following illustration along with several other
adjustments for asset expirations.
Asset expiration adjustments take the following form.
Expense Account Debited ........... xxx
Asset (Contra Asset) Account Credited ......... xxx
Example-6: Adjusting journal entries
Date Particulars L.F. Debit Rs. Credit Rs.
20-A
Jan. 31 Depreciation expense (Motorcycle) , 400
Accumulated depreciation 400
(Motorcycle)
(To record motorcycle depreciation
for January)
Jan. 31 Insurance expense 200
Unexpired insurance 200
(To record insurance premiums for
January)
Jan. 31 Rent expense 450
Prepaid rent 450
(To recognize rent expense for Jan.)
Jan. 31 Supplies expense 300
Office Supplies 300
(To record office supplies used during
January)

1.4 Identifying the Basis for Adjustments

You should know what adjustments are necessary at the end of the period.
i. Some readily determinable cases requiring adjustment are outstanding bills for
electricity, telephone, and invoices related to the accounting period, but are received
so late that payment could not be made during the period. In such cases, relevant
expense accounts are debited and accrued accounts are credited. Difficulty however
arises in cases where no bills, invoices, and other documents are outstanding such
cases are dealt with as under.
ii. Different accountants follow different approaches to determine the required
adjustments. One avenue is simply to review the adjustments that were made at the
end of previous accounting period. In some cases the same or similar adjustments
are needed at the end of each accounting period. One flaw in this method is that new
cases may escape proper accounting.
iii. Another approach is to scan the accounts in an unadjusted trial balance, looking for
clues those suggest to the need for adjustments. Certain receivable and payables
involve interest, which must be accrued with the passage of time; depreciable assets
must be depreciated for the period; supplies can be checked to determine what is still
on hand; and so on.

35
iv. A more orderly approach is to examine or audit each account starting at the beginning
of the ledger, to determine if any adjustments are needed. Bank accounts are
reconciled with bank statements to prove the cash account. Files of unpaid invoices,
orders, and other documents are examined in an attempt to discover unrecorded
payables or receivables. Receivables and payables are reviewed for any accrued
interest receivable or payable. In fact, all available evidence is considered in an effort
to locate any misstatements as each account is examined.
Your ability to identify the need for adjustments will improve, as you become more
skilled in accounting. However it is important to note that failure to prepare proper
adjusting entries will upset the correctness of net income and the balance sheet. The
following diagram shows the effect on net income and balance sheet items failing to record
each of the major types of adjusting entries:

Effect on Effect on Balance

No. Failure to recognize
Net income sheet items
Consumption of the
Overstate assets
1. benefits of an asset Overstate net income.
and retained earnings
(Prepaid expense).

Overstate liabilities and

Earning of previously Understate net
2. understate retained
unearned revenue. income.
earnings.

Overstate net Understate Liabilities and

3. Accrual of expenses.
income. Overstate retained earnings.

Understate assets and

4. Accrual of revenue. Understate net income
retained earnings.

Example 7: Suppose that the trial balance of BMW Ltd. Company for December 31 of the
current year includes, among other items, the following accounts balances:
Debits Rs. Credits Rs.
Office supplies on hand 6000
Prepaid rent 25200
Buildings 200000
Accumulated Depreciation - Building 33250
Salaries expenses 124000
Unearned delivery fees 4000
Additional Data
l. Part of supplies represented by Rs.6000 balance of the office supplies on hand
accounts have been consumed. An inventory count of the supplies actually on hand
on December 31 totaled to Rs.2400/-.

36
2. On May 1 of the current year, a rental payment of Rs.25, 200 was made for 12 months
and it was debited to prepaid rent.
3. The annual depreciation of the building is based on the cost shown in the building
account less an estimated salvage value of Rs.10,000. The estimated useful lives of
the buildings are 40 year each.
4. The salary expense of Rs. 124000/- does not include Rs.6000 of unpaid salaries
earned since the last payday.
5. One fourth of the unearned delivery fees have been earned by December 31.
6. Delivery services of Rs.600 were performed for a customer, but the bill has not yet
been sent.

Required: Prepare the adjusting journal entries for December 31, assuming adjusting
entries are prepared only at year-end.
Solution: BMW Ltd. Company … General Journal
Date Particulars L.F Debit Rs. Credit Rs.
20-A
Dec. 31 Office supplies expense 3600
Office supplies on hand 3600
(to record office supplies expense
{6000-2400} =Rs. 3600
Dec. 31 Rent expense 16800
Prepaid rent 16800
(to record rent expense for 8 months
{25200 x 8/12}
Dec. 31 Depreciation expense - Buildings 4750
Accumulated depreciation-buildings 4750
(to record depreciation-buildings)
{200000 - 10000}
(40 years)
Dec. 31 Salaries expense 6000
Salaries payable 6000
(to record accured salaries)
Dec. 31 Unearned delivery fees 1000
Delivery service revenue 1000
(to record delivery fees earned)
4000 / 4 = 1 000
Dec. 31 Accounts receivable 600
Delivery service revenue 600
(to record delivery fees earned but
remaining unbilled and un-received)
It is clear from the above that each case must be examined thoroughly to determine
that expenses and incomes relating to a period is properly and accurately accounted for in
that period.

37
2. THE WORKSHEET
2.1 Definition and Purpose of a Worksheet
Under IFRS, as with other accounting frameworks, the preparation of financial statements
requires that all relevant financial data be adjusted, summarized, and verified to ensure
compliance with the accrual basis of accounting. Although IFRS does not mandate a
specific format for working papers, accountants typically use a worksheet as an internal
tool to facilitate this process.

A worksheet is essentially a columnar document that:

• Collects and Organizes Data: It gathers trial balance information and subsequent
adjustments (such as depreciation, expired prepaid insurance, supplies used, and
accrued expenses) into a single format. This ensures that every necessary adjustment
required by IFRS—such as the recognition of expenses in the period they occur—is
properly recorded.
• Ensures Arithmetical Accuracy: By summarizing data in a structured manner, the
worksheet helps accountants verify the accuracy of their computations. This step is
crucial for ensuring that the figures reported in the financial statements are
mathematically correct.
• Facilitates the Preparation of Financial Statements: The worksheet typically
includes columns for the unadjusted trial balance, adjustments, the adjusted trial
balance, and, in many cases, preliminary drafts of the income statement (or statement
of comprehensive income) and balance sheet. This structured approach makes it easier
to prepare IFRS-compliant financial statements, which now often include a statement
of comprehensive income. This statement goes beyond net income to include items
such as revaluation surpluses, foreign currency translation adjustments, and other
components of other comprehensive income.
• Serves as Evidence: While the worksheet itself is not published or part of the formal
accounting records, it provides a detailed audit trail. This documentation is invaluable
during internal reviews or external audits, as it demonstrates how figures were derived
and ensures that the adjustments comply with IFRS disclosure requirements.
Key Points in the IFRS Context
• Accrual Basis and Matching Principle: IFRS emphasizes the accrual basis of
accounting, meaning that revenues and expenses must be recognized in the period in
which they are earned or incurred, not necessarily when cash transactions occur. The
worksheet assists in making the necessary adjustments so that the financial statements
reflect the true financial performance and position of the business.
• Disclosure Requirements: IFRS requires comprehensive disclosures, including
details on estimation methods (e.g., for depreciation or provisions). While the
worksheet is an internal document, it underpins the reliability of these disclosures by
ensuring that all adjustments are carefully calculated and documented.
• Flexibility in Format: Unlike published financial reports, worksheets can vary in
format. They are often prepared in pencil or electronically to allow for corrections,
reflecting their role as a working paper rather than a final report.

38
2.2 Specimen Format of the Worksheet
Shahid & Umar Limited
Twelve-column worksheet for the year ended December 31 st 20-A
S. Trial Adjusted Trading Balance
Accounts Adjustments PLSA/c
No. balance trial balance A/c sheet
Dr. Cr Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

Note: The trading and PLS account columns are together called income Statement columns
in American terminology.

2.3 Steps in Preparing the Work Sheet

For smaller companies, adjusting entries are directly entered into the journal and posted to the
ledger, with financial statements prepared from the adjusted trial balance. For larger companies,
adjusting entries may be numerous and require a worksheet. The worksheet includes the
company name, title 'Work Sheet', and the period. Under IFRS, it’s important to ensure
compliance with structured presentation and transparency, which is why the formal steps in the
worksheet preparation are necessary. IFRS-compliant summary of the five steps in preparing
a worksheet:
1. Enter Account Balances: Copy the account titles and balances from the ledger (or
trial balance) into the worksheet’s trial balance columns.
2. Record Adjustments: Enter the necessary adjustments (e.g., depreciation, accrued
expenses, expired prepaid items) in the adjustment columns. Use reference letters
to link each debit and credit adjustment to its supporting documentation. This step
ensures that adjustments comply with IFRS’s accrual basis of accounting.
3. Prepare the Adjusted Trial Balance: Combine the trial balance amounts with the
adjustments to produce the adjusted trial balance. This verifies that the debits equal
the credits and that the numbers are arithmetically correct.
4. Allocate Balances to Financial Statement Columns
Transfer each adjusted account balance to its appropriate section:
o Income Statement Columns: For revenue and expense accounts.
o Balance Sheet Columns: For assets, liabilities, and equity accounts.
This classification supports IFRS financial statements, including the
statement of comprehensive income.
5. Total the Columns and Balance : Sum the income statement and balance sheet
columns. Calculate the net income or net loss as the difference between the debit
and credit totals in the income statement columns.
o If there is a net profit, record it as a debit in the profit and loss columns and as
a credit in the balance sheet columns (reflecting an increase in equity).
o For a net loss, apply the opposite entry.
This final step confirms the overall arithmetic accuracy of the worksheet
and supports the preparation of accurate IFRS-compliant financial
statements.
This streamlined process not only ensures that all necessary adjustments are captured but also
that the financial statements are prepared in line with IFRS requirements.

39
Example-8.The Trial Balance of Shahid & Umar Co. as of 30th June is given below:
Rs. Rs.
Cash in hand 680 -
Sundry debtors 46000 -
Discount 300 -
Drawings 11000 -
Opening stock 30000 -
Purchases 75000 -
Sales returns 2700 -
Miscellaneous trade expenses 755 -
Labor wages 3500 -
Salaries 5600 -
Traveling expenses 850 -
Advertising 500 -
Rent and insurance 2800 -
Interest and bank charges 215 -
Bad debts 400 -
Buildings 6000 -
Plant and machinery 10000 -
Furniture 5000
Capital 35000
Purchases returns 1300
Sales (gross) 125000
Creditors 30000
Bank Overdraft 10000
Total Rs.201300 Rs.201300
Following additional information is also available
i: Closing stock on 30th June is Rs.45,000.00
ii: Charge depreciation at 10% on
a. Plant and machinery
b. Furniture.
iii: Make provision for bad and doubtful debts at 5% of sundry debtors.
iv. Rs. 150 on account of insurance is prepaid.

Required: (a) Trading and P & L Account (b) Balance sheet as of 30th June
Solution:
Shahid & Umar Company
Trading, Profit & Loss Account
For the year ended 30th June.
Sales
Opening stock 30000 125000
Purchases 75000 Less returns 2700
Less returns 1300 Net sales 122300
Net Purchase 73700 Closing stock 45000
Labour charges 3500

40
 Gross profit (carried down) 60100
Total 167300 Total 167300
Expenses: Gross profit B/d 60100
Discount 300
Salaries 5600
Advertising 500
Rent insurance (2800-150) 2650
Interest & bank charges 215
Bad debts 400
Depreciation (machinery) 1000
Depreciation (furniture) 500
Provision for bad debts 2300
Miscellaneous trade expenses 755
Travelling expenses 850
Net profit carried to balance
Sheet 45030

60,100 60,100

SHAHID AND UMAR COMPANY

Balance Sheet as on 30th June
Capital & Liabilities Assets
Capital 35000 Cash in hand 680
Add: Profit 45030 Prepaid Insurance 150
80030 Sundry Debtors 46000
Less: Drawings 11000 Less: Provision 2300 43700
69030 Stocks 45000
Creditors 30000 Plant & Machinery 10000
Bank Overdraft 10000 Less: Depreciation 1000 9000
Furniture 5000
Less: Depreciation 500 4500
Building 6000
109030 109030
Example-9: This solved problem illustrates the use of a worksheet where the columns of
trading and profit & loss account has been substituted by the Income Statement column.
The trial balance for the B & M Delivery Company as on December 31 was as follows:
B & M Delivery Company
Debit Rs. Credit Rs.
Cash 10650
Accounts receivable 6400
Supplies on hand 1400
Prepaid insurance 2400
Prepaid rent 40000
Accounts payable 3130
Service Fee received in advance 4500
Capital stock 50000
Dividends (drawings) 3000
Service revenue 10700
Advertising expenses 50

41
 Gas & oil expenses 680
Salaries expenses 3600
Utilities expenses 150
Total 68330 68330
Additional data:
a. Insurance expense for the month of December Rs. 200/-
b. Rent expense for the month of December Rs. 400/-
c. Supplies used during the month Rs. 500/-
d. Depreciation for December Rs. 50/-
e. One-third of the fees received in advance account has been earned by 31st December.
f. Interest earned but not yet received Rs. 600/-
g. Unbilled service Rs. 1000/-
h. Accrued salaries Rs. 180/-
B & M delivery Company worksheet as of 31st December
Solution:
The worksheet is given below. The student should prepare the following financial
statements using the data developed in this worksheet:
i. Trading and profit and loss account for the year ending 31st December.
ii. Retained earning statement for the period, and
iii. Balance sheet of the company as of 31st December.

42
 Account Title Trail Adjustments Adjusted Income Balance
Balance Trial Statement Sheet
Balance
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 10650 10650 10650
Account receivable 6400 6400 6400
Supplies on hand 1400 500 900 900
Prepaid insurance 2400 200 2200 2200
Prepaid Rent 40000 400 39600 39600
Account Payable 3130 3130 3130
Service fee 4500 1500 3000 3000
received in
advance
Capital Stock 50000 50000 50000
Dividends 3000 3000 3000
(drawings)
Service revenue 10700 2500 13200 13200
Advertising 50 50 50
expenses
Gas and oil 680 680 680
expenses
Salaries expenses 3600 180 3780 3780
Utilities expenses 150 150 150
Insurance expense 200 200 200
Rent expense 400 400 400
Supplies expense 500 500 500
Depreciation 750 750 750
Accumulated 750 750 750
Depreciation
Interest receivable 600 600 600
Interest revenue 600 600 600
Salaries payable 180 180 180
Service Revenue 1000 1000 1000
Receivable
Net Profit 7290 7290

Total 68330 68330 5130 5130 70860 70860 13800 13800 64350 64350

43
3. THE FINANCIAL STATEMENTS (As per IFRS Standards)
Financial statements are essential for assessing a company’s financial performance and
position, prepared using data from the worksheet. As per IFRS (International Financial
Reporting Standards), these statements provide transparency, consistency, and
comparability for stakeholders.
3.1. The Income Statement (Profit or Loss Statement - IAS 1): The income statement
reports a company's financial performance over a specific period, including revenues, expenses,
gains, and losses. It follows the accrual principle, ensuring that income and expenses are
recognized when incurred, not when cash is received or paid. Unlike strictly standardized
formats, IFRS allows flexibility in presentation while ensuring key elements like:
• Revenue (IFRS 15 - Revenue Recognition)
• Cost of Goods Sold & Operating Expenses
• Other Gains/Losses & Net Profit
The statement is dated as "For the year ended [Date]", providing clarity on the reporting period.
The Balance Sheet (Statement of Financial Position - IAS 1): The balance sheet presents
a company’s financial position at a specific date, categorizing:
• Assets (IAS 16 - Property, Plant & Equipment)
• Liabilities (IFRS 9 - Financial Instruments)
• Equity (Shareholders' Funds)
This statement follows the going concern principle, ensuring an accurate representation of
a company’s stability and financial health.
Compliance with IFRS: IFRS ensures global standardization, improving investor
confidence and regulatory compliance. The financial statements must:
• Provide a true & fair view of financial performance and position.
• Follow the matching principle for income and expenses.
• Maintain comparability across periods for better decision-making.
B & M Company
Income Statement
For the month ended 31st December
Rs. Rs.
Revenues:
Delivery services revenue 13200
Interest revenue 600
Total revenue 13800
Expenses:
Advertising 50
Gas & Oil 680
Salaries 3780
Utilities 150
Insurance 200
Rent 400
Supplies 500
Depreciation (delivery truck) 750
Total expenses 6510
Net income 7290

44
3.2 Trading and Profit & Loss Account Under IFRS
In large businesses, financial transactions such as purchases, sales, discounts, bad debts,
commissions, and extraordinary losses occur frequently. To ensure accurate financial
reporting, businesses prepare the Trading Account and Profit & Loss Account, which
together determine the net profit or loss for a given period.
3.3 Trading Account (Part of Profit & Loss Statement - IFRS Standard)
The Trading Account records all direct income and expenses related to a company's core
business operations, ultimately determining gross profit or loss.
A. Debit Side (Direct Expenses - Cost of Sales)
• Opening Stock: Value of inventory at the start of the period.
• Purchases (Net): Total purchases minus purchase returns.
• Direct Expenses: Costs related to production or sales (e.g., wages, freight, and
transportation).
B. Credit Side (Direct Revenues - Sales & Closing Stock)
• Total Sales (Net): Sales revenue after deducting sales returns.
• Closing Stock: Value of inventory at the end of the period.
C. Determining Gross Profit/Loss
• If total credit (revenues) > total debit (expenses) → Gross Profit
• If total debit (expenses) > total credit (revenues) → Gross Loss

The resulting gross profit/loss is then transferred to the Profit & Loss Account for
further processing.
3.4 Profit & Loss Account (Statement of Financial Performance - IAS 1) Once gross
profit/loss is calculated, it is included in the Profit & Loss Account, where indirect
expenses and incomes are recorded to determine net profit or loss.
3. Compliance with IFRS Standards: The Profit & Loss Account is a fundamental
component of the Income Statement, ensuring compliance with:
• IFRS 15 (Revenue Recognition) – Sales and revenue are recorded when
earned, not when received.
• IAS 2 (Inventory Valuation) – Proper valuation of opening and closing
stock in the Trading Account.
• IAS 1 (Financial Statements Presentation) – Ensures clarity and consistency
in reporting business profitability.
Performa / Specimen of the trading account ABC Limited Trading Account for the year
ended.
Debit Amount Rs. Credit Amount Rs.
To opening stock By sales
To purchases Less sales returns.
Less returns By closing stock
To carriage inward By gross loss
To wages (Transferred to the debit
To coal, gas, electricity side of the profit and loss
To freight accounts)

45
 To cartage, excise, etc.
To gross profit (if any Transferred to
the credit side of the profit and loss
account)

Comprehensive Overview of Trading & Profit and Loss Account Under IFRS
Financial statements are prepared by IFRS to provide a transparent and accurate view of a
company's financial performance. The Trading Account and Profit & Loss Account are
critical components of the Statement of Financial Performance (Income Statement), which
helps determine gross and net profit or loss.
1. Trading Account (Gross Profit Calculation - IFRS Compliant)
The Trading Account records direct revenues and expenses related to production or sales,
ultimately determining gross profit or loss.
A. Key Components of the Trading Account
Opening Stock (IAS 2 - Inventories): Manufacturing businesses have three types of stock:
1. Raw Material – Materials used for production.
2. Work-in-Process – Partially completed goods.
3. Finished Goods – Ready-for-sale products.
• Trading businesses hold only finished goods stock.
Purchases (Net of Returns & Discounts)
• Includes cash and credit purchases used for production or resale.
• Purchase returns & trade discounts are deducted to get the net purchases.
Direct Expenses (Factory Overheads - IAS 2 & IAS 16)
• Expenses directly linked to production:
o Wages, carriage inward, freight, factory rent, power, excise duty, lubricants.
• These costs form part of inventory valuation under IAS 2 - Inventories.
Sales (Net of Returns & Discounts - IFRS 15 Revenue Recognition)
• Total sales = Cash sales + Credit sales.
• Any sales returns or discounts are deducted to reflect net sales.
Closing Stock (Valuation - IAS 2)
• Unsold inventory at year-end is valued at a lower of cost or market value.
• This ensures compliance with IAS 2 - Inventory Valuation principles.
Gross Profit Calculation
• If net sales > total cost, the company earns gross profit.
• If total cost > net sales, the company incurs gross loss.
• Gross profit/loss is transferred to the Profit & Loss Account.

2. Profit & Loss Account (Net Profit Calculation - IFRS Compliant): The Profit & Loss
Account determines net profit or loss by including indirect incomes and expenses incurred
during the period.
A. Key Components of the Profit & Loss Account
Credit Side (Incomes & Gains)
• Gross Profit (Transferred from the Trading Account).

46
• Other Incomes & Gains (e.g., commission received, interest received, discount
received).
Debit Side (Indirect Expenses - IAS 1 & IAS 16)
• Administrative Expenses: Office rent, salaries, utilities.
• Selling & Distribution Expenses: Advertising, sales commission, transportation.
• Financial Expenses: Interest on loans, bank charges.
Net Profit or Loss Calculation
• If total income (credit side) > total expenses (debit side) → Net Profit.
• If total expenses > total income → Net Loss.
• Net profit is added to capital, while net loss reduces capital in the Balance Sheet.
3. IFRS Compliance in Financial Reporting
• IFRS 15 - Revenue Recognition: Ensures sales are recorded when earned, not when
received.
• IAS 2 - Inventory Valuation: Governs opening & closing stock valuation.
• IAS 1 - Financial Statement Presentation: Requires proper classification of direct &
indirect expenses.
Performa/Specimen of profit & loss account.
Profit and loss account for the year ended 20-A
Dr. Cr.
Gross loss (if any) Gross profit
Salaries
Rent Interest received
Rates & taxes
Discount allowed Commission received
Insurance
Repairs & maintenance Discount received
Advertising expenses
Bad and doubtful debts Miscellaneous receipt
Entertainment
Printing & stationary Net loss
Depreciation (transferred to the
Interest paid capital account in the
General expenses balance sheet)
Bank charges
Trade charges
Legal expenses
Net profit (if any)
(Transferred to the capital account in balance sheet)
Fortheillustrative
balance sheet)
purposes, the same data already mentioned in the worksheet example are
illustrated in this format of Profit and Loss Account.

47
 B & M Delivery Company
Profit and Loss Account
For the month ended December 31, 20-A
Debit Amount Credit Amount
Advertising 50 Delivery service revenue 13200
Gas & oil 680 Interest revenue 600
Salaries 3780
Utilities 150
Insurance 200
Rent 400
Supplies 500
Depreciation delivery truck 750
Net profit 7290
13800 13800
3.5 Statement of Retained Earnings (Profit & Loss Appropriation) Under IFRS
The Statement of Retained Earnings, also known as the Profit & Loss Appropriation
Account, summarizes changes in a company’s retained earnings over a financial period. It
applies only to limited companies, where net profit is not transferred to the capital account
but recorded in retained earnings. Key Components of Retained Earnings Statement
(IAS 1 & IAS 10)
1. Opening Retained Earnings – The balance carried forward from the previous
period.
2. Net Profit for the Period – Transferred from the Profit & Loss Account.
3. Dividends (IAS 10 - Events After Reporting Period) – Earnings distributed to
shareholders, deducted from retained earnings.
4. Ending Retained Earnings – The final balance carried forward to the Balance Sheet
(Statement of Financial Position).
Comparison to Sole Proprietorship
• In limited companies, profits are retained for reinvestment or distributed as dividends.
• The dividend account is like the drawings account in a sole proprietorship but applies
only to corporate structures.
The Statement of Retained Earnings ensures accurate financial reporting, aligning with
IFRS (IAS 1 & IAS 10). It reflects how net income is allocated, whether retained for future growth
or distributed to shareholders, providing transparency in financial statements.
B & M Delivery Company Limited
Statement of Retained Earnings
For the Month of December 31, 20-A
Retained earnings, 1st December 20-A -0-
Net income for December 7290
Total 7290
Less: dividends 3000
Retained earnings 31st December 20-A shown in the balance sheet 4290

3.6 Balance Sheet (Statement of Financial Position) Under IFRS: The Balance Sheet,
also known as the Statement of Financial Position, provides a snapshot of a business’s
financial health at a specific date. It presents economic resources (assets), claims
against those resources (liabilities), and owners' equity, helping investors and creditors
assess the financial strength, flexibility, and liquidity of an entity.

48
Key Components of a Balance Sheet (As per IAS 1 - Financial Statement
Presentation)
1. Assets (Right Side) – Represents what the business owns, categorized into:
o Current Assets (Cash, Accounts Receivable, Inventory)
o Non-Current Assets (Property, Equipment, Long-Term Investments)
2. Liabilities (Left Side) – Represents what the business owes, categorized into:
o Current Liabilities (Accounts Payable, Short-term Loans)
o Non-Current Liabilities (Long-term Loans, Bonds Payable)
3. Owner’s Equity (Shareholder’s Equity) The owner's interest in the business,
calculated as: Assets=Liabilities Owner’s Equity
Presentation and Classification Under IFRS
• Sundry Creditors (Payables), All creditor accounts are grouped under Accounts
Payable.
• Sundry Debtors (Receivables) – All debtor accounts are grouped under Accounts
Receivable.
• The Balance Sheet must balance – any difference indicates an accounting error.
The Balance Sheet, prepared under IFRS (IAS 1), provides a clear and structured
view of a company’s financial position. It ensures transparency, accuracy, and
comparability, assisting stakeholders in making informed decisions. The specimen of the
balance sheet is given below:
ABC Company, Balance Sheet, As on 31st December
Capital & Liabilities Assets
Capital Rs. Rs. Fixed Assets: Rs. Rs.
Balance 90000 Buildings 40000
Net Profit: 59159 Less accumulated Dep. 4000 36000
149159
Less drawings 20009 Machinery 20000
129150 Less accumulated Dep. 2000 18000
Long term liabilities
Mortgaged loan 20000 Current Assets
Stock 60000
Current liabilities Prepaid rent & rates 300
Bank overdraft 10000 Debtors/ receivables 40000
Sundry creditor/Accounts Less reserve for
Payables 15000 doubtful
Accrued expenses 5200 Debts 2000
38000
Total current liabilities 30200 Less reserve for 950 37050
Discount
Cash at bank 27000

Cash in hand 1000

Total capital &
179350 Total assets 179350
Liabilities
Now we would like to study various items shown in the balance sheet. A short description
of each item is given below.
3.7 Difference between Trial Balance & Balance Sheet: After studying both the
statements, the following points of distinction should be carefully noted by the students:

49
4. SUMMARY

Adjusting entries are made at the end of an accounting period to update and correct
account balances before preparing financial statements. These adjustments are classified
into deferred items (previously recorded data requiring revision) and accrued items
(transactions not yet recorded). A worksheet helps organize adjustments, ensuring
accuracy in financial reporting. The Income Statement measures business profitability,
while the Statement of Retained Earnings tracks profit distribution and transfers balances
to the Balance Sheet. The Balance Sheet presents the financial position by showing assets,
liabilities, and owner’s equity. It follows the fundamental accounting equation: Assets =
Liabilities + Owner’s Equity. These statements provide transparency, aiding investors,
creditors, and other stakeholders in assessing business performance. Financial reports
ensure compliance with accounting standards and enhance decision-making. Ultimately,
they reflect whether a business has achieved its objective of generating income.

50
UNIT – 3

ACCOUNTING FOR
MERCHANDISING OPERATIONS

Written by:
Syed Umar Farooq
Reviewed by:
S.M. Aamir Shah
Asia Batool
Sohail Amjed
51
 CONTENTS
Sr. No. Subject Page No.
Introduction 53
Objectives 53
1. OVERALL, VIEW 54
1.1 Income Statements for a Merchandising Concern54
2. REVENUES FROM SALES 55
2.1 Gross Sales 55
2.2 Sales Returns and Allowances 55
2.3 Sales Discounts 56
2.4 Cost of Goods Sold 57
3. MERCHANDISE INVENTORY 57
3.1 Measuring Merchandise Inventory 57
4. PURCHASES 58
4.1 Purchases Returns and Allowances 58
4.2 Purchase Discounts 58
4.3 Freight-In 59
4.4 Control of Purchase Discounts 59
4.5 Inventory or Stock Losses 60
4.6 Handling Merchandise Inventory at the End of 61
the Accounting Period
7. SUMMARY 62

52
 INTRODUCTION
A merchandising enterprise is a business that purchases finished goods at low prices
and sells them at higher prices to earn profit. This unit is concerned with the accounting
for a merchandising enterprise that does not make or process the products itself.

As you are well aware many shops and companies attempt to earn profit by buying
and selling merchandise. Merchandising firms or Companies either wholesale or retail, do
use the same basic accounting methods as service companies, but the process of buying
and selling merchandise requires some additional accounts and concepts. Their activities
also result in a more complicated income statement than for a service business.

Accounting systems for merchandising companies normally provide for

accumulating various kinds of data relative to buying and selling transactions.

OBJECTIVES
After studying this unit, you shall be able to:
− Identify the components of the income statement for a merchandising concern.
− Journalize transactions involving sales and purchases of goods for merchandising
concerns.
− Calculate the cost of goods sold and differentiate between perpetual and periodic
inventory systems.
− Prepare a worksheet for a merchandising concern.
− Prepare adjusting and closing entries for a merchandising concern.
− Prepare an income statement for merchandising concerns.

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1. OVERALL, VIEW
The accounting process for merchandising firms involves recording transactions
related to buying and selling goods, without significant changes in their form. When
inventory is purchased, it increases both the inventory and accounts payable. Upon selling,
revenue is recognized, and the cost of goods sold (COGS) is recorded. Inventory is valued
using methods like FIFO or weighted average cost. These transactions are reflected in
financial statements: the income statement shows profit, the balance sheet provides a
snapshot of the financial position, and the cash flow statement tracks cash movements.
Adhering to IFRS ensures accuracy and consistency in financial reporting.
1.1 Income Statement for a Merchandising Concern
Following is a summarized income statement of Mahmood Trading Company for the year
ended December 31, 20-A. Mahmood Trading Company, Income statement
For the year ended 31" December 20-A
Rs.
Income (revenue) from sales 239325
Less cost of goods sold 131360
Gross profit from sales 107965
Less operating expenses 89284
Net profit (income) 18681
The above income statement highlights three major parts: (1) revenue or income from
sales, (2) cost of goods sold, and (3) operating expenses. Such an income statement differs from
the income statement for a service firm where net income is measured as the difference between
revenues and expenses whereas in case of merchandising business you have to calculate gross
profit from sale before operating expenses are deducted to arrive at net income or net profit.
Revenue from sales arise from sales of goods by the merchandising company and the cost of
goods sold tells how much the merchant paid for the goods that were sold.
The difference between revenues from sales and cost of goods sold is known as gross
profit from sales, or simply gross profit. To be successful, the merchant must sell the goods
more than cost and resulting gross profit from sales must be greater enough to pay operating
expenses and have an adequate profit or income left over. Operating expenses are those
expenses, other than cost of goods sold that are incurred in running the business. Net
income for merchandising companies is what is left after deducting operating expenses
from gross profit. Mahmood Trading Company had a gross profit from sales of Rs.107965/-
(Rs. 239325- Rs.131360) and net income of Rs.18681 (Rs.107965 - Rs. 89284).
All three parts of the merchandising income statement are important for a company's
management. Management is interested both in the percentage of gross profit on sales and
in the amount of gross profit (45 percent and Rs. 107965/- respectively, for the Mahmood
Trading Company. This information is helpful in planning business operations. For
instance, if management wants to increase total sales by reducing the selling price, this
strategy will result in reduction in the percentage of gross profit.
In this Unit, we discuss three parts of the merchandising income statement and
transactions that give rise to the amounts in each part. Then we present two alternative
methods for preparing worksheets for a merchandising company. The unit ends with a
comprehensive illustration of the merchandising income statement.
MAHMOOD TRADING CO. Partial Income Statement
Revenue from sales 246350
Less: Sales returns and allowances 2750
Sales discounts 4275 7025
Net Sales 239325

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2. REVENUE FROM SALES
The first part of a merchandising income statement is revenue from sales, which is
computed as net sales. Net sales are derived from the gross proceeds of merchandise sales,
minus sales returns, allowances, and discounts. For a business to succeed, net sales must be
sufficient to cover the cost of goods sold (COGS), and operating expenses, and generate an
adequate net income. Sales trends, such as increasing or decreasing sales, are key indicators of
a firm's financial health. To detect these trends, comparisons of net sales across periods are
often made, helping management, investors, and stakeholders assess growth and potential
financial challenges.
2.1 Gross sales
Under accrual accounting, revenues from the sale of merchandise are considered to be
earned in the accounting period. Because the customer may not pay immediately, the cash
for the sale may be collected in a following period, but this does not affect the recording
of sales. For this reason, there is likely to be quite a difference between revenue from sales
and cash collected from those sales in a given period.
The journal entry to record a sale of merchandise for cash is as follows:

Date Particulars Dr. Cr.

Sept. 16 Cash 1286
Sales 1286
(To record the sale of merchandise for cash).
The Sales account is used only for recording sales of merchandise, whether the sale is made
for cash or for credit. If the sale of merchandise is made on credit, the entry will be as
shown below:
Date Particulars Dr. Cr.
Sept. 16 Account Receivable 1286
Sales 1286
(To record the sale of merchandise on credit).

2.2 Sales Returns and Allowances; Under IFRS, when a customer returns a defective
or unsatisfactory product, the business may issue a refund, credit, or allowance. These
transactions are recorded as a debit to the "Sales Returns and Allowances" account. This
provides management with insights into customer dissatisfaction. For example, if a product
is returned, the journal entry would
Date Particulars Dr. Cr.
Sept. 17 Sales returns & allowances 76
Accounts receivable (or cash) 76
(To record return or allowance on unsatisfactory
merchandise)
Sales returns and allowances are a contra account and are accordingly deducted from gross
sales in the income statement.
2.3 Sales Discounts
Under IFRS, sales discounts are offered to encourage early payment and improve liquidity
by reducing accounts receivable. Common discount terms like 2/10, n/30 mean the
customer can take a 2% discount if payment is made within 10 days; otherwise, the full
amount is due in 30 days. Since it’s not always known upfront whether the customer will
take the discount, the discount is recorded when payment is received.

55
 For example, if Mahmood Trading Company sells merchandise worth $300 on
September 20 with terms of 2/10, n/60, and the customer pays within the discount period,
the journal entry upon payment (assuming the discount is taken) would be:
At the time of sale the entry would be:
Dr. Cr.
Sept. 20 Accounts receivable 300
Sales 300
(To record the sale of merchandise on credit, terms
2/10, n/60)
The customer may take advantage of the sales discount at any time on or before
September 30. This is 10 days after the date of the invoice. If he or she pays on September
29, the entry in Mahmood Trading Company's record will be:
Date Particulars Dr. Cr.
Sept. 29 Cash 294
Sales discount 6
Account Receivable 300
(To record payment for Sept. 20 sale discount taken)
This reflects the sale and the reduction in accounts receivable based on the discount, in line
with IFRS 15 Revenue from Contracts with Customers.
2.4 Cost of Goods Sold
Under modern accounting and IFRS, the Cost of Goods Sold (COGS) represents the
expense incurred for the goods that have been sold during an accounting period. It is
calculated by subtracting the ending merchandise inventory from the total goods available
for sale.
Formula:
• Goods Available for Sale = Beginning Inventory + Net Purchases
• COGS = Goods Available for Sale - Ending Inventory

This approach aligns with IFRS 2 - Inventories, which requires businesses to

account for the inventory that remains unsold at the end of the period. The remaining
inventory is shown on the balance sheet, and the COGS is recorded on the income statement
to reflect the cost of the goods sold.
In modern accounting practices, this method ensures that the matching principle is
adhered to, recognizing the expense of the goods sold in the same period as the revenue
they generated.
The partial income statement in the following example shows the cost of goods sold
section for Mahmood Trading Company. Mahmood Trading Company
Partial income statement (Only Cost of Goods Sold Statement)
For the year ended 31 S` December 20-A
Rs. Rs.
Merchandise inventory January 1st 52800
Purchases 126400
Less: Purchases return & allowance (5640)
Purchases discounts (2136)
Add: 118624
Freight-in 8236
Net purchases 126860
Cost of goods available for sale 179660

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Less merchandise inventory Dec. 31 48300
Cost of goods sold 131360
To understand fully the concept of the cost of goods sold, it is necessary to examine the
value of merchandise inventory at the start of the period, as well as at the end of the period.
3. MERCHANDISE INVENTORY OR STOCK
Under modern accounting and IFRS, inventory includes the goods available for
sale, such as meats and canned goods for a grocery store or gasoline and parts for a service
station. Inventory is purchased from suppliers like wholesalers or manufacturers.
• Beginning Inventory (Opening Stock) is the inventory on hand at the start of the
accounting period.
• Ending Inventory (Closing Stock) is the inventory on hand at the end of the period.
These inventories are essential in calculating Cost of Goods Sold (COGS) for the
income statement and are also shown as a current asset on the balance sheet as per IFRS 2
- Inventories. The inventory valuation impacts the business’s financial health by reflecting
unsold goods in the balance sheet and the cost of sold goods in the income statement.
3.1 Measuring Merchandise Inventory: Under IFRS, merchandise inventory is crucial
for determining Cost of Goods Sold (COGS). To accurately account for inventory,
businesses use either the perpetual inventory method or the periodic inventory method,
depending on the nature of the goods sold.
a. Perpetual Inventory Method:
• Used by businesses with high-value items like appliances or automobiles.
• Under this method, inventory records are updated in real-time as items are bought and sold.
• Each sale reduces the inventory and updates the COGS account, providing an ongoing
record of inventory levels.
• The IFRS 15 revenue recognition standard guides this real-time updating, ensuring The
IFRS 15 revenue recognition standard ensures proper cost matching with sales in real-
time inventory updates.
b. Periodic Inventory Method:
• Used by businesses with low-value, high-volume goods, such as grocery stores.
• This method does not track inventory continuously but instead relies on a physical
count of goods at the end of the period.
• The ending inventory is determined by multiplying the quantity of goods by their unit
cost, and the COGS is calculated by subtracting the ending inventory from the total
goods available for sale.
• The periodic system is simpler but requires more work at the period-end to compute
accurate inventory and COGS.
c. Taking Physical Inventory:
• The physical inventory count should include all saleable goods owned by the company,
whether on shelves, in warehouses or in transit (if ownership has passed to the
business).
• Goods that are damaged, obsolete, or unsellable should not be included unless sold at
a reduced price.
• The process involves counting items at the end of the fiscal year, usually after business
hours, and recording the information on numbered tickets or sheets.
• This process must be carefully checked and recorded to ensure accuracy in the final
financial statements, in line with IFRS 2 - Inventories.

57
 In modern accounting, both methods aim to provide accurate financial reporting,
with the periodic method offering simplicity and the perpetual method offering real-time
insights into inventory levels and COGS.
4. PURCHASES
Under the periodic inventory method, the net purchases consist of gross purchases
less purchase discounts, purchase returns, and allowances plus any freight charges on the
purchases and other expenses incurred thereon. When the periodic inventory method is
used, all purchases of merchandise for resale are debited to the purchases account at the
gross purchase price, as shown below:
Date Particulars Dr. Cr.
Nov. l2 Purchases 1500
Accounts payable 1500
(To record purchases of merchandise, term 2/10, n/30
The purchases account, a nominal or temporary account, is used only for merchandise
purchased for resale. Its sole purpose is to accumulate the total cost of merchandise
purchased during an accounting period. Inspection of the purchase's account alone does not
indicate whether the merchandise has been sold or is still on hand. Purchases of other assets
such as equipment should be recorded in the appropriate fixed asset account.
4.1 Purchases Returns and Allowances: Under IFRS, when a company returns
merchandise or receives an allowance for defective goods, the transaction is recorded in a
Purchases Returns and Allowances account. This is a contra account, meaning it reduces
the total purchases on the income statement.
The process is as follows:
• The company debits Accounts Payable or Cash and credits Purchases Returns and
Allowances.
• This ensures that returns and allowances are separately tracked for management to
assess the impact on inventory and purchasing practices.
The cost of returns includes non-recoverable expenses like ordering, accounting,
freight, and interest on the invested funds. Excessive returns can highlight issues with
supplier quality, ordering practices, or product suitability, prompting the company to
reassess its procurement processes or find new suppliers.
This approach follows IFRS 15 - Revenue from Contracts with Customers,
ensuring returns and allowances are accurately reflected in the financial records, allowing
for better decision-making and cost control.
Date Particulars Dr. Cr.
Nov. 14 Accounts payable 200
Purchases returns & allowances 200
Returns of damaged merchandise Purchased on
November 12.
4.2 Purchase Discounts
Merchandise purchases are usually made on credit and commonly involve purchase discounts
for early payment. It is almost always worthwhile for the company to take a discount if offered.
For example, the terms 2/10, n/30 offer a 2 percent discount for paying only twenty days early
(the period including the eleventh and the thirtieth days). This is an effective interest rate of 36
percent (there are 18/twenty days/periods in a year) on a yearly basis. Most companies can
borrow money for less than this rate. For this reason; management wants to know the amount
of discounts, which is a separate account and is recorded as follows when the payment is made:

58
 Date Particulars Dr. Cr.
Nov. 22 Accounts payable 1300
Purchase discounts 26
Cash. 1274
(Paid the invoice of November 12)
Note:
Purchases November 12 1500
Less return 200
Net purchases 1300
Discount 2% 26
Cash paid 1274
Like purchase returns and allowances, purchase discounts are a contra account that
is deducted from purchases on the income statement. If a company can make only a partial
payment on an invoice, most creditors will allow the company to take the discount
applicable to the partial payment. The discount usually does not apply to freight, postage,
or other charges that might appear on the invoice.
4.3 Freight In
In some industries, it is customary for the supplier (seller) to pay transportation costs,
charging a higher price to include them. In other industries, it is customary for the purchaser
to pay transportation charges on merchandise.
These charges, called freight-in or transportation-in, should logically be included as
an addition to purchases, but as in the case of purchase discounts, they should be
accumulated in the freight-in account so that management can monitor this cost. The entry
for the purchaser is as follows:
Dare Particulars Dr. Cr.
Nov. 12 Freight in 134
Cash (or Accounts payable) 134
Freight charges incurred on merchandise purchased)
In some cases, the supplier pays the freight charges but bills the buyer by including
freight charges as separate items on the sale invoice. When this occurs the buyer should
still record the purchases and the freight-in in separate accounts. For example, assume an
invoice for the purchase of merchandise inventory totaling Rs.1890/- including the cost of
merchandise of Rs.1600/_freight charges of Rs.290/- and terms of 2/10. n/30. The entry to
record this transaction would be:
Date Particulars Dr. Cr.
Nov. 12 Purchases 1600
Freight in 290
Accounts payable 1890
Purchased merchandise for Rs. 1600/- included in the
invoice were freight charges of Rs. 290/- and terms of 2/10,
n/30

If this invoice is paid within ten days, the purchase discount will be Rs.32/- (1600 x
2%) because the discount will not apply to the freight charges. It is important not to confuse
freight-in costs with freight-out or delivery costs. If you, as seller agree to pay
transportation charges on goods you have sold, this expense is a cost of selling
merchandise; not a cost of purchasing merchandise.
4.4 Control of Purchase Discounts: Under IFRS and modern accounting practices, it's
important for companies to capture the full financial impact of purchase discounts to aid
decision-making and cash flow management. To properly account for missed discounts,

59
purchases should initially be recorded at the net price (after discount), not the gross price.
This allows businesses to track both the discounts taken and those lost.

For example, if a company purchases goods on November 12 for Rs. 1500 with
terms 2/10, n/30 and returns Rs. 200 worth of goods on November 14, the amount owed
would be adjusted. However, if payment is delayed until December 12, missing the
discount period, the company needs to record the lost discount.
In this case:
• Initial Purchase (Gross): Rs. 1500
• Return: Rs. 200
• Adjusted Purchase Amount: Rs. 1300
• Lost Discount: Rs. 1300 x 2% = Rs. 26 (debited to a Lost Discount account)

If the company pays by November 22 and uses the net method for recording
purchases, it will make a payment of Rs. 1,274. Since purchases are recorded at net prices,
there is no need for a purchase discount account. However, if the company makes the
payment after the discount period, management will become aware of the missed discount
by reviewing the discounts lost account. The amount of discounts lost will be reported as
an operating expense on the income statement.
This process helps businesses understand and avoid missed discount opportunities,
enhancing cash flow and financial control, in line with IFRS 15 - Revenue from
Contracts with Customers. The entries to record these three transactions are as
follows:
Date Particulars Dr. Cr.
Nov. 12 Purchases 1470
Accounts payable 1470
(To record purchases of merchandise at net Price term
2/10, n/30)
Nov. 14 Accounts payable 196
Purchases returns and allowances 196
(Return of damaged merchandise purchased on November
12)
Recorded at net price:
Rs.200-(0.2xRs.200)=Rs.196/-
Dec. 22 Accounts payable 1274
Discounts lost (or discount expenditure) 26
Cash 1300
4.5 Inventory or Stock Losses: Under the periodic inventory method and IFRS, losses
from spoilage, theft, or employee pilferage are automatically reflected in Cost of Goods
Sold (COGS). This is because the physical count of inventory will not include the missing
items, and the ending inventory is therefore understated. As a result, the COGS is
overstated by the value of the lost inventory.
For instance, if a company lost Rs. 1250 due to theft or spoilage, the inventory count
will exclude these items. When the physical inventory is subtracted from the goods
available for sale, it results in a higher COGS than would be the case if all items were
accounted for. The journal entry to record this loss would be:
Journal Entry:
Dr. Cr.
Inventory loss 1250
Trading account 1250

60
 This entry reflects the loss in inventory, ensuring that the COGS is correctly inflated
to reflect the merchandise that is no longer available for sale. This aligns with the IFRS
guidelines, which require the recognition of such losses in financial statements for
transparency and accurate profit.
4.6 Handling Merchandise Inventory at the End of the Accounting Period
Under the periodic inventory system and IFRS, at the end of the accounting period, the
balance of Merchandise Inventory reflects only the beginning inventory until adjusted. The
steps for proper accounting include:
1. Removing the beginning balance from the Merchandise Inventory account.
2. Entering the ending inventory in the Merchandise Inventory account.
3. Calculating net income by adjusting the Profit & Loss (Income) statement,
considering the changes in inventory and purchases. For example, Mahmood
Trading Company would adjust its accounts to ensure the Cost of Goods Sold
(COGS) is accurately reported by adding beginning inventory to net purchases and
subtracting ending inventory, thus reflecting the correct net income in compliance
with IFRS standards.
Merchandise Inventory Account
Date Particulars Dr. Rs. Date Particulars Cr. Rs.
Jan. 1,20A Opening inventory 52800 Dec. 31 Trading account 52800
Dec.31,20A Trading account 48300 20-A
Dec. 31 Balance C/d 48300
101100 101100
Jan.1, 20-B Balance b/d 48300
Trading account
for the year ending 31st December 20-A
Rs. Rs.
Opening inventory 52800 Sales 778000
Purchases 532000 Less return 38000
Less returns 32000 Net sales 740000
Net purchase 500000 Closing Inventory 48300
Gross Profit 235500
Total 788300 Total 788300
Gross Profit B/d 235500
Using the adjusting entry method, the following two journal entries arc prepared at the time
the other adjusting entries are made. Adjusting entries
Dr. Cr.
Dec. 31 Trading account 52800
Merchandise inventory (opening) to 52800
remove beginning balance of merchandise inventory
and transfer it to income summary.
Dec. 3I Merchandise inventory 48300
Trading account (Closing) to 48300
establish ending balance of merchandise inventory and
deduct it from goods available for sale in income summary
It would be clear from the above that closing stock is adjusted by debiting
merchandise inventory account and crediting trading account. The effect of this entry
would be that closing merchandise inventory balance would appear in the balance sheet as
an asset whereas the credit balance would appear in the Trading account credit side below
the amount of net sales for the year.

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5. SUMMARY
A merchandising company earns profit by buying and selling merchandise, with
its income statement consisting of three major parts: revenues from sales, cost of goods
sold, and operating expenses. Revenues are calculated by subtracting sales returns,
allowances, and discounts from gross sales. The cost of goods sold is determined by
adding beginning inventory to net purchases and subtracting ending inventory. The
inventory can be tracked using the perpetual or periodic method, with adjustments or
closing entries made to reflect the beginning and ending inventory balances. The
income statement is divided into sales, cost of goods sold, and operating expenses,
including administrative, selling, and financial expenses. The net income is transferred
to the capital account and shown on the balance sheet.

62
UNIT – 4

FIXED ASSETS
AND DEPRECIATION

Written by:
Syed Umar Farooq
Asia Batool
Reviewed by:
S.M. Aamir Shah
Sohail Amjed
Mr. Muhammad Munir Ahmad
63
 CONTENTS
Sr. No. Subject Page
No.
Introduction 65
Objectives 65
1. LONG LIFE ASSETS 66
1.1 Characteristics of Fixed Assets 66
1.2 Determining the Cost of Fixed Assets 66
1.3 Subsequent Costs Incurred on Fixed Assets 67
2. DEPRECIATION 67
2.1 Accounting for Depreciation 67
2.2 Depreciation on Interim Statements 68
2.3 Depreciation on Assets Purchased During Period 69
2.4 Procedure in Pakistan 69
3. COMPUTING RATE OF DEPRECIATION 69
3.1 Estimating the Life of the Assets 69
3.2 Methods of Computing Depreciation 70
3.3 Accelerated Depreciation Methods 73
3.4 Depletion Method 76
3.5 Consistency in Use of Depreciation Method 76
4. SALE OF FIXED ASSETS 77
4.1 Gain or Loss on Sale of Plant Assets 77
4.2 Plant Assets Sold during the Year 80
4.3 Depreciation for the Year of Sale in Pakistan 81
4.4 Gains and Losses on the Income Statements 81
5. RETIRING FIXED ASSETS 81
5.1 Retiring Fully Depreciated Assets 81
5.2 Retiring Plant Assets at a Loss 81
6. EXCHANGING PLANT ASSETS 82
6.1 Gain on Exchange of Plant Assets 82
6.2 Loss on Exchange of Plant Assets 83
6.3 Plant Assets on the Balance Sheet 84

64
 INTRODUCTION
You have already been acquainted with two categories of assets, VIZ fixed assets and
current assets. Fixed assets or plant assets are long-life assets. Their useful life is expected
to last for more than one year. These long-life assets consist of both tangible assets, having
physical existence as well as intangible assets, having no physical existence that we can
see or touch. Instead, they represent exclusive privileges and rights to the owners. When a
company purchases a long-life asset, the asset is usually recorded at cost. As the company
receives benefits from the asset, the cost is transferred from an asset account to an expense
account called depreciation.

OBJECTIVES
After studying this unit, you should be able to:
1. Recognize the characteristics of fixed assets and the methods of working at initial costs
of their acquisition.
2. Understand various methods of calculating depreciation.
3. Apply the concept of capital and revenue expenditures for fixed asset.

65
1. LONG-LIFE ASSETS
Long-life assets are grouped under various headings in balance sheet presentations.
The term fixed assets or plant assets are frequently used for tangible productive assets that
are used over a number of years in the operations of an entity. Tangible assets are properties
that have physical substance, in other words, assets that can be seen and touched. On the
other hand, intangible assets are property rights, which have value but no physical
substance. Patents, copyrights, goodwill, etc., are examples of intangible assets.
Furniture, equipment, machinery, buildings, and the land they are located are usually
included under the main heading "Fixed Assets."

1.1 Characteristics of Fixed Assets

Fixed assets, also known as plant assets, refer to tangible productive assets used in the
operations of a business over multiple years. The key characteristics required for an asset
to be classified as fixed are:
i. Tangible Nature: The asset must have a physical form, meaning it can be seen and
touched.
ii. Long Life: The asset is expected to last for more than one year.
iii. Operational Use: The asset is used in the business's daily operations.
iv. Not Held for Resale: The asset is not intended for normal resale in the ordinary course
of business.

A significant factor in determining whether an asset qualifies as a fixed asset is its

intended use in operations. For example, a truck used by a distributor is a fixed asset,
whereas the same truck held by an automobile dealer for resale is classified as inventory.
Similarly, a typewriter used by a law firm is a fixed asset (office equipment), but it is
inventory for an office supply company.

1.2 Determining the Cost of Fixed Assets: Under IFRS, fixed assets should be recorded
at cost, which includes all expenditures incurred to acquire the asset and make it ready for
use. The cost of a plant asset comprises:
i. Purchase Price: The net purchase price, excluding any cash discounts.
ii. Direct Costs: This includes delivery charges, installation fees, and sales taxes.
iii. Insurance and Taxes: Insurance costs incurred during transit and any import duties
or non-refundable taxes.
iv. Site Preparation and Installation: Any costs necessary to bring the asset into
operational condition, such as assembling machinery or preparing land.
v. Construction Costs (if applicable): When an asset is constructed, the cost includes:
o Construction expenses,
o Architect’s fees,
o Insurance during construction,
o Interest on borrowed funds used for construction,
o Any additional costs required to prepare the asset for use.

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 1.3 Subsequent Costs Incurred on Fixed Assets: Subsequent expenditures on fixed
assets should be classified based on their impact:
i. Capital Expenditures: If a cost increases the asset's efficiency, extends its useful life,
or enhances its value for multiple accounting periods, it should be capitalized. For
example, installing a new engine in a delivery truck should be recorded as an addition
to the asset’s cost.
ii. Revenue Expenditures: If a cost only benefits the current accounting period, it
should be recorded as an expense. For example, a routine tune-up of the truck's engine
should be debited to repair and maintenance expenses.

2. DEPRECIATION (IFRS)
Under IFRS, depreciation is the systematic allocation of the depreciable amount of
an asset over its useful life. The depreciable amount is the cost of an asset, or other amount
substituted for cost, less its residual value. Depreciation methods should reflect the pattern
in which the asset’s future economic benefits are expected to be consumed by the entity.

2.1 Accounting for Depreciation

When a plant asset is acquired, the asset account is debited and the cash account payable
is credited. For example, assume that a microcomputer (office equipment) was purchased
at a cost of Rs.38000/-. The following entry in general journal form, is required:
General Journal
Date Particulars Dr. Cr.
Office equipment 38000
Jan. 2 Cash 38000
(To record purchase of office equipment)

Depreciation of this computer is recorded by the use of an adjusting entry at the end of the
period debiting, "Depreciation, Office Equipment" and crediting "Accumulated
Depreciation - Office Equipment". If it was estimated that the depreciation charge for the
computer is Rs.6000 per year, the adjusting entry would be as under.
Date Particulars Dr. Cr.
Dec. 31 Dep. Exp. Office equipment 6000
Accum. Dep. Office equipment 6000
(To record depreciation for the ear)
"Depreciation Expense---Office Equipment" is shown in the income statement as an
operating expense. However, the other accounting; "Accumulated Depreciation-Office
Equipment" is shown on the balance sheet as a contra account, subtracted from office
equipment in the fixed asset section. Fixed assets are shown as a major caption on the
balance sheet below current assets. The office equipment and accumulated depreciation
would appear as follows:

Assets side
Total current assets 86000
Plant assets:
Office equipment 38000

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 Less accumulated depreciation 6000 32000
The original cost of the asset less accumulated deprecation represents the un-expired cost
of the asset and is called the book value or written down value of the relevant asset. The
book value of the office equipment above is Rs.32000/-.

2.2 Depreciation on Interim Statements

In the preceding example, the adjustment for depreciation was made at the end of the year.
If the business prepares interim statements, it is necessary to record depreciation for the
period covered by the statement. Assume that the company prepares interim financial
statements on a quarterly basis. The adjusting entry at the end of March will be for three
months, (one-fourth of a year) i.e. Rs. 1500/- of Rs. 6000/-. The adjustment is recorded in
the general as follows:
March Depreciation exp. - Office equipment. 1500
31 Accum. Depreciation-office equipment 1500
(To record depreciation for the January to
March quarter)
In the quarterly financial statements, the Office equipment is shown on the balance sheet
at March 31, as follows:
Plant assets:
Office equipment 38000
Less accumulated depreciation 1500 36500
Since the interim statements are prepared quarterly, the Rs. 1500 adjustment for the
depreciation will also be made at the quarter end, viz on June 30, September 30, and
December 31. After the adjusting entries and the closing entry have been made for the year,
the office equipment, accumulated depreciation---office equipment, and depreciation
expense---office equipment accounts will appear as follows:
Account office equipment account No.24
Balance
Date Item PR Debit Credit Debit Credit
Jun.2 J-6 38000 38000

Account Accumulated Depreciation - Office Equipment Account No. 24

Balance asd
Date Item PR Debit Credit Debit Credit
Mar.31 Adjusting J-11 - 1500 - 1500
Jun.30 Adjusting J-16 - 1500 - 3000
Sep.30 Adjusting J-22 - 1500 - 4500
Dec.31 Adjusting J-29 - 1500 - 6000
Dec.31 Closing J-30 - - 6000 -

Many businesses make adjusting entries for interim statements only on the worksheet. If
that were the case in the preceding example, there would be only one adjusting entry for
Rs.6000/- recorded in the ledger accounts.

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2.3 Depreciation on Asset Purchased during Period: When a plant asset is purchased
during the period, depreciation at the end of the first year will be computed for the fraction
of the year the asset is used. For example, if the office equipment in the preceding example
had been purchased on 1st November the adjusting entry on 31st December of the first year
would be for Rs.1000 (2/12x6000) as follows:
Date Particulars Debit Credit
Dec. 31 Depreciation Exp. Office equipment 1000
Accumulated dep. Office equipment 1000
(To record depreciation for 2 months)
The book value of the equipment at the end of the first year would then be Rs.37000 (38000-1000).

2.4 Procedure in Pakistan: Depreciation Procedure in Pakistan Under IFRS,

depreciation is charged based on the asset’s useful life and expected consumption of
economic benefits. However, in Pakistan, full depreciation is charged for the year in which
an asset is purchased, regardless of the purchase date. Conversely, no depreciation is
charged in the year an asset is sold or disposed of, which differs from IFRS guidelines
requiring depreciation to be recorded up to the disposal date.
Example 01: The accounts of XYZ Co. are closed on 31st December annually. A truck
was purchased for Rs.500000 on 13th October. The annual depreciation is Rs. 40000.
Record journal entry for the depreciation.

Solution: The Journal entry would be:

Particulars Debit Credit
Depreciation (truck Account) 40,000
Accumulated depreciation-truck 40,000
(To record truck depreciation at full rate during the year of
purchase)

3. COMPUTING RATE OF DEPRECIATION

Depreciation expense is calculated by allocating the depreciable amount of an asset
over its estimated useful life. The depreciable amount is the original cost of the asset minus
its salvage value. The salvage value, also known as residual value, scrap value, or trade-in
value, represents the expected amount realizable when the asset is disposed of. For
example, if a fixed asset is purchased for Rs.38,000 and has an estimated salvage value of
Rs.8,000, the depreciable cost is Rs.30,000 (Rs.38,000 – Rs.8,000).

3.1 Estimating the Life of the Asset: A key factor in determining depreciation is
estimating the useful life of the asset, which may be expressed in years or units of service.
For example, a delivery vehicle with an estimated useful life of 60,000 miles can have
depreciation allocated per mile. Similarly, if the asset has an expected life of five years and
provides similar service each year, the depreciable cost should be equally allocated over
the five years. The estimation of useful life is based on past company experience,
government or industry statistics, or professional appraisals. Other factors, such as
technological obsolescence or business growth, may also affect the asset’s lifespan.

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3.2 Methods of Computing Depreciation (IFRS)
IFRS allows multiple depreciation methods to reflect how the asset’s economic benefits
are consumed. The three most commonly used methods are:
1. Straight-Line Method: The asset’s depreciable cost is allocated evenly over its
useful life. It is commonly used for assets that provide equal service throughout their
life, such as buildings.
2. Units-of-Production Method: Depreciation is based on actual usage or production
output, making it suitable for assets where wear and tear depend on usage, like
machinery.
3. Declining-Balance Method: A higher depreciation expense is charged in the earlier
years, which is useful for assets that lose value more quickly, such as computers or
vehicles.

To illustrate the straight-line method, assume that an item of equipment is purchased

for Rs.6500. The equipment has an estimated salvage value of Rs.500 and an estimated
useful life of 5 years. The depreciable cost of the asset is Rs.6000 (Rs.6500 - Rs.500). The
annual depreciation would be R.s.1200, computed as follows:
Rs.6500 - Rs.500 = Rs.6000 = Rs.1200 per year
5 years 5 years

Based on the five-year life, the depreciation rate would be 1/5 per year or 20% of the
depreciable cost. You should carefully study the schedule showing the cost of the asset,
depreciable cost, depreciation expense, accumulated depreciation, and book value which
is given below. The entries in the table presume that the straight-line rate of 20% was
applied each year to the depreciable cost of Rs.6000.

If the equipment is used for five years, the book value at the end of the fifth year will
be Rs.500 which is the estimated salvage value because this is the amount that is expected
to be received when the asset is disposed off.
Year Cost Dep. Cost Dep. Exp. Rs. Accum. Dep. Book value
Rs. Rs. End of year end of year
l. 6500 6000 1200 1200 5300
2. 6500 6000 1200 2400 4100
3. 6500 6000 1200 3600 2900
4. 6500 6000 1200 4800 1700
5. 6500 6000 1200 6000 500

The principal advantage of the straight-line method of depreciation is its simplicity.

When assets are equally useful from period to period, this method provides a reasonable
allocation of costs for each period.

Example 02
Machinery cost Rs. 1000,000
Estimated life of machinery 5 years
Residual value Rs. 100,000

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Depreciable cost of assets (Rs.1000, 000 - Rs.100, 000) Rs. 900,000
You are required to prepare the schedule for depreciation expense using the Straight-
line method:
Solution:
Yea Cost Dep. Cost Depreciation Dep. Exp. Accum. Book value
r Rate Per year Rs. Dep. End of End of year
Rs. Rs. (w-1) (w-2) year (w-4)
(w-3)
1. 1000,000 900,000 20% 180,000 180,000 820,000
2. 1000,000 900,000 20% 180,000 360,000 640000
3. 1000,000 900,000 20% 180,000 540,000 460,000
4. 1000,000 900,000 20% 180,000 720,000 280,000
5. 1000,000 900,000 20% 180,000 900,000 100,000
Working -1 For depreciation rate
1/5 × 100 = 20%
Working -2 m For Depreciation Exp (1st to 5th year) fixed depreciation method
= Cost – Residual value ÷ no. of years
= Rs. 1000,000 - 100,000 ÷ 5 = 180,000 per year
Depreciable cost × rate of depreciation = Depreciation Exp
900,000 × 20% = 180,000
Working -3 Accumulated Dep. End of year (1 to 5th year)
st

Current year Dep. + Pervious Year Dep. = Accumulated Dep. End of year
180,000 + 0 = 180,000
180,000 + 180,000 = 360,000
180,000 + 360,000 = 540,000
180,000 + 540,000 = 720,000
180,000 + 720,000 = 900,000
Working -4 Book value End of year: (1st to 5th year)
Cost of machinery - Dep. Exp. = Book Value
1000,000 - 180,000= 820,000
820,000 - 180,000= 640,000
640,000 - 180,000 = 460,000
460,000 - 180,000= 280,000
280,000 - 180,000= 100,000
3.2.2 Units-of-Production Method: The units-of-production method of depreciation
allocates the depreciable cost to the estimated number of units to be produced by the asset.
For example, assume that the equipment previously mentioned will produce 120000 units
during its useful life. The depreciable cost of Rs.6000 (Rs.6500 - Rs.500) is divided by the
estimated number of units to be produced, 120,000 to yield depreciation cost per unit of
Rs.05:
Rs.6000 /120000 units = Rs.05 per unit
If the machine produced 30000 units during the first year of operation, the adjustment
for depreciation expense at the end of the year would be Rs.1500 (30000 x Rs.05).

71
Assuming that the units produced during the second through the fifth year are 26000,
23000, 21000, and 20000 respectively, the schedule for depreciation expense, accumulated
depreciation, and book value using the units-of-production method, is shown in the
following table:
Year Cost Dep. Unit Dep. Rate Dep. Exp. Rs. Accum. Dep. Book value
Rs. Cost Rs. Prods. Rs. Per Unit End of year end of year
l. 6500 6000 30000 .05 1500 1500 5000
2. 6500 6000 26000 .05 1300 2800 3700
3. 6500 6000 23000 .05 1150 3950 2550
4. 6500 6000 21000 .05 1050 5000 1500
5. 6500 6000 20000 .05 1000 6000 500
The units-of-production method is advantageous when the use of a plant asset varies widely
from period to period. This method is frequently used for recording depreciation on
vehicles and is based on the number of miles driven.

Example 03: On 1st January, 2011 Mr. Noman purchased Machinery for Rs. 39,000. The
machine has an estimated salvage value of Rs. 3,000 and an estimated useful life of 5 years.
The depreciable cost of the asset is Rs. 36,000 (39,000-3,000). The machine will produce
720,000 units during its useful life. The units produced first through fifth year are 180,000
units, 156,000 units, 138,000 units, 126,000 units and 120,000 respectively.
You are required to prepare the Depreciation schedule using the units of production
method: Solution:
Year Cost Dep. Units Dep. Rate Dep. Accum. Book value
Cost Prods. per Unit Exp. Dep. End of End of year
Rs. Rs. (w-1) Rs. (w-2) year (w-3) (w-4)
31st
Dec. 39, 000 36,000 180,000 0.05 9,000 9,000 30,000
2011. 39, 000 36,000 156,000 0.05 7,800 16,800 22,200
2012. 39, 000 36,000 138,000 0.05 6,900 23,700 15,300
2013. 39, 000 36,000 126,000 0.05 6,300 30,000 9,000
2014. 39, 000 36,000 120,000 0.05 6,000 36,000 3,000
2015.

Working: 1 : Dep. Rate per unit = Depreciable cost ÷ No. of production units
0.0 5 = 36,000 ÷ 720,000
Depreciable cost = Cost of Equipment – Residual Value
36,000 = 39,000 - 3,000
Working: 2
Depreciation Exp. 31st Dec, 2011 to 2015
Units Prods. × Dep. Rate per = Depreciation Exp
180,000 × 0.05 = 9,000
156,000 × 0.05 = 7,800
138,000 × 0.05 = 6,900
126,000× 0.05 = 6,300
120,000× 0.05 = 6,000

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 Working: 3Accumulated Dep. End of year: 31st Dec, 2011 to 2015
Current year Dep. + Pervious Year Dep. = Accumulated Dep. End of year
9,000 + 0 = 9,000
7,800 + 9,000 = 16,800
6,900 + 16,800 = 23,700
6,300 + 23,700 = 30,000
6,000 + 30,000 = 36,000
Working: 4 Book value End of year: 31st Dec 2011 to 2015
Cost of machinery - Dep. Exp. =Book Value
39,000 - 9,000 = 30,000
30,000 - 7,800 = 22,200
22200 - 6,900 = 15,300
15,300 - 6,300 = 9,000
9,000 - 6,000 = 3,000

3.3 Accelerated Depreciation Method addresses the following concepts:

1. Larger Depreciation in Early Years: The method charges higher depreciation expenses
during the asset's early years, which then decreases progressively in later years.
2. Reason for Use: This method is used for assets that require increasing maintenance and
repair costs as they age, balancing depreciation and maintenance costs over time.
3. Tax Advantage: By accelerating depreciation, businesses can report lower taxable
income in the early years, resulting in reduced taxes. Later, depreciation expenses
decrease, increasing taxable income.
4. Declining Balance Method: The most common application is the declining-balance
method, where the depreciation rate is typically double the straight-line rate, applied to
the asset's remaining book value each year.
5. Ignoring Salvage Value: The declining-balance method does not account for salvage
value when calculating depreciation.
6. Depreciation Applied to Book Value: The depreciation rate is applied to the asset's
remaining book value, not its original cost, which reduces the depreciation expense each
year.
7. IFRS Compliance: This method complies with IFRS (International Financial
Reporting Standards), which governs the reporting of depreciation for tax and financial
accounting purposes.
There are several different ways to apply this method, but the most commonly used
one is to double the straight-line rate and multiply that rate by the declining book value of
the asset. For example, if the estimated life of an item of equipment was 5 years, the
straight-line rate of depreciation would be 1/5 year or 20%. The declining balance rate of
depreciation would, therefore, be 2/5, or 40% per year, or twice the straight-line rate.
There are two important points to be noted about the declining balance method: (1)
this is the only method of depreciation that does not consider the salvage value when
computing depreciation, and (2) the rate of depreciation determined (40% in the example)
is applied to the asset’s remaining book value or written down value at the end of the earlier
year.

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 Using the same Rs.6,500 asset from the preceding illustration, the schedule of
depreciation for the declining-balance method is shown below:
Year Cost Dep. Cost Dep. Exp. Accum. Dep. End of Book value end of
year year
l. 6500 40% 2600.00 2600.00 3900.00
2. 6500 40% 1560.00 4160.00 2340.00
3. 6500 40% 936.00 5096.00 1404.00
4. 6500 40% 561.60 5657.60 842.40
5. 6500 40% 336.96 5994.56 505.44

The depreciation rate, 40% is applied to the cost, Rs.6500, in the first year to determine the
depreciation expense of Rs.2600. Note that the cost of Rs.6500 is also the first year's book
value until depreciation is recorded at the end of the year. In the second and all following
years the 40% rate is applied to the book value as of the end of the preceding year. For
example, in the second year, the 40% rate was applied to the book value at the end of the
first year, Rs.3900; therefore, the depreciation computed was Rs.1560 (Rs.3900 x 40%).
Although the salvage value of the asset is not considered in computing the annual
depreciation for the declining-balance method, the asset should not be depreciated below
the estimated salvage value.

Example 04: A firm purchased machinery for Rs. 250,000 on January 1st 2012. It
purchased additional machinery for Rs. 222,500 and spent Rs. 22,500 on 1st Jan 2014. The
firm financial year closed on 31st December every year. Depreciation is charged @ 10%
p.a on Reducing Balance Method.
Required: Prepare machinery account for 5 year
Solution: Machinery Account
Dr. Cr.
Date Reference Rs. Date Reference Rs.
2012 Cash account 250,000 2012 Depreciation 25,000
Jan.1 Dec.31 account 225,000
Dec.31 Balance c/d
250,000 250,000
2013 2013
Jan.1 Balance b/d 225,000 Dec.31 Depreciation a/c 22,500
Dec.31 Balance c/d 202,500
470,000 470,000
2014 2014
Jan.1 Balance b/d 202,500 Dec.31 Depreciation a/c 44,750
Jan.1 Cash account 245,000 Dec.31 Balance c/d 402,750
(222,500+22500)
447,500 447,500
2015 Balance b/d 2015
Jan.1 402,750 Dec.31 40,275

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 Dec.31 Depreciation a/c 364,475
402,750 Balance c/d 402,750
2015 Balance b/d
Jan.1 364,475

Working:
1. Depreciation for 31st December 2012.
Rate 10%
Machinery cost Rs. 250,000 *10/100 = 25,000
2. Depreciation for 31st December 2013.
Rate 10%
Machinery cost Rs. 225,000 *10/100 = 22,500
3. Depreciation for 31st December 2014.
Rate 10%
1st Machinery cost Rs. 202,500*10/100 = 20,250
2nd Machinery cost Rs. 245,000*10/100 = 24,500
Total machinery = 44,750
4. Depreciation for 31st December 2015.
Rate 10%
Machinery cost Rs. 402750*10/100 = 40,275
Total machinery – Total depreciation = Balance
495000 - 132,525 = 364,475
Example 05: Mr. Ali purchased A Truck for Rs.500, 000 and the depreciation rate is 10%
p.a. You are required to prepare the Depreciation schedule using Diminishing Balance
Method
Solution:
Year Cost Rs. Dep. Dep. Exp. Rs. Accumulated Book value
Rate p. a (W-1) Dep. End of year End of year (W-3)
(W-2)
1. 500, 000 10% 50,000 50,000 450,000
2. 500, 000 10% 45,000 95,000 405,000
3. 500, 000 10% 40,500 135,500 364,500
4. 500, 000 10% 36,450 171,950 328,050
5. 500, 000 10% 32,805 204,755 295,245

Working: 1: For Depreciation Exp (1st to 5th year) under reducing balance method
1st-year Depreciation Exp=
Truck cost × rate of depreciation = Depreciation Exp
500,000 × 10% = 50,000
2nd year Depreciation Exp =

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 Book value or Balance b/d of 2nd year × rate of depreciation = Depreciation Exp.
450,000 × 10% = 45,000
rd
3 year Depreciation Exp =
Book value or Balance b/d of 3rd year × rate of depreciation = Depreciation Exp.
405,000 × 10% = 40,500
4th year Depreciation Exp =
Book value or Balance b/d of 4th year × rate of depreciation = Depreciation Exp.
364,500 × 10% = 36,450
th
5 year Depreciation Exp =
Book value or Balance b/d of 5th year × rate of depreciation = Depreciation Exp.
328,050 × 10% = 32,805

Working: 2: Accumulated Dep. End of year: (1st to 5th year)

Current year Dep. + Pervious Year Dep. = Accumulated Dep. End
50,000 + 0 = 50,000
45,000 + 50,000 = 95,000
40,500 + 95,000 = 135,500
36,450 + 135,500 = 171,950
32,805 + 171,950= 204,755

Working: 3 (1st to 5th year): Book value End of year:

Truck cost – Accumulated Dep. Exp = Book Value
500,000 – 50,000 = 450,000
Balance b/d 2nd year 450,000 – 45,000 = 405,000
Balance b/d 3rd year 405,000– 40,500 = 364,500
Balance b/d 4th year364,500 – 36,450 = 328,050
Balance b/d 5 th year
328,050 – 32,805 = 295,245

3.4 Depletion method: This method is used for natural resources and wasting assets like
mines, quarries. These wasting assets do not depreciate, but "deplete" gradually as a result
of their periodical consumption.
Example 06: A mine is acquired for Rs.1000000 it is estimated that 250000 tons of coal
will be extracted over its life. Therefore, the rate of depletion would be Rs.1000000 /
250000 = Rs.4 per ton. Suppose in 20-A, 20000 tons of coal were extracted from the mine.
The journal entry would be:
Particulars Debit Credit
Depletion expenses 80000
Accumulated depletion 80000

3.5 Consistency in Use of Depreciation Method: The standard accounting methods

require that when a company or firm uses a particular method of depreciation it must be
used consistently. The company or firm should not change that method frequently. For
example, if XYZ Company is using a straight-line method of depreciation in 20-A, it
should not start using a declining balance method in 20-B or subsequent years. If in

76
exceptional cases a company wants to change its existing method, it should change it for
previous years also. It must however be noted that it would upset the profit or losses of
earlier years, which is not desirable and may put the company in a very awkward position.

4 SALE OF FIXED ASSETS

When an asset is disposed of, the first step is to update the depreciation. When a plant
asset is sold, this procedure is necessary in order to determine the book value of the asset
at the date of sale. The next step is to record the cash received and write the asset off the
books. This entry requires debits to cash and accumulated depreciation and a credit to the
asset account for its original cost.

Any difference between the amount received for the asset and its book value is
recognized as a gain or loss from the sale. For example, assume that store equipment
purchased January 2, 20-A for Rs. 2400 is being depreciated at the rate of Rs. 300 per year.
The equipment is sold for Rs. 900 on January 2, 20-F, the beginning of the sixth year. The
store equipment and accumulated depreciation accounts at the end of the fifth year
immediately prior to the sale would appear as follows: Account store equipment
Account No.23
Balance
Date Item PR Debit Credit Debit Credit
Jan 2 Store equipment P-6 2400 - 2400 -
20-A
Account accumulated depreciation store equipment Account No.23.1
Balance
Date Item PR Debit Credit Debit Credit
Dec. 31,20-A Adjusting J-14 - 300 - 300
Dec. 31,20-B Adjusting J-26 - 300 - 600
Dec. 31,20-C Adjusting J-33 - 300 - 900
Dec. 31,20-D Adjusting J-39 - 300 - 1200
Dec. 31,20-E Adjusting J-43 - 300 - 1500
The book value or written-down value of the store equipment at the date of sale is Rs.900
(Rs.2400 cost –Rs.1500 accumulated depreciation). Since the equipment is sold for Rs.900,
an amount equal to its book value, there is no gain or loss on the sale. The entry, in general
journal form, to record the sale is:

Jan. 2 Cash 900

Accumulated depreciation 1500
(Store equipment) 2400
4.1 Gain or Loss on Sale of Plant Assets: When any fixed or plant asset is sold, the
amount realized from the sale is seldom equal to the book value of the asset. If the cash
received is greater than the book value, a profit is realized on the sale. This profit is called
gain on the sale of plant assets. If the cash received is less than the book value of the asset,
a loss is realized on the sale. This loss is called loss on the sale of plant assets. The gain or

77
loss must be properly identified in the accounts, for example, a "Gain on sale of Machinery"
or "Loss on Sale of Store Equipment".
If the equipment in the preceding example had been sold for 700, there would be a loss of
Rs.200 on the sale (900 book value-700 selling price). This transaction would be recorded
as follows:
Date Particulars Debit Credit
Jan. 2 Cash 700
Accumulated depreciation 1500
Loss on sale of store equipment 200
Store equipment 2400
If the equipment had been sold for Rs.1150, there would be a gain of Rs.250 on the sale
(Rs.1150 selling price-Rs.900 book value). This transaction would be recorded as follows:
Jan. 2 Cash 1150
Accumulated dep. Store equipment 1500
Store equipment 2400
Gain on sale of store equipment 250
Example 07: A firm whose Accounting year is calendar year, purchased on 1st April 2013
machinery costing Rs. 150,000. It purchased further machinery on 1st Oct 2013 costing
Rs. 100,000, and on 1st July 2014, costing Rs. 50,000. On 1st January 2015, machinery
installed on 1st April 2013 became obsolete and was sold for Rs. 45,000.

Show how the machinery Account would appear in the books of the company, if the
machinery was depreciated by fixed installment method @ 10% p.a. What would be the
balance of the machinery Account on 1st January 2016?
Solution:
Dr. Machinery Account Cr
Date Reference Rs. Date Reference Rs.
2013 2013
Apri1 Bank A/c 150,000 Dec.31 Dep. A/c (w-1) 13,750
Oct. 1 Bank A/c 100,000 Dec.31 Balance c/d 236,250

250,000 250,000
2014 2014
Jan.1 Balance b/d 236,250 Dec.31 Dep. A/c (w-2) 27,500
July Bank A/c 50,000 Dec.31 Balance c/d 258,750

286,250 286,250
2015 2015
Jan.1 Balance b/d 258,750 Jan.1 Bank A/c 45,000
Jan.1 Pr. and Los. A/c 78,750
Dec.31 Depreciation A/c 15,000
Dec.31 Balance c/d 120,000
258,750 258,750

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 2016 120,000
Jan.1

Working
1. Depreciation for 31st December 2013.
Rate 10%
Depreciation on 150,000 for 9 months: 150,000*10/100*9/12 = Rs.11,250
Depreciation on 100, 000 for 3 months: 100,000* 10/100*3/12 = Rs. 2,500
Total depreciation for 2013 Rs. 13,750
2. Depreciation for 31st December, 2014.
Rate 10%
Depreciation in 250,000 for full year: 250,000*10/100 = 25,000
Depreciation on 50,000 for 6 months: 50,000*10/100*6/12 = 2,500
Total depreciation for 2014 Rs. 27,500
3. Cost of Machinery sold:
Rs.
st
Machinery installed on 1 April 2013 150,000
Book value of machine on 1st January 2015:
Less Depreciation for 9 months Rs.11,250
Less Depreciation for full-year Rs.15,000 -26,250
Rs.123,750
Sales proceed 45,000
Loss on sale of machinery: Rs. 78,750
Depreciation for 31st December, 2015:
Depreciation on 150,000 for full year: 150,000*10/100 = 15,000
Example 08: On 1st July 2011, Mr. Naeem purchased a second–hand Truck for Rs.
200,000. On 30th 2014, the machinery was disposed off for a sum of Rs. 68,000. Assuming
the books are closed on 31st December each year and taking the rate of depreciation @ 10%
on reducing balance method. Required:
Prepare Truck account
Truck Account
Dr. Cr.
Date Reference Rs. Date Reference Rs.
2011 Cash a/c 200,000 2011
July 1 Dec31 Dep. A/c(w-1) 10,000
Balance c/d 190,000
200,000 200,000
2012 2012
Jan.1 Balance b/d 190,000 Dec31 Dep. A/c (w-2) 19,000
Balance c/d 171,000
190,000 190,000
2013 2013

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 Jan.1 Balance b/d 171,000 Dec31 Dep. A/c (w-3) 17,100
Balance c/d 153,900
171,000 171,000
2014 2014
Jan.1 Balance b/d 153,900 Dec.31 Dep. A/c (w-4) 7,695
Bank a/c 136,000
Profit and loss A/c 10,205
153,900 (loss written off) 153,900
2015
Jan.1 Balance b/d

Working:
1. Depreciation for 31st December 2011.
Rate 10%
Depreciation on 200,000 for 6 months: 200,000*10/100*6/12 = 10,000
2.
Depreciation for 31st December, 2012.
Rate 10%
Depreciation on190, 000 for 12 months: 190,000*10/100= 19,000
3. Depreciation for 31st December 2013.
Rate 10%
Depreciation on 171,000 for 12 months: 200,000×10÷100= 17,100
4. Depreciation for 31st December 2014.
Rate 10%
Depreciation on 153,900 for 6 months: 153,900×10 ÷ 100 ÷ 6×12 = 7,695
(153,900-7695 =
Book value of Truck 1st July 2014 Rs. 146,205
The truck was Disposed off Rs. 136,000
Rs. 10,205
4.2 Plant Assets Sold during the Year: Because the equipment was sold at the
beginning of the period and the depreciation had been recorded at the end of the previous
year, there was no entry required to update the accumulated depreciation. Assume,
however, that the store equipment is sold on 1st July 20-F for Rs. 900. An adjusting entry
is required to record the depreciation of the asset from 1st January 20-F to 1st July 20-F.
The depreciation to be recorded for the six-month period at an annual rate of Rs. 300 is Rs.
150.
Date Particulars Debit Credit
July 1,20-F Depreciation exp. Store equipment 150
Accum. Dep. Store equipment 150
(to record depreciation for 6 months)
Accumulated depreciation-store equipment now has a balance of. 1650. The book value of
the equipment is 750 (2400-1650); therefore, there is a gain on the sale of 150.
Account - Accumulated Depreciation - Store Equipment
Balance
Date Item PR Debit Credit Debit Credit

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 Dec. 31,20-A Adjusting J-14 - 300 - 300
Dec. 31,20-B Adjusting J-26 - 300 - 600
Dec. 3.1,20-C Adjusting J-33 - 300 - 900
Dec. 31,20-D Adjusting J-39 - 300 - 1200
Dec. 31,20-E Adjusting J-43 - 300 - 1500
July 1,20-F Adjusting J-46 - 150 - 1650
An entry to record the sale would be:
Date Particulars Debit Credit
Cash 900
Accumulated depreciation – store equip 1650
Store equipment 2400
Gain on sale of store equipment 150

4.3 Depreciation for the Year of Sale in Pakistan; The procedure described above is
prevalent in America. In Pakistan, the procedure is simple. We have already stated in the
paragraphs above that full depreciation -is charged for the year of purchase irrespective of
the date of purchase. On the sale of any item of fixed asset, no depreciation is charged for
the year of sale. This makes depreciation accounting very simple.

4.4 Gains and Losses on the Income Statement: Gain and losses on the disposal of
plant assets are not considered part of' the normal operations of the business. They are
therefore shown on the income statement as separate items below "Income from operation".
Income from operations 12500
Other income and expense:
Gain on sale of machinery 430
Loss on sale of equipment 180 20
Net income
12750

5. RETIRING FIXED ASSETS

If a plant asset is no longer useful, it should be disposed off even though the asset
has not been depreciated fully. If the asset cannot be sold, it should be retired.

5.1 Retiring Fully Depreciated Asset: If a plant asset that has been fully depreciated is
retired, there will be no gain or loss on its disposal. For example, if a machine that costs
Rs.2200 with no estimated salvage value is retired after it has been fully depreciated, the
following journal entry will be required:
Debit Credit
Jan. 4 Accumulated Depreciation-machine 2200
Machinery 2200
(To write off machinery retired)

5.2 Retiring Plant Assets at a Loss: If a plant asset is retired before it is fully
depreciated and no salvage is realized the asset is retired at a loss, for example, a typewriter
that cost Rs.500 on January 2 is being depreciated at Rs.50 per year. If the typewriter is

81
retired on June 30 of the eight-year of its life, the accumulated depreciation total for the
first seven-year would be Rs.350 (7 years X Rs.50). The office equipment and accumulated
depreciation-office equipment accounts at the end of seven years will appear as follows:

Office Equipment Account

Balance
Date Item PR Debit Credit Debit Credit
Jan. 2,20,-A - - 500 - 500
Accumulated Depreciation Account – office equipment
Balance
Date Item PR Debit Credit Debit Credit
Dec.31,20-A Adjusting - - 50 50
The book value of the typewriter at June 30 is 125 (500 cost - 375 accumulated
depreciation). If the machine is retired on this date, a loss of 125 is recognized. The entry
to record the retirement of the asset is:
Debit Credit
June 30 Acc. Dep. office equipment 375
Loss on retirement of office equipment 125
Office equipment 500
(To write off equipment retired)
Plant assets that have been fully depreciated but are still being used should not be written
off. As long as the assets are being used, the cost and depreciation should continue to be
shown in the ledger.

6. EXCHANGING PLANT ASSETS

When equipment or machinery becomes worn, it is often traded in for new equipment
or machinery of a similar nature. The buyer will normally be given a trade-in allowance on
the old asset, which is deducted from the price of the new asset. The difference between
the price of the new asset and the trade-in allowance is payable at the time of the transaction
or as specified in the purchase agreement. When the trade-in allowance is more than the
book value of the asset, there is a gain on the exchange when the trade-in allowance is less
than the book value; there is a loss on the exchange.

6.1 Gain on Exchange of Plant Assets: Recent accounting pronouncements require that
the gain or loss on the exchange of plant assets be determined by the difference in the book
value and fair market value of the asset being exchanged. All examples in this unit will
assume that the trade-in allowance for the asset is equal to its fair market value.

Assume that the delivery truck, which costs Rs.38000 and accumulated depreciation
to date of Rs.31000, is traded in on a new truck costing 41000. The book value of the old
truck is 7000 (38000 - 31000). If a trade-in allowance, representing the fair market value
of the old truck, of Rs. 9000 is allowed, there is Rs. 2000 gain on the exchange (9000 trade-
in allowance-7000 book value). For financial reporting purposes, the gain on the exchange

82
of plant assets cannot be recognized. The tile balance he paid (32000) is determined by
subtracting the trade-in allowance from the cost of the new truck (41000-9000). The cost
of the new asset (39000) is determined by adding the balance and the book value of the old
asset (32000 + 7000). The entry to record the transaction is as follows, assuming the
balance is paid in cash
Particular Debit Credit
Jan. 4. Delivery Truck (new) 41000
Accumulated dep. On Old Delivery Truck 31000
Delivery Truck (Old) 38000
Gain on sale of Truck 2000
Cash 32000
6.2 Loss on Exchange of Plant Assets: If the trade-in allowance is less than the book
value of the asset, there is a loss on the exchange. For example, if a trade-in value of only
Rs.4000 had been allowed on the delivery truck in the preceding example, a loss of Rs.3000
(Rs.7000 hooks value- Rs.4000 trade-in allowance) would result. Unlike the non-
recognition of gain on the exchange of a plant asset, the loss is recognized immediately.
The balance to be paid, Rs.37000 is determined by subtracting the trade-in allowance from
the cost of the new truck (Rs.41000-Rs.4000). The entry to record this transaction,
assuming that cash is paid, is as follows:
Particular Debit Credit
Jan. 4. Delivery equipment 41000
Accumulated dep. Old deliver equips 31000
Loss exchange of delivery equips 3000
Delivery equipment 38000
Cash 37000
In the above example, the trade-in was recorded at the beginning of the year, therefore the
accumulated depreciation was up to date and no adjusting entry was required. If the trade-
in had taken place during the year, the first step in recording the transaction would have
been to update the depreciation. This adjustment must be made to determine the book value
of the asset.
To illustrate, assume that a truck is traded for a new truck costing Rs.41000 on 1st April.
The cost of the old truck was Rs.38000 and the accumulated depreciation as of December
31 of last year was Rs.31000. The old truck has been depreciated at 6000 per year. The
entry to record depreciation for the 3-month period January 1 to March 31 is:
Debit Credit
April. l, Depreciation-delivery equipment 1500
Accumulated dep - Delivery equips. 1500
(To record depreciation for 3 months)
Accumulated Depreciation-Delivery Equipment now has a 32500 balance (31000 + 1500).
The book value of the truck is now 5500 (38000 cost - 32500 accumulated depreciation).
If a trade-in allowance of 4000 is granted, the entry to record the exchange is:
Debit Credit
Jan. 4, 98 Delivery equipment 41000

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 Accumulated dep. Old delivery equips. 31000
Loss on exchange of delivery equips. 3000

Delivery equipment 38000

Cash 37000
6.3 Plant Assets on the Balance Sheet: Plant assets on the balance sheet are typically
presented by showing cost, accumulated depreciation, and book value (written-down
value) in a single line. This format provides a clear and concise view of asset valuation.
(IFRS: IAS 16 – Property, Plant, and Equipment)
Plant Assets Cost Acc. Book Value Total Assets
Depreciation
Store equipment 60630 20150 40480 Current Assets 260260
Office equipment 20480 1990 18490
Building 260000 140000 120000
Land 116000 116000
Total plant assets 162140
457110 294970
Another way of presentation usually adopted by companies is as under:
Fixed Assets Rs. Rs.
Land 116000
Building at cost 260000
Less accumulated depreciation 140000 120000
Office equipment 20480
Less accumulated depreciation 1990 18490
Store equipment at cost 60630
Less accumulated depreciation 20150 40480
294970
The first method is better.

84
UNIT – 5

CAPITAL AND REVENUE,

CORRECTION OF ERRORS, AND
ACCOUNTING FROM
INCOMPLETE RECORDS

Written by:
Syed Umar Farooq
Mr. Muhammad Munir Ahmad
Reviewed by:
Talat Mahmood
Sohail Amjed
Asia Batool
85
 CONTENTS
Sr. Subject Page No.
No.
Introduction 87
Objectives 87
1. CAPITAL AND REVENUE 88
1.1 Terms and their Definitions 88
1.2 Necessity for Differentiation between Capital & 88
Revenue
1.3Nature of Capital and Revenue Items 88
2. RECTIFICATION/CORRECTION OF ERRORS 91
2.1 Definition of Errors 91
2.2 Kinds of Errors 91
2.3 Book-Keeping Errors 91
2.4 Trial Balance Errors 92
2.5 Errors and Final Accounts 92
2.6 Location of Errors 91
2.7 Corrections of Errors 93
2.8 Suspense Account 94
2.9 Effect of Errors on Financial Statements 96
3. ACCOUNTING FROM INCOMPLETE RECORD 97
3.1 Introduction to Single Entry System 97
3.2 Determination of Profit or Loss 99
4

86
 INTRODUCTION
This unit covers key accounting concepts, including capital and revenue
expenditure, essential for preparing final accounts. It explains how errors occur in journals,
ledgers, trial balances, and final accounts, along with techniques for their correction. The
unit also introduces accounting from incomplete records, focusing on the single-entry
system used by small businesses. Methods for determining profit or loss from incomplete
records are discussed with theoretical explanations and practical illustrations. Self-
assessment questions and problems are provided for better understanding.

OBJECTIVES
The aim of this unit is to enable you to carry out the following very important
activities while dealing with accounts:
− To distinguish between capital and revenue items.
− Classify expenditure into these two important categories.
− Learn the nature of errors and the ways, which have to be followed for their
correction.
− Understand the concept of Single Entry System of Accounting
− Know the features of single entry system
− Be familiar with the methods of calculating the profit or loss of an entity
− Differentiate between a statement of affairs and a balance sheet
− Convert the single-entry system into double entry system of accounting

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1. CAPITAL AND REVENUE (IFRS ACCOUNTING
STANDARDS)
Capital expenditure refers to the amounts spent to acquire, improve, or extend the useful
life of fixed assets (such as property, plant, and equipment) and is capitalized on the balance
sheet under IFRS. It is intended to provide long-term benefits to the business. In contrast,
revenue expenditure involves the costs incurred for day-to-day operations (like rent, utilities,
and maintenance) that are expensed in the period they occur, as they do not provide long-term
benefits. Capital expenditure results in the creation or enhancement of assets, while revenue
expenditure is related to maintaining current operations and is directly reflected in the profit
and loss account.
1.1 Terms and their Definitions
i. Fixed Assets: Tangible assets used in business operations with a useful life exceeding one
year (e.g., land, buildings, machinery, vehicles, and furniture). They are recorded at
historical cost and subject to depreciation (except land).
ii. Current Assets: Assets expected to be converted into cash or used up within one
accounting period (e.g., cash, bank balances, receivables, inventory, and prepayments).
They are vital for liquidity management and are classified under short-term assets.
iii. Capital Expenditure: Expenditure for purchasing or improving fixed assets. This
expenditure is capitalized and added to the asset's value, reflecting long-term investments
in the business.
iv. Capital Receipts: Proceeds from the sale of fixed assets, such as property or machinery. These
receipts are not part of regular business income and are considered non-operating inflows.
v. Revenue Expenditure: Costs incurred for day-to-day business operations, such as
rent, utilities, and salaries. These are expensed in the period incurred and are necessary
for maintaining operational efficiency.
1.2 Necessity for Differentiation between Capital and Revenue
The distinction between capital and revenue is essential for accurately determining accounting
profit and recognizing business assets. Capital refers to assets that are utilized for the
production of goods and services, providing long-term value.
Following International Financial Reporting Standards (IFRS), capital is recognized
for its potential to create long-term value, while revenue represents the periodic income
generated from operations.
1.3 Nature of Capital & Revenue Items
Capital Expenditure refers to funds spent on acquiring assets or improving fixed assets
that provide benefits over more than one accounting period. These assets are not meant for
resale in the normal course of business and are capitalized on the balance sheet. Examples
include the purchase of land, buildings, machinery, and furniture, goodwill, preliminary
expenses, additions to existing assets, overhauling second-hand machines, and costs
incurred to enhance business earning capacity.

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Revenue Expenditure involves funds spent on day-to-day operational costs that benefit
the current accounting period only. It is expensed in the period incurred. Examples include
salaries, rent, depreciation, consumable stores, raw material inventory, insurance
premiums, taxes, and miscellaneous expenses.
1.4 Distinction between Capital and Revenue
Capital Expenditure Revenue Expenditure
1. Its effect is long-term i.e. it is not exhausted 1. Its effect is temporary, i.e. it is exhausted,
within the current accounting year; its within the current accounting year.
benefit is enjoyed in future years or years
also.
2. An asset is acquired or the value of an asset 2. Neither an asset is acquired nor the value of an
increases due to this expenditure. asset is increased.
3. Generally, it has a physical existence and it 3. It has no physical existence i.e., it is invisible.
is visible.
4. It does not occur again and again it is non- 4. It occurs repeatedly, it is recurring and regular.
recurring and irregular.
5. This expenditure improves the position of 5. This expenditure helps to maintain the concern.
the concern.
6. A portion of this expenditure is shown in the 6. The whole amount of this expenditure is shown
trading and profit & loss account or income in the trading and PLS account or income and
and expenditure account as depreciation. expenditure account. However, deferred
revenue expenditure and prepaid expenses are
shown as assets in the balance sheet.
7. It appears in the balance sheet until its 7. It does not appear in the balance sheet.
benefit is fully exhausted. Deferred revenue expenditure, outstanding
expenses, and prepaid expenses are,
however, temporarily shown in the balance
sheet.
8. It does not reduce the revenue of the 8. It reduces revenue. Payment of salaries to
concern. The purchase of fixed assets does employees decreases revenue.
not affect revenue.

1.5 Capitalized or Deferred Revenue Expenditure

Deferred Revenue Expenditure refers to costs that provide benefits over multiple
accounting periods but are not fully consumed in the current year. Under IFRS, such
expenditures are capitalized and written off over time. Examples include substantial repairs
to buildings, where the expense is initially treated as revenue expenditure but later
capitalized to reflect the long-term benefit. Similarly, prepaid insurance premiums are a
typical case: if paid for multiple years, only the portion relating to the current period is
treated as revenue expenditure, while the remaining amount is recorded as an asset and
expensed over future periods. This ensures that the expense matches the period of benefit.
1.6 Capital and Revenue Receipts: We have discussed capital and revenue expenditure
or payment in the above paragraphs. Now we would consider capital and revenue receipts.

89
 The income resulting from goods and services of a business are termed revenue
receipts. For example, sales of shoes made by Bata Shoes Company are its revenue receipts.
On the other hand, if any items of fixed assets are sold, they result in capital receipts.
Examples of capital receipts are:
a. Sale of old furniture by firm
b. Disposal of an old truck
c. Sale of a building by a company and so on
1.7 Capital & Revenue Profits and Losses: Examples
a. Suppose there is a surplus machine in your factory. The cost of the machine is Rs.5000.
You sell it at Rs.7000 thus earning a capital profit of Rs.2000. Capital profit results from
the sale of fixed assets at a profit.
On the other hand, if you sell goods costing Rs.7000 for Rs.10000. The profit of Rs.3000
is a revenue profit. Similarly, income from investments, rent, etc. is revenue income.
b. Capital profit or income should either be transferred to the capital account of the
proprietor of a business or credited to the capital reserve account.
These would thus appear on the liability and capital side in the balance sheet.
c. Revenue profits on the other hand should be transferred to a profit and loss account
because they arise out of regular and normal business activities.
Capital and Revenue Losses: The distinction is the same as given above. Capital loss
means a loss made on the sale of a fixed asset or a loss resulting from the rising of money
for the business. For example, discount on the issue of shares or debentures. Revenue loss
on the other hand is one incurred in trading operations such as loss on the sale of goods.
Such losses appear in the Profit and Loss Account of the year in which they occur.
Example 1: Ahmad is carrying on building business. Weather is poor and his men cannot
proceed outside to different sites of work. He decides to alter and extend his own premises,
enlarging the shop front, altering storage facilities, shelves, etc. This involves the following
expenses on the extension of his own premises.
a. Materials Rs.45, 000
b. Labor Rs.82, 000
c. Other overheads Rs.23, 000
The value of his premises is thus increased by Rs.150000/-, giving journal entries for
capitalizing these apparent revenue expenses. Solution:
Account Dr. Cr.
Building account 150000
Material Account 45000
Wages Account 82000
Miscellaneous expenses 23000
150000 150000

The result would be to increase in the capital value of the building and a decrease in the
above revenue expenses. Example 2: While checking the accounts of Nasim and
Company, you come across the following expenses in the books.

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 a. Telephone expenses 530
b. Office salaries 2540
c. New weighing machine 85600
d. New counters for the shop building 60000
e. Wages incurred on the counters 12000

You are required to classify the above expenses into capital or revenue expenses. State how
these expenses would appear in the final accounts of Nasim and Company. Solution
a. Telephone expenses Rs.530 are revenue expenses and these would appear in the
profit and loss account.
b. Office salaries are also revenue expenses and would appear in the profit and loss
account of the firm.
c. Expenditure on the purchase of a new weighing machine is capital expenditure. It
would be shown on the asset side of the balance sheet.
d. The cost of new counters (Rs.60000) and wages (Rsl2000) would be capitalized, as
they would enhance the value of the premises. The building account at enhanced cost
would appear in the balance sheet. Depreciation under normal rules would however
be charged to the building account.

2. RECTIFICATION/CORRECTION OF ERRORS
2.1 Definition of Errors: Rectification or correction of errors under IFRS involves
adjusting financial statements to fix any mistakes or inaccuracies from prior periods. These
errors can result from mathematical errors, the incorrect application of accounting policies,
or oversights in recording transactions. When these errors are discovered, the corrected
amounts are retrospectively adjusted in the financial statements, and the financials from
previous periods are restated to reflect the correct figures. This process ensures that the
financial statements present a fair and accurate representation of the company’s financial
performance and position. Corrections are made based on the nature and materiality of the
error, in compliance with IAS 8 (Accounting Policies, Changes in Accounting Estimates,
and Errors).
The examples are as under:
a. The amount of a voucher is Rs.785 but it is written in the journal as Rs.875.
b. The total of an invoice is written as Rs.15620 instead of the correct total of Rs.20620.
c. Advance of Rs.700 paid to Mr. Ahmad is debited to salary expense.
2.2 Kinds of Errors: The errors which we may find place in the books of accounts may
be broadly classified as follows:
a. Bookkeeping errors
b. Trial Balance errors
2.3 Book-Keeping Errors: Bookkeeping errors are those errors, that may be made in
the original documents, in the original entry books, and then posting from the books
of original entry into the ledger, taking balances of the ledger accounts, etc.
Bookkeeping errors are of four categories:

91
i. Errors of Omission: An error of omission is one where the transaction has been
absolutely omitted from the records. Suppose goods are bought from Abdul Rehman but
no entry is made in the Purchases Book. Such errors do not affect the agreement of trial
balance and can only be detected by careful checking or linking of vouchers with posting
into the journals.
ii. Errors of Commission: These errors are the most common. An error of commission
occurs when a transaction is wholly or partly incorrectly recorded in the journal or
ledger. It is committed through carelessness or oversight and may be in the form of
wrong entries, wrong postings incorrect additions or calculations, etc. Errors of
commission may or may not affect the agreement of a trial balance.
Examples of such errors are:
a. Posting a wrong amount to the ledger.
b. Posting an amount on the wrong side of an account.
c. Posting an amount to the wrong account.
d. Making a wrong entry in a book of original record, etc.
iii. Errors of Principle: An error of principle is one where a transaction is entered
without due regard to the fundamental principles of double entry or proper head of
account. It is an error that violates some principles of accountancy. It may consist of:
a. Wrong allocation of expenditure between Capital and Revenue.
b. Inadequate provision for bad and doubtful debts
c. Insufficient depreciation
iv. Compensation Errors: The errors cancel themselves and do not result in any
difference between the debit and credit side of the trial balance. Thus, an error of
Rs.200 on the debit side of an account may be compensated by an error of the same
amount on the credit side of another account. These errors are very difficult to
discover and require a 100% check of accounts to locate them.
2.4 Trial Balance Errors : Errors that are made in the preparation of the trial balance are
called trial balance errors. These are:
a. Omission of balance from the trial balance.
b. Transfer of balance to the wrong column or wrong head of account in the trial balance.
c. The amount of the balance wrongly entered in the trial balance.
d. Wrong additions of the trial balance columns.
2.5 Errors and Final Accounts: An error may affect the profit and loss account by
wrongly increasing or decreasing the net profit and it may affect the balance sheet by
making the amount of an asset or a liability too much or too little. It is, therefore, necessary
that the errors should be carefully traced out and suitably rectified in order to get the correct
results of the business.
2.6 Location of Errors: When the trial balance does not agree, the accountant must try
to locate the errors and correct them. There is no set procedure, which can be followed for
locating errors in every case. The following steps, however, can be suggested for speedy
location of errors:
a. Re-checking the totals of the trial balance.
b. Re-checking that the items appearing in the trial balances are on their correct side.

92
c. See that the balance of all accounts have been written in the trial balance correctly.
d. See that there is no mistake in the balance of the various accounts.
e. Find out the exact difference in the trial balance. Look for such accounts as show the
same amount.
f. Posting of all amounts corresponding to the difference or half the difference should
be checked.
g. Error due to transposition of figures, i.e. Rs.36 taken as Rs.63 are also easily made.
In this case the trial balance is always divisible by 9. If that is so, bear this fact in
mind and recheck your work.
h. If the difference is not located, in spite of the fact that all the above tests have been
applied then all the account's balances in the ledger have to be checked thoroughly.
2.7 Correction of Errors: There are three ways of correcting the errors, which have been
committed.
a. By striking off the wrong figure and replacing it by the correct one.
b. By passing a correcting journal entry which neutralizes the wrong entry and at the
same time, results in making the correct entry.
c. By making a further debit or credit entry in the account in which the mistake has
been committed as may be necessary.
2.7.1 Correction of Errors Before Balancing of Books: In accounting work, correction of
errors should not be done by erasing or tempering the existing entries. In such a case books will
not be considered reliable in the court of Law. There should be no overwriting of figures.
.Students sometimes try to convert figure '3' into '5' and figure '6' into '8' this is bad. Whenever
any correction is made, it should be done by drawing a straight line through the wrong figure
and writing the correct figure above it. Every correction must be initialed by the person making
the correction. This method of correcting errors may be resorted to only in cases when the
books have not been added up and the ledger accounts have not been balanced.
Golden Rule: If accounts staff works properly and carefully, chances of errors will be
minimized to a great extent. The accounts manager or supervisor must check the work done
by the assistants regularly on a daily basis so that mistakes are located in time and no
difficulty is faced at the time of preparation of the Trial Balance.
2.7.2 Correction of Double-Sided Errors: The second method is passing a correcting
journal entry to rectify an error is more frequently used because it avoids the necessity of
canceling figures and the mistakes that are discovered after a long time can be rectified
without correcting several other wrong entries. This method of rectification of errors can
be applied only to mistakes, which are double-sided. Double-sided errors are one, which
exists simultaneously in two accounts. If the errors are double-sided, the following three
points may be kept in mind while correcting it.
i. What should have been the correct entry?
ii. Compare it with the entry actually made.
iii. How the correct position can be restored?
Example-1: A sum of Rs.670 spent on repairs of machinery has been charged to the Wages
Account. It is double-sided error. The mistake has affected both the machinery a/c and

93
wages a/c. The wages a/c is debited with Rs.670 too much. Repair's a/c is debited with
Rs.670 too short. There is an excess debit in the wages a/c and a short debit in the repair
a/c to rectify this error the following correcting entry should be passed:
Account Dr. Rs. Cr. Rs.
Repair account 670
To wages account 670
(Being the amount spent on repairs of the
machinery wrongly debited to wages a/c)

2.7.3 Third Method: One-Sided Errors: The third method of making a further debit or
credit entry in the account in which the mistake has been committed is applicable only to
one-sided errors. A one-sided error is one that affects only one aspect of the transaction or
that exists only in one ledger account. If an error is one-sided, it can be rectified by making
a journal entry debiting or crediting the ledger account which is wrong with the suspense
account which may be opened for the purpose if it does not already appear in the books.
For example, suppose the sale of Rs.100 has been recorded as the sale of Rs. 50 in the sales
book. This is a one-sided error. It affects only the sales account in the ledger. It means that
the entries in the sales book are correct and therefore, correct amounts have been posted to
the debit of individual customers in the ledger. The sales account has been credited with
Rs.50 too short. Therefore, to rectify this mistake the following entry should be made.
Debit the suspense account and credit the sales account with Rs.50 it may also be corrected
by making an adjusted credit entry in the sales account.
2.8 Suspense Account: A suspense account is opened in two cases
i) To balance a disagreed trial balance.
ii) To post doubtful items.
i. To balance a Disagreed Trial Balance: Sometimes, a trial balance does not tally
despite all efforts; but one cannot wait indefinitely, as accounts must be closed at the
end of a financial year. In such a case the amount of difference is entered in the
lighter column against the suspense account. A suspense account is opened in the
ledger and is given the debit or credit, as the case may be. Later, when the mistakes
are detected, the rectifying entries are passed.
ii. To Post Doubtful Items : Sometimes, an item cannot be posted to the correct account
for one reason or another. For instance, you may receive a remittance of Rs.1500 but
you may not know who has sent it. Then you should pass the following entry:
Example-5 Journal
Date Particulars LF Dr. Rs Cr. Rs

Cash A/c 1500

To suspense A/c 1500
(Being remittance, received from unknown sender)
Later, you get the information that Rahim, Shamim & Co, had sent this amount. Then you
should pass the following entry:
Date Particulars LF Dr .Rs Cr. Rs

94
 Suspense a/c 1500
Rahim, Shamim & Co. a/c 1500
(Being credit given to the sender for a remittance that had been
credited previously to suspense a/c)

Now, the following examples show the way for rectification of one-sided errors:
Example 6: Goods worth Rs. 1000 were sold to Mr. Rahim Sharif on credit. This was entered
in the sales daybook but was not posted into Sharif’s account. Here only the Sales Account has
been credited by Rs. 1000 without a corresponding debit. The trial balance will show a short
debit of Rs.1000. Now if the difference in trial balance has been transferred to the suspense
account, it implies that Rs.1000 has been debited by Rs.1000. For rectification, Sharif's account
is to be debited, and suspense account is to be credited to cancel the wrong entry. So, the
effective entry will be:
Sharifs A/c Dr. 1000
To Suspense A/c Cr. 1000
Example 7: An account Assistant failed to balance his trial balance, the credit side
exceeding the debit side by Rs.175. This amount was entered into a suspense account. Later
the following errors were discovered:
a. The total of the credit side of Rahim's account was overcast by Rs.100.
b. The sales book was undercast by Rs. 100.
c. Goods worth Rs.100 purchased from Chand were wrongly entered in the sales books.
The account of Chand was correctly credited.
d. The total of returns outward book amounting to Rs.200 was not posted to the ledger.
e. Rs.1500 paid for furniture purchased has been charged to the ordinary purchases
account.
f. A credit balance of Rs.755 of the rent receivable account was shown as Rs.570.
g. Goods worth Rs.620 sold to Rahman were correctly entered in the sales book but
posted to Rahim's account as Rs. 260/-.

Give the journal entries to rectify the errors and prepare the suspense account
Solutions: Journal
Date Particulars LF Dr. Rs. Cr. Rs
(a) Rahim’s account 100
To suspense account 100
(Being credit side of Rahim's account was overcast, now
corrected)
(b) Suspense account 100
To sales account 100
(Being the sales book was under-cast, now corrected)
(c) Purchases account 100
Sales account 100
To suspense account 200
(Being correction of wrong entry in sales book of a
purchase of goods from chand)

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(d) Suspense account 200
To returns outward account 200
(Being the total of returns outward book was not posted
to ledger, now posted)
(e) Furniture account 1500
To purchase account 1500
(Being the rectification of furniture wrongly debited to
purchase account
(f) Suspense account 185
To rent receivable account 185
(Being, a credit balance of Rs. 755/- of rent receivable
account was shown as Rs. 570/- now corrected
(g) Rehman’ account 360
To suspense account 360
(Being goods for Rs.620/- sold to Rahman were wrongly
posted to his account as Rs. 260/- now corrected.)
Suspense Account
Dr. Rs. Cr. Rs
Difference in T/B 175 Rahim 100
Sales account 100 Purchase account 100
Return outward a/c 200 Sales account 100
Rent receivable a/c 185 Rehman 360
660 660

2.9 Effect of Errors on Financial Statements: In order to calculate the effect of errors
on net profit it is essential to understand that only those accounts, which are taken to trading
or profit and loss, account affect profits. For example, purchases account, sales account,
salaries account, wages account, rent commission, depreciation, stock account, etc., affect
the net profit because they are shown either in the trading account or profit and loss
account. If any of these accounts are debited in the rectification entry, it reduces the profit
and if any of these accounts are credited then it increases the profit. Accounts, which are
shown in the balance sheet, do not affect net profit.
Example-8: The books of a firm were balanced on 31st December. On checking the books
and accounts the following mistakes were discovered:
a. Goods to the value of Rs.68 had been returned by Siraj on 30th December, and were
taken into stock but the entries recording the return were not passed through the
books until January of the following year.
b. Iron bars to the value of Rs.218/-purchased for enlarging the factory had been debited
to the purchases account.
c. Dishonored cheques for Rs.20 had been posted to the allowances account instead of
the account of Niamat, from whom it had been received.
d. Several creditor's balances, amounting to Rs.270/- stood in the bought ledger,
representing cash paid for goods but for which no invoices had been passed through
the books.

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 You are required to make journal entries to correct these errors. What was the effect
of these errors on the profit of the firm?
Solution: Journal Entries
Particulars Dr. Rs. Cr. Rs.
(a) Returns inward account 68
To Siraj's A/c 68
(Being goods returned by Smith now recorded)
(b) Factory building account 218
To purchases account 218
(Being rectification of iron bars wrongly debited to purchases)
(c) Niamat's A/c 270
To allowance account 270
(Being the rectification of the dishonored bill of Niamat wrongly
debited to allowances account)
(d) Purchases account 270
To sundry creditors 270
(Being the purchases not entered now recorded)

Effect of the errors on the profit of the firm:

Items Profit Overstated Profit Understated
(a) 68
(b) 218
(c) 20
(d) 270
338 238

Profit will remain overstated by a net amount of Rs.100 (338-238)

3. Accounting from Incomplete Record
3.1 Introduction to Single Entry System: The Single-Entry System is a simplified
bookkeeping method used primarily by small businesses, such as sole traders, to record
financial transactions. Unlike the Double Entry System, which is the standard and formal
accounting method, the single-entry system only records one aspect of each transaction,
typically focusing on cash receipts and payments, and may sometimes include records of
customers and suppliers. It does not maintain a complete record of assets, liabilities,
revenues, or expenses, as cash received is treated as revenue, and cash paid is treated as
expenses.

In this system, the concept of recording dual aspects of a transaction is not followed,
leading to incomplete records. As a result, the operating results must be derived from these
partial records, making it commonly referred to as “Accounting from Incomplete
Records.” Under IFRS standards, while the single-entry system may be acceptable for
very small businesses, it is generally not recommended for larger enterprises due to its
limitations in providing a comprehensive and accurate financial picture.

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3.1.1 Features of Single-Entry System
i. Application of Accounting Rules
No accounting rule is followed in this system of accounting, and transactions are
recorded by ignoring the principles of debit and credit.
ii. Real and Nominal Accounts
Real and nominal accounts i.e. assets, liabilities; expenses revenues, etc. are not
prepared and maintained.
iii. Personal Accounts
Under this system, only the personal accounts are maintained, to know the amount
due from customers and the amount owing to suppliers.
iv. Suitability: This system of bookkeeping is suitable for small businessmen, who are
operating his/her business as sole traders or on a partnership basis.
v. Economy
It is economical for the businessman because no proper accountant or bookkeeper is
hired to record the business transactions. A businessman himself may keep a record
of business transactions.
vi. Simple and Easy
It is very simple and easy because there is no rule or accounting principle followed.
Any person may record business transactions without getting any special education
or training in this regard.
vii. Variation in Recording Business Transactions
As we know no accounting policy is observed while recording the business
transactions. So every businessman records the transaction as per their own style and
convenience. So it varies from one businessman to another businessman.

3.1.2 Demerits or Drawbacks of Single-Entry System: Apart from the advantages of

single entry system, it has a number of drawbacks, which are described below:
i. Inaccurate operating results
Under the single-entry system, nominal accounts like revenue, expense, gain or
losses are not prepared. In the absence of these accounts, this is not possible to find
out accurate reporting results in terms of profit and loss.
ii. Financial Position of Business: The record of real accounts, i.e. assets and liabilities
is not kept properly, so the financial position of the business can’t be determined. In
case of liquidation, a businessman is not able to find out the book value of their assets
and liabilities.
iii. Unable to prepare the trial balance: Trial balance can be prepared only under the
double entry system and can’t be prepared under the single entry system. So it is not
possible to ensure the arithmetical accuracy of the described amounts.
iv. Risks of Fraud: Anyone can commit fraud easily because no proper accounts are
maintained under this system. So there are higher chances of fraud to be incurred.
v. Risks of Errors: Errors may occur in recording the transactions and can’t be found
easily because no trial balance is prepared and accounts are also not maintained
properly.

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vi. Incomplete system: Some transactions are not recorded and some are recorded
partially, so there is an incomplete system of accounting or we may say that there is
no system of bookkeeping or accounting.
vii. Unacceptable for tax: For the purpose of assessment of tax, this system is not
acceptable by the tax authorities. Because twofold aspects of each transaction are not
recorded, and the proper financial statements are not prepared.
3.2 Determination of Profit or Loss: It is not an easy task to estimate profit or loss from
the incomplete records of bookkeeping. However, the following two methods are used to
determine the profit or loss account and to know the financial position of the business:
A. By preparing the statement of affairs
B. By conversion into double entry

3.2.1 Profit/Loss Ascertainment by Preparing Statements of Affairs: The Net Worth

Method, also known as the Capital Method, calculates the operating results by comparing
the opening and closing capital of a business, based on two statements of affairs prepared
at different times. This method is used when detailed information about assets, liabilities,
revenues, and expenses is unavailable. Profit is determined if the closing capital is greater
than the opening capital, while a loss occurs if the closing capital is lower, assuming no
additional investments or withdrawals. Any investments or drawings during the period are
also considered in calculating profit or loss. While this method may be practical under
limited information, it is less precise than other accounting methods and generally not
preferred under IFRS for more detailed financial reporting.
i. Statement of Profit & Loss: That statement, which is prepared under the net worth
method to determine the profit and loss, is known as the statement of profit and loss.
The format of the statement of Profit and Loss is as follows:
ABC Company, Statement of Profit & Loss, For the period ended on …….
Capital at the end of the period Rs.
Add: Withdrawals during the period xxxxx
Less: Additional capital invested during the period xxxxx
Adjusted Capital at the end of the period xxxxx
Less: Capital at the beginning of period xxxxx
Net Profit/Loss during the period xxxxx
xxxxx
xxxxx
Example 09: Mr. Khan owned a tuck shop and used a single entry system to record the
business transactions. You are required to calculate the profit/loss of Mr. Khan’s Business
for the year ended on 31st December 2013 from the given data:
Capital at the beginning Rs. 150,000; Withdrawals during 2013. 25,000 and capital at the
end is reported at Rs. 225,000.

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Solution: Mr. Khan
Statement of Profit & Loss
For the period ended on 31st December, 2013
Capital at the end of the period Rs.
Add: Withdrawals during the period 225,000
25,000
Less: Additional capital invested during the period 250,000
Adjusted Capital at the end of the period Nil
Less: Capital at the beginning of period 250,000
Net Profit during the period 150,000
100,000
Example 10: Chaudhry Sons established a business on July 01, 2013 with a capital of Rs.
300,000. He introduced Rs. 125,000 as an additional investment and withdraws Rs. 50,000
during the year. On 30th June, 2014 he has assets of Rs. 400,000 and liabilities Rs. 40,000.
You are required to calculate the profit or loss of Chaudhry’s business for the year ended
on 30th June, 2014. Solution:
Capital At the end = Ending Assets – Ending Liabilities
= 400,000 – 40,000
= Rs. 360,000
Chaudhry Sons
Statement of Profit & Loss
For the period ended on 30th June, 2014
Rs.
Capital at the end of period 360,000
Add: Withdrawals during the period 50,000
410,000
Less: Additional capital invested during the period 125,000
Adjusted Capital at the end of the period 285,000
Less: Capital at the beginning of period 300,000
Net Loss during the period (15,000)

ii. Statement of Affairs

It is clear now that under the single entry system, the profit or loss of the business can only be
ascertained if the amounts of opening and closing capital are given. In case if the amounts of
opening or closing capitals or both are not given then the accountant will gather the details of
assets and liabilities at the beginning and ending period. After getting the details of assets and
liabilities, these will be enlisted in a statement to know the values of capital. That statement in
which assets and liabilities are recorded to know the amount of capital is known as statement
of affairs.

The statement of affairs is prepared like a balance sheet, in which amounts of assets
are listed on one side and liabilities are recorded at another side, the balancing amount is
considered the value of capital. Anyone who prepares the statement of affairs may get the
details of assets and liabilities from the following sources: A. Personal accounts of debtors
and creditors B. Bank Statement of the Business C. Cash book of the entity

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a. A list of assets and liabilities may be prepared with the help of the owner of the
business and Actual stocktaking.

After collecting the necessary information from various sources, statements of

affairs are prepared at two different points of time i.e. at the beginning and at the closing
period. The format of the statement of affairs is as follows:
XYZ Company
Statement of affairs
As on _________
Assets Amount Liabilities Amount
Cash in hand xxxxx Account Payable xxxxx
Cash at bank xxxxx Note/Bill Payable xxxxx
Sundry Debtors xxxxx Unearned Revenue xxxxx
Note / Bill Receivable xxxxx Expenses Payable xxxxx
Supplies xxxxx Bank Loan xxxxx
Stock xxxxx Debentures xxxxx
Prepaid expenses xxxxx
Capital (Bal. Fig.) xxxxx
Office Equipment xxxxx
Furniture & Fixture xxxxx
Plant & Machinery xxxxx
Building xxxxx
Total xxxxx Total xxxxx
iii. Difference between Statement of Affairs and Balance Sheet
A statement of Affairs is prepared like a balance sheet of the business but there is difference
between a Statement of Affairs and a Balance Sheet, which may be understood from the
following points:
Sr.
Basis Balance Sheet Statement of Affairs
No.
Bookkeeping It is prepared under the double entry It is prepared under the single entry
i.
System system bookkeeping. system of bookkeeping.
It is prepared to know the financial It is prepared to ascertain the
ii. Purpose
position of the business amount of capital.
It prepared on the basis of It doesn’t follow any rule or
iii. Application of Rules accounting rules, known as standard of accounting.
accountant standards and principles.
All the accounts shown in the Valuation of assets and liabilities
balance sheet, i.e. assets and are made on arbitrary or memory
liabilities are valued on the basis of basis of the owner.
Valuations of
iv. some rules or principles of
accounts
accounting, which may be cost basis
or market basis, or replacement cost
basis.

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 It is most reliable statement because It is not reliable statement because
v. Reliability it follows proper system of it is based on incomplete records of
accounting. bookkeeping.
It is prepared by taking data from It is prepared by gathering the data
vi. Source of Data adjusted trial balance. from different sources i.e. cash &
pass book, memory of owner etc.
It is essential part of Financial It is not the part of financial
vii. Essential Element Statements which must be prepared statements, it is just prepared for
and published by a company. his/her convenience.

Example 11: Mr. Kamal started his business on October 15, 2013 by investing Rs. 400,000
and recorded his business transactions under the single entry system of bookkeeping. He
further invested Rs. 200,000 and withdrew Rs. 100,000 during financial year. On
September 30, 2014 he wants to know the operating result of his business, for which he
provided the following data as on September 30, 2014:
Cash Rs. 15,000, Bank Balance Rs. 30,000, Debtors Rs. 55,000, Land & Building Rs.
270,000, Machinery Rs. 230,000, Office Equipment Rs. 120,000, Bank Loan Rs. 60,000
and sundry creditors Rs. 35,000
Depreciation @ 10% is charged annually on Machinery and Office Equipment on a
straight-line basis. Required: i. Prepare the statement of affairs as of 30-09-2014
ii.Prepare a statement of Profit & Loss account for the period ended on 30-09-2014
Solution: Mr. Kamal
Statement of affairs
As of September 30, 2014
Assets Amount Liabilities Amount
Cash in hand 15,000 Sundry Creditors 35,000
Cash at bank 30,000 Bank Loan 60,000
Sundry Debtors 55,000
Land & Building 270,000 Capital (Bal. Fig.) 590,000
Machinery (Net) 207,000
Office Equipment (Net) 108,000
Total 685,000 Total 685,000
Mr. Kamal
Statement of Profit & Loss
For the period ended on 30th September, 2014
Rs.
Capital at the end of the period 590,000
Add: Withdrawals during the period 100,000
690,000
Less: Additional capital invested during the period 200,000
Adjusted Capital at the end of the period 490,000
Less: Capital at the beginning of period 400,000
Net Profit made during the period 90,000

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Example 12: Ruhi Trader keeps his record of business under single entry system and wants
to know the operating result of his business. He provides the following data as on 31st
December 2013 and 31st December 2014 of his business:

As of 31st December, 2013: Cash in hand Rs. 25,000; Cash at bank Rs. 40,000; Account
Receivables Rs. 70,000; Stock Rs. 65,000; Land & Building Rs. 300,000, Office Furniture
Rs. 150,000, Office Equipments Rs. 80,000; Account Payables Rs. 95,000; Bills Payables
Rs. 30,000
As on 31st December 2014: Cash in hand Rs. 40,000; Cash at bank Rs. 60,000; Account
Receivables Rs. 110,000; Stock Rs. 85,000; Account Payables Rs. 75,000; Bills Payable
Rs. 45,000
Depreciation @ 5% on Land & Building; @ 15% on Office Furniture; @ 10% on Office
Equipment is charged annually on original cost.
During the year Ruhi trader withdrew Rs. 158,000 and invested Rs. 112,000 into the
business.
Required: i. Prepare the statement of affairs as on 31-12-2013 and as on 31-12-2014 to
calculate the amounts of capital.
ii. Prepare a statement of Profit & Loss account for the period ended on 31-12-2014
Solution: Ruhi Trader
Statement of Affairs
As on 31-12-2013
Assets Amount Liabilities Amount
Cash in hand 25,000 Account Payables 95,000
Cash at bank 40,000 Bills Payables 30,000
Account Receivable 70,000
Stock 65,000 Capital (Bal. Fig.) 605,000
Land & Building 300,000
Office Furniture 150,000
Office Equipment 80,000
Total 730,000 Total 730,000
Ruhi Trader
Statement of Affairs
As on 31-12-2013
Assets Amount Liabilities Amount
Cash in hand 40,000 Account Payables 75,000
Cash at bank 60,000 Bills Payables 45,000
Account Receivable 110,000
Stock 85,000 Capital (Bal. Fig.) 659,500
Land & Building 285,000
Office Furniture 127,500
Office Equipment 72,000
Total 779,500 Total 779,500

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 Ruhi Trader
Statement of Profit & Loss
For the period ended on 31-12-2013
Rs.
Capital at the end of period 659,500
Add: Withdrawals during the period 158,000
817,500
Less: Additional capital invested during the period 112,000
Adjusted Capital at the end of the period 705,500
Less: Capital at the beginning of period 605,000
Net Profit made during the period 100,500

Example 13 : Mr. Rayyan keeps his books on single entry system and provides the
following information:
January 1, 2014 December 31, 2014
Cash in hand Rs. 74,375 Rs. 122,500
Cash at bank 1,750 2,625
Sundry debtors 26,250 17,500
Merchandise inventory 175,000 166,250
Office equipments 15,750 -
Motor Vehicles 122,500 -
Furniture and Fixtures 140,000 -
Sundry Creditors 192,500 253,750
Advance from Customers 61,250 -
He invested further capital amounting to Rs. 157,500 on 1st April 2014 and withdrew Rs.
122,500 for personal use.
From the above-mentioned information, you are required to prepare the necessary
statements to ascertain the operating results of the business for the year that ended on
December 31, 2014, after considering the following necessary adjustments:
a) Charge 10% depreciation on all fixed assets.
b) Allow 10% interest on capital.
c) Create 5% provision for doubtful debts.
Solution: Mr. Rayyan
Statement of Affairs
As of January 1, 2014
Assets Amount Liabilities Amount
Cash in hand 74,375 Sundry Creditors 192,500
Cash at bank 1,750 Advance from Customers 61,250
Sundry Debtors 26,250
Merchandise inventory 175,000
Office equipment 15,750 Capital (Bal. Fig.) 301,875
Motor Vehicles 122,500
Furniture and Fixture 140,000
Total 555,625 Total 555,625

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 Mr. Rayyan
Statement of Affairs
As of December 31, 2014
Assets Amount Liabilities Amount
Cash in hand 122,500 Sundry Creditors 253,750
Cash at bank 2,625
Sundry Debtors 17,500
(-) Provision for B.D 875 16,625 Capital (Bal. Fig.) 304,675
Merchandise inventory 166,250
Office equipment 15,750
Motor Vehicles 122,500
Furniture and Fixture 140,000
278,250
(-) Depreciation @10% 27,825 250,425

Total 558,425 Total 558,425

Mr. Rayyan
Statement of Profit & Loss
For the period ended on December 31, 2014
Rs.
Capital at the end of period 304,675
Add: Withdrawals during the period 122,500
427,175
Less: Additional capital invested during the period 157,500
Adjusted Capital at the end of the period 269,675
Less: Capital at the beginning of period 301,875
(32,200)
Less: Interest on Capital @ 10% p.a
301,875 x 10/100 = 30,187.5
157,500 x 10/100 x 9/12 = 11,812.5 42,000
Loss made during the period 74,200
3.2.2 Profit/Loss Ascertainment by Conversion Method: The single-entry system is
often used by small businesses; however, as a business grows, it becomes impractical for
larger operations. To address this issue, businesses may switch to the double-entry system,
either with prospective or retrospective effects.
• Prospective Effect: The conversion is applied from the decision date onwards, and
future records are maintained according to double entry principles, without changing
prior records.
• Retrospective Effect: The conversion applies from the start of the accounting period, and
previous records are adjusted to align with the double-entry system.
For example, if a firm decides to convert on August 1, 2014, the records from January 1,
2014, to July 31, 2014, will also be adjusted. This method, especially with retrospective
effect, aligns with IFRS by ensuring accuracy and consistency in financial reporting across
periods.

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i. Procedure of conversion into double entry system: If the businessman keeps their
record on a single entry system and maintains a cash book and personal accounts
then the following procedure may be followed for conversion:
a. Find out the opening capital by preparing the statement of affairs at the beginning of
the period.
b. Calculate the credit purchases and post them into the purchases account.
c. Calculate the credit sales and post them into the sales account.
d. Post all items appearing in the cash book into their relevant accounts.
e. Examine all available information from the single-entry system, if any item found not
treated in the double-entry system should be picked up and incorporated into the double-
entry system.
f. Pass the opening journal entries by debiting the entire asset and crediting the respective
liabilities.
ii. Calculation of missing items: There is another method to obtain final results from
the single-entry system. This shortcut method may be used when the information on
opening and closing assets is given. According to this method, the trading, profit,
and loss account and the balance sheet may be prepared after finding the following
missing items:
a. Credit Purchases b. Sundry Debtors
c. Credit Sales d. Cash in hand
e. Cash at bank f. Cash purchases
g. Cash Sales h. Opening Stock
i. Bills Receivables j. Bills Payables
a. Opening Capital: The value of opening capital may be ascertained by preparing the
statement of affairs.
b. Find out the Sundry Creditors and Credit Purchases
The missing values of creditors and credit purchases may be found by preparing the
sundry creditors' accounts as follows:
SUNDRY CREDITORS ACCOUNT
Particulars Amount Particulars Amount
Cash paid to Creditors xxxx Balance b/d (Opening) xxxx
Purchases Return & Allowances Credit Purchases xxxx
Discount Received xxxx Bills Payable Dishonored xxxx
Bill Payable (Acceptance given) xxxx
Balance c/d (Closing)
xxxx
xxxx
xxxx xxxx
c. Ascertainment of Sundry Debtors and Creditor Sales: The missing values of
debtors and credit Sales may be found by preparing the sundry debtors account as follows

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SUNDRY DEBTORS ACCOUNT
Particulars Amount Particulars Amount
Balance b/d (Opening) xxxx Cash Received from debtors xxxx
Credit Sales xxxx Bill Receivable (Received) xxxx
Bills Receivable (Dishonored) Sales Returns & Allowances xxxx
xxxx Discount Allowed xxxx
Bad Debts xxxx
Balance c/d (Closing) xxxx
xxxx xxxx
d. Ascertainment of cash in hand, cash purchases, and cash sales: By preparing the
cash account, any one of the above-mentioned items may be found.
e. Ascertainment opening Stock: If opening stock is not given, it may be found with the
help of gross profit percentage to sales. A memorandum trading account is prepared by
filling in the given information; calculating the gross profit based on a given percentage
and finding the value of closing stock by taking the balancing figure.
f. Ascertainment Bills Receivable: By preparing the bills receivable account, the
value of bills receivable may be found. The structure of the bills receivable account
is given as follows:
BILLS RECEIVABLE ACCOUNT
Particulars Amount Particulars Amount
Balance b/d (Opening) xxxx Cash (B/R honored) xxxx
Sundry Debtors (Acceptance Creditors A/c (B/R Endorsed) xxxx
Received) xxxx Debtors A/c (B/R Dishonored)
Balance c/d (Closing) xxxx
xxxx
xxxx xxxx
g. Ascertainment Bills Payable: Amount of Bills Payable may be found out by
preparing the bills payable account, described as follows:
BILLS PAYABLE ACCOUNT
Particulars Amount Particulars Amount
Cash A/c (B/P honored) xxxx Balance b/d (Opening) xxxx
Creditors A/c (B/P Dishonored) Creditors A/c (Acceptance given)
Balance c/d (Closing) xxxx xxxx
xxxx
xxxx xxxx
Example 14: Mr. Talal keeps his books on single entry system and provides the following
information and requires from you to calculate credit sales and total sales for the year ended
on 30th September, 2014 (All Amounts are in Rupees):
Cash Sales 420,000 Return inwards 33,600
Debtors (Opening) Debtors
234,000 (Closing) 300,000
Bad Debts B/R
30,000 690,000
Cash collection from Debtors B/R Dishonored
720,000 150,000
Solution:
Credit sales may be obtained by preparing the following debtors account:

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 DEBTORS ACCOUNT
Particulars Amount Particulars Amount
Balance b/d (Opening) 234,000 Cash A/c 720,000
Credit Sales (Bal. Fig.) 1,389,600 Bill Receivable 690,000
Bills Receivable (Dishonored) Returns inwards 33,600
150,000 Bad Debts 30,000
Balance c/d (Closing) 300,000
1,773,600 1,773,600
Total Sales = Credit Sales + Cash Sales
Rs. 1,809,600 = Rs. 1,389,600 + Rs. 420,000
Example 15: Mr. Yaawar is operating a garments shop and doesn’t maintain the record of
his business transactions properly. He wants to calculate the value of total purchases that
he made in the last three months. You are required to help him in calculating the value of
total purchases from the following information provided by him: (All Amounts are in
Rupees):
Cash Purchases 300,000 Return outwards 55,700
Accounts Payables (Beginning) Accounts Payables
275,300 (Ending) 422,800
Cash Paid to Creditors 187,650 Discount Received 27,000
Solution: To calculate the value of total purchases, credit purchases should be calculated
first, which may be calculated from the following account:
CREDITORS ACCOUNT
Particulars Amount Particulars Amount
Cash A/c 187,650 Balance b/d (Opening) 275,300
Purchases Returns 55,700 Credit Purchases (Bal. Fig.) 417,850
Discount Received 27,000
Balance c/d (Closing) 422,800
693,150 693,150
Total Purchases = Credit Purchases + Cash Purchases
Rs. 717,850 = Rs. 417,850 + Rs. 300,000
Example 16: From the following particulars, provided by Mr. Haashim, you are required
to calculate the amount of Acceptance given during the last month of operation:
Opening balance of Bills Payable Rs. 15,600
Closing balance of Bills Payable 23,800
Bills Payable honored during last month 150,500
Bills Payable dishonored during last month 25,900
Solution: BILLS PAYABLE ACCOUNT
Particulars Amount Particulars Amount
Cash A/c (B/P honored) 150,500 Balance b/d (Opening) 15,600
Creditors A/c (B/P Dishonored) Creditors A/c (Acceptance given)
Balance c/d (Closing) 25,900 184,600
23,800
200,200 200,200

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Example 16: Haji Waqar owns a bookshop and keeps his business record based on a
single-entry system. The following Balances are taken from his books of accounts:
June 30, 2014 June 30, 2015
Cash in hand Rs. 44,625 Rs. 73,500
Cash at bank 1,050 1,575
Accounts Receivables 15,750 10,500
Stock 105,000 136,500
Office equipment 9,450 9,450
Furniture and Fixtures 84,000 84,000
Accounts Payables 115,500 152,250
Haji Waqar provides the following further information related to his business:
i. Collected Rs. 22,300 from the debtors and allowed a discount amounting Rs. 750.
ii. Paid Rs. 87,600 to sundry creditors and received Rs. 1,900 as a discount.
iii. Paid Rs. 15,500 as salaries; and Rs. 4,100 as utilities bills.
iv. Withdrew cash Rs. 1,250 for personal use.
Required: Prepare trading, Profit, and loss account for the year ended on June 30, 2015,
and balance sheet as on June 30, 2015.
Solution: Note: Before preparing the trading, profit, and loss account and balance sheet, it
is necessary to prepare the debtors and creditors account to find the value of sales and
purchases, the cash account to ascertain the value of cash sales, and the statement of affairs
to know the opening capital of the entity.

DEBTORS ACCOUNT
Particulars Amount Particulars Amount
Balance b/d (Opening) 15,750 Cash A/c 22,300
Credit Sales (Bal. Fig.) 17,800 Discount 750
Balance c/d (Closing) 10,500
33,550 33,550
CREDITORS ACCOUNT
Particulars Amount Particulars Amount
Cash A/c 87,600 Balance b/d (Opening) 115,500
Discount Received 1,900 Credit Purchases (Bal. Fig.) 126,250
Balance c/d (Closing) 152,250
241,750 241,750
CASH ACCOUNT
Particulars Amount Particulars Amount
Opening Balance 44,625 Creditors (Cash paid) 87,600
Debtors (Cash received) 22,300 Salaries expenses 15,500
Cash Sales (Bal. Fig.) 115,025 Utilities expenses 4,100
Drawings 1,250
Closing Balance 73,500
181,950 181,950

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 HAJI WAQAR
STATEMENT OF AFFAIRS
AS ON JUNE 30, 2014
Assets Amount Liabilities Amount
Cash in hand 44,625 Sundry Creditors 115,500
Sundry Debtors 15,750
Merchandise inventory 105,000
Office equipments 9,450 Capital (Bal. Fig.) 143,325
Furniture and Fixture 84,000
Total 258,825 Total 258,825
Total Sales = Cash Sales
+ Credit Sales
Rs. 132,825 = Rs. 115,025
+ Rs. 17,800
HAJI WAQAR
TRADING, PROFIT & LOSS ACCOUNT
FOR THE PERIOD ENDED ON JUNE 30, 2015
Particulars Amount Particulars Amount
Opening Stock 105,000 Sales 132,825
Purchases 126,250 Closing Stock 136,500
Gross Profit c/d 38,075

269,325 269,325

Salaries Expenses 15,500 Gross Profit b/d 38,075

Utilities Expenses 4,100 Discount Received 1,900
Discount Allowed 750
Net Profit 19,625

Total 39,975 Total 39,975

HAJI WAQAR
BALANCE SHEET
AS ON JUNE 30, 2015
Assets Amount Liabilities Amount
Cash in hand 73,500 Sundry Creditors 152250
Sundry Debtors 10,500 Capital Rs. 143,325
Merchandise inventory 136,500 (-)Drawings 1,250
Office equipment 9,450 142,075
Furniture and Fixture 84,000 (+) Net Profit 19,625
161,700
Total 313,950 Total 313,950

110
UNIT – 6

CASH & BANK

TRANSACTIONS

Written by:
Syed Umar Farooq
Asia Batool
Reviewed by:
Talat Mahmood,
Sohail Amjed
Muhammad Munir Ahmad
111
 CONTENTS
Sr. Subject Page No.
Introduction 113

Objectives 113
1. CASH BOOK 114
1.1 Importance of Cashbook 114
1.2 Advantage of Cashbook 114
1.3 Features of Cashbook 114
1.4 Vouchers 114
2. POSTING OF CASHBOOK 114
2.1 Kinds of Cashbook 114
2.2 Single Column Cashbook 114
2.3 Double or Two Column Cashbook 117
2.4 Three Column Cashbook 123
3. BANKING TRANSACTIONS 127
3.1 Double Record of Bank Transactions 127
3.2 Causes of Disagreement 127
3.3 Bank Reconciliation Statement 127
3.4 First Method 128
3.5 Second Method 128
4. PETTY CASHBOOK 141
4.1 Definition 141
4.3 Imprest System 141

4.4 Advantages of Impress System 142

5. Cash Verification, Cash Short and Over Account 143

6. SUMMARY 144

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 INTRODUCTION
Cash is one of the most important assets in a business organization. No work, no
production, no purchase, and no sale can be done without cash. A cashbook is maintained
to record receipts and payments of cash. In accounting work, cashbook operations are very
important. The student must learn and carefully see how cash books are written and
balanced periodically.

The bank sends a bank statement weekly or monthly. The Accountant must learn
how to check the bank statements with the corresponding record kept by him. He must
learn how to reconcile any differences between the entries made by him in his ledger Bank
Account and those recorded and shown by the bank in the weekly or monthly bank
.statement. All these things will be dealt with in detail in this Unit, and the student is
advised to carefully follow the examples given in each case.

OBJECTIVES
The study of this unit will enable you to understand and learn about the following matters
regarding the cash operations of a firm or company.
- Necessity of writing the cash book
- Different kinds of cash book
- Posting of cash vouchers in the cash book
- Posting to ledger accounts from the cash book

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1. CASHBOOK
1.1 Importance of Cashbook: The cashbook is a critical book of original entries in any
business, used to record all cash receipts and payments. Due to the high volume of cash
transactions and the risk of theft, it is essential to maintain an accurate, up-to-date record
that is monitored by a responsible person. Cashbooks vary in format based on business
needs but serve the vital purpose of tracking all cash dealings, ensuring accuracy and
accountability.

1.2 Advantage of Cashbook: The primary advantage of a cashbook is its role as both a
book of original entries and part of the ledger. It simplifies recording by listing cash receipts
on the debit side and payments on the credit side. As cash transactions are the most frequent
in any business, having a separate book for these entries improves organization and control.
The balances from the cashbook are included in the trial balance and balance sheet, just
like other ledger accounts, ensuring comprehensive financial reporting.

1.3 Features of Cashbook

1. Only cash transactions are recorded in the cashbook.
2. It performs the functions of both the journal and the ledger at the same time.
3. All cash receipts are recorded on the debit side and all cash payments are recorded
on the credit side.
4. It records only one aspect of a transaction i.e. cash.
5. All cash transactions are recorded chronologically, date-wise, in the cashbook.
6. The cashbook, recording only cash transactions, can never show a credit balance.

1.4 Vouchers: For every entry made in the cashbook, there must be a proper voucher.
Vouchers are documents containing evidence of payments and receipts. When money is
received generally a printed receipt is issued to the payer but the counterfoil of the carbon
copy of it is preserved by the cashier. These copy receipts are called debit vouchers, and
they support the entries appearing on the debit side of the cashbook. Similarly, when
payment is made a receipt is obtained from the payee. These receipts are known as credit
vouchers. All the debit credit vouchers are consecutively numbered. For ready reference,
the number of the vouchers is noted against the respective entries. A column is provided
on either side of the cashbook for this purpose.

2. POSTING OF CASH BOOK

2.1 Kinds of Cashbook: The following are the three forms of cashbook met with in
practice:
i. Single-column cashbook or simple cashbook
ii. Double-column cashbook
iii. Triple-column cashbook (or three-column cashbook).
2.2 Single-column cashbook: It records only cash receipts and payments. It has only
one amount column on each of the debit and credit sides of this book. All the cash receipts
are entered on the debit side and the cash payments are on the credit side.

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How to make entries?: While writing a Single Column Cashbook the following points
should be kept in mind:
1. The pages of the cashbook are vertically divided into two equal parts. The left-hand
side is for recording receipts and the right-hand side is for recording payments.
2. Begin the cashbook with the balance brought forward from the preceding period or
with what we start. It appears at the top of the left side as To Balance" or "To Capital"
in case of a new business.
3. Record the transactions in order of date.
4. If any amount of cash is received on the account, the name of that account is entered
in the particular column by the word "By" on the left-hand side of the cashbook.
5. If any amount is paid on an account, the name of the account is written in the particular
column by the word "By" on the right-hand side of the cashbook.
6. It should be balanced at the end of a given period.
Posting: The balance at the beginning of the period is not posted but other entries appearing
on the debit side of the cash book are posted to the credit side of the respective accounts in
the ledger, and the entries appearing on the credit side of the cash book are posted to the
debit side of the proper accounts in the ledger.
Example-1: Write the following transactions in the Simple cashbook and post them into
the ledger:
Date Accounts Rs.
Jan. 1 Cash in hand 15000
Jan. 6 Purchased goods for cash 2000
Jan. 16 Received from Akbar 3000
Jan. 18 Paid to Babar 1000
Jan. 20 Cash sales 4000
Jan.25 Paid for stationery 60
Jan.30 Paid for salaries 1000
Jan. 31 Purchased office furniture 2000
Solution:
Debit Side Credit Side
Date Particulars VN LF Amount Date Particulars VN LF Amount
Jan. 1 Balance b/d 15000 Jan. 6 By Purchase 2000
“ 16 To Akbar 3000 “ 18 By Babar 1000
“ 20 To Sales a/c 4000 “ 25 By Stationery 60
“ 30 By Salaries a/c 1000
“ 31 By Furniture a/c 2000
By Balance b/d 15940
22000 22000

Feb.1 To balance b/c

15940
Akbar Account
January 16, By Cash 3000 Cr.
Sales Account
January 2, By Cash 4000 Cr.

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Purchase Account
January 6, To Cash 2000 Dr.
Babar
January 18, To Cash 1000 Dr.
Stationery Account
January 25, To Cash 60 Dr.
Salaries Account
January 30, To Cash 1000 Dr.
Furniture Account
January 31, To Cash 2000 Dr.
The student should note that when postings to the ledger accounts from the cashbook are
made, the following points should be carefully noted:
A: Cashbook receipt side: (Cash receipts): Cash receipt side denotes debits to cash.
Hence relevant accounts in the ledger would be credited. For example, cash received
from Akbar would be shown in the cashbook on the debit side, while in the ledger,
Akbar's account would be credited.
B: Cashbook payment side (cash payment): In this case cash account has been
credited to the cashbook. Hence corresponding accounts would be debited in the
ledger, for example, payments on account of salaries; stationery, and purchases
would be debited in the following accounts respectively:
- Salaries Account
- Stationery Account
- Purchases Account
Example 2: Mr. Ali is running a sole proprietorship business. Major operations of business
include manufacturing and sale of sports items. The business has limited clients in the city,
but the business is in the phase of expanding its clients by offering discounts and
competitively better prices. The business recently hired a new accountant to look at its
accounting activities. First assignment of the new accountant was to prepare the cash book
of the business for the month of January, 2016.
During the month of January 2016, following transactions were recorded; the
accountant is required to enter the transaction in single-column cash Book.
Date Accounts Amount
2016Jan.1st Mr. Ali started the business with cash 700,000
…..7 Purchased goods for cash 200,000
….13 Paid for stationery 12,000
….18 Sold goods for cash 150,000
….21 Paid for salaries 120,000
….23 Received Cash from Mr. Ahmer 100,000
….24 Paid cash to Mr. Noman 50,000
….26 Drew cash from business for personal use 10,000
….27 Paid for electricity bill 15,000
….29 Paid rent 25,000
Required: Prepare Single Column Cash Book Solution:

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 MR. Ali
Single-column cash Book
For the month of January, 2016
Dr. Cr.
Date Particular V.N L.F Cash Date Particular L.N L.F Cash
Rs. Rs.
2016 2016
Jan.1 Capital a/c 5 700,000 Jan.7 Purchases A/c 6 200,000
...18 Sales A/c 8 150,000 …13 Stationery a/c 3 12,000
…23 Mr. Ahmer 7 100,000 …21 Salaries 4 120,000
…24 Mr. Noman 9 50,000
…26 Drawing 1 10,000
…27 Electricity bill 2 15,000
…29 Rent 13 25,000

Jan.31 Balance c/d 518,000

2015 950,000 950,000
Feb.1 Bal. b/d 518,000
2.3 Double or Two-Column Cashbook: A double-column cashbook is one, which
consists of two separate columns on the debit side as well as the credit side for recording
cash and discount. In many concerns, it is customary for traders to allow or to receive a
small allowance against the dues. These allowances are made for prompt settlement of
accounts. In certain businesses, almost all receipts or payments are accompanied by such
discounts, and in order to avoid unnecessary postings separate columns in the cashbook are
introduced to record the discounts received or allowed. These discount columns are
memorandum columns only. They do not form the 'Discount Account'. The discount
column on the debit side of the cashbook will record discounts allowed and that on the
credit side discounts received.
Posting: The cash columns will be posted in the same way as the simple cashbook. But as
regards discount column. Each item of discount allowed (Dr. side of cashbook) would be
posted to the credit of the respective personal account. Similarly, each item of discount
received will be posted to the debit side of the respective personal account. The total of the
discount column on the debit side of the cash book will be posted to the debit side of the
discount account in the Ledger and the total of the discount column on the credit side of
the cash book on the credit side of the discount account. The discount columns are not
balanced like the cash column of the cashbook.
Example 3: Form the following transactions and write up a two-column cashbook and
posting ledger:
Jan. 1, Cash in hand Rs. 2000/-
Jan. 7, Received from Riaz & Co. Rs. 200/- Discount allowed Rs. 10/-
Jan. 12, Cash sales Rs. 1000/-
Jan. 15, Paid Zahoor Sons Rs. 500/-. Discount received Rs. 15/-
Jan. 20, Purchased goods for cash Rs. 300/-
Jan. 25, Received from Salam Rs.500/-, Discount received Rs.15/-

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 Jan. 27, Paid Hassan & sons Rs.300/-
Jan. 28, Bought furniture for cash Rs.100/-
Jan. 31 Paid rent Rs. 100/
Solution:
Date Particular VN Lf Disc. Cash Date Particular VN LF Disc. Cash
Jan. 1 To balance b/d . 2000 Jan. 15 By Zahoor sons 15 500
Jan. 7 T Riaz & Co. 10 200 Jan. 20 By Purchases 300
a/c
Jan. To sale a/c 1000 Jan. 27 By Hasan & 300
12 Sons
Jan. To Salman 15 500 Jan. 28 By furniture a/c 100
25
Jan. 31 By rent a/c 100
Jan.31 By balance c/d 2400
Total 25 3700 Total 15 3700
Feb. 1 To balance b/d 2400
Riaz & Company Account
Jan. 7 By cash 200
By discount 10
Sales Account
Jan. 12 By cash 1000
Salman Account
Jan. 25 By cash 500
By discount 15
Zahoor & Sons Account
Jan. 15, Cash Discount 500
15
Purchase Account
Jan. 20, Cash 300
Hassan & Sons Account
Jan. 27, Cash 300
Furniture Account
Jan. 28, Cash 100
Rent Account
Jan. 31, Cash 100
Discount Account
Jan. 31, To sundries as per cash 25 Jan. By sundries as per cash book 15
book 31
Example-4: Mr. Fiazan and his sons are running a Partnership business.. Suppose you are
the accountant of the business; you are required to prepare a double-column cash book for
the months of March 2025. During the month of March 2025, the following transactions
were recorded you are required to enter the transactions in a double-column cash Book and
post them into the ledger.

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 2025 Cash in hand. Rs. 900,000
Mar1 Received Cash from Mr. Akber and allowed discount Rs.500. 155,000
…9 Paid for salaries. 18,500
...16 Purchased goods for cash invoice no.21. 150,000
…19 Paid for stationary. 18,000
...22 Goods sold for cash invoice no.25. 165,000
...24 Paid cash to Mr. Noman and received discount Rs.500. 75,000
...26 Goods taken by proprietor for personal use. 15,000
..28 Paid for electricity bill. 22,000
..30 Purchased Machinery. 225,000
..31 Received a cheque from Mr. Waqar 125,000
..31
Required: Prepare Double double-column cash Book and post into the ledger.
Solution: Mr. Fiazan & Sons
Double-column cash Book
For the month of March, 2025
Dr (Page # 3) Cr
Date Particular V.N L.F Disc. Cash Date Particular V.N L.F Disc. Cash
Rs. Rs. Rs.
2025 2025
Mar.1 Balance b/d 900,000 Mar.
09 Mr. Akbar 2 500 155,000 16 Salaries a/c 05 18,500
24 Sales a/c 25 7 165,000 19 Purchases a/c 21 04 150,000
31 Mr. Waqar 18 125,000 22 Stationery a/c 11 18,000
26 Mr. Noman 08 500 75,000
28 Drawing a/c 09 15,000
30 Electricity bill 13 22,000
31 Machinery a/c 15 225,000
Mar.31 Balance c/d 821,500

2025
Apr.1 Balance b/d
500 1,345,000 500 1,345,000

821,500

Ledger
Mr. Akbar Account (Folio 2)
Date Particular J.R V.N Dr. Cr. Balance Cr
Rs. Rs. Rs.
2016
Mar.09 Cash a/c 3 23 55,000 155,000

Salaries Account (Folio 5)

Date Particular J.R V.N Dr. Cr. Rs. Balance Dr.
Rs. Rs.
2016
Mar.16 Cash a/c 3 18,500 18,500

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Purchases Account (Folio 4)
Date Particular J.R V.N Dr. Cr. Balance
Rs. Rs. Dr.
Rs.
2016
Mar.19 Cash a/c 3 21 150,000 150,000
Stationery Account (Folio 11)
Date Particular J.R V.N Dr. Cr. Balance Dr.
Rs. Rs. Rs.
2016
Mar.22 Cash a/c 3 18,000 18,000
Sales Account (Folio 7)
Date Particular J.R V.N Dr. Cr. Balance
Rs. Rs. Cr
Rs.
2016
Mar.24 Cash a/c 3 25 165,000 165,000
Mr. Noman Account (Folio 08)
Date Particular J.R V.N Dr. Cr. Balance Dr.
Rs. Rs. Rs.
2016
Mar.26 Cash a/c 3 75,000 75,000
Drawing Account (Folio 09)
Date Particular J.R V.N Dr. Cr. Balance Dr.
Rs. Rs. Rs.
2016
Mar.28 Cash a/c 3 15,000 15,000
Electricity bill Account (Folio 13)
Date Particular J.R V.N Dr. Cr. Balance
Rs. Rs. Dr.
Rs.
2016
Mar.30 Cash a/c 3 22,000 22,000
Machinery Account (Folio 15)
Date Particular J.R V.N Dr. Rs. Cr. Rs. Balance Dr. Rs.
2016 Mar.31 Cash a/c 3 225,000 225,000
Mr. Waqar Account (Folio 18)
Date Particular J.R V.N Dr. Rs. Cr. Rs. Balance Cr.
Rs.
2016 Mar.31 Cash a/c 3 125,000 125,000
Example-5: Mr. Khazir deals with the purchase and sale of furniture items. Business has
been operating its activities since a decade and has a good reputation in the market.
Recently the accountant of the business left the job. Mr. Khazir is now looking for an
accountant who can look after the recording of transactions and maintenance of cash book
on regular basis. New accountant is required to help Mr. Khizar in preparation of Double
column cash book and the further posting of the transactions into the general ledgers.
During the month of May 2016, following transactions were recorded.

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 2016
May1 Cash in hand Rs. 250,000.
03 Paid for salaries Rs. 25,000.
09 Paid for stationary Rs. 14,000.
12 Goods sold for cash Rs. 50,000 @1% cash discount invoice No. 52.
15 Paid cash to Mr. Ali Rs.25, 000 and received discount Rs.500, which were goods purchased
on credited from him.
17 Drew cash from business for personal use of owner Rs. 10,500.
17 Goods sold for cash Rs.10, 000.
23 Paid for Rent Rs.18, 500.
26 Purchased Furniture Rs. 28,500.
28 Received a cheque from Mr. Amir and deposited into bank Rs. 20,000.
28 Received Cash from Mr. Manan Rs. 29,700 and allowed discount Rs.300
29 Paid for trade expense Rs. 5,000.
31 Cheque Received Rs. 24,500 from Mr. Azeem in full settlement of his account Rs.25, 000.
Required: Prepare Double Column Cash Book and post into ledger.
Solution:
Mr. khazir
Double column cash Book
For the month of May, 2016
Dr. (Page. 108) Cr.
Date Particular V.N L.F Dis. Cash Date Particular V.N L. Disc. Cash
Rs. Rs. F Rs. Rs.
2016 Balance b/d 250,000 2016
May 1 Sales a/c (w-1) 5 500 49,500 May.
12 Sales a/c 52 5 10,000 03 Salaries a/c 2 25,000
17 Mr. Manan 23 300 29,700 09 Stationery a/c 1 14,000
28 Mr. Azeem 28 500 24,500 15 Mr. Ali 5 500 25, 000
31 17 Drawing a/c 0 10,500
23 Rent a/c 9 18,500
26 Furniture a/c 0 28,500
29 Trade 8 5,000
expense 1
May. Balance c/d 2 237,200
31 1
6
1,300 363,700 2 500 363,700
4
237,200
2016 Balance b/d
Jun.1
Working -1 Goods Sold for cash Rs. 50, 000 discount 5% invoice No. 52.
Goods price = Rs.50, 000
Discount rate = 1%
= Rs. 50,000 × 1 ÷ 100 = Rs.500
Discount price = Rs.500
Net goods price after discounts = Rs.50, 000 – Rs.500 = Rs.49, 500
Note:
L.F = Ledger Folio
J. R = Journal References
V.N = Voucher No

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C/D = Carried down / Ending balance
B/d = brow down / opening balance
Ledger
Salaries Account (Folio 2)
Date Particular J.R V.N Dr. Rs. Cr. Balance Dr. Rs.
Rs.
2016
May.03 Cash a/c 108 25,000 25,000
Stationery a/c (Folio 15)
Date Particular J.R VN Dr. Rs. Cr. Balance Dr. Rs.
Rs.
2016
May.09 Cash a/c 108 14,000 14,000
Sales a/c (Folio 5)
Date Particular J.R V.N Dr. Cr. Balance Cr.
Rs. Rs. Rs.
2016
May.12 Cash a/c 108 52 49,500 49,500
May.17 Cash a/c 108 10,000 59,000

Mr. Ali (Folio 09)

Date Particular J.R V.N Dr. Rs. Cr. Balance Dr. Rs.
Rs.
2016
May.15 Cash a/c 108 25,000 25,000
Drawing a/c (Folio 08)
Date Particular J.R V.N Dr. Rs. Cr. Balance Dr. Rs.
Rs.
2016
May.17 Cash a/c 108 10,500 10,500

Rent a/c (Folio 12)

Date Particular J.R V.N Dr. Rs. Cr. Balance Dr. Rs.
Rs.
2016
Mar.23 Cash a/c 108 18,500 18,500
Furniture a/c (Folio 16)
Date Particular J.R V.N Dr. Rs. Cr. Balance Dr. Rs.
Rs.
2016
May.26 Cash a/c 108 28,500 28,500
Mr. Manan A/c (Folio 23)
Date Particular J.R V.N Dr. Rs. Cr. Rs. Balance Cr. Rs.
2016
May.28 Cash a/c 108 29,700 29,700

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Trade expense A/c (Folio 24)
Date Particular J.R V.N Dr. Rs. Cr. Balance Dr. Rs.
Rs.
2016
May.29 Cash a/c 108 5,000 5,000
Mr. Azeem A/c (Folio 28)
Date Particular J.R V.N Dr. Rs. Cr. Rs. Balance Cr. Rs.
2016
May.31 Cash a/c 108 24,500 24,500
2.4 Three-Column Cashbook: A three-column cashbook is one in which there are three
columns on each side, i.e. debit & credit side, one is used to record cash transactions; the
second is utilized for bank transactions, while in the third column, discount is recorded.
When a trader keeps a bank account it becomes necessary to record the amounts deposited
into the bank and withdrawals from it. For this purpose, one additional column is added on
each side of the cashbook. Such a cashbook is very helpful to businessmen since it reveals
the cash and bank account at a glance.
Procedure
1. Put the opening balance (if any) of cash in hand and cash at the bank on the debit
side in the cash and bank column. If the opening bank balance is a credit balance
(overdraft) then it will be put in the credit side of the cashbook in the bank column.
2. Cheques or cash received. If a cheque is received from any person and is paid into
the bank on the same date it will appear on the debit side of the cashbook as "To a
person". The amount will be shown in the bank column. If the cheques received are
not deposited into the bank on the same date, then the amount will appear in the cash
column. Cash received will be recorded in the usual manner in the cash column.
3. Payment by cheques or cash. When we make a payment by cheque, this will appear
on the credit side "by a person or other account" and the amount will be shown in
the bank column. If the payment is made in cash, it will be recorded in the usual
manner in the cash column.
4. Contra Entries. Contra entries are those entries that affect both sides of the cashbook
simultaneously. For instance, when the cash in hand is deposited into the bank
account bank account is debited and the cash account is credited with the same
amount or when the cash is withdrawn from the bank for office use the cash account
is debited and the bank account is credited for this single transaction. These types of
entries are called contra entries.
Further explanation of the contra entries:
a. Cash is deposited into the Bank by office. It is payment from cash and receipt in the
bank. Therefore, enter the "To Cash" column. The reason for making two entries is
to comply with the principle of double entry, which in such transactions is completed,
and therefore, no posting of these items is necessary. Such entries are marked in the
cashbook with the letter "C" in the folio column.
b. Cheques are drawn for office cash. It is payment by bank and receipt in cash.
Therefore, enter on the debit side, the cash column "To bank" and on the credit side,
the bank column "By Cash".

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 Bank charges and bank interest are allowed. Bank charges appear on the credit side, bank
column "By Bank Charges". Bank interest allowed appears on the debit side, bank column
"To Interest".
Posting: The method of posting of a three-column cashbook into the ledger is as follows:
1. The opening balances of cash in hand and cash at the bank are not posted.
2. Contra entries (marked with C) are not posted.
3. All other items on the debit side will be posted to the credit of all other items on the
credit side will be posted to the debit of the respective accounts.
4. As regards discounts, the total of the discount allowed would be posted to the debit
of the discount allowed account in the ledger and the total of the discount received
to the credit side of the discount received account hence these are two separate
accounts one is expense and the other is income.
Example-6: Hussain & Co. is a partnership business dealing with the supply of surgical
items. During January 2025, the following transactions were recorded:
Date Particular
2025
Jan.1 Cash balance 500,000 from which deposited into Bank Rs. 300,000.
3. Cash purchases Rs. 35000 less 2.5% trade discount.
5. Received cheque Rs.85, 000 for sale of old Furniture and deposited into bank same
8. day.
10. Cash drew from bank Rs. 17,500 and paid to salaries Rs. 7,500 and rent Rs. 10,000.
12. Bank charges Rs. 1,800
13. Purchased furniture paid by cheque. Rs. 25,300.
15. Paid salary Rs. 14,000.
19. Cash deposited into Bank Rs. 21,000.
23. Goods sold to Mr. Ali on credit Rs. 28,000.
26. Paid telephone charges Rs. 2000.
27. Received a cheque from Mr. Ali Rs. 27,500 but full settlement of his account Rs.
28. 28,000.
29. Mr. Ali‘s cheque deposited into Bank.
30. Withdrew from the bank for business use Rs. 45,000.
31. Cash drew from business for his personal use. Rs. 5,000.
Stationery purchased for cash Rs. 1,500.
Received cash from Mr. Faqi-ul-Hasan Rs. 19,500 and discount allowed Rs. 500.
Required: Prepare a Column Cash Book
Solution: Husain & Co.
Three-Column Cash Book
For the month of January, 2025
Dr. (Page. 108) Cr.
Dat Particu J V Di Cash Bank Dat Particular J. V D Cash Bank
e lar . . s. e R . i
R N Ns
.

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2025 202
Jan. Balance 200,000 300,00 5 Purchases (w- 34,125
1 b/d 0 Jan. 1) C 17,500
5. Old C 17,500 85, 000 3 Cash a/c 7,500
8. Furniture C 8. Salaries a/c 10,000
15. Bank a/c 500 27,500 21,000 8. Rent a/c 1,800
26. Cash a/c C 8. Bank charges 25,300
27. Mr. Ali C 45,000 27,500 10. Furniture a/c 14,000
28. Cash a/c 500 19,500 12. Salary a/c C 21,000
31. Bank a/c 13. Bank a/c 2,000
Faqi-ul- 15. Telephone a/c C 27,500
Hassan 23. Bank a/c C 45,000
27. Cash a/c 5,000
28. Drawing a/c 1,500
29. Stationery a/c
30. 186,87 267,400
Balance c/d 5
309,500 357,00 Jan 309,50 357,000
Feb 0 31 0
1. 186,875 267,40
Balance 0
b/d
Note: C for Contra entry: A transaction in which cash a/c and Bank a/c are involved is
recorded on both sides of the column cash Book; it is called “contra entry”.
Working -1 : Cash purchases Rs. 35000 less 2.5% trade discount.
Purchases =Rs. 35000
Discount rate @ 2.5%
Discount price = Rs.35, 000 × 2.5 ÷ 100 = Rs. 875
Net purchases after less trade discount = Rs.35, 000 - Rs.875 = Rs. 34,125
❖ The net price of the purchases is Rs. 34,125 is recorded but rs.875 is not recorded
due to a trade discount.
Working -2: 19 January 2017 Goods sold to Mr. Ali on credit Rs. 28,500.
Entry is not passed because it will be treated on a credited basis.
Example-7: Mr. Shaid Sadqi is running a sole proprietorship business. During the month
of April 2017, the following transactions were recorded you are required to enter the
transactions in the column cash Book.
Date Particular
Apr1st Cash in hand Rs. 300,000 overdraft bank Rs. 100,000.
5 Stationery purchased for cash Rs. 2,500.
Received cash from Mr. Naeem Rs. 29,500 and allowed discount Rs.500.
7 Banked cash Rs. 80,000.
9 Bank collected bill receivable from debtor and deposited into business account Rs. 127,500.
13 Paid for salaries Rs. 26,000.
18 Bank paid for notes payable Rs. 25,000 on due date.
23 Mr. Aslam who owed Rs. 70,000 on an invoice subject @ 5% cash discount. A cheque
25 received from him which was lodged into a bank.
28 Paid cash into bank Rs. 15,000.
29 Purchased equipment for business use Rs. 35,000 paid by cheque.

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 30 Purchased furniture for personal use Rs. 16,000 paid by cheque through business account.
Required: Prepare three Column Cash Book
Solution: Mr. Shaid Sadqi.
Three Column Cash Book
For the month of April, 20-
Dr. (Page. 108) Cr.
Date Particular J.R V.N Dis. Cash Bank Date Particular J.R V.N Dis. Cash Bank
Ap.1 Balance Ap.1 Balance
7. b/d 300,000 5. b/d 100,000
9. Mr. Naeem 500 29,500 9. Stationery 2,500
13. Cash A/c C 80,000 18. a/c C 80,000
25. Bill 127,500 23. Bank A/c 26,000
28 receivable 3,500 66, 500 28. Salaries a/c 25,000
Mr. Aslam C 15,000 29. Notes C 15,000
a/c 30 payable 35,000
Cash a/c Bank A/c 16,000
Equipment
2017 a/c
Drawing a/c 207,000 112,000
4,000 329,500 289,000 329,500 289,000

207,000 112,000 Balance

c/d
Balance
b/d
Working -1 For 25 April 2017: Mr. Aslam owed Rs. 70,000 on an invoice subject @5%
cash discount. A cheque was received from him which was lodged in a bank.
Total amount = Rs.70, 000
Discount rate @ 5%
Discount price = Rs.70, 000 × 5 ÷ 100 = Rs.35, 00
Total amount received from Mr. Aslam after discount deduction
= Rs.70, 000 – Rs.35, 00= Rs.66, 500
MR. Aslam‘s cheque is treated as a bank because deposited into the bank on the same date.

3. BANKING TRANSACTIONS
3.1 Double Record of Bank Transactions
From time to time the balance shown by the bank and cash column of the cashbook required
to be checked. The balance shown by the cash column of the cashbook must agree with the
amount of cash in hand on that date. Thus reconciliation of cash balance is a simple matter.
If it does not agree it mean that either some cash transactions have been omitted from the
cashbook or an amount of cash has been stolen or lost. The reason for the difference is
ascertained and cashbook can he corrected. So far as bank balance is concerned its
reconciliation is not so simple. The balance shown by the bank column of the cashbook
should always agree with the balance shown by the passbook because the "Bank Pass
Book" is a copy of the customer's account in the bank's ledger. But the bank balance as per
cash book and bank balance as shown by the bank passbook (bank statement) seldom agree.
Periodically, therefore, a statement is prepared called "Bank Reconciliation Statement" to
find out the reasons for disagreement between the bank passbook balance and the cash
book balance, and to test whether the apparently conflicting balance really agrees.

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3.2 Causes of Disagreement: Usually, the reasons for the disagreement are:
1. That our banker might have allowed interest, which has not yet been entered in our
cashbook.
2. That our banker might have debited our account for any such item. As interest on
overdraft, commission for collecting cheques, incidental charges etc., which we have
not entered in the cash book.
3. That some of the cheques which we drew and for which we credited out bank account
prior to the date of closing, were not presented at the bank and therefore, not debited
in the passbook (Bank statement).
4. That some cheques or drafts which we deposited into bank for collection and for
which we debited our bank account were not realized within the date of closing and
therefore, not credited by the bank.
5. That the banker might have credited our account with amount of a "Bill of Exchange"
or any other direct payment into bank and the same may not have been entered in the
cash book.
6. That cheques dishonored might have been debited in the passbook but have not been
given effect to in our books.
3.3 Bank Reconciliation Statement
To prepare the bank reconciliation statement, the following rules may be useful for the
student:
1. Check the cashbook receipts and payments against the bank pass book.
2. Items not ticked on either side of the cashbook will represent those, which have not
yet passed through the passbook. Make a list of these items.
3. Items not ticked on either side of the passbook will represent those, which have not
yet passed through the cashbook. Make a list of these items.
4. Adjust the cashbook by recording therein those items which do not appear in it but
which are found in the passbook, thus computing the correct balance of the cash
book. There are two methods of preparing a reconciliation statement.

3.4 First Method (starting with the cashbook balance)

a. If the cash book balance is a debit balance, deduct from it all cheques, etc., paid into
the bank but not collected and credited by the bank and add all cheques drawn on the
bank but not yet presented for payment. The balance will agree passbook balance.
b. If the bank balance of the cash book is a credit balance (overdraft), add to it all
cheques, drafts, etc., paid into the bank but not collected by the bank and deduct from
it all cheques drawn on the bank but not yet presented for payment. The new balance
will then agree with the balance of the passbook.

3.5 Second Method (starting with the pass book balance)

a. If the pass book balance is a debit balance, (an overdraft) deduct from it all cheques,
drafts, etc., paid into the bank but not collected and credited by the bank and add to
it all cheques drawn on the bank but not yet presented for payment. The new balance
will agree with the balance of cashbook.
b. If the pass book balance is a credit balance (in favor of the depositor) add to it all
cheques, drafts, etc., paid into the bank but not collected and credited by the bank

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 and deduct from it all cheques drawn on the bank but not yet presented for payment.
The new balance will agree with the balance of the cashbook.

The rule for recording transaction in the cash book and in the pass book (bank statement)
is as follows:
Particular Cash book Pass book
Favorable balance /surplus balance Dr. Cr.

Un-favorable balance / Deficit /overdraft Cr. Dr.

balance

Double book Single book

(adjusted balance) (pass book
/cashbook)
Cash book Pass book
(depositor’s book) (bank’ s book)
Un-presented cheque Dr. Dr.
Un-credited cheque Cr. Cr.
Cheque directly deposited into bank by Dr. Dr.
customer
• Bank charges Cr Cr
• Interest debited by bank/ Cr Cr
overdraft
• Commission charged Cr Cr
• Misc. expenses directly paid by Cr Cr
bank

Dishonored cheque Cr Cr
• Interest credited by bank Dr Dr
• Dividend collected by bank Dr Dr
• Notes receivable collected by Dr Dr
bank
When we deposited cash into bank
Dr. Bank A/c
Cr. Cash A/c
In order to prepare the Bank Reconciliation statement the following methods are
used: First method (starting with the cash book balance)
Second method (starting with pass book balance)
Adjusted balance method (double book/ cash book and pass book)
Example-12: Mr. Asfer is running a sole proprietorship business. The business is newly
established and Mr. Asfer hired an accountant for keeping the cash book updated. During
the month of March 2017, he opened a current account with Habib Bank Ltd. Suppose you
are the accountant of Mr. Asfer’s business, prepare the cash book for the month of March,
2016. You are also required to suggest the entries into the passbook. Detail of the
transactions during March, 2016 are given as follows:
March 1. Mr. Asfer opened the account with Habib Bank Ltd. for Rs. 2,000,000.

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March 5. A cheque received from Furqan Rs.40,000 and deposited into the bank the same day.
March 11. Purchased furniture Rs. 50,000 paid by cheque.
March 16. Cash drew from bank for office use Rs. 15,000.
March 19. Paid rent by cheque Rs. 25,000.
March 23. Misc. expense debited by bank Rs. 30,000
March 25. Purchased goods from Mr. Ali amounting to Rs. 85,000 and the payment was
made through a cheque.
March 29. Interest received from bank Rs. 25,000.
Required: Prepare cash book (only bank column) and passbook.
Solution : Mr. Asfer
Cash Book (only bank column)
For the month of March, 2016
Dr. Cr.
Date Particular V.N L.F Bank Date Particular V.N L.F Bank
Rs. Rs.
2016
Mar 1 Cash a/c C 2,000,000 11. Furniture a/c 15 6 50,000
5. Furqan a/c 25 9 40, 000 16. Cash a/c 18 C 15,000
29. Interest a/c 5 25,000 19. Rent a/c 56 3 25,000
23. Misc. expense 85 4 30,000
25. Mr. Ali 90 1 85,000
2016
Mar.31 Balance c/d 1,860,000

2016 2,065,000 2,065,000

Apr1 Balance b/d
1,860,000
Note: Cash Book is showing the bank column and the entries related to the bank only.
Pass book (record of Mr. Asfer A/c in bank’s ledger)
Date Particular Dr Cr Dr / Cr Balance
(Withdrawal) (Deposits)
Rs. Rs. Rs. Rs.
2016
Mar 1. Cash 2,000,000 Cr 2,000,000
5. Furqan a/c 40, 000 Cr 2,040,000
11. Furniture a/c 50,000 Cr 1,990,000
16. Cash a/c 15,000 Cr 1,975,000
19. Rent a/c 25,000 Cr 1,950,000
23. Misc. expense 30,000 Cr 1,920,000
25. Mr. Ali 85,000 Cr 1,835,000
29. Interest a/c 25,000 Cr 1,860,000
Balance as Per Pass Book Cr. Rs.1,860,000
Note: It is observed that the Cash Book and the Pass Book are showing similar balances.
However, usually, both balances do not equate due to the timing differences and the errors.
Bank reconciliation statement: When there is a discrepancy between the balance of the
cash book and the passbook, the depositor prepares a statement to clarify the reasons for
the differences and to reconcile the balances. This explanatory statement is known as a
"bank reconciliation statement."

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Example 13: Mr. Noman is a renowned book dealer. He has a great business history, and
he enjoys a very good reputation in the market. Given as follows is the extract of Mr.
Noman’s cash book and passbook. You being an accountancy student Mr. Noman need
your expertise to prepare a bank reconciliation statement for the month of December 2016
from the available information.
Mr. Noman
Cash Book (only bank column)
For the month of December, 2016
Dr. Cr.
Date Particular Bank Date Particular Bank
Rs. Rs.
2016 2016
Dec.1 Balance b/d 7,00,000 Dec.
5. Mr. Naeem 55,000 7. Akber a/c 75,000
8. Mr. Anwar 85,000 18. Mr. Amir sh 1,20,000
25. Nazakat a/c 2,00,000 23. Mr. Jahangir 44,000
30. Mr. Asad 62,500

2016
Dec.31 Balance c/d 7,38,500
10,40,000 10,40,000

Passbook (record of Mr. Noman A/c in bank’s ledger)

For the month of December, 2016
Dr. Cr.
Date Particular Amount Date Particular Amount
Rs. Rs.
2016 2016
Dec. Dec.1 Balance b/d 7,00,000
7. Akber a/c 75,000 5. Mr. Naeem 55,000
8. Insure. paid 50,000 19. Interest in deposit 12,000
15. (directly) 5,000 25. Nazakat a/c 2,00,000
23. Bank charges a/c 44,000 30. Divd.collected 13,000
26 Mr. Jahangir a/c 52,000 directly
Misc.exp (directly)
754,000
Balance c/d 980,000 980,000

Required: Prepare Bank Reconciliation Statement

How to prepare bank reconciliation?
• Compare both books and note all the transactions of disagreement.
• Modify all the items in the cash book in the standard method, which is not recorded
in it due to lack of information about bank a/c’s record. However, if there is a mistake
at the bank’s end there is no need to rectify it. It will only be identified in the
reconciliation statement and will send to the bank for correction.

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• Reconcile the other transactions in a logical statement, starting with on balance and
finishing with the other.
The Bank Reconciliation Statement will be arranged in the following way.
1st step: A revised cash book is prepared.
Solution Mr. Noman
Cash Book (Revised cash book)
For the month of December, 2016
Dr. Cr.
Date Particular Bank Rs. Date Particular Bank Rs.
2016 2016
Dec1. Balance b/d 7,00,000 Dec.7 Akber a/c 75,000
5. Mr. Naeem 55,000 8. Insurance paid (directly) 50,000
8. Mr. Anwar 85,000 15. Bank charges a/c 5,000
19. Interest in deposit 12,000 18. Mr. Amir sh. 1,20,000
25. Nazakat a/c 2,00,000 23. Mr. Jahangir 44,000
30. Dividend collected 26. Misc.exp (directly) 52,000
directly 13,000 30. Mr. Asad 62,500

2016
Dec.31 Balance c/d 656,500
10,65,000 10,65,000
2017 656,500
Jan.1 Balance b/d
Mr. Noman
Bank Reconciliation Statement
As on 31st December 2016
Sr. Particular Cash Book
No Dr / Cr Rs. Balance Rs.
Balance as cash book (Dr) 656,500 (Dr.)
Add:
Un – presented cheque. (Mr. Amir’s cheque-w-2 ) 1, 20,000 (dr)
Mr. Asad’s cheque was not presented for +1,82,500
payment.(w-3) 62, 500
Less :
Un-credited cheque (Mr. Anwar’s cheque -w-1) 839,000 (Dr.)
Balance as pass book (Cr.) favorable 85,000 (Cr) -85,000
754,000
(Note: W for working) Working -1: A cheque received from Mr. Anwar Rs. 85,000 on
08 December and deposited into bank a/c but credited by the bank in January 2017. As it
is a timing difference, it will only be stated in the bank reconciliation statement and no
adjustment is required.
Working -2: A cheque was issued to Mr. Amir for Rs. 1, 20,000 on 18 December 2016
but not presented to the bank for payment in December 2016. It was not recorded in the
cash book due to this reason showing the discrepancy in the balance of the pass book and
cash book. Working -3: Purchased goods from Mr. Asad for Rs.62, 500 on 30 December
2016 paid by cheque but it cheque were not presented to the bank for payment in December

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2016. It was not recorded into the cash book due to this reason show the discrepancy in the
balance of the book and cash book
Example-14:
On 31st December the balance of cash at the bank as shown by the cashbook of a trader
was Rs.1401/- and the balance as shown by the pass book was Rs.2253/. On checking the
passbook with the cash book it was found that cheques for Rs.116/- paid in on the 31st of
December was not credited until the 1st January and the following cheques drawn prior to
31st of December were not presented at the bank for payment until the 5th January; Rashid
& Sons Rs.29/-Bashir & Co., Rs.801/-. M. A. Jaleel Rs.6/-; Khalid Bros., Rs.132/-.
Prepare a statement reconciling the two balances.
Solution: Bank reconciliation statement on 31st December
First Method
Balance as per cashbook (Dr.) 1401
Less: cheque paid in but not collected 116
Add: cheque drawn but not presented: 1285
Rashid & Sons. 29
Bashir & Company 801
M.A. Jalil 6
Khalid Brothers 132 968
Balance as per pass books Cr. 2253
Second Method
Balance as per passbooks (Cr.) 2253
Less: cheque drawn but not presented 968
1285
Add: cheques paid in but not collected 116
Balance as per cash books 1401
Example-15: Mr. Naeem is running a motor car showroom. He is the only owner of the
business. Recently the accountant working at Mr. Naeem’s office has left the job and Mr.
Naeem himself lacks the expertise to reconcile the cash book and the pass book. You being
an accounting student, Mr. Naeem asked you to prepare a Bank reconciliation statement of
Mr. Naeem as on 31st March 2017 from the following given information:
1. Balance as per Cash Book (favorable) Rs. 500,000.
2. Cheque deposited but not credited by bank until 31st March 2017 Rs. 120,000.
3. Cheque issued to the creditor but was not presented to the bank for payment until
31st March 2017 Rs. 110,000
4. Bank charges debited by bank Rs. 1,500.
5. Credited by the bank as dividend of Rs. 20,000 but not entered into the cash book.
6. Insurances premium was directly paid by the bank for Rs. 50,000 which is not
recorded in the cash book.
7. A cheque for Rs. 56,000 deposited into the bank has been dishonored, but no entry
is made in the cash book.
Required: Prepare the bank reconciliation statement as of 31st March 2017 in the
following two methods. 1. Starting with the cash book balance 2. Starting with pass book
balance
Solution: 1. starting with the cash book balance

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 Mr. Naeem
Bank Reconciliation Statement
As on 31st March 2017
Sr. Particular Cash Book
No Dr. Rs. Cr. Rs.
1. Balance as cash book (favorable) 500,000
2. Un-credited cheque 120,000
3. Un -presented cheque 110,000
4. Bank charges debited by the bank 1,500
5. Dividend credited by the bank. 20,000
6. Insurance premiums paid by a bank but not entered into a cash 50,000
book.
7. Dishonored cheque 56,000

Balance as pass book (Cr.) favorable 402,500

630,000 630,000
Important tips for balance: The procedure for balancing this statement is as under:-
• First all the entries related to Dr Items are entered into Dr Column/side and those
related to Cr Items are put into the Cr side.
• Add up both the Dr. Side and Cr side.
• Find out the difference.
• The difference so placed is “Balance”. If the Dr Side is greater as compared to the
Cr side then the balance will be written on the credit side or if Cr items are greater
as compared to the Dr Side then the balance will be written on the Dr Side.
For example: Like this question cash book shows the favorable balance (Dr) and after
some transactions add up on both sides, the Dr Side is greater as compared to the Cr side
then placing the figure of Rs.630, 000 on both sides of the difference Rs. 402,500 put on
the Cr side or smallest side.
Note: a cheque received, deposited, and returned dishonored is adjusted in the same
way uncollected / un-credited cheque.
(2) Starting with passbook balance. Mr. Naeem
Bank Reconciliation Statement
As on 31st March 2017
Sr. No Particular Cash Book
Dr. Rs. Cr. Rs.
1. Balance as pass book (Cr.) Favorable 402,500
2. Un-credited cheque 120,000
3. Un -presented cheque 110,000
4. Bank charges debited by the bank 1,500
5. Dividend credited by the bank
6. Insurance premium paid by bank 20,000 50,000
7. Dishonored cheque 56,000
Balance as cash book (Dr. ) Favorable 500,000
630,000 630,000
Solution (example-15 - with another
method)

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 Mr. Naeem
Bank Reconciliation Statement
As on 31st March 2017
Sr. No Particular Cash Book
Dr. Rs. Cr. Rs. Running Balance
.Rs.
1. Balance as cash book (Dr) 500,000 500,000
2. -Un-credited cheque 380,000
3. -Un -presented cheque 110,000 120,000 490,000
4. -Bank charges debited by the bank 488,500
-Dividend credited by the bank. 20,000 1,500 508,500
5. -Insurances premium paid by bank but not
6. entered into cash book. 50,000 458,500
-Dishonored cheque 56,000 402,500
Balance as pass book (Cr.) favorable
7.
402,500
OR
Mr. Naeem
Bank Reconciliation Statement
As on 31st March 2017
Sr. Particular Cash Book
No Dr / Cr. Rs. Balance. Rs.
Dr.
Balance as cash book (Dr) 500,000
Dr.
Add: 110,000
-Un -presented cheque 20,000
-Dividend credited by the bank. +130,000
630,000
Less : Cr.
-Un-credited cheque 120,000
-Insurance premium paid by bank but not entered into
cash book. 50,000
-Dishonored cheque 56,000
-Bank charges debited by the bank 1,500
-227,500
402,500
Balance as pass book (Cr.) favorable
Example-16: Mr. Ali Run is a trader of household items. In recent years, as his business
grew, he is faced problems in managing the accounts of his business. Due to the large
number of transactions now and the complicated nature of them, he is finding it difficult to
identify the difference in the cash book and the passbook. The paragraph given below
shows the transactions in the month of August pertaining to the business of Mr. Ali. On
31st August 2016 the bank statement of Mr. Ali showed the credit balance of Rs. 515,500.
Cheques for Rs. 123,000 were deposited into the bank in August 2016 out of which a
cheque of Rs. 53,000 was not credited in August, 2016. Cheques amounting to Rs. 75,000

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were issued, but only one cheque for Rs. 50,000 was presented for payment into the bank
in August 2016. Electricity bill Rs.5, 600 was directly paid by the Bank but was not
recorded in the cash book. A cheque of Rs. 15,000 for stationary but was recorded as Rs.
14,000 in cash book. Bank collected notes receivable from Miss. Hareem Rs. 50,000 and
collection charges Rs.700 debited by bank.
Required: You being an accounting professional, Mr. Ali asked to prepare bank
reconciliation statement as on August 31, 2016
Solution Mr. Ali
Bank Reconciliation Statement
As on August 31, 2016
Sr. No Particular Cash Book
Detail (Dr / Cr) Rs. Balance
Rs.
Balance as pass book (Cr.) favorable Cr. 515,500 (Cr)
Add:
Un-credited cheque 53,000
Electricity bill paid by bank 5, 600
Under cost (15,000-14,000) (w-2) 1,000
Collection charges 700 + 60,300
575,800
Less :
Un-presented cheque (w-1) 25,000
Notes receivable 50,000 -75,000

Balance as cash book (Dr)

500,800

Working -1: As on 31st cheques issued for Rs. 75,000 for payment out of which cheque
was presented for Rs. 50,000 in August 2016.
Total cheques amount =Rs. 75,000
Less: Presented cheque into bank =Rs. 50,000
Un-presented cheque = Rs. 25,000
Working -2: Cheque issued for stationary expense for Rs. 15,000 but recorded into cash
book Rs. 14,000. Total cheque amount = Rs. 15,000
Recorded into cash book = Rs. 14,000
Under cost amount = Rs. 1,000
Like this general journal entry:
Particular Dr . Rs. Cr . Rs.
Stationary expenses 15,000
Bank a/c 14,000
Balance 15,000 14,000
Note: Cr side balance for Rs. 1,000 is under cost so added into Cr balance Rs. 1,000.
Example-17: On- 31st March the passbook showed the credit balance of Rs.10500/-
cheques amounting to Rs.2750/- were deposited in the bank but only cheques of Rs.750/-
had not been cleared up to 31st March. Cheques amounting to Rs.3500/- were issued, but
cheques for Rs.l200/-had not been presented for payment in the bank up to 31st March.

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Bank had given the debit ofRs.35/- for sundry charges and also bank had received directly
from customers Rs.800/-and dividend of Rs.130/- up to 31st March. Find out the balance
as per the cashbook.
Solution: Bank reconciliation statement as on 31st March.
Account Rs.
Balance as per pass book (Cr.) 10500
Add cheques deposited but not credited 750
11250
Less cheques issued but not presented 1200
10050
Add bank charges made by the bank 35
10085
Less omission in cash book (Rs.800 + 130) 930
Balance as per cash book 9155
Note:1. Charges made by the bank of Rs.35 have not been recorded in the cashbook;
therefore, the balance in the cashbook is more. Add to passbook balance also.
2. Dividends and amounts from clients received by the bank have not been recorded in
the cashbook. Therefore, in the cash book, there is no entry of Rs.930 (800 + 130).
Deduct from the passbook balance to adjust it according to the cashbook balance.
Example-18: From the following particulars prepare a Bank Reconciliation Statement as
of 31st December.
Balance as per cash book 5877
Cheques issued but not presented for payment 2013
Cheques deposited but not cleared up to 31st December 1419
Bankers had wrongly debited the firm's account with Rs.225/- which was
not rectified until 31st December
Solution: Bank reconciliation statement as on 31st December.
Balance as per cash book (Dr.) 5877
Less: Cheques deposited but not cleared. 1419
4458
Add: all cheques issued but not presented for payment. 2013
6471
Less amount wrongly debited by the Bank 225
Balance as per pass book (Cr.) 6246
Note: A wrong debit of Rs.225 has reduced the balance as per the passbook. Deduct it from
the cash balance because there is less amount as per the passbook.
Example-19: On 25th June 1 had an overdraft of Rs.7915/- as shown by my cash book
columns. Cheques amounting to Rs.1000/- had been paid in by me on 24th June, but of this
only Rs.750/- were credited in the passbook. 1 had also issued cheques amounting to
Rs.2500/- of which Rs.2000/- worth only seems to have been presented. There is a debit in
my passbook of Rs.75 - for interest. I also find that cheques for Rs.60/-, which I had debited
to my Bank Account in my books, have been omitted to be banked. An entry of Rs.300/-
of a payment by a customer direct into the bank appears in the passbook. Prepare a
reconciliation statement.
Solution Cashbook

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 June 25 To customers a/c 300 June, 25 By balance b/c 7915
To balance a/d 7690 By interest a/c 75
7990 7990
Bank reconciliation statement as on 25th June.
Balance as per cash book (overdraw) 7690
Add cheques paid in but not credited 250
Ad cheques omitted to be banked 60
310
Less cheques issued but not presented 8000
Balance as per pass (Dr.) book 500
7500
Example-20: Mr. Naeem has a trading business of computer accessories. The business has
been successfully run from last 10 years and is considered as one of the leading trading
store of the city. Recently, due to the increase in volume of the transactions, Mr. Naeem is
unable to identify the difference in the balances of Cash book and the pass book. Details
of the transactions are given in the preceding paragraph.
On 31st March, 2017 the pass book showed a credited balance of Rs. 500,000 and as per
cash book is Rs. 408,750 of Mr. Naeem Trader. These are following discrepancy items
between pass book and cash book:-
1. Cheque for Rs. 100,000 was paid in 5 October, 2017, but out of which Rs. 80,000
credited by the bank on 25 March, 2017 and remaining balance on 5 April 2017.
2. Interest on investments collected by bank Rs. 1,750.
3. Bank charges for the above period also debited in the passbook of Rs. 500
4. Cheque for Rs.85, 000 was issued to the creditor but not presented to bank for
payment till 31st March 2017.
5. On 29 March 2017 a cheque of Rs. 25,000 was deposited into the bank but was
omitted to the entered into cash book.
Required: Prepare bank reconciliation statement under double balance method
Solution: Mr. Naeem
Bank Reconciliation Statement
As on 31st March 2017
Sr. Particular Cash Book Pass Book
No Dr/ Dr/ Cr
Cr Rs Rs.

Balance Dr 408,750 Cr 500,000

-Un-credited cheque (w-1) Cr 20,000
-Interest on investments collected by bank Dr 1,750
-Bank charges Cr 500
-Un- presented cheque Dr 85,000
-Cheque omitted from recording Dr 25,000

435,000 435,000

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Working -1: Total cheque Rs. 100,000 deposited into bank in 5 March.
Credited cheque Rs. 80,000 by the bank on 25 March 2017
Credited cheque remaining balance Rs. Rs.20, 000 (Rs.100, 000- Rs. 80,000 = Rs.20, 000)
on 5 April 2017.
Its cheque was credited by the bank to next month not in March 2017 so this cheque is an
un-credited cheque of Rs. 20,000.
Example-21: Mr. Nadeem had an overdraft facility in one of the leading banks. An
overdraft facility is used to meet the operational requirement of the business and the same
is settled on the receipt of the payments from the debtors.
On 31st October 2016, the passbook showed a balance of Rs. 480,000 (unfavorable/Dr) and
as per cash book is Rs. 592,000 (unfavorable/Cr). These are the following discrepancy
items between the book and the cash book:-
a. Cheque deposited into the bank but not yet credited by bank Rs.155, 200.
b. Cheque paid to the creditor but not yet presented to the bank for payment Rs.
256,000.
c. Insurance premium directly paid by bank Rs. 4,800
d. Bank collected notes receivable from Miss. Hira Rs. 16,000 but not entered into cash book.
Required: Prepare bank reconciliation statement under the double balance method.
Solution : Mr. Nadeem
Bank Reconciliation Statement
As on 31st October, 2017
Sr. Particular Cash Book Pass Book
No Dr Rs. Cr Rs. Dr Rs. Cr Rs.
Balance 592,000 480,000
-Un – credited Cheque 155, 200
-Un- presented Cheque 256,000
-Insurance premium directly paid by
bank 4,800
-Bank collected notes receivable
16,000
Adjusted Balance
580,800 580,800

596800 596800 736000 736000

Example-22: The following facts relate to the business of X, a client of yours who requires
you to reconcile his bank passbook balance with his cash book balance:
Balance as per passbook (in favor) Cr. 600
Balance as per cash book (overdrawn) Cr. 800
Un-presented cheques 1440
Un-credited cheques 260

In addition you ascertain the following:

1. A cheque for Rs.200/- paid to M. Jamil has been entered in error in the cash column.
2. Bank commission of Rs.80/- has not been entered in the cashbook.
3. The debit side of the cashbook (Book Column) has been under-cast by Rs.500/-
Solution: Cashbook

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 Rs. Rs.
To adjustment of under casting 500 By balance B/F 800
To balance c/d 580 By cheques issued entered
wrongly in cash column 200
By commission 80
1080 1080
Bank reconciliation statement as on:
Balance as per cash book (Cr.) 280
Add un-credited cheques 260
840
Less un-presented cheques 1440
Balance as per pass book (Cr.) 600
Example-23: From the following particulars, ascertain the bank balance as would appear
in the passbook of the trader as at 31st December 1996:
1. The bank overdraft as per the cash book on 31 ' December was Rs.6000/-.
2. Interest on overdraft for six months ending 31st December Rs.200 is debited in the
passbook.
3. Bank charges for the above period were also debited in the passbook amounting to Rs.50/-.
4. Cheques issued but not chased, prior to 31st December amounting to Rs.1500/-
5. Cheques paid into bank, but not cleared and credited before 31st December for
Rs.2500/-
6. Interest on investments collected by the bankers and credited in the passbook
amounting to Rs.1800/-.
Solution: Cashbook
Rs. Rs.
Dec. 31 To interest a/c 1800 Dec. 31 By balance b/d 6000
To balance c/d 4450 By interest a/c 200
By bank charges a/c 50
6250 6250
Bank reconciliation statement as on 31st December 1996
Balance as per cashbook (Cr.) 4450
Add cheques paid in but not credited 2500
6950
Less: cheques issued but not presented 1500
Balance as per passbook (overdraft) 5450
Example-24: From the following extracts of the cashbook and bank passbook, prepare a
bank reconciliation statement as of 31st December:

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Cash Book
Date Particular Amount Date Particular Amount
Mar. 1 To balance b/d 13743 Mar. 1 By rent 120
Mar. 4 To Ismail 1545 Mar. 6 By Wali & Co. 500
Mar. 8 To Jalil & Co. 3562 Mar. 9 By cash 3000
Mar. 12 To fair deal store 2630 Mar. 12 By drawings 2500
Mar. 16 To Rustam 4496 Mar. 19 By Smith & Co. 4200
Mar.26 To Zelin & Co. 1960 Mar.24 By Masood 1250
Mar.30 To Adam Jee 1200 Mar.30 By Zaheer 2400
Mar. 30 By M. Iqbal 2560
By balance c/d 12606
29136 29136
Pass Book
Date Particular Amount Date Particular Amount
April 2 To salaries 400 April 1 By balance b/d 12314
April 5 To salaries 1200 April 6 By cash 1500
April 7 To self 250 April 7 By Jalil & Co. 3562
April 11 To smith & Co 4200 April 10 By wages 118
April 12 To wages 170 April 14 By cash 1500
April 17 To Wali & Co. 500 April 18 By fair deal stores 2630
April 21 To Zaheer 2500 April 24 By Ibrahim & Co. 1570
April 21 To rent 100 April 28 By Adam Jee 1200
April 30 By cash 950
Solution: Bank Reconciliation Statement as on 31st March
Balance as per cashbook (Dr.) 12606
Add cheques issued but not presented for payment:
Wali & Company 500
Smith & Company 4200
Zaheer 2400 7100

Less cheques sent to bank for collection but not cleared: 19706
Jalil & Company
Fair deal store 3562
Adam Jee 2630
1200
7392
Balance as per pass book
12314
4. PETTY CASHBOOK
4.1 Definition: The Petty Cashbook is a subsidiary book used to record minor cash
expenses like postage, telegrams, stationery, and travel expenses.
Necessity: Reduces the workload of the main cashier, allowing efficient handling of
routine payments.
• Facilitates cash transactions in businesses where most payments are made via bank.
• Ensures proper tracking of small expenditures while maintaining internal control.

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Structure & Posting:
• Debit Side: Records cash received from the main cashier.
• Credit Side: Contains multiple columns for different expense categories.
• Balance Calculation: The difference between total receipts and payments represents
petty cash in hand.
• Ledger Posting: At the end of each period (monthly or as required), total expenses
are transferred to the respective accounts in the ledger.
4.2 Imprest system: Definition:
“The Imprest System is a controlled method of managing petty cash where a fixed sum is
provided to the petty cashier for minor expenses.”
Process:
1. Fixed Fund: A predetermined amount is allocated at the beginning of the period (e.g.,
a month).
2. Expense Recording: The petty cashier maintains a record of all petty expenses.
3. Reimbursement: At the end of the period, the chief cashier reimburses the exact
amount spent, restoring the imprest balance.
Accounting Treatment:
• Part of Cash Balance: The petty cash in hand is included in the total cash balance in
the Trial Balance and Balance Sheet under IFRS.
• Control & Accountability: Ensures accurate financial reporting and prevents
unauthorized use of petty cash.
• Not a Cashbook: The petty cash book is a subsidiary record, not a primary cashbook
but a part of it.
4.3 Advantages of Imprest System: The main advantages of an imprest system of petty
cash are as follows:
a. As the Petty Cashier has to produce to the Chief Cashier the Petty Cash Book for
inspection, it acts as a healthy check on the petty cashier.
b. As the Petty Cashier has to account for his expenses before he can draw further sums,
the petty cash book remains up to date.
c. As the Petty Cashier cannot draw as and when he likes, it prevents unnecessary
accumulation of cash in his hand thus the chances of defalcation of cash are
minimized.
Example-25: Enter the following transactions in the columnar petty cash book of cashier
who was given Rs.100/- on 1st March on the Imprest System.
Date Account Rs.
March 2. Paid for posting stamps 8
March 2. Paid for stationery 10
March 3. Paid for cartage 4
March 3. Paid for postage stamps 6
March 8. Paid for paper 1
March 12. Paid for cartage 6
March 18 Paid for tips to office peons 2
March 23. Paid for ink and nibs 4
March 25. Paid for tiffen to office peons 6
March 26. Paid for train fare 5

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 March 28. Paid for bus fare 4
March 29. Envelops and letter heads 6
March 30. Printing address on above 4
March 31. Taxi fare to Manager 10
Solution : Petty Cashbook
Amount Date Particulars VN Total Postage Printing & Cartage Traveling Misc.
Received Rs. Stationery expend
Rs. 100 Mar. 1 To cash
Mar. 2 By Postage 8 8
Mar. 2 By stationery 10 10
Mar. 3 By cartage 4 4
Mar. 3 By postage 6 6
Mar. 8 By paper 1 1
Mar. 12 By cartage 6 6
Mar. 18 By tip to peons 2 2
Mar. 23 By ink & nips 4 4
Mar. 25 By tiffen to peons 6 6
Mar. 26 By train fare 5 5
Mar. 28 By bus fare 4 4
Mar. 29 By envelopes etc. 6 6
Mar. 30 By printing 4 4
Mar. 31 By Taxi fare 10 10
Mar. 31 By balance c/d 24
100 14 25 10 19 8
April 1 To balance b/d
April 1 To cash
5. CASH VERIFICATION, CASH SHORT AND OVER
ACCOUNT
5.1 Cash Checking: The cashbook shows the position of cash receipts, cash payments,
and the balance. The balance must be checked by the cashier daily and verified. The
Accounts Manager may also occasionally verify the cash balance with the actual cash
available with the cashier. If the actual cash is more or less than the balance shown by
cashbook, the difference must be located. There may be some differences due to non
availability of change if payments or receipts involve Paisas. Such short differences are
adjusted to a special account column "Cash Short and Over".
Example-26: On verifying and reconciling cash book balance with the actual cash balance
following shortages and excesses came to light.
31st January Rs. 6.50 short
29th February Rs. 5.45 excess
31st March Rs. 2.95 excess
Shown journal entries and relevant adjustment account in the ledger.
Solution: (a) Journal entries
Date Account Dr. Cr.
31st January Cash short and over 6.50
Cash account 6.50
29th February Cash account 5.45
Cash short & over 5.45

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31st March Cash account 2.95
Cash short & over 2.95
Ledger cash short and over
Date Account Dr. Date Account Cr.
Jan, 31, 96 Cash Shortage 6.50 Feb. 29, Excess cash 5.45
Mar. 31 Excess cash 2.95
5.2 Closing Cash Short & Over Account: At the year-end the net balance of cash short
and over will be adjusted to the profit and loss account.
5.3 Cash Defalcations: The above procedure applies only for small periodical shortages and
excesses of cash. However when a large shortage come to light, it must be investigated. If the
cashier is held responsible for the shortage, his personal account will be debited and cash credited.
If however, he is not held responsible and loss cannot be recovered from any specific person, loss
will be debited to profit and loss account and cash account will be credited.

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6. Summary
1. Cashbook
The cashbook is a book of original entry used to record all cash receipts and payments. It
serves as both a ledger and a record of financial transactions.
2. Types of Cashbook
• Single Column Cashbook: Records only cash transactions, with receipts on the debit
side and payments on the credit side.
• Double Column Cashbook: Records both cash and bank transactions, allowing
businesses to track cash and bank balances simultaneously.
• Triple Column Cashbook: Includes cash, bank, and discount columns for businesses
that frequently deal with discounts, cash, and cheques.
• Petty Cashbook: Used for small, regular expenses, managed by a petty cashier for
minor cash transactions.
3. Bank Account
Businesses open bank accounts to manage funds. Transactions such as deposits,
withdrawals, and charges are reflected in the Bank Statement, which provides a summary
of all transactions over a period.
4. Bank Reconciliation Statement (BRS)
BRS helps reconcile differences between the Bank Column of the Cashbook and the Bank
Statement. Differences arise due to timing, unrecorded transactions, or errors. Regular
reconciliation ensures accurate financial records and internal control.
5. Causes of Differences in Bank Balances
• Timing Differences: Delays in cheque clearance and deposits.
• Bank Transactions: Charges, interest, or dishonoured cheques not yet recorded in the
cashbook.
• Errors: Mistakes in the bank’s records or the cashbook.
6. Preparing a Bank Reconciliation Statement
Two methods are used:
• Starting with the Cashbook Balance and adjusting for bank transactions.
• Starting with the Bank Statement Balance and adjusting for unrecorded cashbook
entries.
7. Cash Verification & Cash Short and Over Account
Cash balances must be verified regularly by the cashier and periodically by the accounts
manager. Differences, if any, are adjusted in the Cash Short and Over Account, ensuring
accuracy in financial records.

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UNIT – 7

ACCOUNTS FOR
NON-PROFIT MAKING
ORGANIZATION

Written by:
S.M. Aamir Shah
Reviewed by:
Asia Batool
Muhammad Irshad
Sohail Amjed
145
 CONTENTS
Introduction 147
Objectives 147
1 DISTINCTION BETWEEN PROFIT & NON-PROFIT 148
ORGANIZATIONS
1.1 Trading Concerns 148
1.2 Non-Trading Concerns 148
1.3 Difference Between Trading and Non-Trading 148
Concerns
1.4 Accounting Treatment for Non-Profit Organization 148
Activities
2 RECEIPT AND PAYMENT ACCOUNTS 149
2.1 Over of Books of Accounts 149
2.2 Main Features of Receipt and Payment Accounts 150

2.3 Preparation of Receipt & Payment Accounts 150

3 INCOME AND EXPENDITURE ACCOUNTS 151
3.1 Difference Between Receipt & Payment Account and 151
Income and Expenditure Account
3.2 Preparation of Income & Expenditure Account 151
4 ANCILLARY SERVICES 154
4.1 Trading Activities 154
4.2 Non-Trading Activities 154
5 BALANCE SHEET 159
5.1 Preparation of Balance Sheet 159
5.2 Illustration 159

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 INTRODUCTION
There is a football club in your town. The management is receiving the subscriptions
from the members and donations etc from elites of the town and the expenses is being made
from this receipt for the last many years. Once the management of the club thought that
there should be a proper record of the accounts. So that the members and donors can know
the financial state of affairs of the club at any time and they can satisfy themselves that the
funds are being utilized for specific purposes and no misappropriation is going on. They
know that you are a student of accounting, and they assigned you the task of preparing
accounts for the football club. You have not yet studied this unit "Accounting of Nonprofit
Organizations" you first wonder but after studying this unit you become capable of
preparing the books of accounts not only for the town football club but also for all the non-
profit concerns.

OBJECTIVES
After studying this unit you should be able to:
1. Make a distinction between profit-making & non-profit-making organizations.
2. Develop an understanding about the books of accounts required for non-profit
making organizations.
3. Understand the concept and preparation of receipt and payment account.
4. Understand the concept and preparation of income & expenditure account.
5. Understand the concept of ancillary services and their treatment in the books of
accoun

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1. DISTINCTION BETWEEN PROFIT AND NON-PROFIT
ORGANIZATIONS
Organizations may be grouped into two classes from the objectives point of view:-
1. Profit-making organizations (generally known as trading concerns)
2. Not-for-profit organizations (non-trading concerns)
1.1 Trading Concerns: The basic objective of the trading concerns is to provide goods
and services for making a profit or maximizing the wealth of the proprietor. In unit
3, you have studied the preparation of accounts for the trading concerns, the
preparation of income statements and balance sheets, so that the trader may know
the result of this trade (profit or loss) at the end of a specific period of time.
1.2 Non-Trading Concerns: The basic objective of non-trading concerns is to provide
social services to those who either have less purchasing power or no purchasing
power for utilizing those services. These institutions are financed by donations,
subscriptions, legacies, or any other special funds. As these institution’s object is not
to make a profit, if its revenue is exceeded by its expenditure, it is treated as surplus
and utilized in coming years for providing more social services to the people.
Generally, these institutions fall in any of the following two categories.
1. Social welfare institutions, which work for society’s welfare, like clubs, Social
Welfare associations, etc.
2. Charitable institutions, which may be a hospital, educational institutions, religious
institutions, libraries, etc.
1.3 Difference between Trading & Non-Trading Concerns
Trading Concerns Non-Trading concerns
1. Its main object is to earn profit. 1. Its main object is welfare of the society / members
/ community.
2. Its main source of revenue is sale of goods 2. Its main source of revenue are donations,
or services. subscriptions, fees etc.
3. Its nature from ownership point of view may 3. Its nature from ownership point of view may be
be a sole proprietorship, partnership or an association of persons in the form of club,
company. society or trust etc.
4. It is started by the investment of sole 4. It is started by funds of the donations, member’s
proprietor, partner or shareholders of the subscriptions etc.
concern.
5. It is managed either by sole proprietor, 5. It is managed either by committees, trustees or
partners or directors etc. governing bodies etc.
1.4 Accounting Treatment for Non-Profit Organization’s Activities
The basic purpose of accounting is to provide information to the interested parties. As the
nature and objects of trading and non-trading organizations differs the information required
for both types of organizations also differ. In case of trading concerns detailed set of
accounts record (Books) is required, because the parties involved are interested in the
information of these parties may be investors, creditors, banks, management etc. You have
already studied the book of accounts for trading concerns in unit 3. As they deal with the

148
sale of goods & services, their transactions normally include credit transactions. Hence
they may need special journals and subsidiary ledgers to have more detailed accounting
information.
1.5 Books of Accounts for Non-Trading Concerns: In the non -trading concerns books
of accounts differ from the trading concerns because here the parties involved are interested
in different types of information. These parties may be the government, governing bodies'
members of societies, etc. These parties are interested in the organization's (1) receipt and
payment (2) income and expenditure (3) assets and liabilities. Non-profit concerns do not
deal with the sale of goods and services, so they don't have to make credit transactions.
Mostly there are cash transactions. So they need not to maintain detailed set of accounts
books as required in the trading concern. Sometimes non-profit organizations involve
themselves in helping activities like selling of equipment or offering bar services to their
members etc. then they need to prepare bar trading accounts etc. These ancillary services
of nonprofit making organizations will be discussed in detail later in this unit. It must be
kept in mind that books of accounts may differ from organization to organization
depending upon their activities and information required, but the basic rules for recording
transactions apply equally to all type of organizations.
1.6 Difference in Accounting Treatment of Trading Concerns and Non-Trading
Concerns
Trading Concerns Non-Trading concerns
• A complete set of books of accounts is • Only few books of accounts are maintained.
maintained.
• Its main object for maintaining the accounts • Its main object is to have check over the income
record is to know the profit or loss. and expenses.
• Net income earned during a financial period • If there is an excess of income over expenditure.
is distributed among the owners. It is not distributed to anyone. But is used for the
betterment of the public.
• In order to know the result of the financial • In order to know the result of the financial year
year profit and loss account is prepared. Income & expenditure account is prepared.
• The result of the profit and loss account is • The result of the income & expenditure account
treated as profit or loss. is either called surplus of income over
expenditure or excess of expenditure over
income.
• Profit or Loss is transferred to the capital • The surplus of income over expenditure or
account. excess of expenditure over income is transferred
to accumulated fund.

2. RECEIPT AND PAYMENT ACCOUNTS

2.1 Overview of Books of Accounts for Non-Trading Organizations & Financial
Reporting (IFRS): Non-trading concerns, such as clubs and charities, primarily engage in
cash transactions rather than credit dealings. Their financial records typically include a
cashbook, members register, minutes book, fee register, and outstanding fee register,
varying based on organizational needs.
At the end of the accounting period, final accounts are prepared, which include:

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1. Cashbook: Records cash receipts and payments chronologically.
2. Receipts & Payments Account: Summarizes all cash transactions under appropriate
headings.
Under IFRS, non-profit institutions must ensure accurate financial reporting, proper
classification of funds, and compliance with accrual accounting principles where
applicable.
2.2 Main Features of Receipt & Payment Accounts
1. It is a summary of cashbook. All receipts are recorded n the debit (left) side and all
payments are recorded on the credit (right) side.
2. It starts with the opening balance of cash or bank. The favorable balances are written
on the debit (left) side and bank overdraft is recorded on the credit (right) side of the
receipt and payment accounts.
3. It records all cash receipts and payments irrespective of the fact whether they are of
capital or revenue nature or whether they relate to the current year or not.
4. Similar type of receipts and payments are gathered under the appropriate head of
accounts.
5. It ends up with the balance of cash or bank at the end of the accounting period.
2.3 Preparation of Receipt and Payment Accounts
Given below is the summarized information of cash receipts and payments from the cash
book of FAQUEEH WELFARE CLUB for the year 2000. You are required to prepare a
receipts and payment account for the year ended on 31.12.2000.
Balance (1.1.2000)
Cash in hand Rs. 500
Cash at Bank Rs. 2500
Subscription
(Including Rs. 2000 for 1999 and Rs.5000 for 2001) 32000
Donations 2600
Membership fee 500
Payments
Rent paid 12000
Stationery charges 2000
Postage, telephone 1000
Salaries to staff 10000
Refreshment charges 700
Mise. Expenses 500
Investment in prize bonds 1000
Investment in DSC 1000
Office equipment 1000
Closing cash balance 900
Solution: FAQUEEH WELFARE CLUB
Receipt & Payment Account for the year 2000
Receipt Amount Payment Amount
Balance b/d Rent expenses 12000
Cash in hand 500 Stationery charges 2000

150
Cash at Bank 2500 3000 Postage, telephone 1000
Subscription:- Salaries to staff 10000
Previous years 2000 Refreshment charges 700
Current year 25000 Misc. expenses 500
Advance 5000 32000 Investment in prize bonds 1000
Investment in DSC 1000
Donation 2600 Office equipment 1000
Membership fee 500 Closing balance c/d
Cash in hand 900
Cash at Bank 8000
38100 38100
You have already studied that in the cashbook transactions are recorded in
chronological order. In this illustration you may imagine that the data given to you is
summarized (similar type of receipts and payment accounts repeatedly occurred during the
year were gathered and given to you for preparation of receipt, and payment, account). For
example, rent paid Rs. 12000 occurring in the illustration may be a result of 12 entries in
the cash in 12 months @. Rs. 1000/-.

3. INCOME AND EXPENDITURE ACCOUNT (IFRS)

Non-trading concerns do not prepare a Profit & Loss Account but instead use an
Income & Expenditure Account to track financial performance over a specific period. This
account ensures that expenditures remain within income limits and reflects a true and fair
view of surplus or deficit by matching only current period incomes (received/receivable)
and expenses (paid/payable).
Key Features (IFRS Compliant):
i. Accrual Basis: Records all income (credit side) and expenses (debit side) related to
the current period, whether received/receivable or paid/payable.
ii. Excludes Capital Items: Only revenue transactions are recorded; capital items are ignored.
iii. No Past/Future Transactions: Items from previous or future periods are omitted.
iv. Fair Presentation: Ensures transparency and compliance with IFRS standards.
v. Surplus or Deficit: The balance represents either excess income (surplus) or excess
expenditure (deficit) for the period.
3.1 DIFFERENCE BETWEEN RECEIPT & PAYMENT ACCOUNT AND
INCOME & EXPENDITURE ACCOUNT
Receipt and payment account Income & expenditure account
1. This account is the summary of cash 1 This account is the replacement of profit & loss
transactions. . account.
2. It starts with the opening balances of cash 2. It does not start with any opening balance.
and bank account.
3. It includes receipts and payments of 3. It includes receipts and payments of only the
previous, current and coming periods. current period.
4. It includes the items of both capital & 4. It includes the items of only revenue nature.
revenue nature.

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 5. On the debit (left) side of this account, 5. On the debit (left) side of this account expenses
receipts are shown and on the credit (right) are shown and on the credit (right) side incomes
side, payments are shown. are shown.
6. End result of this account shows the 6. The end result of this account shows either a
balance of cash in hand or at bank or both surplus or a deficit.
which must agree with balance appearing in
cashbook.
7. The balances are carried forward to the 7. The balance instead of carrying forward
next period. deducted or added to the accumulated capital
fund.
8. It is a real account. 8. It is a nominal account.

3.2 Preparation of Income & Expenditure Account: After going through the
theoretical discussion regarding the income and expenditure account, we should be able to
prepare this account. However, let us summarize the previous discussion before preparation
of income and expenditure account. You must know that the sources for preparation of this
account are cashbook and receipt and payment account.
1. Opening and closing balances of cash in hand or at bank are not relevant here, hence
should be ignored.
2. Incomes and expenses of the previous and coming periods are not relevant here,
hence should be ignored.
3. Income and expenses of capital nature are not relevant here, hence should be ignored.
4. Income received or receivable relating to the current period should be recorded in
this account.
5. Expenses paid or payable relating to the current period should be recorded in this
account.
6. Any depreciation or other decrease in the value of assets should be charged to the
income and expense account. Illustration No.1
Following is the extract of one head of account "Subscriptions" of the Receipt and
Payment Account for the year 2000 and some other information relating to this receipt.
You are required to compute the income from subscriptions, which will be shown in the
income & expenditure account for the year ending 31-12-2000. Subscriptions: Rs.
1999 2700 As shown in the Receipt and
2000 15000 Payment Account for the year
2001 6000 ending 31-12-2000
Additional information:
(i) Subscriptions outstanding as on 31.12.1999 Rs. 3000
(ii) Subscriptions outstanding as on 31.12.2000 Rs.4500
(iii) Subscriptions received in advance as on 31.12.1999 Rs.3000
Solution: On the income side of the income and expenditure account for the year ending
31-12-2000, the subscription income will appear as follows:

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Income and Expenditure Account for the Year Ending 31st December 2000
Expenditure Amount Income Amount
Subscription 15000
Add. O/s for the year 2000 (4500 -300) 42000
Add received in advance as on 31.12.1999 3000
22200 Balance 22200
You might have noticed that in the income and expenditure account for the year 2000, we
included the subscriptions relating to the year 2000 only.
From the receipt and payment account, we have been given three figures for the year
1999, 2000, 2001. As we are preparing the income & expenditure account for the year 2000,
we have picked up the subscription relating to the year 2000 i.e. Rs.15000. In the additional
information from other records, like registers for outstanding and advance subscriptions, we
added the outstanding subscriptions for the year 2000 i.e. Rs.4200 (Rs.4500 - 300). Deduction
of Rs.300 is in the sense that this outstanding amount pertains to the year 1999. If you look at
the additional information, there is stated that subscription outstanding as on 31.12.1999 is
Rs.3000 and in the receipt and payment account for the year 2000, we received Rs.2700 relating
to the year 1999. What is left is Rs.300 still outstanding for the year 1999. The information
given to you for the year 2000 is that the subscription outstanding as of 31.12.2000 is Rs.4500.
Here the words 'as on' means that up till the end of 2000, including the previous years, this 4500
is outstanding. As this outstanding subscription includes the previous year's subscription which
is Rs.300 (3000 -2700) and we are concerned with only the current year's subscription, we will
deduct the previous year's amount.
We added the subscription received in advance as of 31.12.1999 i.e. Rs.3000 because
this subscription amount was for the year 2000 and was treated as advance up till the end
of the year 1999 but in the year 2000, this will become part of the income. We have already
discussed the preparation of income & expenditure in detail, so you should have no
confusion in this regard, if you are still not clear about the rules, you are advised to study
carefully this point again and try to understand the concept. Illustration No. 2: From
the information given in illustration 2.3 prepare an income & expenditure account.
Solution: Income & Expenditure Account for the year ended 31.12.20---
Expenditure Amount (Rs.) Income Amount (Rs.)
Rent expenses 12000 Subscriptions for 2000 25000
Stationery charges 2000 Donation 2600
Postage, telephone 1000 Membership fee 500
Salaries to staff 10000
Refreshment charges 700
Miscellaneous expenses 500
Excess of income over 1900
expenditure
(surplus)
28100 28100

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 Here you should observe that source of information for preparation of income and
expenditure account may be cashbook or previously prepared receipt and expenditure
account but we should select only the revenue items relating to the current period.
Practically most of the time, we have to make adjustments in respect of certain items
(heads of accounts) so that the accounts records present the true and fair picture.
For example, in a sports club, there may be certain sports material at the beginning of the
year. There may be certain materials purchased during the year and some of the material
may be in the stock at the end of the year, in this type of situation when we prepare an
income and expenditure account, we have to make certain adjustments. You know that we
need here items relating to the current period. Calculation of the amount pertains to the
current period from the given date is the adjustment of the concerned item.
The following example will clear you more about the above discussion:
(i) Sports Material as on 1.1.1999 Rs.3000
Purchased sports material during 1999 Rs. 12000
Sports material stock on 31.12.1999 Rs.4500

From the income and expenditure account, we need the sports material consumed
during the year. For this purpose we will calculate the required figure by adjusting the data
in the following manner:

Income & Expenditure Account for the year ended 31.12.1999

Expenditure Amount Income Amount
(Rs.) (Rs.)
Opening stock 3000
Add. Purchase during the year 12000
Material available for use 15000

Less closing stock 4500

Sports material consumed 10500
4. ANCILLARY SERVICES
Ancillary services mean subordinate activities. Non-profit making organizations like clubs
etc. can start helping activities to increase their subscription income. The purpose is the welfare
of the members of the organization. The ancillary activities may be trading or non-trading:
4.1 Trading Activities: The clubs can sell equipment or publication etc. They can also
offer bar facilities. This service is in the form of trading. In case of bar facilities there is
needed to prepare bar trading account in order to know the profit or loss from this service.
The profit earned or loss sustained is transferred to the income and expenditure account.
4.2 Non-Trading Activities: There are other activities like provision of refreshment and
raffles. Such activities are called non-trading activities. In case of non-trading activities
like sale of refreshment and raffle tickets there is no need to prepare separate account. The

154
income from sale of refreshments and expenses incurred on purchase of refreshment are
adjusted directly in income and expenditure account.
4.3 Preparation of Accounts for Non-Trading Ancillary Activities : Following
illustration further clarifies the treatment of non-trading ancillary activity, where the library
and debating society offers the entertainment facility to its members. The summary of cash
transaction of library and debating society is available for the year ended December 2001.
Receipt and Payments Account
Receipts Rs. Payments Rs.
Balance b/d 3000 Rent and rates 1200
Entrance fee 5000 Wages 1300
Subscription 2500 Lecture's fee 1700
Donation 20000 Electricity 500
Life member ship fee 10000 Books 15000
Receipts from entertainment 1500 Office expenses 3800
Entertainment exp. 1000
Balance c/d 17500
42000 42000
The accumulated fund of the society is Rs.43000/-. Subscription in arrear is Rs.1500/-, rent is
unpaid Rs.800/-, depreciation is to be provided on books Rs.2000/= and furniture Rs.1000/-.
The opening balance of books is Rs.25000/- and opening balance of furniture is 15000/-.
Required: i) Income and expenditure account (ii) Balance sheet
Solution:
Library and Debating Society
Income and Expenditure Account
For the year ended December 31, 2001Expenditure
Expenditure Rs. Income Rs.
Rent 1200 +800 2000 Entrance fee 5000
Wages 1300 Subscription 2500 + 1500 4000
Lecture fee 1700 Receipt from entertainment 1500
Electricity 500 Entertainment exp. 1000 500
Office exp. 3800 Excess of exp. over Income 2800
Dep. On books 2000
Dep. On furniture 1000
12300 12300
Library and debating Society
Balance Sheet
As at December 31, 2001
Liabilities Rs. Assets Rs.
Donation 20000 Cash 17500
Life membership fee 10000 Subscription 1500
Rent due 800 Books (25000+15000- 2000) 38000
Accumulated fund 43000 Furniture (15000 -1000) 14000
Less excess exp. Over income
2800 40200
71000 71000

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4.4 Preparation of Accounts for Trading Ancillary Activities
Illustration: The following illustration further clarifies the treatment of trading ancillary
activity where ABC Sports and Social Club operates or bar facility for its members The
following information is available relating to the financial activities of ABC Sports Club.
ABC Sports Club
Receipt and payment accounts
For the year ended December 31, 2002
Receipts Rs. Payments Rs.
Balance b/d 361 Honorary secretary exp. 61
Subscription 1020 Affiliation fee 50
Subscription previous year 30 Equipment 400
Bar taking 2050 Bar stock 1025
Sale of tickets for annual dinner 1200 Barman wages 375
Sale of raffle tickets 90 Dinner expenses 870
Raffle prizes 30
Rent of hall 750
Printing and package 100
Electricity exp. 290
Equipment repair 150
Balance c/d 650
4751 4751
The assets and liabilities of the club at the dates stated were as follows.
Liabilities 2001 2002 Assets 2001 2002
Akram subscription 65 55 Cash at bank 361 650
Creditors for bar stock 175 215 Subscription in arrear 100 90
Rent owing 75 50 Bar stock 400 300
Electricity owing 52 70 Equipment 1250 1400
Required: i). trading account ii). Income and expenditure account iii.) Balance sheet
as at December 31, 2001
ABC Sports Club
Bar Trading Account
For the year ended December 31, 2002
Rs. Rs.
Bar stock 400 Bar taking 2050
Bar purchases (1025+215-175) 1065 Bar Stock 300
Barman wages 375
Bar profit 510
2350 2350
Income and Expenditure Account
For the year ended December 31, 2002
Expenditure Rs. Income Rs.
Rent of hall 725 Subscription (1020+100) 1120
Printing and postage 100 Bar profit 510
Electric exp. 290+(70-52) 308 Sale of tickets for
Honorary secretary exp. 61 annual dinner 1200
Subscription written off 70 Expenses 870 1 330

156
 Affiliation fee 50 Sale of raffle tickets 90
Equipment repair 150 Cost of prizes 30 60
Equipment depreciation 250
Excess Income 306
2020 2020
Balance Sheet
As at December 31, 2002
Liabilities Rs. Assets Rs.
Advance subscription 55 Cash at bank 650
Creditor, for bar stock 215 Subscription in arrear 90
Accumulated expenses (50+70) 120 Bar stock 300
Accumulated fund 1744 Equipment 1250
Excess of income 306 Addition 400
Depreciation (-) 250 1400
2440 2440
4.5 Illustration: Old Stamps Society offers its members an opportunity to attend
meetings to hear talks on postage stamps, attend exhibitions and auctions of stamps, and to
buy and sell stamps through society. The financial year ends on April 30 every year. The
Secretary of Society has provided the following information:-
Liabilities Assets
1998 1999 1998 1999
Advance subscription 140 192 Bank 1456 8508
Electricity due 210 280 Subscription in arrear 350 280
Printing expenses due 52 140 Prepaid rent of hall 350 245
Debtors for stamps 700 385
Stock of stamps 7700 10920
Equipment 5600 6440
Display case 3500 3500
Receipts and payment account
Balance 1456 Purchases of stamps 10500
Subscription 3850 Equipment 1400
Sale of stamps 17990 Rent 3150
Sale of raffle tickets 1050 Electricity 805
Refreshment 1540 Printing 210
Raffle prizes 350
Surety expenses 123
Refreshments 840
Balance c/d 8508
25886 25886
Note: Display cases are to be depreciated at the rate of 10% on book value.
Required:- 1.Stamps trading account 2.Income and expenditure account 3.Balance sheet
Solution:- Postage Stamps Society
Stamps Trading Account
For the year ended December, 1999
Stock of stamps 7700 Sale of stamps (17990 -700 + 385) 17675
Purchases 10500 Stock of stamps 10920
Profit on stamps 10395
28595 28595

157
 Postage Stamps Society
Income and expenditure account
For the year ended December, 1999
Expenditure Rs. Income Rs.
Rent 3150+(350-245) 3255 Subscription 3850-(140-192+350-280) 3728
Printing 210+(140-52) 298 Profit on stamps 10395
Electricity 805+(280-210) 875 Income from raffle tickets 1050
Secretary exp. 123 Less cost of prizes 350 700
Dep. Equipment 560 Refreshments 1540
Dep. Display cases 350 Less cost of food 840 700
Surplus income 10062
15523 15523
Balance Sheet As at December, 2001
Liabilities Rs. Assets Rs.
Subscription in advance 192 Cash at bank 8508
Electricity 280 Rent prepaid 245
Printing expenses 140 Subscription in arrear 280
Accumulated fund 19254 Debtors for stamps 385
Surplus income 10062 Stock of stamps 10920
Display cases (3500 -350) 3150
Equipment 6440
(5600+1400-560)
29928 29928
4.6 Illustration: The following accounts were taken from the books of XYZ Trust
Hospital for the year ended Dec. 31, 2001. Receipts and payments accounts
Receipts Rs. Payments Rs.
Indoor patients 1600 Services to poor patients 200
Out -door patients 250 Services to senior citizen 80
Operating room 150 Nursing services 125
Labour room 60 Medical services 450
Anesthesiology 15 Pharmacy 90
Radiology 40 Medical library 75
Laboratory 200 Operating room 135
Pharmacy 55 Anesthesiology 50
Medical supplies 12 Radiology 25
Emergency 40 Laboratory 60
General contribution 900 Admn. Expenditure 555
Government grant 612 Dietary 940
Medicine donated 50 Out -patient & emergency 325
Income from investment 400 Other expenditure 380
Miscellaneous income 250 Surplus 1144
Total 4634 Total 4634
Note: There are depreciation expenses of Rs.425/- and interest expense of Rs.300/-.
Solution: XYZ Trust Hospital
Income and expenditure account
For the year ended Dec. 31-2001
Expenditure Rs. Income Rs.
Poor patients 200 Indoor patients 1600

158
Senior citizens 80 Out -door patients 250
Nursing services 125 Operating room 150
Medical services 450 Labour room 60
Pharmacy 90 Anaesthesiology 15
Medical library 75 Radiology 40
Operating room 135 Laboratory 200
Anaesthesiology 50 Pharmacy 55
Radiology 25 Medical supplies 12
Laboratory 60 Emergency 40
Admn. Exp. 555 Deficit from operations 1068
Dietary 940
Emergency services 325
Other expenses 380
3490 3490
Deficit from operation 1068 General contribution 900
Interest exp. 300 Government grant 612
Depreciation 425 Medicine donation 50
Surplus income 419 Income from investment 400
Miscellaneous income 250
2212 2212

5. BALANCE SHEET
5.1 Preparation of Balance Sheet: A balance sheet is one of the essential financial
statements. You have already studied about this statement in unit No. 2. There is no change
in the format of the balance sheet for non-trading concerns as compared to trading concerns
except the account titles. If you are given the information regarding assets and liabilities,
you can prepare the balance sheet. Sometimes the opening capital fund (excess of assets
over liabilities) is not given, then it become problem to ascertain the opening capital fund
first. This may be calculated as follows: -
Opening Assets - Opening Liabilities = Capital Fund (Accumulated) So the balance sheet
prepared in this way at the end of the period show the financial position of the organization
as on that date.
5.2 Illustration: Given below are the Receipts and Payments Account of the National
Club for the year ended 31 March 20-….Receipts and Payments Account of the National
Club
for the year ended 31 March 20---
Receipts Rs. Payments Rs.
To balance b/d 1025 By salaries 600
To subscription: By General expenses 80
1998-1999 40 By entertainment Programme
1999-2000 2050 Expenses 450
2000-2001 60 By newspapers 150
To donations 540 By municipal taxes 50
To proceeds of entertainment By charity 350
Programme 950 By investment (Govt. Bonds) 2000
To sale of waste paper 45 By electricity charges 140

159
 By balance c/d 890
4710 4710
Prepare the Club's Income and Expenditure Account for the year ended 31st March 2000
and the Balance Sheet as of that date, after taking the following information into account:
a) There are 500 members each paying an annual subscription of Rs. 5/-and Rs. 50/- is
still in arrear for 1998 - 1999.
a. Municipal taxes amounting to Rs.40/- per annum have been paid up to 30th
June 2000 and Rs.50/- for salaries is outstanding.
b) Building stands in the books at Rs.5000/- and it is required to write off depreciation
@ 5% per annum.
c) Six percent per annum interest is accrued on Government Bonds for 5 months.
Solution: National Club
Income & Expenditure Account
For the year ended 31.3.2000
Expenditure Rs. Income Rs.
To salaries 600 By subscriptions 2050 2500
Add: Outstanding 50 650 Add: outstanding 450
To general expenses 80 (500x5= 2500-2050)
To news papers 150 By donations 540
To municipal taxes 50 By proceeds of entertainment
Less: Pre –paid 10 40 programme 950
To charity 350 Less: expenses 450 500
To electricity charges 140 By sale of waste paper 45
To dep. - building 250 By interest on Govt. Bonds 50
To excess of income 1975
Over expenditure
3635 3635
Balance Sheet
Liabilities Rs. Assets Rs.
Opening capital fund: 6115 Buildings 5000
Add: excess of income Less depreciation 250 4750
Over expenditure 1975 8090 Investment in Govt. Bonds 2000
Subscriptions received in Interest receivable 50
Advance (2000-2001) 60 Subscriptions
Outstanding expenses 50 Outstanding 1999-00 450
1998-99 50 500
Prepaid taxes (40x3/12) 10
Cash in hand 890
8200 8200
Working for the calculation of Capital fund: From the information provided, the
opening assets are as follows: - Cash in hand Rs. 1025
Buildings 5000
Subscription for the year
1998-99-received Rs. 40
Add sub. Receivable 50 90
Less opening liabilities Capital fund Nil
Capital fund Rs. 6115

160
UNIT – 8

PARTNERSHIP-1

Written by:
Jawaid Aamin
Reviewed by:
Asia Batool
Talat Mahmood
Sohail Amjed
161
 CONTENTS
Sr. No. Subject Page No.
Introduction 163
Objectives 163
1. PARTNERSHIP BASIC CONCEPTS 164
1.1 What is Partnership? 164
1.2 Advantages of Partnership 164
1.3 Kind of Partners 165
1.4 Essential Partnerships 165
1.5 Partnership Agreement/Deed 166
2. GENERAL ACCOUNTING PROCEDURE FOR
167
PARTNERSHIP BUSINESS
2.1 Capital Accounts 167
2.2 Current Accounts 167
2.3 Drawing Accounts 167
2.4 Interest in Drawing 167
2.5 Interest on Capital Account 167
2.6 Partners Salary 167
2.7 Capital Ratio as Basis of Sharing Profit & Loss 172
3. ADMISSION OF A NEW PARTNER 174
3.1 Admission Procedure 174
3.2 Goodwill in Partnership 174
3.3 Accounting Treatment of Goodwill/Bonus 175
3.4 Re-Valuation of Assets and Liabilities 181
3.5 The Profit-Sharing Ratio 183
4. RETIREMENT OR DEATH OF A PARTNER 186
4.1 Retirement of Partner 186
4.2 Death of Partner 193
5. SUMMARY 196

162
 INTRODUCTION
In the earlier units you have learnt how to maintain accounts on general basis. You will
appreciate that accounting systems must take into consideration the form of business
organizations. A single person may carry out business; on expansion another one or two
persons may join and form partnership. Later the business may take the form of limited
companies. In this unit you will learn the accounting practices to be followed for
partnership firms, especially on formation of such firms, addition of new partners or
leaving of a partner.

OBJECTIVES
After reading the unit you should be able.
− To acquaint with general accounting procedure of partnership.
− To list essential legal requirements regarding formation of partnership.
− To state how to conduct the partnership business.
− To follow accounting procedure on admission of incoming partner or a new partner.
− To work out the goodwill on changes in partnership.
− To prepare the revaluation account of assets & Liabilities as and when necessary.
− To calculate the New Profit sharing ratio on admission of new partner.

163
1. PARTNERSHIP: BASIC CONCEPTS
1.1 What is a partnership?
In Pakistan, the Partnership Act, of 1932 regulates the law of partnership. According to
Section 4 of this Act:
A. Definition of Partnership
A partnership is a legal relationship between two or more individuals who agree to share
the profits of a business carried on by all or any of them acting for all. It involves the
combination of resources, including capital and services, to conduct a lawful business.
Under IFRS (IAS 28 - Investments in Associates and Joint Ventures), partnerships are
classified as joint arrangements or associates based on control and influence. The
financial reporting of a partnership follows IFRS guidelines, ensuring fair valuation of
assets, liabilities, and profit-sharing transparency.
B. Partner and Firm; Persons who have formed a partnership are individually called
partners & collectively a firm.
Glossary of Terms: Certain terms specially used in partnership accounts are defined as
under:
i. Articles of Partnership; These are terms and conditions in the agreement between
the partners.
ii. Business: It includes any trade, profession or vocation that carries on earning profit.
iii. Firm: Partners are collectively known as a firm.
iv. Firm Name: It is the name under which the business is carried on as known to the
outside world.
v. Co-Ownership: It is a relation between two or more persons who own property
jointly or in common.
1.2 Advantages of Partnership: There are several reasons why sole - traders combine
and enter into a partnership. Partnership enjoys many advantages, which are enumerated below:
i. Simplicity of Formation: Like sole proprietorship, the partnership can be easily
organized. No legal formalities are involved in the formation of the partnership. The
partners enter into an agreement, get the firm registered, and start a business.
ii. Larger Capital: l In the case of sole proprietorship, the capital is limited to the
savings and borrowing capacity of one man. The partnership is normally in a stronger
position to collect large capital to expand the business.
iii. Favorable Credit Facilities: As the liability of each partner is unlimited, the
Financial Institutions can easily advance loans to the partnership forms.
iv. Greater Management Ability
As there are many partners involved in the conduct of a business, the duties and
responsibilities may be distributed to each partner. It increases the efficiency of the firm.
v. Combined Judgment: "Two heads are better than one". In partnership, the partners
consult each other and as a result wise decision-making is possible.
vi. Admission or Retirement: If any partner wishes to leave the firm or new man wants
to join with the consent of all the partners, it is possible to introduce the new blood
and allow the disinterested partner to leave the firm.
vii. Easy to Dissolve
The partnership can be dissolved at any time without any difficulty.

164
1.3 Kind of Partners
i. Active Partner
The partner who invests capital and takes active part in the conduct of a
business is called an active partner.
ii. Senior Partner
A partner who invests considerable amount and has leadership in the
management of the business is called a senior partner.
iii. Dormant or Sleeping Partner
The partner who invests capital but does not take part in the conduct of a
business and is not known to the public is called a sleeping partner.
iv. Silent Partner
A partner, who does not take any part in the management of the business but
is known to the public as a partner, is called silent partner.
v. Nominal Partner
The person who lends his name and reputation to the firm but neither invests
may capital or takes any part in day-to-day conduct of a business is called a
nominal partner. He does not share in the profits and losses of the firm.
vi. Holding out Partner or Partner by Estoppels
A person who represents himself as partner although he has no right in the
partnership is called a holding out partner.
vii. General Partner
The partner who have unlimited liability are called general partner.
viii. Limited Partner
If one or more than one partner have limited liability and at least one other
partner has unlimited liability, it is said to be a limited partnership. There is no
example of such partnership in Pakistan.
ix. Secret Partner
A partner who takes active part in the affairs of a business but is not known to
the public as a partner is called secret partner.
x. Junior Partner
A person who contributes small amount of investments and has limited
experience of business is called a junior partner.
xi. Minor Partner
Partnership is a contract and a contract with a minor is void. But under section
30 of the partnership Act, a minor may be admitted to the partnership with the
consent of all the partners for the time being.
xii. Partner in Profit Only
If a partner is entitled to a certain share of profit and is not responsible for the
losses he is known, as a partner in profit only. He is not allowed to take part in
the management of the business.
1.4 Essentials of Partnership: Thus the following essentials must exists in a business
before it can be called partnership.
i. There must be at least two partners.
ii. There must be an agreement either oral or in writing.

165
iii. The agreement must show how to share the profit & loss of the business.
iv. The business should be for lawful purposes/consideration.
v. The business should be carried on by all or any of them acting for all.
vi. The liability of each partner is unlimited for all debts of the partnership business.
vii. During business every partner is the agent of other partners or the firm.
viii. No one is allowed to transfer his share or interest to any other person without the
consent of all partners.
1.5 Partnership Agreement/Deed: The document which contains terms and conditions
of the partnership is known as partnership deed. In the absence of an agreement, the
provisions of partnership Act are applicable. However the Act leaves it tot the discretion
of partners to frame rules and regulations for running on the partnership business. Written
agreement between partners will be helpful in case of disputes between the partners.
The following points are to be written into partnership deed:
1. Date of agreement.
2. Name and location of the business.
3. Nature of the business to be conducted.
4. Names of the partners and their details.
5. Investment of each partner.
6. Basis on which profits or losses are to be shared by the partners.
7. If interest is to be allowed on capitals, the rate of such interest.
8. Salary allowances to the partners.
9. The limit of drawings for private purpose and rate of interest on such drawings (if any).
10. The procedure of admission of a new partner.
11. The retirement of any existing partner.
12. Purchase and sales of interest to the other partners and outsiders.
13. Treatment of goodwill in case of change in membership on admission, retirement or
death of partner.
14. Right, duties and liabilities of each partner.
15. In case of disputes among partners the method of arbitration.
16. The procedure of preparing the accounts and their audit.
17. Head office of the firm and places of its branches.
18. Name of the firm’s bankers.
19. Division of assets upon dissolution of the partnership.
20. Length and time the partnership to run.
21. Signature of the partners.
22. Treatment of assurance policy if any.

2. General Accounting Procedure for Partnership Business

General accounting procedure which you learnt in earlier units regarding maintaining
account books (journals, day books, subsidiary ledgers, general ledger, preparation of
trading, profit and loss accounts and balance sheet) is the same for all types of business
organizations and as such in applicable to partnership also. Following accounts are
however of special importance in case of partnerships.

166
2.1 Capital Accounts: These accounts show the financial contribution of each partner
in the firm. Except for amendments to the proportions and extent of capital held, as for
example, on the admission of another partner, these capital amounts may remain
unchanged.

2.2 Current Accounts: These accounts show day-to-day transactions affecting the
partners apart from other business transactions. For example; credit for the share of profits
and interest (if any) on capital, debits for drawings (at the end of year), and any charge for
interest on drawings.

2.3 Drawing Accounts: During the course of the year when it is apparent that business
is operating at a profit, the partners may wish to make drawings, either in cash or in kind
against their anticipated share of profits. These drawings must be kept away from the profit
and loss account. At the end of the year these drawing accounts are closed to the current
accounts of the partner (see 2.2 above).

2.4 Interest on Drawings: According to the Partnership Act no partner’s drawing

should be charged unless there is an agreement amongst the partners to the contrary.
Usually no interest is charged on reasonable drawings of the partners, but when the
withdrawals are heavy, the partnership deed should provide for charging interest on
drawings. Interest is charged on Drawings in the following cases:
a. Where the drawings of the partners are unequal.
b. Where the drawings are made on different dates.

2.5 Interest on Capital Account: According to the Partnership Act no interest is

payable on the capital supplied by the partners. But if there is an agreement as to the
payment of interest on capital, interest is payable at an agreed rate before the division of
profits. For the sake of equity, it is necessary to allow interest on partners' capitals in the
following cases:
a. Where partners share profits equally but have unequal capital,
b. Where the partners have equal capital but share profits unequally.

2.6 Partners Salaries: According to the Partnership Act, no partner is entitled to any
salary for the work done for the firm. But if there is an agreement, a partner may be entitled
to remuneration for his work to the firm. Where some of the partners devote the whole of
their time to the business, while others do not, it is usual to allow the former a salary before
distributing the net profit. This practice is also followed where there are junior partners,
having small capital in the firm who get remuneration from the business for their services.
The salary is either drawn out in cash or credited to the Current Account of the partners.
Example-1: A and B enter into a partnership on 1st January by introducing Rs.50000/-
and Rs. 100000/- respectively. Partnership deed provides 10% interest on equity/capital. A
is entitled to a monthly salary of Rs. 1000. Income for the year before charging interest on
capital and A’s salary amounting to Rs.57000. They share income and expenses equally.
A’s drawings 1500, B’s drawings 2000. Show the distribution of incomes, journal entries,
and accounts relating to partners under:

167
i. Fixed nature of capital ii. Fluctuating nature of capital.
Solution: PLS appropriation account for the year ended.
To Salary – A 12000 By balance b/d 57000
To interest on capital
A 5000
B 10000 15000
To net profit:-
A = 15000
B = 15000 30000
57000 57000
General Journal: A. When Capital are Fluctuating
Date Description PR Dr. Cr.
Dec. 31 Salaries 12000
A’s capital 12000
Salary allowed to A
Interest on capital 15000
A’s capital 5000
B’s capital 10000
Interest allowed on capital
Profit on capital 30000
A’s capital 15000
B’s capital 15000
Income distributed
B. When the Capitals are Fixed
Date Description PR Dr. Cr.
Dec. 31 Salaries 12000
A’s current-account 12000
Salary allowed to A
Interest on capital 15000
A’s current account 5000
B’s current account 10000
Interest allowed on capital
Profit and loss account 30000
A’s current account 15000
B’s current account 15000
Income distributed
Capital Account (When capitals are fixed)
Date Description A B Date Description A B
Dec. 31 Balance 50000 100000 Jan.1 Cash 50000 100000

50000 100000 50000 100000

Partner’s Current Accounts
Date Description A B Date Description A B
Dec.31 Cash (drawings) 1500 2000 Dec. 1 Salary Interest 12000

168
 5000 10000

Dec.31 Balance 30500 23000 PLS a/c 15000 15000

32000 25000 32000 25000
Capital Accounts(When Capitals are Fluctuating)
Date Description A B Date Description A B
Jan. 1 Cash (drawings) 1500 2000 Jan. 1 Cash 50000 100000
Dec. 31 Dec. 31 Salary 12000
Balance Interest 5000 10000
80500 123000 PLS a/c 15000 15000
82000 125000 82000 125000
Balance 80500 123000
Example 2: X, Y, and Z are partners in a firm. On 1st January, the balance of their capital
was Rs.50000/-, Rs.75000/- and 100000/- respectively. During the year each partner drew
Rs.3000/-. They share profit and loss in the ratio 1:1:2 during the year. The firm earned a
profit of Rs.52050/- without having the following adjustments.
i. Interest on capital and drawings at the rate of 10%
ii. Z is to be provided a salary of Rs.500 a month. Each partner’s drawings are Rs.3000.
Show profit and loss appropriation account and capital accounts. Capital under fixed
and fluctuating methods.
Profit and Loss Appropriation Account
Dr. Cr.
Date Description Amount Date Description Amount
Dec.31 interest on capital Jan.1 By balance b/d 52050
A- 5000 By interest on
Drawings
B - 7500 X – 150
C - 10000 22500 Y – 150
salary 6000 Z – 150 450
profit transferred to:
X - 6000
Y - 6000
Z – 12000 24000
52500 52500
Capital Accounts (When Capitals are Fluctuating)
Description X Y Z Description X Y Z
Cash (Drawings) 3000 3000 3000 Balance 50000 75000 100000
Interest on drawings 150 150 150 Interest 5000 7500 10000
Salary 6000
Balance 57850 85350 124850 PLS account 6000 6000 12000

Total 61000 88500 128000 Total 61000 88500 128000

Balance 57850 85350 124850

169
 Capital Account (When capitals are fixed)
Dr. Cr.
Date Description X Y Z Date Description X Y Z
Dec.31 Balance 50000 75000 100000 Jan.1 Balance 50000 75000 100000

50000 75000 100000 50000 75000 100000

Current account: Dr. Cr.
Description X Y Z Description X Y Z
Cash (Drawings) 3000 3000 3000 Interest 5000 7500 10000
Interest on drawings 150 150 150 Salary 6000
Exp. & Rev
Balance 7850 10350 24850 Summary 6000 6000 12000
Total 11000 13500 28000 Total 11000 13500 28000
Note: If the dates on which amounts are withdrawn are not given the interest on the whole
of the amount will be charged for six months on the assumption that amounts were
withdrawn-evenly throughout the year. Example-3: Mr. Akbar, Ali, and Ahmed formed
a partnership on 1st January contributing Rs.50000. 70000 & Rs.100000 respectively. They
share profit and loss in the ratio of 5:7:10. During the year they earned a profit of Rs.49000.
They however omitted the following matters.
i. Interest on capital was not provided, rate is 10%.
ii. The salary of Mr. Ali amounting to Rs 5000 was not paid.
iii. Reserve at the rate of 5% was to be provided at the figure of net profit after all the
adjustments. Show the capital accounts of the partners if capitals are fluctuating.
Drawings were: Akbar Rs.6000, Ali Rs.8000 and Ahmed Rs.10000/-.
Solution: PLS Account
For the period ended on 31st December
To interest on capital By balance 49000
Akbar – 5000
Ali – 7000
Ahmed – 10000 22000
To salary Ali 5000
To reserve fund 1100
To net profit
Akbar – 4750
Ali – 6650 20900
Ahmed – 9500
49000 49000
Capital account
Description Akbar Ali Ahmed Description Akbar Ali Ahmed
To cash (drawings) 6000 8000 10000 By balance 50000 70000 100000
By interest 5000 7000 10000
By Salary 5000

To Balance 53750 80650 109500 By PLS a/c 4750 6650 9500

59750 88650 119500 59750 88650 119500

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Example-4: Mr. Aslam, Akbar and Azhar are partners in a partnership business,
contributing Rs. 40000/-, Rs. 50000/- and Rs. 50000/-.
i. Mr. Aslam is entitled to a salary Rs. 3000/- per year.
ii. Interest of 10% is to be provided on capital of each partner.
iii. Akbar is entitled of a commission of 10% of any surplus after (i), (ii),
iv. Remaining profit is to be distributed in the ratio of 4:3:1: Profit before all the
adjusting amounts is Rs. 61000/-. Prepare a statement of Income Distribution and
capital accounts of the partners. PLS Account for the year end
To salary (Aslam) 3000 By balance 61000
To interest on capital
Aslam 4000
Akbar 5000
Azhar 5000 14000
To commission – Akbar 4000
To net profit
Aslam 20000
Akbar 15000
Azhar 5000 40000
61000 61000
Capital account
Date Description Aslam Akbar Azhar Date Description Aslam Akbar Azhar
Dec.31 Balance 67000 74000 60000 Jan.1 Balance 40000 50000 50000
Salary 3000
Interest on
Capital 4000 5000 5000
Commission 4000
PLS a/c 20000 15000 5000
67000 74000 60000 67000 74000 60000
Note: Commission has been calculated with the help of the following formula.
NP x Rate of Commission = 44000 x 10 = 4000
100 + Rate of Commission 110
Example-5: Balance of capital of M/s Z & M on 1st January is Rs.80000/- and Rs.50000/-
respectively. The partnership deed provides the following:
i. Interest to be charged on capital 10% and on drawings 8% per annum.
ii. Mr. Z is entitled for salary of Rs.1000/- per month. Each partner withdrew Rs.400/-
per month on first of each month.
iii. Mr. Z withdrew salary for 6 months i.e. Rs.6000/- and this was charged to profit and
loss account.
iv. Profit for the year before charging interest on drawing and capital and unpaid salary
amounts to Rs.44247- They share income and expenses 2:1. Prepare capital accounts.

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Solution: M/s Z & M
PLS account for the period end
To interest on capital 3000 By balance 44247
Z – 8000 By interest on drawing
M – 5000 13000
To salary – Z 6000 Z – 130
To net profit M –130
Z – 14998 260
M – 7499 22497
44497 44497
Interest on drawing has been calculated as under: Product
Rs.400/- draws on 1st Jan. stands for 12 months 400 x 12 = 4800/-
Rs.400/- on 1st February stands for 11 months 400 x 11 = 4400/-
Rs.400/- draws on 1st march stands, 10 months 400 x 10 = 4000 and so on.
The sum will be Rs.31200. By dividing it on 12 we will get the weighted average of
drawings that remained outstanding throughout the year.
Weighted Average Drawing = Rs.31200 = Rs.2600
12
Interest on Drawings = Rs.130
Date Detail Z M Date Detail Z M
Dec.31 Interest on Jan. 1 Balance 80000 50000
drawings 208 208 Dec.31 Interest on capital 8000 5000
Cash drawings 4800 4800 Salary 6000
Balance 104068 57569 PLS a/c 14998 7499

108998 62499 108998 62499

2.7 Capital Ratio as Basis of Sharing Profit and Loss: Under this system, the profit
or loss of the business is divided in the ratio of the capital. The capital ratio may be of the
following type:
i. Beginning capital ratio
ii. Ending capital ratio
iii. Average capital ratio
i. Beginning Capital Ratio: When profit or loss is to be divided according to
beginning capital ratio, the capital balance on 1st day of the accounting period is taken as
a base. If the capital balances of M/s A & B on 1st day of the accounting period is
Rs.30000/- and Rs.50000/- respectively, the profit or loss will be divided between them in
the ratio of 3:5.
ii. Ending Capital Ratio: When profit or loss is to be divided according to ending
capital ratio, the capital balance on the last day of the accounting period is taken as a base.
If the capital balance of M/s Y and Z on the last day of accounting is Rs.70000/- and
Rs.30000/- the profit will be divided in the ratio of 7:3. If the capital at the end of a
particular period is not given it will be calculated in the following way:
Ending Capital = Beginning capital + additional investment (-) drawing

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Example – 6: Akbar, Babar and Shan started business on 1st January, with Rs.30000/-. Rs.
50000/- and Rs. 60000/- respectively. They made additional investment during the year
Rs.10000/-, Rs.4000/- and Rs. 5000/- respectively. During the year Akbar withdrew Rs.
4000/- and Shan Rs. 2000/-. During the year the firm earned a profit of Rs.21420. Give the
necessary journal entries, if profit is distributed.
(a) Beginning capital ratio
(b) Ending capital ratio
Solution: Beginning capital ratio
Akbar Babar Shan
Capital 30000 50000 60000
Profit ratio 3 5 6
Or 3/14 5/14 6/14
Share of Akbar = 3/14 x 21420 = Rs.4590/-
Share of Babar = 5/14 x 21420 = Rs.7650/-
Share of Shan = 6/14 x 21420 = Rs.9180/-
Ending Capital Ratio
Akbar Babar Shan
Capital 30000 + (10000 – 4000) 50000 + (40000-0) 60000+(5000-2000)
Profit 36000 54000 63000
ratio 4 6 7
Or 4/17 6/17 7/17
Share of Akbar = 4/17 x 21420 = Rs.5040/-
Share of Babar = 6/17 x 21420 = Rs.7560/-
Share of Shan = 7/17 x 21420 = Rs.8820/-
Case (a) General journal Dr. Cr.
Profit on Capitals: 21420
To capital – Akbar 4590
To capital – Babar 7650
To capital – Shan 9180
(income distributed)
Case (b) Dr. Cr.
Profit and loss account 21420
To capital – Akbar 5040
To capital – Babar 7560
To capital – Shan 8820
(income distributed)
i. Average capital ratio: If the profit or loss of the business is to be divided in the ratio
of average capital, the average capital is ascertained as under:
(a) Periodical balance of each partner’s capital is ascertained.
(b) Periodical balance is multiplied by the unchanged period and product is
calculated.
(c) Add the product of each period to get the total product.
(d) Divide the total product by total period.
(e) The resulting figure will be the average capital.

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3. ADMISSION OF A NEW PARTNER
You have already learnt the reasons why traders combine resources and enter into
partnership. In this connection paragraph 1.2 may be referred to. The same reasons are
applicable for admission of a new partner in an existing firm.

Subject to special agreement, a new partner can be admitted only with the consent of
all the existing partners. The partners reconsider the working arrangements and agree on
fresh terms and conditions under which the reconstituted business shall be run. On
admission of a new partner the existing partners will naturally become entitled to have
satisfactory compensation for surrendering a part of their share in the profit of the firm.
The following paragraph deals with admission of a new partner in the firm.
3.1 Admission Procedure: When a new person is admitted as a partner, certain
adjustments in account books become necessary. Chiefly this is because, the new partner
will require a share in the profits of the firm and due to this reason, the old partners will
stand to loss and sacrifice a part of their profit when accommodating the incoming new
partner. At the time of admission the main questions to be dealt with are:
(a) Treatment of goodwill/or bonus
(b) Revaluation of assets and liabilities
(c) Settlement of new profit sharing ratio. All these issue are discussed in the following.
3.2 Goodwill in Partnership: The first thing, which is to be taken in consideration on
admission of a new partner, is goodwill. The term goodwill has been defined in various
ways:
(a) “Nothing more than the probability that the old customers will resort to the old place”.
(b) “The benefits and advantages accruing from the habitual customers of a successful
business”.
(c) “The excess value of an old established business over the capital value of the same”.
(d) “The value attaching to the reputation of business”.
In fact, goodwill means the goodwill, rather the good wishes of the buying public
towards a particular business as a result of which, that business attracts a regular flow of
customers and good profits. Briefly, goodwill may be said to be that element arising from
the reputation, connection or other advantages possessed by the business, which enables it
to earn profits greater than the return normally expected on capital invested in the tangible
assets employed in the business. It is the value of the reputation of the firm.
Goodwill is a positive asset, no doubt, but it is an intangible asset unlike plant and
machinery, land and building, stock is trade, etc. goodwill cannot be seen but its existence
can be felt and appreciated. The existence of changes hands and its goodwill fetches a good
sum, although the old proprietors were not perhaps fully aware of its existence and value.
The factors, which are responsible for the goodwill of a business, may be one or more of
the following:
(a) The name of the business.
(b) The nature or reputation of the article sold or of the service rendered.

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(c) The personality or personal reputation of the proprietors.
(d) The particular advantage of the site of business.
(e) The possession of the trade marks, patents, or trade name by the firm.
The factors named above result in extra profits and hence goodwill will arise when business
is profitable. A business running into losses will have, generally, no goodwill.
3.2.1 Valuation of Goodwill
There are various methods in practice for the valuation of goodwill. The usual methods are
as under:
i. Average Profit Basis: In this case the profits of the past few years are averaged. The
average is multiplied by a certain number (2 or 3 or 5) as agreed. It is expressed, for
example, as 3 years purchases of 5 year’s average profits. The profits for the year
20-A to 20-F have been Rs.8000/-, Rs.10000/-, Rs.12000/-, Rs.7000/-, and
Rs.13000/-. First of all ascertain the average for 5 years profits and then multiply that
average by three. The product will be the amount of goodwill. The average comes to
Rs.10000/-. The goodwill be 3 x 10000 = Rs.30000/-.
ii. Super Profit Basis: In this case interest on capital employed at the rate prevailing
in the market and also reasonable salary of the proprietor is deducted from the
average profit. What remains is “Super Profits”. Suppose in the case discussed above
the capital of the firm consists of Rs.80000/- and that 5 percent is reasonable return
in the industry. The reasonable or normal profit @ 5 percent has come to Rs.4000/-.
The average profits being Rs.10000/-, the super profits in this case come to Rs.6000/-
. In the example given above, if goodwill is to be calculated at 3 years purchase, the
goodwill is 6000 x 3 = Rs.18000/-
iii. Capitalization Method
In this method the value of the whole business is found out by the formula,
Profit x 100
Reasonable or normal return

From this figure the assets of the firm are deducted and the remainder is goodwill.
In the above example of the value of the whole business is 10000 x 100 or Rs.10000/-. Net
assets or capital is Rs.80000/-. Hence the goodwill will be 10000 – 80000 = Rs. 20000/-.

When is Goodwill Valued? The necessity for the valuation of goodwill arises in the
following cases:
(a) When a new partner is admitted to a partnership
(b) When a partner retires or dies
(c) When the profit sharing ratio amongst the partners is changed and
(d) When the business is dissolved or sold
3.3 Accounting Treatment of Goodwill/Bonus: When a new partner joins an existing
business, they may be required to contribute goodwill in addition to capital. Goodwill
represents the firm's reputation and earning potential. Under IFRS, goodwill is treated as
an intangible asset and must be accounted for properly. The following methods are
commonly used:

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1. Cash Payment – The new partner directly pays the existing partners for their share of
goodwill.
2. Adjustment in Capital Accounts – Goodwill is adjusted in partners' capital accounts
based on the agreed profit-sharing ratio.
3. Goodwill Raised and Written Off – Goodwill is first recorded in the books and then
written off among existing partners.
4. Hidden Goodwill – If no specific goodwill amount is given, it is determined by
adjusting the capital contribution to match the new profit-sharing ratio.
a. Debit cash or Bank Account Cr. (with the actual amount, which is brought
goodwill account in as goodwill)
b. Debit goodwill account (in the ratio in which old partners are
Credit old partner capital sharing)
account
One point must, however, be noted. This should be the case when the admission of a person
as a partner, the ratio as among the old partners does not change. But on the admission of
a new partner, the profit sharing of old partners as among them is also changed. It has been
made clear above that goodwill is compensation to old partners. Therefore, the amount
brought in as goodwill by the incoming partner should be credited to the old partners in the
ratio of their sacrifice and not in the old profit-sharing ratio.
Suppose A and B were sharing profits in the ratio of 5:3, C is admitted and the new
profit sharing ratio is 2:1:1. This means that A will now get one-half, B will get one-fourth,
and C also one-fourth. The ratio of sacrifice can be calculated by finding out how much A
& B (old partners) lose. A loses 5/8-1/2 i.e., 1/8. B loses 3/8-1/4, i.e. 1/8. Therefore, on C’s
admission both A & B lose equally. The amount brought in by C should be credited to the
capital accounts of A & B equally. The students must note that the treatment of goodwill
is necessary only when goodwill is brought in cash. This is shown in the following
example:
The following is the balance sheet of Abid and Akbar as at Dec. 31st:
Capital & Liabilities Amount Assets Amount
Sundry creditors 30000 Cash account 10000
Sundry assets 50000
Owner’ equities
Capital – Abid 15000
Capital – Akbar 15000 30000
60000 60000
The particulars shared profits and losses in the ratio 3:2. On the above date Asghar was
admitted as partner for 1/5 share in the business.
Required: Giver necessary journal entries and prepare balance sheet under the following
cases separately.
i. Asghar has invested Rs.10000/- in the partnership.
ii. If it is agreed that Rs.30000/- would represent 4/5 of the total capital of the new firm.
Solution: Case (1) General Journal
Date Description Dr. Cr.
Dec. 31 Cash 10000

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 Capital - Asghar 10000
The investment made by Asghar
Name:_____________
Balance sheet as on Dec. 31st
Capital & Liabilities Amount Assets Amount
Sundry creditors/account, payable 30000 Cash (10000 + 10000) 20000
Owners equities: Sundry assets 50000
Capital – Abid 15000
Capital – Akbar 15000
Capital – Asghar 10000
40000
70000 70000
Case (2.) New partner’s interest = 1/5
Remaining interest of old partners = 4/5
Capital for 4/5 interest = 30000/-
Total capital of new firm = 30000 x 5/4 = 37500/-
Asghar’s capital = 37500 x 1/5 = 7500/-
General Journal
Date Description Dr. Cr.
Dec. 31
Cash 7500
Capital – Asghar 7500
The investment made by Asghar
Name:_____________
Balance sheet as at Dec. 31st
Capital & Liabilities Amount Assets Amount
Sundry creditors/accounts payable 30000 Cash (10000 + 7500) 17500
Owners’ equities Sundry assets 50000
Capital Abid 15000
Capital Akbar 15000
Capital Asghar 7500
37500
67500 67500
iii) By purchasing interest in an existing partnership business: When a new partner
purchases the interest of the old partner neither the total assets nor the total capital of the
business is affected. The new partner pays the purchase price directly to the old partners,
therefore, payment is not recorded in the books of the firm. The only entry will be for the
transfer of capital of the old partners to the new partners. The capital of the old partner will
be decreased and capital of new partner will be increased, the journal entry would be:
Old partner’s capital Dr.
To new partner’s capital Cr.
Example-9: X and Y are carrying on business as general merchants, sharing profit and
losses in the ratio of 2:3. Their balance sheet as on 31st December is as under:
Equities & Liabilities Amount Assets Amount
Sundry creditors 32000 Cash at bank 2000
Bills payable 6000 Bills receivable 3000

177
 General reserve 4000 Stock 8000
Capital X 8000 Investment 4000
Capital Y 6000 Machinery 19000
Building 20000
56000 56000
It is decided to admit Z into the partnership on the condition that he would pay Rs.4000/-
as capital on 1st January. Goodwill is to be valued at 3 years purchase of 4 years average
profit, the profit or loss for the 4 years are:
1st-year profit 2200 2nd-year profit 1600
3rd-year loss 800 4th-year profit 1800
The new profit-sharing ratio is 5:6:7
Required: Give journal entries and show the balance sheet under the following methods
of treatment, of goodwill:
i. Goodwill paid privately
ii. Goodwill paid in cash and retained
iii. Goodwill paid in cash and withdrawn half share of goodwill
iv. Goodwill raised
v. Goodwill raised and written off
Solution: i) No Entry is required
Goodwill will be calculated as follows:
− Four year total profit = 2200+1600-800+1800=Rs.4800/-
− Four years average profit = 4800/4 = Rs.1200/-
− Goodwill = Rs.1200 x 3 = Rs.3600/-
− Z’s share of goodwill = 3600x7/18 = Rs.1400/-
ii) Goodwill Paid in Cash and Retained
General Journal
Date Description Dr. Cr.
General reserve account 4000
To capital – X 1600
To capital – Y 2400
(General reserve transferred to capitals)
Bank account 4000
To capital – Z 4000
(Capital paid in by Z)
Bank account 1400
To goodwill account 1400
(Goodwill paid by Z)
Goodwill account 1400
To capital – X 440
To capital – Y 960
(Goodwill a/c is transferred to old partners’
a/c in the ratio of sacrifices i.e. 11:24.
The sacrifice ratio will be calculated as follows:
Sacrifices ratio of X = 2/5 – 5/18 : 36-25 = 11/90
90
Sacrifices ratio of Y = 3/5 – 6/18 : 54-30 = 24/90

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 90
Sacrifices ratio = 11/90 : 24/90 = 11 : 24
The balance sheet of new firm as on 1st January
Equities & Liabilities Amount Assets Amount
Sundry creditors 32000 Cash at bank 7400
Bills payable 6000 Bills receivable 3000
Capital – X 10040 Stock 8000
Capital – Y 9360 Investment 4000
Capital – Z 4000 Machinery 19000
Building 20000
61400 61400
iii) When goodwill paid in cash and withdraws: This method is similar to the second,
with the exception that the money paid in by the incoming partner for goodwill is not left
in the business but is withdrawn by the old partners. The journals entries in this method are
similar to those made in second method, except the following additional entry, which is
made when the old partners withdraw goodwill.
Old partner capital Dr. With the amount of cash
To cash / bank account Cr. Withdrawn by old partners
Note: As under methods second and third the old partners are compensated in cash for the
share of their goodwill, which they surrender to the new partner, therefore, no goodwill
account is shown in the balance sheet for the new partnership. This will be clear from the
following example:
Goodwill paid in cash and withdrawn
General Journal
Date Description Dr. Cr.
General reserve account 4000
To capital – X 1600
To capital – Y 2400
(General reserve transferred to old partner’s capital account)
Bank account 4000
To capital-Z 4000
(Capital paid by Z)
Bank account 1400
To Goodwill a/c 1400
(Goodwill paid by Z)
(Goodwill a/c 1400
To Capital – X 440
To Capital – Y 960
Goodwill credited to old partners in the ratio of Sacrifice
Capital – X 220
Capital – Y 480
To Bank a/c 700
(Goodwill withdrawn by X & Y)
Balance sheet of new firm as of 31st Dec.
Equities & Liabilities Amount Assets Amount
Sundry creditors 32000 Cash at bank 6700
Bills payable 6000 Bills receivable 3000

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 Capital – X 9820 Stock 8000
Capital – Y 8880 Investment 4000
Capital – Z 4000 Machinery 19000
Building 20000
Goodwill 3600
63600 63600
iv. Goodwill Raised: Sometimes, it happens that the incoming partners fail to pay the
old partners their share of goodwill in cash. In such a case, to compensate the old partners,
it is agreed to raise a goodwill account in the books of firm. Goodwill account is raised at
full-agreed value and is shown as an asset in the balance sheet. The entry will be:
Goodwill account Dr.
To old partners' capital account) Cr.
(In the old profit sharing ratio)
A point to note is that if the goodwill is already appearing in the books of old firm, the
entry will be for the difference only, if the amount of goodwill already appearing in the
books is more then the present value then it means that there is a loss to be suffered by
the old partners, in this case, the entry will be:
Old partners capital Dr.
To goodwill account Cr.
(In the old profit sharing ratio)
This will be clear from the following example:
v. Goodwill raised and Written Off: It is not considered proper to continue to show
goodwill in the balance sheet. This is because goodwill is an asset, which can be realized,
only if the firm is dissolved. Therefore if the goodwill is raised on the admission of a
partner, it is often written off immediately. This is done by debiting all partners including
the new partner, in the new profit sharing ratio and by crediting goodwill.
a. Debit goodwill account (goodwill raised)
Credit old partner’s capital account
b. Debit all partners’ capital accounts (goodwill written off
Credit goodwill account in the new ratio)
Note: Goodwill in this case will not appear in the balance sheet of the newly formed
partnership as shown in the following example:
vi. Goodwill raised and written off: General Journal
Date Description Dr. Cr.
General reserve account 4000
To capital – X 1600
To capital – Y 2400
(General reserve transferred to old partner’s capital account).
Bank account 4000
To capital – Z 4000
Capital paid in by Z
Goodwill account 3600
To capital – X 1440
To capital – Y 2160
(Goodwill raised and credited to old partners capital in old ratio)
Capital – X 1000
Capital – Y 1200

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 Capital – Z 1400
To Goodwill A/c 3600
(Goodwill written off)
Balance sheet of new firm as on 1st January
Equities & Liabilities Amount Assets Amount
Sundry creditors 32000 Cash at bank 6000
Bills payable 6000 Bills receivable 3000
Capital – X 10040 Stock 8000
Capital – Y 9360 Investment 4000
Capital – Z 2600 Machinery 19000
Building 20000
60000 60000
3.4 Revolution of Assets and Liabilities: On a new partner's admission, assets and
liabilities are revalued at market value to reflect their true financial position. This ensures
that the new partner neither benefits from asset appreciation nor suffers from devaluation
losses. The revaluation adjustments are recorded in a Revaluation Account, with gains or
losses transferred to the existing partners' capital accounts in their old profit-sharing ratio.

Under IFRS (IAS 16 & IAS 36), asset revaluation must be based on fair value, and any
impairment loss should be recognized immediately. Revalued amounts should be disclosed
in financial statements for transparency. Accounting procedure: The assets, which are
appreciated, will be debited with the increased value, while revaluation account will be
credited. On the other hand the assets, which are reduced in value, are credited with the
amount of decrease and revaluation account will be debited. Reverse entries, will be passed
in case of revaluation of liabilities.
a. When value of asset is increased
Particular assets a/c Dr. (With the amount of increase
To revaluation a/c Cr. In the value of assets.)
b. when value of asset is decreased
Revaluation a/c Dr. (With the amount of decrease
To particular asset a/c Cr. in the value of assets)
c. When value of liabilities is increases
Revaluation a/c Dr. (With the amount of increase
To particular liabilities a/c Cr. In the value of liabilities)
d. When value of liabilities is decreased
Particulars liabilities a/c Dr. (With the amount of decrease
To revaluation a/c Cr. In the value of liability)
After passing the entire journal entries regarding revaluation of assets and liabilities,
revaluation account will be prepared. If credit side of revaluation is greater than the debit
side, there will be gain on revaluation. This again will be distributed among the old partners
in their old income sharing ratio. The journal entry will be:
e. Revaluation account Dr. (with their respective share of
To partners capital Cr. profit)

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If debit side of revaluation is greater than the credit side there will be loss on revaluation.
This loss distributed among old partners in their old income-sharing ratio. The journal entry
will be reverse of the above entry, will now appear as under:
f. Old partners capital a/c Dr. (with their respective share of
To revaluation a/c Cr loss)
General Reserve: At the time of admission of a partner any general reserve or balance of
profit or loss account appearing in the books of account should be transferred to the old
partners in their old income-sharing ratio. The journal entry will be:
General reserve / profit and loss a/c Dr. (with their respective share of
To old partners capital a/c Cr. General reserve
This is illustrated in the following example: Example 10 Rizwan, Imran and Rehan are
partners in a firm. They share profit and loss in 5:3:2 ratio. Their balance sheet on 31st
December is as under.
Equities & Liabilities Amount Assets Amount
Sundry creditors 15000 Cash in hand 5650
Bank overdrafts 6000 Cash in bank 3000
Capital – Rizwan 90000 Sundry debtors 11500
Capital – Imran 70000 Stock 45850
Capital – Rehan 50000 210000 Furniture 6000
Less depreciation 600 5400
Machinery 49000
Less depreciation 4400 44600
Building 76000
Tools (less depreciation) 39000
231000 231000
They admit Kamran, at the time of admission, assets were re-valued as such:
1. Stock re-valued Rs.42300/-
2. Rs.200/- on sundry debtors is not to be received
3. Building is appreciated by Rs.34000/-
4. Tools are re-valued at Rs.37000/-
5. Furniture is valued at Rs.5000/- Machinery at Rs.42000/-
6. Kamran contributed Rs.80000/- for share in profit
7. Goodwill account for Rs.84750/- is raised
Required: Journalize the above matters. Prepare balance sheet of the new firm.
Solution: General journal
Date Description Dr. Cr.
Revaluation account 8750
To stock 3550
To allowance for un-collectable a/c 200
To tools account 2000
To furniture account 400
To machinery account 2600
(Sundry assets are re-valued)
Building account 34000
To revaluation account 34000
(Building is appreciated)
Revaluation account 25250

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 To capital – Rizwan 12625
To capital – Imran 7575
To capital – Rehan 5050
(Loss or revaluation transferred to old partners at their old ratio)
Goodwill account 84750
To capital – Rizwan 42375
To capital – Imran 25425
To capital – Rehan 16950
(Goodwill raised in the books)
Revaluation account
Sundry debtors 3550 By building account 34000
Allowance for un-collectable 200
To tools 2000
To furniture 400
To machinery 2600
Profit transferred to:
Capital – Rizwan 12625
Capital – Imran 7575
Capital – Rehan 5050 25250
34000 34000
Capital accounts
Rizwan Imran Rehan Rizwan Imran Rehan
Balance 145000 103000 72000 By balance 90000 70000 50000
By revaluation a/c 12625 7575 5050
Goodwill a/c 42375 25425 16950

145000 103000 72000 145000 103000 72000

Name:________________
Balance sheet as at 1st January
Capital & Liabilities Amount Assets Amount
Sundry creditors 15000 Current assets 85650
Bank overdraft 6000 Cash (5650 + 80000) 3000
Rizwan – capital 145000 Cash at bank
Imran – capital 103000 Sundry debtors 11500 11300
Rehan – capital 72000 Less allowance 200
Kamran – capital 80000 Stock 42300
Non-current assets
Machinery 42000
Furniture 5000
Building (76000 + 34000) 110000
Tools 37000
Goodwill 84750
421000 421000

3.5 The Profit Sharing Ratio

A. Finding out the new ratio might involve a little problem. The language of the agreement

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is most important. In some cases the new ratio is given. In others only the share to be given
to the new partner is given. The assumption is that as between the old partners the ratio
does not change. In such a case one should deduct from the share of the new partner and
then divide the remainder in the old partners in the old ratio. Suppose A & B are partners
sharing profit and loss in the ratio of 5:3. They admit C and agree to give him 3/10 of the
profit. Then the new ratio will be calculated as follows. C’s share is 3/10; deducting this
from 1, what is left is
1-3/10 = 7/10
A’s share = 7/10 x 5/8 = 35/80
B’s share = 7/10 x 3/8 = 21/80
C’s share = 3/10 or-24/80
The ratio is 35:21:24
B. In certain cases the incoming partner “Purchases” share from the other partners is
different proportions. Suppose A and B sharing profit in the ratio of 5:3 admit C giving
him a 3/10 share of profits of the firm. If C acquires this share 4/20 from A and 2/20 from
B, the new ratio will be: A=5/8-4/20 = 1.7/40
B = 3/8 – 2/20 = 11/20
C = 3/10 or = 12/40
If C acquires his 3/10 equally from both
A’s share would be 3/20 – 3/20 = 19/40 and
B’s share would be 3/20 – 3/20 = 9/40
Reserve etc. in the balance sheet: Whenever a new partner is admitted, any reserve, etc,
which may be lying in the balance sheet should be transferred to the capital account of the
old partners in the old profit sharing ratio. In examination problems it should be done even
if there is no instruction of this point.
D. Capitals in the profit sharing ratio: If is often agreed on admission of a partner
that the capitals of all partners should be in proportion to their respective share in profits.
The starting point may be the new partner capital or the new partner himself may be
required to bring in capital equal to his share in the firm. If the new partner’s capital is
given, one should find out the total capital of the firm on the basis of the share. Then the
capital required of other partners should be ascertained. This question should be taken up
after making all adjustments in respect of goodwill, transfer of profit or loss on revaluation
of assets and reserves, etc. Suppose A and B are two partners sharing in the ratio of 3:2
having capitals Rs.30000/- and Rs.16000/- respectively. They admit C in a firm with a
share of ¼ in the profit of firm, C contributes Rs.15000/- as his capital. Then the required
capital of A and B should be calculated as follows:
A’s share of profit[1-1/4] x 3/5 = 9/20
B’s share of profit [1-1/4] x 2/5 = 6/20
C’s share of profit [1-1/4] x 1/5 = 5/20
If C’s share is Rs.15000/- then the total capital should be Rs.15000 x 4/1 = Rs.60000/-
A’s share therefore should be 60000 x 9/20 = 27000
B’s share therefore should be 60000 x 6/20 = 18000

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A’s share therefore, should be paid Rs.3000/- i.e. 30000 – 27000/-, B should bring
Rs.2000/- i.e. 18000 – 16000.
We can get these figures in another way also. If for 5/20 share of profits, the capital
is Rs.15000, for 9/20 share of profits, the capital should be 15000 x 2/5 x 9/20 = 27000A.
This is what A’s capital should be, similarly for 6/20 share of profits the capital should be
15000 x 20/5 x 6/20 = 18000/-.

Example-II; The following is the balance sheet of Zafar and Muzammal on 31st
December. Profit being divided equally.
Capital & Liabilities Amount Assets Amount
Sundry creditors 20000 Cash 200
Bank overdraft 6000 Sundry debtors 24400
Capital Zafar 8400 Stock 14000
Capital Muzammal 6400 Investment 1200
Furniture 1000
40800 40800
It is arranged that Asif shall be taken in partnership and as a result of the negotiations, it is
agreed to make the following adjustments in the above balance sheet.
i. Investment is decreased by 25%, stock by 15% and furniture 6%.
ii. Goodwill raised in the books Rs.4000/-
iii. Bad debts written off Rs.6000/-
iv. Asif introduces Rs.4000/- as his one-third share of the capital, the capital accounts
of other partners shall be adjusted.
Required: Make journal entries and prepare an amended balance sheet
Solution: Journal
Date Description Dr. Cr.
Revaluation account 3000
To investment account 300
To stock account 2100
To furniture account 600
(Being the decrease in the value of various assets)
Goodwill account 4000
To capital – Zafar 2000
To capital – Muzammal 2000
(Being the good will raised)
Revaluation account 6000
To sundry debtors account 6000
(Being the bad debts written off)
Cash account 4000
To capital – Asif 4000
(Being the amount of capital paid by Asif)
Capital – Zafar 4500
Capital – Muzammal 4500
To revaluation account 9000
(Being the loss on revaluation transferred to old partner’s capital
a/c)

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 Capital – Zafar 1900
To cash account 1900
(Being the excess capital withdrawn)
Cash account 100
To capital – Muzammal 100
(Additional capital paid in)
Capital of Zafar and Muzammal have been adjusted as follows: Asif,s share is 1/3,
deducted from 1
Which is left is = 1/1-1/3 = 2/3
Zafar’s share is new firm = 2/3x1/2 = 1/3
Muzammal’s share in new firm = 2/3 x ½ = 1/3
Capital of Asif for 1/3 share = Rs. 4000/-
Total capital of new firm = 3/1 x 4000 = 12000
Capital of Zafar in new firm = 12000 x 1/3 = Rs.4000
Zafar should be paid = Rs. 1900 = (5900 – 4000)
Muzammal should bring = Rs. 100 = (4000 – 3900)
Balance sheet of new firm
Capital & Liabilities Amount Assets Amount
Sundry creditors 20000 Cash (2200+200) 2400
Bank overdraft 6000 Sundry debtors 18400
Capital Zafar 4000 Stock (24000-2100) 11900
Capital Muzammal 4000 Furniture (1000-600) 400
Capital Asif 4000 Investments (1200-300) 900
Goodwill 4000
38000 38000
4. RETIREMENT AND DEATH OF A PARTNER
4.1 Retirement of a Partner
A partner may not want to remain as partner due to any reason, other than death and may
wish to withdraw his capital from the firm. This type of withdrawal is known as retirement.
Technically speaking partnership comes to an end unless remaining partners are agreed to
continue it. If they want to continue it, they should form a new partnership. At the
retirement, the following matters are to be decided:
i. To ascertain the amount due to the retiring partner
ii. New profit sharing ratio between remaining partners
iii. To determine the value of goodwill if necessary
iv. Revaluation of assets and liabilities
v. Mode of payment to the outgoing partner
vi. Capital account transferred to loan account
vii. Reserve etc.
i. To Ascertain the Amount due to the Retiring Partner
Retiring partner will be entitled to:
a. Capital balance on the date of retirement or on the date of previous balance
sheet as agreed.
b. Interest on capital from the last date of balance sheet to the date of retirement
if due as per partnership deed.

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 c. Share of profit from the date of previous balance sheet to the date of retirement.
d. Profit or loss due to revaluation of assets and liabilities.
e. Share of goodwill.
ii. New Profit Sharing Ratio
After the retirement or death of partner, distribution basis of income between the
remaining partners is a matter to be decided. They may distribute it in the same ratio
or otherwise decide a new ratio among themselves. For example A, B and C are
partners sharing profit and loss equally. In the absence of any agreement profit will
be distributed in the ratio before retirement equally.
iii. Treatment of Goodwill on Retirement of a Partner
Treatment of goodwill may take following forms.
(a) Goodwill raised at full value
(b) Goodwill raised at full value and written off
(c) Goodwill raised equal to retiring partner share
(d) Goodwill raised equal to retiring partner share and written off
iv. Revaluation of Assets and Liabilities: Revaluation of assets and liabilities is a must
on the retirement of a partner unless the deed specially says that these are not to be
re-valued. The method of dealing with revaluation of assets is exactly similar to that
followed at the time of admission of a partner. Revaluation account will be debited
with reduction in the value of assets and increase in the amount of liabilities. This
account (revaluation) will be credited with increase in the value of assets and
reduction in the amount of liabilities. The profit or loss on revaluation must be
transferred to the capital accounts of all partners (including retiring) in the old profit
sharing ratio.
v. Mode of Payment to Retiring Partner: The amount due to a retiring partner may
be paid in lumpsum immediately after retirement or it may be paid by installments
to the retiring partner.
If the amount due to a retiring partner is paid off in lumpsum, the entry will be.
Retiring partners capital Dr.
To cash / bank account Cr.
If the payment to the retiring partner is to be made by means of periodic installment,
the balance of his capital will be transferred to a loan account in his name, the entry will be.
Retiring partner capital Dr.
To partner loan Cr.
vi. Reserve, etc
On the retirement of a partner any reserve or accumulated profits appearing in the
books should be transferred to capital account of all the partners in the old ratio.
Alternatively, only the retiring partner may be credited with his share, the remaining
reserve continuing to appear in the books.
vii. Capital Account to be transferred to Loan Account: When the formalities of
retirement are over, the balance standing to the credit of the retiring partner’s capital
should be transferred to his loan account until it is paid off in lumpsum or in
installments.
Example – 12: Tufail, Jamal and Kamal were running a business under the name Globe
General Store. They shared profit and loss as 3:2:1 respectively. They close their books on

187
31st December each year. Jamal retired from the business. On the date of his retirement
the balance sheet of the firm was under:
Capital & Liabilities Amount Assets Amount
Sundry creditors 10200 Cash in hand 10000
Loan of Jamal 3600 Sundry debtors 10000
Less allowance 500 9500
Tufail – Capital 22700 Stock 16000
Jamal – Capital 16000 Office equipment 12000
Kamal – Capital 7000 45700 Less depreciation 2000 10000
Plant & machinery 17000
Less depreciation 3000 14000
59500 59500
Following adjustment is to be made before ascertaining the amount due to Jamal:
i. Goodwill is to be valued at Rs.18000/- which is to be remained in the books.
ii. Allowance for un-collectible is to be increased to Rs.1000/-
iii. Stock valued at Rs.15000/-
iv. Office equipment and plant and machinery are to be depreciated at 10% of the net
value.
v. Amount due to Jamal is to be transferred to his loan account, at the rate of 15%
interest, but loan in the balance sheet is to be paid immediately.
Required: Pass necessary journal entries; prepare the balance sheet of the new firm.
Solution: Journal
Date Description Pr. Dr. Cr.
Goodwill account 18000
To Tufail – capital 9000
To Jamal – capital 6000
To Kamal – capital 3000
(Goodwill raised in the books)
Revaluation account 3900
To allowance for un-collectible a/c 500
To stock account 1000
To office equipment 1000
To plant & machinery 1400
(Assets are reduced as agreed)
Tufail – capital 1950
Jamal – capital 1300
Kamal – capital 650
To revaluation account 3900
(Loss on revaluation transferred to partner’ capital)
Jamal – capital 20700
To Jamal – Loan 20700
(Jamal’s capital transferred to his loan)
Jamal loan 3600
To cash 3600
(Jamal’s loan paid off)
Revaluation account
To allowance for un-collectible a/c 500 By Tufail – capital 1950

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To stock account 1000 By Jamal – capital 1300
To office equipment account 1000 By Kamal – capital 650 3900
To plant & machinery account 1400
3900 3900
Capital account
Tufail Jamal Kamal Tufail Jamal Kamal
To revaluation 1950 1300 650 By balance 22700 16000 7000
To Jamal’s loan 20700 By goodwill 9000 6000 3000
To balance 29750 9350

31700 22000 10000 31700 22000 10000

Balance sheet
Capital & Liabilities Amount Assets Amount
Sundry creditors 10200 Cash (10000 – 3600) 6400
Jamal – loan 20700 Sundry debtors 10000
Tufail – capital 29750 Less allowance 1000 9000
Kamal – capital 9350 39100 Stock 15000
Non-current assets:
Office equipment 12000
Less depreciation 3000 9000
Plant & machinery 17000
Less depreciation 4400 12600
Goodwill 18000
70000 70000
Example-13: A, B C and D are partners sharing profit and loss in the ratio of 4:3:2:1. The
balance sheet position of the firm on 30th June is as under:
Capital & Liabilities Amount Assets Amount
Sundry creditors 10000 Cash 8750
A - capital 24000 Sundry debtors 16950
B - capital 18000 Less allowance for un- collectible
C - capital 12000 700 16250
D -capital 6000 60000 Prepaid rent 5000
Un-expired insurance 3000
Office equipment 23000
Less depreciation 3000 20000
Furniture 20000
Less depreciation 3000 17000
70000 70000
On 30th June D retires from the business and following adjustments are to be made before
ascertaining the amount due to D. Half of the amount due to him is to be paid immediately,
balance after six months which is transferred to his loan account.
i. Allowance for un-collectible is enhanced by Rs.1000/-
ii. Rs.2000/- of the prepaid rent is expired.
iii. Un-expired insurance amount is Rs.1000/-
iv. Office equipment is to be depreciated at 10% on depreciated value.

189
v. Goodwill of the firm is valued at Rs.15000/-. It is decided among the remaining
partners that goodwill should not remain in the books. New profit ratio is 4:3:3.
Required: Pass the necessary journal entries, prepare ledger accounts and balance sheet
on 1st July.
S.No. Description Pr. Dr. Cr.
(1) Revaluation account 7000
Allowance for un-collectable 1000
Un-expected insurance 2000
Prepaid rent 2000
Depreciation (equipment) 2000
(Assets are re-valued)
(2) Goodwill account 15000
A’s – capital 6000
B’s – capital 4500
C’s – capital 3000
D’s – capital 1500
(Goodwill raised and distributed among partners)
(3) A – capital 2800
B – capital 2100
C – capital 1400
D – capital 700
To revaluation account 7000
(Loss on revaluation transferred to partners’ capital
(4) A – capital 6000
B – capital 4500
C – capital 4500
To goodwill account 15000
(Goodwill written off according to new ratio)
(5) D’s capital 6800
Cash account 3400
D – loan 3400
(D’s capital account closed)
Revaluation Account
To allowance for un-collectible a/c 1000 By A – capital 2800
To un-expired insurance 2000 By B – capital 2100
To prepaid rent 2000 By C – capital 1400
To depreciation (equipment) 2000 By D – capital 700
7000 7000
Capital Accounts
Depreciation A B C D Depreciation A B C D
Goodwill 6000 4500 4500 By balance 24000 18000 12000 6000
Revaluation a/c 2800 2100 1400 700 By goodwill 6000 4500 3000 1500
Cash 3400
D’s loan 3400
Balance 21200 15900 9100

30000 22500 15000 7500 30000 22500 15000 7500

Balance Sheet

190
Capital & Liabilities Amount Assets Amount
Sundry creditors 10000 Cash (8750 – 3400) 5350
Sundry debtors 16950
Less allowance for u/col. 1700 15250
D’s loan account 3400 Prepaid rent 5000
Less expired rent 2000 3000
Un-expired insurance 3000
Owner’s equity: Less insurance exp. 2000 1000
A – capital 21200 Office equipment 23000
B – capital 15900 Less depreciation 5000 18000
C – capital 9100 46200 Furniture 20000
Less depreciation 3000 17000
59600 59600
Example – 14: Give below is the balance sheet of X, Y and Z as on 31st March. Their
profit sharing ratio is 3:2:1.
Assets Amount Capital & Liabilities Amount
Cash in hand 50 Current liabilities: 6700
Cash at bank 900 Sundry creditors 1300
Sundry debtors 6200 Non-liabilities
Stock 4100 General reserve
Non current assets:
Furniture & fittings 400 X – capital 6400 12650
Machinery & Plant 3000 Y – capital 4000
Building 6000 Z – capital 2250
20650 20650
On 31st March Y served a notice of retirement on the following terms, that he will be paid
half of the amount in cash at the moment he retires and balance as a bill of exchange
payable after three months. Other tangible and intangible assets are valued as such. Any
cash required is to be taken from bank.
i. Goodwill is to be valued at Rs.18000/-
ii. Furniture and fittings is to be taken over by Y at Rs.300/-
iii. Machinery and plant is to be depreciated at 10% building is to be appreciated by
Rs.2000/-
iv. Stock is adjusted at the market price i.e. Rs.3700/-
v. Capital of the firm should be Rs.25000/-, ratio among the remaining partner capital
is 3:2, excess or deficit cash is to be paid or brought in by the partner.
Required: Pass the necessary journal entries and prepare the balance sheet of the new firm.
Solution: Journal
S.No. Description Pr. Dr. Cr.
Goodwill 18000
X – capital 9000
Y – capital 6000
Z – capital 3000
(Goodwill distributed among the partners)
Revaluation account 100
Y – capital 300
Furniture account 400
(Furniture taken over by Y and loss debited to revaluation)

191
 Revaluation account 700
Plant & Machinery account 300
Stock account 400
(Assets reduced as required)
Building account 2000
Revaluation account 2000
(Value of building appreciated)
Revaluation account 1200
X – capital 600
Y – capital 400
Z – capital 200
(Profit from revaluation transferred to capital)
Reserve account 1300
X – capital 650
Y – capital 433
Z – capital 217
(General reserve transferred to partners capital)
Y Capital 10533
Cash account 5266.50
Bills payable account 5266.50
(Y’s capital closed)
Cash account 4333
Z – capital 4333
(Cash paid in by Z)
X – capital 1650
Cash account 1650
(Cash paid to XI)
Cash account 1633.50
Bank 1633.50
(Loan taken from bank)
Capital Account
Depreciation X Y Z Depreciation X Y Z
Furniture 300.00 Balance 6400 4000 2250
Cash 1650 5266.50 Goodwill 9000 6000 3000
Bills payable 5266.50 Reserve 650 433 217
To balance 15000 10000 Revaluation 600 400 200
Cash 4333

16650 10833 10000 16650 10833 10000

Cash Account Revaluation Account

Balance 50.0 - capital 1650.00 Furniture 100 Building a/c 2000
Bank 900.0 - capital 5260.50 Plant 300
Z – capital 4333 Stock 400
Bank 1633.50 Capital:
X – 600
Y – 400
Z – 200 1200
6916.50 6916.50 2000 2000

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 Bank account
Capital & Liabilities Amount Assets Amount
Balance b/d 900.00 By Cash 900.00
Balance c/d 1633.50 By Cash 1633.50
2533.50 2533.50
Balance sheet as at 31st March
Capital & Liabilities Amount Assets Amount
Sundry creditors 6700.00 Sundry debtors 6200
Bank 1633.50 Stock 3700
B/P 5266.50 Non-current assets:
Machinery 3000
Owner’s equity: Less dep. 300 2700
X – capital 15000 Building 6000
Y – capital 10000 25000.00 Add. Appreciation 2000 8000
Goodwill 18000
38600.00 38600
Adjustment of Capital
Capital of new firm = Rs.25000/- X’s capital should be = Rs.25000/- x 3/5 = Rs. 15000/-.
X’s capital after adjustment is Rs.16625/-, therefore he should withdraw Rs.1650/-. Z’s
capital should be = Rs.25000/- x 2/5 = Rs.10000/-. Z’s capital after adjustment is Rs.5667/-
therefore, he should bring Rs.4333/-
4.2 Death of a Partner: According to the partnership Act of 1932, on the death of a
partner, the partnership comes to an end. Usually the surviving partners carry on the
business by purchasing the share of the deceased partner after determining the amount due
to him. On the death of a partner, the following points have be decided.
i. Treatment of goodwill (as in the case of admission).
ii. Revaluation of assets and liabilities (as above discussed).
iii. Payment to the executors of deceased partner.
iv. Share of profit.
4.2.1 Share of Profit: The death of partner may occur on any day. The executor of
deceased partner will be entitled to the share of profit from the beginning of the trading
period to the date of death. The profit for such period can be calculated by one of the
following methods.
a. On the basis of time
b. On the basis of sales (turnover)
a. On the basis of time: When profit from the beginning of the trading period to the
date of death of a partner has to be calculated on the basis of time, the last years profit is
multiplied by the number of months/days from the beginning of the trading period to the
date of death and divided by 12 month or 365 in case of days. This method can be explained
with the help of the following example.
Example – 15: Suppose ‘A’ died on 16th May. The profit for the trading period ended on
31st March, was Rs.8760/- = A was entitled to a share of 1/6 of the business. His share of
profit on time basis will be computed as under:
Days from 1st April to 26th May = 56

193
 Profit from the year ended on 31st March = Rs.8760/-
Profit for the year ended on 31st March =8760x56 = Rs.1344/-
356
A’s share of profit = 1344 x 1/6 = Rs.224/-
b. On the Basis of Sales (Turn Over): When profit at the beginning of the accounting
period to the date of death of a partner is to be computed on the basis of sales, the last years
profit is multiplied by the total amount of sales from the beginning of the accounting period
to the date of death and divided by the total sales of the previous year. This method can be
explained with the help of the following example.
Example-16: Suppose Mr. M died on 18th June 20-B.The net profit for the year ended
on 31st December 20-A was Rs.25000/-. The total sales for the year 20-A was Rs.
125000/- and from 1st January 20-B to 18th June was Rs.65000/-. Mr. M is entitled a
share of 1/5 of the business. The share of profit of Mr. M will be calculated as under.
Total profit for the year 20-A = Rs.25000/-
Total sales for the year 20-A = Rs.125000/-
Total sales from 1st Jan to 18th June = Rs.65000/-
Profit from 1st Jan to 15th June 25000 x 65000 = Rs.13000/-
125000
M’s share of profit = 13000 x 1/5 = Rs.2600/-
Example: 17: X, Y and Z are partners in a firm. They share profit’ and loss as 5:3:2.Z dies
on 30th June 20-B. The balance sheet of the firm as on 31st December 20-A is as follows:
Balance sheet as at 31st December 20-A.
Capital & Liabilities Amount Assets Amount
Sundry creditors 5000 Cash 4380
Bank loan 625 Sundry debtors 3120
X – capital 3750 Less allowance for Un-receivable
Y – capital 3750 312 2808
Z – capital 5000 12500 Stock 4687
Plant & machinery 1875
Free hold premises 4375
18125 18125
Z is entitled for the following:
i. Interest at the rate of 15% on capital balance.
ii. Profit to date of death based on the previous year profit which is estimated
Rs.20000/-
iii. Goodwill is valued as Rs.25000/-. The partners decided to raise goodwill equal to
the share of Z.
iv. Fixed assets are to be depreciated at the rate of 10%.
v. Deceased partner’s executors will be paid Rs.3000/- immediately and the balance in
two equal installments.
Required: Pass necessary journal entries and prepare revised balance sheet.
Solution: Journal
S.No. Description Pr. Dr. Cr.
(i) Profit and loss account 375
To Z – capital 375
(Interest for half year is credited to Z)

194
(ii) Profit and loss account 2000
To Z – capital 2000
(Share of profit credited to Z)
(iii) Goodwill account 5000
To Z – capital 5000
(Goodwill raised)
X – capital 3125
Y – capital 1875
To goodwill 5000
(Goodwill written off)
(iv) Revaluation account 625
To plant & machinery account 187.50
To free-hold premises account 437.50
(Non-current assets adjusted to market value)
X – capital 312.50
Y – capital 187.50
Z – capital 125.00
To revaluation account 625
(Loss on revaluation transferred to capital)

Revaluation Account Z’s Account

Plant a/c 187.50 X capital 312.50 Revaluation a/c 125 Balance 5000
Free hold 437.50 Y-capital 187.50 Cash account 3000 PLS account 375
premises a/c Z-capital 125.50 Loan account 9250 Goodwill 5000
PLS account 2000

625 625 12375 12375

Capital account
Depreciation X Y Depreciation X Y
Revaluation a/c 312.50 187.50 Balance a/c 3750 3750
Goodwill a/c 3125.00 1875.00
Balance 312.50 1687.50

3750.00 3750.00 3750 3750

Cash account
Amount Amount
Balance 4380 By Z – capital 3000
By balance 1380
4380 4380
Balance sheet
Capital & Liabilities Amount Assets Amount
Sundry creditors 5000 Cash 1380
Bank loan 625 Sundry debtors 3120
Z – loan 9250 Less un-receivable 312 2808
Stock 4687
X capital 312.50 PLS a/c (To be adjusted at the end
Y capital 1687.50 2000 of the year) (2000+375) 2375
Plant & Machinery 1875.00
Less depreciation 187.50 1687.50

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 Free – hold premises 4375.00
Less depreciation 437.50 3937.50
16875 16875
Example – 18: Aslam, Akram and Alam are partners sharing profit and loss in ratio of
4:3:2. Akran died on 6th April. Partnership deed provides that:
i. On the death of a partner goodwill will be valued on the basis of three year purchases
of average profit of three previous years which are Rs. 15000/-, Rs. 12000/- and Rs.
9000/-. Books are closed on 31st December each year.
ii. Executors of the deceased will be entitled for his share of profit, to the date of death,
based on average profit of three previous years.
iii. Deceased partner capital is to be credited for interest at the rate of 15% on capital
balance of the previous year balance which was Rs.20000/-.
iv. His drawings to the date of death amount to Rs.5000/-
Required: Show the amount due to the executors.
solution: Akram capital
To cash (drawings) 5000 By balance 20000.00
To balance 28802.05 Goodwill 12000.00
Expense & revenue summary 1052.05
Interest on capital 750.00
33802.05 33802.05
Computations:
Goodwill: Average profit: 15000 x 12000 x 9000 = 12000
3
Goodwill: 12000 x 3 = 36000
Akram’s share 36000 x 3 = 12000
9
Profit: Average profit of the year Rs. 12000/-.
Profit up-to 6th April: 12000 x 96 = 3156.16
365
Akram’s share: 3156.16 = 1052.05
3
Interest on capital capital =2000
Rate 15% =20000x15% =3000
Interest for 3 months = 3000x3/12 =750

5. SUMMARY
Salient points regarding partnership accounts are given below:
a. The partnership operations are generally governed by the terms and conditions
contained in the partnership agreement.
b. Partnership accounts follow the usual principles and procedure of accounting.
c. Accounts peculiar to the partners are classified into three categories; viz; drawing
accounts, current accounts and capital accounts.
d. While admitting a new partner special attention should be paid to:
i. Valuation of the business.
ii. Terms on which a new partner is admitted and new profit-sharing ratios
agreed.
iii. accounting treatment of goodwill.

196
UNIT – 9

PARTNERSHIP-II

Written by:
Jawaid Aamin
Reviewed by:
Asia Batool
S.M. Aamir Shah
Sohail Amjed
197
 CONTENTS
Sr. No. Subject Page No.

Introduction 199
Objectives 199
1. ANNUITY 200
1.1 What is an Annuity? 200
1.2 Accounting for Annuity 200
1.3 Joint Life Policy 201
1.4 Treatment in Books of Accounts 201
2. Amalgamation 205
2.1 Definition 205
2.2 Accounting for the Amalgamation 205
2.3 Reasons for Amalgamation 206
2.4 Accounting Procedure for the Amalgamation Firms 206
2.5 Accounting Process for New Firms 207
3. Dissolution of Partnership 211
3.1 Definition 212
3.2 Dissolution Conditions 212
3.3 Realization Accounts 213
3.4 Settlement of Accounts 214
4. Solvency or Insolvency 218
4.1 When all Partner are Solvent 218
4.2 When One of the Partners is Insolvent 222
4.3 Garner Vs Murray Rule 223
4.4 Fixed and Fluctuating Capitals 224
4.5 When all Partners are Insolvent 227
4.6 Gradual Realization of Assets and Piecemeal 228
Distribution
5. Conversion Of Partnership into Limited Company 230
5.1 Accounting Procedure 230

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 INTRODUCTION
A partnership is an un-incorporated business owned by two or more partners. A
partnership often is referred to as a firm.

In earlier units we used the sole proprietorship to illustrate the basic principles and
practices of accounting. In the previous unit you have acquainted yourself with basic
Partnerships proceedings. This unit will focus on accounting for partnership from of business
organization in greater detail. Different dimensions like amalgamation, dissolution and
preparation of partnership accounts have been dealt with in this unit.

OBJECTIVES
After studying this unit, you should be able to:
1. In case of annuity transactions, how accounts are maintained
2. Understand the concept and meaning of amalgamation
3. Record the accounting process or procedure for amalgamation
4. List the dissolution f partnership procedure
5. Prepare the “realizations Account:
6. Use to apply the garner Vs Murray rule
7. Acquaint with essential legal requirements of dissolution
8. Work-out or settle the capital accounts of the partners in case of solvent or insolvent
partners

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1. ANNUITY
1.1 What is an Annuity?
In some cases, the amount due to a retiring or deceased partner is not paid immediately but
instead settled through an annuity (annual payments) until the partner or their executor
passes away. The annuity amount is estimated based on life expectancy, prevailing interest
rates, and capital balance.
Under IFRS (IAS 19 - Employee Benefits & IFRS 9 - Financial Instruments), annuity
payments are considered financial liabilities and must be fairly valued. The present value of
future annuity obligations is recorded in financial statements, ensuring accurate liability
recognition and compliance with IFRS.

1.2 Accounting for Annuity: So far the accounting treatment of annuity is concerned, it
follows the following course of action.
i. After determining the amount due to the outgoing partner or executor, it is transferred
to annuity account. The entry will be:
Retiring partners capital account... Dr.
To Annuity account Cr.
ii. At the end of each year, interest is calculated on yearly balance of interest, the entry
will be:
Interest account ...................Dr.
To Annuity account..............Cr
(with amount of interest)
iii. At the time of annual payment the journal entry will be:
Annuity account…. ……………………..Dr.
To Cash/bank account……...Cr.
(with the amount of annual installment)
Journal entry Nos. (ii) and (iii) will be repeated annually till the retiring partner or his
widow or executor is alive.
iv. If retiring partner or executor of the deceased dies before the credit balance in annuity
A/c is finished, the remaining balance will be transferred to profit and loss account,
the journal entry will be:
Annuity a/c ….. ….. Dr.
To profit and loss A/c …….Cr.)
(With the amount of annual installment)
v. In case the retiring partner or executor of the deceased is still alive and the annuity
account is exhausted further payment of annuity would represent a loss to the
remaining partners, the entry will be:
Profit Loss A/c ………….... Dr.)
To annuity A/c ……………. Cr.)
(With the amount of annual installment)
Example-1’:Sultan, Ramzan and Imran were partners in a cloth business sharing profits and
losses in the ratio of 2/5, 2/5 and 1/5, Imran died on 1st January 20A. At that date his capital
balance stands Rs.80000/-. It was decided that Mrs. Imran should receive an annuity, taking

200
her future life to be 5 years, and taking 5% P.A. as interest. Annuity tables show that Rs. l
@ 5% is equal to Rs. 0.230975/- per year for 5 years. The first payment was to be made on
31st December 20-A.
Required: Prepare Annuity accounts assuming:
a. That Mrs. Imran died on 1st annuity 20-E
b. That Mrs. Imran was still alive on 1st January 20-H
Solution: The annual payment to be made is: =0.230975 x 80000 = Rs. 18478/-
Mrs. Imran's annuity account
Date Description Amount Date Description Amount
20-A 20-A
Dec. 31 To Bank A/c 18478 Jan. 1 By Imran's Capital 80000
Dec. 31 To Balance 65522 Dec.31 By Interest A/c 4000
84000 84000
20-B 20-B
Dec. 31 To Bank A/c 18478 Jan. 1 By balance 65522
Dec. 31 To Balance 50320 Dec. 31 By interest 3276
68698 68798
20-C 20-C
Dec.31 To bank 18478 Jan. 1 By balance 50320
Dec.31 To balance 34358 Dec.31 By interest 2516
52836 52836
20-D 20-D
Dec.31 To bank 18478 Jan. 1 By balance 34358
To balance 17598 Dec.31 By interest 1716
36076 36076
20-E 20-E
Jan.1 To PLS a/c 17598 Jan. 1 By balance 17598
17598 17598
In case 'B' up to December 31, 20-D, the annuity account will be shown as case 'A' above.
After that it will be as under:
Mrs. Imran's annuity account
Date Description Amount Date Description Amount
20-E 20-E
Dec. 31 To Bank a/c 18478 Jan. 1 By Balance 17598
_____ Dec.31 By Interest A/c 880
18478 18478
20-F 20-F
Dec.31 To bank a/c 18478 Dec.31 By PLS account 18478
18478 18478
20-G 20-G
Dec.31 To bank a/c 18478 Dec.31 By PLS account 18478
18478 18478
1.3 Joint Life Policy:
1.4 Treatment in the Books of Account: Under IFRS 17 (Insurance Contracts), firms
purchase joint-life policies to manage financial obligations upon a partner’s retirement or
death. Premiums paid are recorded as expenses, while policy payouts are recognized as
assets or income upon maturity or surrender.

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There are two methods by which the joint life policy transactions can be treated in the books
of a firm. A. First Method
i. Under the first method, the annual premium paid to insurance company is
treated as business expense. The following entry will be made at the time of
payment of insurance premium.
Profit and loss a/c ... …………… Dr.
To cash/ bank a/c.................Cr.
(With the amount of insurance premium)
ii. On the death of a partner the insurance company will pay the assured amount to
the firm the entry will be:
Cash/bank a/c…………………….Dr.
Joint life policy…………...Cr.
(With the assured amount)
iii. The assured amount received from the insurance company will be distributed
among all the partners including the deceased partner in their profit sharing ratio.
The entry will be:
Joint life policy …………………… Dr.
To all partner's capital …….. Cr.
(In old profit-sharing ratio)
Example: A, B and C are partners in a firm sharing profit as 6:3:1. They have taken out a
Joint Life Policy for 50000/- on 5th January 20-A at an annual premium of Rs.1500/- being
charged to profit and loss account. B died on 31st March 20th. The policy amount was
realized in full. You are required to show the entries relating to the policy.
Solution: Journal
Date Description Pr. Dr. Cr.

Jan. 5 Profit and loss a/c 1500

bank a/c 1500
(insurance premium paid)
20-b
Jan. 5 Pls account 1500
bank account 1500
(insurance premium paid)

20-c
Jan. 5 Pls account 1500
bank account 1500
(insurance premium paid)
20-d
Jan. 5 Pls account 1500
bank account 1500
(insurance premium paid) -
March 31 Bank account 50000
joint life policy a/c 50000
(being the amount received from insurance
company)
Joint life policy a/c 50000

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 capital - a 30000
capital - b 15000
capital - c 5000
(amount of policy distributed)
B. Second Method
Under the second method the insurance premium paid is debited to joint life policy
account and its accumulated debit balance is shown as an asset in the balance sheet.
The accounting treatment of this method is explained below:
i. When the insurance premium is paid, the entry will be:
Joint life policy a/c ... Dr.) (with the amount of
To cash/bank a/c ...Cr.) insurance premium)
ii. At the end of each year with a view to reduce the divisible profit, the following
entry will be made.
Profit and Loss a/c .. .Dr.) (with the amount of
To joint life policy reserve a/c ...Cr.) annual premium)
iii. In order that the joint life policy may not appear in the books higher than the
surrender value of the policy, the following entry will be passed at the end of
each year:

Joint life policy reserve a/c ... Dr.) (with amount of

Joint life policy a/c ……...Cr.) the difference
between the
balance of Joint
life policy account
and the surrender
value of policy)

Note: The entry Nos. (i) to (iii) will be repeated annually. The joint life policy a/c will appear
as an asset at surrender value and joint life policy reserve account as a liability at the same
figure.
iv. On the death of one of the partners the firm will receive the full amount of the policy. The entry
will be:
Cash/Bank a/c ...Dr.) To (with the full amount of
Joint life policy a/c ...Cr.) policy)
v. The existing balance of the joint life policy reserve a/c, will be closed by transfer to
the joint life policy account. The entry will be:
Joint life policy reserve a/c ...Dr.) (with the balance of joint life
Joint life policy a/c….....Cr.) policy reserve account)
vi. The joint life policy account is then closed by transfer to the capital accounts of all the
partners in old profit-sharing ratio. The entry will be:
Joint life policy reserve 'a/c ...Dr.) (in old profit-sharing Ratio)
All partners' capital a/c ...Cr.)

Example-3: A, B, and C are partners in a firm, sharing, profit as 6:3:1. They have taken out a
joint life policy for Rs.50000 on 15 ' March 20-A at an annual premium of Rs.1500/-. The

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partners decided to maintain a joint life policy account in the books of the firm on a surrender
value basis. Assume that the surrender value of the policy was as follows:

In 20-A = nil, in 20-B = Rs.150. in 20-C = Rs 500

B died on 10"' April 20-D. The policy was realized in full Prepare a joint life policy account.
Solution: Journal
Date Description Pr. Dr. Cr.
20-A Joint life policy A/c 1500
Bank A/c 1500
Being the payment of premium)
Dec. 31 -Profit and Loss A/c 1500
Joint Life policy reserve 1500
(Premium paid to be transferred to profit & loss)
Dec. 31 -Joint life policy reserve 1500
Joint life policy A/c 1500
(To transfer the joint life policy to joint life policy reserve)
20-B
March 15 Joint life policy 1500
Bank A/c 1500
(Being the payment of premium
Dec. 31 Profit and Loss A/c 1500
Joint Life Policy reserve A/c 1500
(Premium paid transferred to expenditure and revenue
summary
Dec. 31 Joint Life Policy reserve 1350
Joint Life Policy 1350
(To transfer the joint life policy to surrender value
Joint Life Policy 1500
20-C Bank A/c 1500
(Premium paid for the policy)
Dec. 31 Profit and Loss A/c\ 1500
Joint Life Policy reserve 1500
(Premium paid to be transferred to profit and loss

Dec. 31 -Joint Life Policy reserve 1150

Joint life policy 1150
(To transfer the joint life policy to joint life reserve
20-D -Joint Life Policy 1500
March 15 Bank A/c 1500
(Premium paid for the policy)
April 10 -Bank A/c 50000
Joint life policy 50000
(Amount of the policy received on death of a partner)

April 15 Joint life policy –reserve 500

Joint life policy 500
(Reserve transferred to joint life policy account)
Joint life policy 48500

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 A -Capital 29100
B - Capital 14550
C - Capital 4850
Joint life policy account
Date Description Amount Date Description Amount
20-A -To Bank A/c 1500 31.12.20-A - J.L.P. reserve 1500
1500 1500
15.3.20-B -To Bank A/c 1500 31.12.20-B -By J.L.P. reserve 1350
1500 -By Balance 150
1500
15.3.20-C To Balance 150 -By J.L.P. reserve 1150
-To Bank A/c 1500 31.12.20-C -By Balance 500
1650 1650
1.1.20-D -To Balance 500 10.4.20-D -By Bank 50000
15.3.2-D -To Bank A/c 1500 -By Joint Life Policy 500
A – Capital Reserve
29100
B – Capital
14550
C – Capital
4850 48500
50500 50500

2. AMALGAMATION
2.1 Definition: Under IFRS 3 (Business Combinations), amalgamation occurs when two
or more firms merge, ceasing their separate identities to form a new entity. Assets,
liabilities, and goodwill are recognized at fair value, ensuring transparency in financial
reporting.
Amalgamation leads to the dissolution of the existing firms, and a new entity is formed.
The new entity must apply IFRS 3 to recognize assets and liabilities at fair value and account
for goodwill or gains.

2.2 Accounting for the Amalgamation IFRS 3

When two or more firms merge to form a new entity, the existing books of accounts are
closed, and a new set of books is prepared. Assets and liabilities are revalued at fair value,
and partners' capital is determined by deducting liabilities from the agreed asset value. The
new firm records assets by debiting asset accounts, crediting liability accounts, and
recognizing partners' capital based on net contributions. The opening balance sheet reflects
these adjustments, ensuring compliance with IFRS 3 – Business Combinations, which
mandates fair value measurement and proper recognition of goodwill or gains.
2.3 Reasons for Amalgamation
Amalgamation between different firms is made due to the following reasons:
i. To avoid mutual competition
ii. To minimize management expenses
iii. To have a monopoly in the business

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 iv. To strengthen the business by combining different skills, experiences and
resources of individual partners
2.4 Accounting Procedure for the Amalgamated Firms (Old Firms)
Following are the steps in case of accounting when amalgamation takes place:
i. The assets and liabilities taken over by the new firm will be bring down to the market
value or as agreed upon among the partners. For this purpose each firm will open a
revaluation account. The procedure is the same as explained in previous section i.e.
admission of a partner.
ii. If an asset is not taken over by the new firm and is sold for cash, the journal entry as
under in the books of old firms.
a. If asset is sold at a loss
Cash a/c Dr. (with sale price)
Revaluation A/c Dr.
Particular Asset Cr.
b. If asset is sold at a profit
Cash Dr. (with sale price)
Particular assets Cr. (with book value)
Revaluation a/c Cr. (with the amount of Profit)
iii. If an asset is taken over by any partner, the journal entry will be:
Partner's capital a/c Dr.
Particular assets a/c Cr.
iv. If any liability is not taken over by the new firm and is paid off:
a. Out of old firms cash
Particular liability a/c Dr.
Cash/bank a/c Cr.
b. By partners
Particular liability a/c Dr.
Partners capital a/c Cr.
v. Goodwill as agreed upon among the partners will be Journalized as such:
Goodwill a/c Dr.
Partners' capital a/c Cr. (According to the
income sharing ratio)
vi. Balance of Revaluation will be transferred to partners' capital in their income-sharing
ratio.
a. In case of Loss
Partners' capital a/c Dr.
Revaluation a/c Cr.
b. In case of Profit
Revaluation a/c Dr.
Partners' capital a/c Cr.
vii. When assets and liabilities are transferred to the new firm, the entry will be:
All liabilities (transferred) Dr. (With agreed value)
Investment in new firm Cr. (With the difference
between the net

206
 assets and liabilities
taken over)
All assets (transferred) Cr. (With agreed value)
viii. Investment in the new firm will be transferred to partner's capital with the help of the
following journal entry:
Partner's capital a/c Dr. (With credit balance of
Investment in new firm Cr. partners' Capital)
All accounts of amalgamated firm will be closed after above noted steps.
2.5 Accounting Process for New Firm
When the assets and liabilities of the amalgamated firm are taken the journal entry will be:
All assets (taken over) Dr.
All liabilities (taken over) Cr.
Partners Capital Cr.
Example-4: A and B who were partners trading under the name Modern General Store and
X and Y. who were partners trading under the name Madina General Store, decided to
amalgamate as on 1st April. Their Balance Sheets as on that date were as follows:
Modern General Stores
Capital & Liabilities Amount Asset Amount
Sundry Creditors 1000 Stock 3000
Reserve 2000 Sundry Debtors 1200
Capital -A 3000 Investment 2000
Capital -B 2000 5000 Premises 1800
8000 8000
A and B share profits in the ratio of their capitals : Madina General Stores
Capital & Liabilities Amount Asset Amount
Sundry Creditors 2200 Sundry Debtors 2400
Bank Loan 800 Stock 2600
Capital -X 1500 Goodwill 1000
Capital -Y 1500 3000
6000 6000
X and Y share profits equally.
The terms of the amalgamations were as follows:
i. New firm will - run under the name Muslim General Store consisting of A, B, X and
Y as partner. Partners will share profits and losses in the ratio of their capitals in the
new firm after all the adjustments had been made.
ii. The premises owned by A and B should be taken over by the new firm at valuation of
Rs.2300.
iii. Goodwill appearing in the books of X and Y was worthless.
iv. After the above adjustments X and Y brought in an additional capital Rs.500 each in
the new firm.

Required: Goodwill journal entries of the amalgamated firms to close their books. Also
show the journal entries and Balance Sheet of the new firm.
Solution: Modern General Stores

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Date Description Dr. Cr.
April 1 Premises a/c 500
Revaluation a/c 500
(Premises adjusted to new value Rs.2300)
April 1 Reserve a/c 2000
Capital - A 1200
Capital - B 800
(Being transfer of reserve to partners)
April 1 Revaluation a/c 500
Capital -A 300
Capital -B 200
(Being transfer of profit after adjustments)
Investment in Muslim General Store 7500
Sundry Creditors a/c 1000
Stock 3000
Sundry Debtors 1200
Investment 2000
Premises 2300
(Being the decrease in the value of various assets
Capital -A 4500
Capital - B 3000
Investment in M. G, Store 7500
(Partner's capital are closed
Madina General Store Journal
Date Description Dr. Cr.
April 1 X- Capital 500
Y -Capital 500
Goodwill A/c 1000
(Goodwill appearing in books written of)
Cash A/c 1000
Capital - X 500
Capital - Y 500
(Shortage of capital contributed)
Investment in Muslim General Store 3000
Sundry Creditors 2200
Bank Loan 800
April 1 Sundry debtors 2400
Stock 2600
Cash 1000
(Assets & Liabilities taken over by M.G.S.)
April 1
Capital - X 1500
Capital - Y 1500
Investment in Madina General Store 3000
(The Partners capitals are closed)
Muslim General Store Journal
Date Description Dr. Cr.
April l Stock 3000
Sundry debtors 1200

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 Investment 2000
Premises 2300
Sundry creditors 1000
A - Capital 4500
B - Capital 3000
(Business of A & B taken over)
Sundry debtors 2400
Stock 2600
Cash 1000
Sundry Creditors 2200
Bank loan 800
Capital - X 1500
Capital - Y 1500
(Business of X & Y taken over)
Muslim General Store Balance sheet as at 1st April
Capital & Liabilities Amount Assets Amount
Sundry Creditors 3200 Cash 1000
Bank Loan 800 Sundry Debtors 3600
Capital – A 4500 Stock 5600
Capital – B 3000 Investment 2000
Capital – X 1500 Premises 2300
Capital – Y 1500
10500
14500 14500
Example- 5: On 1st January A & B running their individual businesses agree to amalgamate
them. The balance sheet of the two firms on the date of amalgamation was as follows:
A's Balance sheet
Capital & Liabilities Amount Assets Amount
Sundry Creditors 3000 Cash 50000
Bills Payable 6000 Sundry Debtors 30000
Capital 100000 Bank 1500
Premises 20000
Plant & Machinery 5000
Prize Bonds 2000
Furniture & Fixtures 500
109000 109000
B's Balance sheet
Capital & Liabilities Amount Assets Amount
Sundry Creditors 25000 Stock 75000
Bank 10300 Sundry debtors 45000
Capital 105000 Furniture 300
Plant 20000
140300 140300
Revaluation of both businesses were agreed:
i. Premises and Plant & Machinery of A should be taken over by the new firm at
Rs.25000 and Rs. 10000 respectively.
ii. B was to be credited with Rs.5000 as value of patent, which did not appear in his
balance sheet, patent now becomes the property or new firm.

209
iii. Prize Bonds appearing in the balance sheet of A were not to be taken over the
partnership firm.
iv. All other assets of both firms were taken over by the new firm at book value.
v. It was decided that A and B would discharge their liabilities.
vi. A should introduce cash to make his capital equal to that of B.
Required: Pass journal entries to close the books of A & B and also prepare the opening
balance sheet and opening journal entries of the new firm.
Solution: A's Journal
Date Description LR Dr. Cr.
(i) Plant & Machinery a/c 5000
Premises 5000
Revaluation a/c 10000
(Premises and Plant appreciated)

(ii) Revaluation a/c 10000

Capital - A 10000
(Being the transfer of income to capital)
(iii) Capital - A 2000 2000
Prize Bonds a/c
(Prize Bonds taken over by A)
(iv) Cash a/c 28300
Capital - A 28300
(Cash brought to adjust the capital)

Note: Assets i.e. premises of plant machinery appreciated by Rs. 5000/- each and prize
bonds are not taken and by the new firm. So AIOU brings cash of Rs 28300/- to make his
capital at per of B. (B.s capital 145300 - 1170100 A's capital = Rs. 28300/-)
Sundry Creditors 3000
Bills Payable a/c 6000
Capital - A 9000
(Liabilities and Discharged)
Investment in new firm 145300 28300
Cash
Stock 50000
Sundry Debtors 30000
Bank 1500
Premises 25000
Plant & Machinery 10000
Furniture and Fixture 500
(Assets taken over b new firms)
Capital - A 145300
Investment in new firm 145300
(Capital – As Amount closed)
B's Journal
Date Description LR Dr. Cr.
(i) Patent Rights A/c 5000

210
 Capital – B 5000
(Patent right credited to B)
(ii) Sundry creditors a/c 25000
Bank A/c 10300
Capital – B 35300
(Liabilities are discharged)
(iii) Investment in new firm 145300
Stock A/c 75000
Sundry debtors A/c 45000
Furniture A/c 300
Plant A/c 20000
Patent Rights A/c 5000
(Assets transferred to new firm)
Capital - B 145300
Investment in new firm 145300
(P.S Capital account closed)
New Firm's Journal
Date Description Dr. Cr.
Cash in hand A/c 28300
Bank A/c 1500
Sundry Debtors 30000
Stock 50000
Furniture & Fixture A/c 500
Premises a/c 1500
Plant & Machinery A/c 10000
Capital - A 145300
(Assets of A taken over
Stock A/c 75000
Sundry debtors 45000
Furniture A/c 300
Plant A/c 20000
Patent Rights A/c 5000
Capital - B 145300
(Assets of B taken over)
Balance sheet of New Firm as at January
Capital & Liabilities Amount Assets Amount
Capital - A 145300 Cash in hand 28300
Capital B 145300 Bank a/c 1500
Stock 125000
Sundry Debtors 75000
Furniture & Fixture 800
Plant & Machinery a/c 30000
Premises a/c 25000
Patent Rights 5000
290600 290600
3. DISSOLUTION OF PARTNERSHIP
According to the Partnership Ac 1934t, a partnership is dissolved upon the admission,
retirement, or death of a partner. However, this does not always lead to business

211
discontinuation. Instead, the partnership is reconstituted with a new agreement while
operations continue. Under IFRS, financial reporting requires fair valuation of assets and
liabilities, with adjustments recorded in the partners' capital accounts. If dissolution leads to
liquidation, assets are realized, liabilities settled, and remaining balances distributed as per
the agreement.
3.1 Definition
If a business is discontinued, it is called as dissolution. The dissolution of firm means a
complete break-down of the relation of partnership among all the partners. Dissolution
involves selling of assets, payments of liabilities and return of capital to the partners.
3.2 Dissolution Conditions
(A) Dissolution of partnership is affected under one or more of the following
circumstances.
i. At the death of a partner.
ii. At the retirement of a partner.
iii. If any one of the partners becomes insolvent.
iv. After the completion of a project, for which partnership was formed.
v. At the expiry of a specific period, for which partnership was formed.
In the circumstances mentioned above some of the partners may continue to carry on
the business in the presence of an express agreement to this effect. In case remaining partners
do not continue, dissolution of partnership takes place automatically. Under the following
circumstances, dissolution of firm also takes place:
i. If all the partners mutually decide to dissolve the firm.
ii. If all the partners, but one, is involvement.
iii. In case of partnership at will, if any of the partners gives notice of his will to
discontinue the firm.
iv. The firm is dissolved, if it is doing some illegal business.
(B) Dissolution by court: A competent court on filing of a suit may also dissolve a
partnership firm by any one partner on of the following grounds:
i. That a partner has become of unsound mind.
ii. That a partner other than suing is incapable of performing business duties.
iii. That a partner is guilty of misconducting the partnership affairs.
iv. That a partner has willfully or persistently committed breach of contract.
v. That a partner, without the consent of other partners has transferred his interest
to a third person.
vi. That a business cannot be carried on, except at a loss.
(C) Settling up of account: When partnership business is discontinued the accounts will
be settled between partners and other parties having interest in the business as follows:
i. All the properties and assets of the firm (including the original investment of
the partners and any subsequent one, if made to make up the deficiencies) must
first be applied towards payment of liabilities of the firm.
ii. After making payments against sundry creditors and the liabilities as above if
there is a surplus that will be used for the payment of any advance or loan from

212
 partners other than capital. If loan is taken from more than one partner this will
be paid proportionately.
iii. Surplus is applied in making payment of each partner's capital and loans. This will
also be paid. Term proportionately means first of all payment will be made to a
partner whose capital is proportionally more than his profit and loss sharing ratio.
3.3 Realization Account: Upon dissolution or liquidation, all assets are sold, and
liabilities are settled, a process known as realization. A Realization Account is used to
determine the gain or loss from asset disposal and liability payments. Under IFRS, assets
and liabilities must be measured at fair value, and any resulting gain or loss is allocated
among partners based on their agreed profit-sharing ratio. After settlement, the books are
closed, and any remaining balance is distributed accordingly. The journal entries are the
following: i. To Close Assets: All the assets other than cash and bank are transferred to a
newly opened account like this: -
Realization A/c Dr. (With the amount of
All Assets (individually) Cr. books Value.)
ii. To Close Liabilities
Liabilities other than owners; capital and loan are transferred to realization account at the
book value. In a way that accounts of liabilities are closed Journal entry will be as such.
All Liabilities Dr. (With book value)
Realisation Cr.
iii. To Close Reserve: If reserve or balance of profit and loss account exists in the balance
sheet that should be transferred to the partner's capital accounts according to their income-
sharing ratio. Journal entry will be:
Reserve/PLS a/c Dr. (In old profit sharing
All partner's capital Cr. ratio)
iv. Disposal of Assets: All assets other than cash and cash at bank are disposed off either by:
a. Selling in the Market
b. Transferring to partners
a. Selling of assets
When assets are sold and cash in realized from the sale of Assets, the
journal entry will be:
Cash Bank A/c Dr. (With sale price of all
Realization A/c Cr. assets)
(Assets realized into cash)
b. Transferring to partners
When assets are taken over by a partner/partners at a value agreed
between them, the entry will be:
Partner's capital Dr. (with agreed value)
Realization A/c Cr.
Disposal of liabilities
a. By payment
When cash is realized from the sale of assets, this cash will be utilized for making
payment of liabilities such as, sundry creditors, notes payable, unpaid expenses, loan
from banks and etc. the entry will be:

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 Realization a/c Dr
Cash/Bank a/c Cr.
Note: Those liabilities will be paid, which were transferred to realization.
b. Transferring to Partners:
If a partner or partners take the responsibility of paying some liabilities, the entry will
be:
Realization a/c Dr
Partners' capital (who takes the responsibility) Cr.
vi. Payment of Partner's Loan
After the payment of liabilities such as sundry creditors, notes payable, unpaid
expenses, bank overdrafts, bank loan etc. Loan of partners other than their capitals
will be paid off. The Journal entry for this payment will be:
Partner's loan a/c Dr.
Cash/bank a/c Cr.
(Being payment of partners' loan)
vii. Expenditures Incurred on Disposal of Assets
If expenditure is incurred for selling of Assets such as commission paid to auctioneer,
advertisement expenditure etc., the journal entry will be:
Realization a/c . Dr (with the amount of
To Cash/Bank a/c Cr. realization expenses)
viii. Closing of Realization Account
Realization account will show either gain or loss on realization this gain or loss will
be transferred to partners' capital account according to their income-sharing ratio.
Credit balance of realization account represents gain and debit balance indicates loss.
Journal entry for loss will be as such:
All partners' capital a/c Dr (In old profit sharing
Realization a/c Cr. ratio.)
(Loss or realization transferred to partners)
Note: Reverse entry will be passed in cash of gain.
ix. Making up of Deficiency
If any partner's capital account shows a debit balance, he will pay cash to make up this
deficiency. Journal entry will be:
Cash a/c Dr.) (With the amount of
Respective partner's capital a/c Cr.) deficiency)
(Being receipt of cash from partner to cover up his deficiency)
x. Closing of Capital Account
Now balance of cash/bank account will exactly be equal to the total credit balance of
all partners' capital account. The cash will be paid to all partners equal to credit balance
of their capital. The journal entry will be:
Partners' capital a/c Dr. (With the amount credit
Cash/Bank a/c Cr. balance of partners capital )
(Being payment of each partner's capital)
3.4 Settlement of Accounts
When it is proposed to dissolve a partnership, it's as sets are sold off, and the amount realised
by the sale is applied in the following order:

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 i. In paying debts due to third parties,
ii. In paying ratably advances or loans made by partners to the firm, and
iii. In paying the partners of sums due to them on account of capital.
If there is still some surplus, it has to be distributed among the partners in the profit
sharing ratio.
The losses of the firm on dissolution have to be made up:
a. First out of past accumulated profits
b. Then out of capitals of the partners, and
c. If the loss is still not covered fully, out of contributions from the private estates
of the partners in the profit sharing ratio.

Example-6: B and C are in partnership sharing profit and loss in the proportions of 4:3 and
2. Their balance sheet prepared on 31 S` December, was as follows:

Creditors 3500 Cash 1500

Capital - A 4000 Debtors 1000
Capital - B 2000 Stock 2000
Capital - C 500 Land & building 5500
10000 10000
They agreed to dissolve partnership as on this date.' To prevent a disastrous loss on sale A
agree to take over the stock at a valuation of Rs.1500 and the debtors at a valuation of Rs.700.
Land and buildings are sold at an auction for Rs.2700/-.
Show by means of ledger accounts how the partnership books will be closed, C being
insolvent and unable to provide any more cash.
Solution: Realization account
Rs. Rs.
Dec. 31 To Sundry Assets Dec. 31 By A's C. a/c 2200
Debtors 1000 By Cash 2700
Stock 2000 By Balance being
Land & Building 5500 8500 Loss
A 1600
B 1200
C 800
3600
8500 8500
A's Capital account
Rs. Rs.
Realization Account 2200 Balance B/d 4000
Realisation Account 1600 Cash A/c 1600
C's Capital 200
Cash 1600
5600 5600
B's Capital account
Rs. Rs.
Realisation Account 1200 Balance B/d 2000
C's Capital Account 100 Cash 1200
Cash 1900

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 3200 3200
C's Capital account
Rs. Rs.
Realisation Account 800 Balance B/d 500
A's Capital Account 200
B's Capital Account 100
800 800
Cash account
Rs. Rs.
Balance b/d 1500 Creditors 3500
Realisation a/c 2700 A's capital a/c 1600
A's capital a/c 1600 B's Capital a/c 1900
B's capital a/c 1200
7000 7000
Note:Rs.3600 being loss caused by C's insolvency is shared A and B in the ratio of their
last agreed capitals viz. Rs.4000 and Rs.2000.
Example-7: P, Q and R were sharing profits and losses in the ration 5:3:2. On 1st January
their balances were as under.
Liabilities Rs. Assets Rs.
Sundry Creditors 11500 Furniture & Fixture 3000
General Reserve 5000 Stock 13000
Capital Accounts Debtors 20000
P 10000 Less Provision -1000 19000
Q 8000 Cash 1000
R 1500 19500
36000 36000
The firm was dissolved on that date. The assets realized are as under: Furniture and fixture
Rs.1000/- stock Rs. 10000/- debtors Rs.12000.Rs.500/of Rs. 12000. Rs.500/- of the creditors
were not to be paid and the remaining creditors were paid at a discount of 5%. It was found
however that there was a liability for Rs. 3050 for damages, which had to be paid. The
expenses came to Rs.1000. R could contribute only Rs.100/-.
Give ledger accounts to close the books of the firm.
Solution: Realisation account
Rs. Rs.
Jan. l S’s Assets Cash a/c 23000
Furniture & Fix. 3000 Provision against
Stock 13000 Debtors 1000
Debtors 20000 Sundry creditors 11500
Cash account 1000 Loss transferred to
(Expenses) P-5/10 7500
Cash account Q-3/10 4500
(Liabilities Rs 11000/- 10450 R-2/10 3000 15000
less5%)
Cash Account 3050
(Damage)
Total 50500 Total 50500

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P's Capital account
Rs. Rs.
Jan.l Realization a/c loss 7500 Jan.l Balance b/d 10000
R's capital a/c 222 General Res. 2500
Cash a/c 12278 Cash a/c 7500
20000 20000
Q's Capital account
Rs. Rs.
Jan.1 Realization a/c loss 4500 Jan.1 Balance b/d 8000
R's capital a/c 178 General Res. 1500
Cash a/c 9322 Cash a/c 4500
14000 14000
R's Capital account
1991 Rs. 1991 Rs.
Jan.1 Realization a/c 3000 Jan.1 Balance b/d 1500
General Res. 1000
Cash a/c 100
P's capital a/c 222
Q's capital /c 178
3000
Cash account
Rs. Rs.
Jan.1 Balance b/d 1000 Jan.1 Realisation a/c
Realization a/c 23000 Expenses 1000
R's capital a/c 100 Creditors 10450
P's capital a/c 7500 Damages 3050
Q's capital a/c 4500 P's capital a/c 12278
Q's capital a/c 9322
36100 36100
Example-8 (When the realization of assets results in a profit): P, Q and R are partners in a
business sharing profits and losses in the ratio of 1/2:1/3:1/6 respectively. They dissolve the
partnership and realize the assets. Their position after the realization of assets is as follows:
Liabilities Rs. Assets Rs.
Sundry creditors 2800 Cash at bank 6000
P's capital 3000 R's capital overdrawn 2000
Q's capital 1000
Realization account (profit) 1200
8000 8000
R is insolvent; he can contribute only Rs.300 towards his deficiency. Draw up the necessary
account showing the final adjustments among the partners:
Capital Accounts
P Q R P Q R
Bal. b/d 2000 Balance b/d 3000 1000 -
R's capital a/c 1125 375 - Realization 600 400 200
Cash a/c 2475 1025 - Cash a/c - - 300
P's capital a/c - - 1125
Q's capital a/c - - 375

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 360 140 2000 3600 1400 2000
Cash account
Rs. Rs.
Balance B/F 6000 Sundry creditors 2800
R's capital a/c 300 P's capital account 2475
Q's capital account 1025
6300 6300

Liabilities Rs. Assets Rs.

B's capital a/c 3050 Lease 1250
W's capital a/c 960 Fixtures 220
Sundry creditors 480 Sundry debtors 840
Stock 2060
Cash at Bank 120
4490 4490
The lease and fixture were sold for Rs.2700 and cash received. The book debts were
collected and realized Rs.752. The stock was sold in auction for Rs. 1340/- after the payment
of commission and expenses. The sundry creditors were paid off, Rs.38/- being allowed for
discount. The expenses of realization amounted to Rs.87. Prepare the necessary accounts to
show the result of realization and the amounts received by each partner.

4. SOLVENCY OR INSOLVENCY
4.1 When all the Partners are Solvent: When a partnership is dissolved, it is usual to
prepare an account called a "Realization Account". The object of preparing this account is
to find out the result of dissolution i.e. the profit or loss resulting from the sale of assets and
the payments of liabilities. The procedure for preparing this account is as follows:
1. Debit realization account and credit all the assets to be sold excluding cash in hand
and cash at bank at book values. In this way the account of different assets are closed.
It should be remembered that debtors and provision for bad debts A/c's. are two
separate accounts and the gross amount of debtors.
2. Debit liabilities to third parties i.e. excluding loans from partners and their capitals at
book values and credit the realization account. In this way, the accounts of different
liabilities are closed.
3. When the assets -are sold for cash, debit cash account and credit realization account.
4. If an asset is taken up by one of the partner, his capital account is debited and the
realization account is credited. .
5. If the dissolution of partner has entitled some expenses. Debit realization account and
credit cash account with the amount of such expenses.
6. Liabilities towards third partners will have to be paid off. The actual amount paid to
them should be debited to realization account and credited to cash account.
7. If a partner takes over any liability or they agree to discharge a liability his capital
account should be credited and realization account debited.
8. Realization account is then complete; it will show profit or loss. If the debit side is
greater there is a loss; if the credit side is greater there is a profit. The profit or loss
resulting from the realization a/c is transferred to the capital accounts of partners in

218
 the profit sharing ratio. In ease of profit realization account is debited and capital
accounts credited. The entry for loss is naturally, reverse of this.
9. Any reserve or accumulated profit or loss lying in the books (as shown by the balance
sheet) should be transferred to the capital accounts in the profit sharing ratios.
10. Partner’s loans, if any, should now be paid. The entry will be to debit loan account
and credit cash account.
11. At this state, the capital accounts will show how many amounts are due to them or
from them. If a partner's capital account shows a deficiency, he should be asked to pay
cash into the business to make up that deficiency. The entry is to debit cash account
and credit partner's capital account. if a partners capital account shows a surplus, the
excess money will be paid to him: his capital account will be debited and the cash
account credited. This will close the capital account as well as the cash account.
12. If any asset of the firm does not appear in the firms balance sheet i.e unrecorded or
underscored in disposed off (it is a gain) debit cash A/c and credit realization account.
Example-9: P and Q agree to dissolve partnership on 31" December on which their Balance
Sheet was as follows:
Balance sheet
Liabilities Rs. Assets Rs.
Sundry creditors 6000 Cash 1000
P's loan account 8000 Sundry debtors 5000
Capital - P 20000 Stock 20000
Capital - Q 10000 Plant & fixture 14000
Goodwill 4000
44000 44000
The partners share profits and losses in proportion to their capitals. The sundry debtors
realized Rs.4200/, stock Rs.18000/, plant & fixtures 20% less than the book value and the
goodwill Rs.6000/- The creditors were paid off at a discount of 5% and the costs of
dissolution amounted to Rs.6001-.
Pass the necessary journal entries to show the process of realization and open the dissolution
account: .Journal Realization Account
Rs. Rs.
Dec.31 Sundry assets 43000 Dec.31 Sundry liability 6000
Cash expenses 600 Cash assets realised 39400
Cash liabilities 5700 Capital account
P - 2/3 2600
Q- 1/3 1300 3900
49300 49300
P’s Loan Account
Date Particulars Amount Date Particulars Rs.
Dec.31 Cash 8000 Dec.31 Balance 8000
P's Capital account
Date Particulars Amount Date Particulars Rs.
Dec.31 Realization account 2600 Dec. 31 Balance 20000
Cash 17400

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 20000 20000
Q’s Capital Account
Rs. Rs.
Dec. 31 Realization account 1300 Dec.31 Balance 10000
Cash 8700
10000 10000
Example-10: The Balance Sheet of "Fast and Quick" sharing profits and losses in the ratio
of 3:2 was as follows on 31st December.
Liabilities Rs. Assets Rs.
Sundry creditors 2000 Plant & machinery 4000
Fast's loan 1000 Patents 600
General reserve 1000 Stock 2500
Capital: Fast 3000 Sundry debtors 1900
Quick 2500 Less Reserve 100
1800
5500 Cash 600
9500 9500

On 1st January next year, the firm was dissolved. Fast take over the patents at a
valuation of Rs.500/-. The other assets realized as under:
Goodwill Rs.1500, plant and machinery Rs.3000 stock Rs.2200 sundry debtors Rs.1850/.
The sundry creditors were paid off at a discount of 5%. The expenses amounted to Rs.350.
Give journal entries and ledger accounts to close the books of the firm

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Solution: Journal
Rs. Rs.
Jan.1 Realization account 9000
Plant and machinery 4000
Patents 600
Stock 2500
Sundry debtors 1900
(Various assets transferred to realisation a/c)
Sundry creditors 2000
Reserve for bad debts 100
Realization account 2100
(Transfer of liabilities to realisation a/c)
Cash account 8550
Realization account 8500
(Amount realised by sale of various assets)
Fast's capital account 500
Realization account 500
(Patents taken over by fast at Rs.500/-)
Realization account 350
Cash account 350
(Payment of expenses)
Realization account 1900
Cash account 1900
(Payment to sundry creditors 2000x5/100less)
Fast's capital account 60
Quick's capital account 40
Realization account 100
(Transfer of loss)
Fast's loan account 1000
Cash account 1000
(Payment of fast's loan)
General reserve 1000
Fast's capital account 600
Quick's capital account 400
(General reserve transferred to capital a/c)
Fast's capital account 3040
Quick's capital account 2860
Cash account 5900
(Payment to partners)
Realisation Account
Rs. Rs.
Jan.1 Sundry assets 9000 Jan.1 Sundry creditors 2000
Cash account 350 Provision for b/d 100
Cash 1900 Cash 8500
Fast's capital a/c 500
Loss Fast 60
Quick 40 100

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 11250 11250
Cash account
Rs. Rs.
Jan.1 Balance b/d 600 Jan.1 Realization a/c
Realization a/c 8550 Expenditure 350
Realization a/c
Creditors 1900
Fast's loan a/c 1000
Fast's capital a/c 3040
Quick's capital a/c 2860
9150 9150
Fast's Capital account
Rs. Rs.
Jan.1 Realization a/c 500 Jan.1 Balance b/d 3000
Realization loss 60 General reserve. 600
Cash account 3040
3600 3600
Quick's Capital Account
Rs. Rs.
Jan.1 Realization a/c 40 Jan.1 Balance b/d 2500
Cash account 2860 General reserve 400

2900 2900
4.2 When One of the Partners is Insolvent: If a partner's capital account shows a
deficiency after realization, they must contribute the shortfall. However, if insolvent, the
loss is distributed among solvent partners. Under Garner vs. Murray (1903), solvent partners
are only liable for their share of deficiency, and remaining assets are distributed based on
their capital ratios rather than profit-sharing ratios. Under IFRS, insolvency losses are
recognized based on equity accounting principles, ensuring fair allocation of financial
responsibility.
l. That solvent partners should bring cash equal to their share of loss on realization.
2. That the loss on account of the insolvent partner should be borne by the Solvent
Partners, in the ratio of their capitals as they stand just before dissolution.
Example-11: The balance sheet of A and B showed as under when they resolved to dissolve
their business.
Equities & Liabilities Amount Assets Amount
Creditors 14000 Cash 1500
Capital - A 5000 Debtors 6500
Capital - B 12600 Stock 8600
Machinery 15000
31600 31600
A and B share in the ratio of 3:2. Debtors,' stock and machinery realized at 75% of the book
value. Rs.2000 of the creditors were not to be paid and the remaining creditors were paid at

222
discount of 5%. It was found that the same liability for Rs.4700 for damages which had to
be paid. The expenses of realization came to Rs.1200/. A could not contribute anything to
make up his deficiency.
Required: Give ledger accounts to close the books of the firm.
Solution: Realization account
Debtors account 6500 Creditors a/c 14000
Stock account 8600 Bank a/c
Machinery account 15000 (Assets realized) 22575
Cash %( 12000 less 5%) 11400 Loss transferred To
Cash account damages 4700 Capital
Cash account expenses 1200 A– 6495
B– 4330 10825
47400 47400
Capital account
Depreciation A B Depreciation A B
Realization a/c 6495 4330 Balance 5000 12600
(Loss) B's capital 1495
A's capital 1495
Cash a/c 6775

16495 12600 16495 12600

Cash account
Description Amount Description Amount
Balance 1500 Realization (creditors paid) 11400
Realization Realization (damages) 4700
(assets realization) 22575 Realization (expenses) 1200
Capital - B 6775
24075 24075
4.3 Garner vs. Murray Rule
If a partner becomes insolvent, the loss must be distributed among solvent partners. Before
Garner vs. Murray (1903), such losses were allocated based on profit-sharing ratios.
However, the ruling established that, in the absence of an agreement, the insolvent partner's
deficiency must be borne by the solvent partners in proportion to their capital contributions.
Under IFRS, this aligns with equity accounting principles, ensuring losses are fairly
allocated based on capital structure rather than profit-sharing ratios.
i. The solvent partners should bring cash equal to their share of loss on realization.
ii. That the loss on account of the insolvent partner should be borne by the solvent
partners in the ratio of their capital as they stand -lust before dissolution.
The following illustration will explain the application of Garner Vs. Murray case.
The facts of the case were as follows:
Garner, Murray and Wilkins entered into partnership, their capitals being unequal but they
shared profits and losses equally. In dissolution of the firm, the amounts realized were not
very much. After paying off the sundry creditors and advances to the firm by two of the
partners, the balance left was not sufficient to repay the partners capitals.

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Balance sheet
Liabilities Assets
Capital accounts Cash 1916
Garner 2500 Wilkins deficiency 263
Murray 314 Loss on realization 635
2814 2814
The decision created a big surprise amongst accountants. So far as the first point in
the decision is concerned some accountants say that it is unnecessary to ask the solvent
partners to bring cash to make good their share of loss on realization when they already have
sufficient. Credit balance is these capital accounts to page off the firms defacing their
arguments are:
(a) When a partner has already a credit balance in his capital or current account at is
unreasonable to ask him to bring in cash.
(b) It might be impossible for a partner to bring-in further cash, the whole of the cash
having been already sunk into the business.
(c) The share of loss may be made up even from the credit balance of loan account of a
partner.

Under IFRS, the treatment of a solvent partner’s obligation in case of an insolvent

partner’s deficiency follows IAS 37 (Provisions, Contingent Liabilities, and Contingent
Assets) for recognizing liabilities. The Garner vs. Murray case established that solvent
partners should bring in cash to cover their share of the loss on realization. This ensures the
firm’s obligations are settled properly, aligning with IFRS principles of fair presentation and
liability recognition in financial reporting.

4.4 Fixed are Fluctuating Capitals

Under IFRS (IAS 27 - Separate Financial Statements), when an insolvent partner’s loss is
allocated, the treatment depends on whether capital accounts are fixed or fluctuating. If
capitals are fixed, the loss is borne in the fixed capital ratio. If capitals fluctuates, adjustments
for reserves and profits (excluding realization loss) must be made first, and the resulting
capital ratio determines the loss distribution. This ensures accurate liability recognition and
fair financial reporting.

Suppose A's capital is Rs.10000 and B's capital is Rs.6000 C's capital shows a debit balance
of Rs.4000. there is a reserve of Rs.6000 dividing the reserve fund among A, B and C each
partner will be credited with Rs.2000/-. C is insolvent then:
a. If the capitals are fixed, the loss on C's capital account will be borne by A and B in the
ratio of 10:6 (i.e. capital without adjustment of reserve).
b. If the capitals are fluctuating, the loss on C's capital account will be borne by A and B
in the ration of 12:8.

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Example-12Mango, Banana and Orange were sharing profit and losses in the ratio of 2:1:2
on 1 st January, their balance sheet was as under:
Balance sheet
Capitals & Liabilities Amount Assets Amount
Sundry creditors 23000 Cash 2000
General reserve 10000 Sundry debtors 40000
Capital accounts Less provision 2000 38000
Mango 25000 Stock 26000
Orange 15000 40000 Machinery 6000
Capital Banana 1000
73000 73000
The partners decided to dissolve the firm on that date. The assets realized as under:
Machinery = 20% less
Stock = 15% less
Debtors = 25000
Rs. 1000 of the creditors were not to be paid and the creditors were paid at a discount of 5%.
The expenses came to Rs. 1000 and Banana could contribute only Rs.400-.
Required: Give ledger accounts to close the book (I) if the capitals are fixed (ii) if the
capitals are fluctuate.
Solution: Realization
Liabilities Amount Assets Amount
Sundry debtors a/c 40000 Sundry creditors 23000
Stock a/c 26000 Provision debts 2000
Machine a/c 6000 Cash realized 51900
Cash a/c (Cr. Paid) 20900 Loss transferred to
Cash (expenses) 1000 Capital Mango 6800
Capital Banana 3400
Capital Orange 6800 17000
93900 93900
Capital accounts'
Depreciation Mango Banana Orange Depreciation Mango Banana Orange
Balance 1000 Balance 25000 15000
Realisation General Reserve 4000 2000 4000
(Loss) 6800 3400 6800
Capital – B 1250 750 Cash 6800 400 6800
Cash 27750 18250 Capital-Mango 1250
Capital-Orange 750
35800 4400 25800 35800 4400 25800
Example-13 The following is the balance sheet of A, B and C on 31st December:
Liabilities Rs. Assets Rs.
Creditors 2000 Cash 6000
Reserve fund 15000 Stock 20000
Capital accounts: Plant and tools 20000
A 25000 Sundry debtors 10000
B 15000 Bills receivable 10000

225
 C’s capital overdrawn 9000
75000 75000
C's insolvent but his estate pays Rs.2000/-. It is decided to wind up the partnership. The
assets realized as follows: Sundry debtors, Rs.7500/; bills receivable Rs.7000/; stock
Rs.16000/ and plant and tools Rs.14000/-. The costs of winding up came to Rs.2500/-. Give
accounts to close the books of the firm (1) if the capital are fixed and (2) if the capital are
fluctuation.
Solution: Realization account
Rs. Rs.
Dec.31 Sundry assets 60000 Dec.31 Creditors 20000
Cash expenses 2500 Cash assets realized 44500
Cash creditors 20000 Loss transferred to:
A 6000
B 6000
C 46000 18000
82500 82500
Capital account
A B C A B C
Balance b/d 9000 Balance b/d 25000 5000
Loss on Reserve fund 5000 5000 5000
Realization 6000 6000 6000 Cash a/c 6000 6000 2000
C’s capital a/c 500 3000 A’s capital a/c 5000
Cash a/c 25000 17000 B’s capital a/c 3000
36000 26000 15000 36000 26000 15000
Note: C's deficiency of Rs.8000 has been divided between A and B in the ratio of their
capitals as they stood just before realization after the transfer of reserve fund.
Example-14: P, Q, R and S are equal partners in a business. On 31 S` December they
dissolved their partnership when their position is a follows:
Liabilities Rs. Assets Rs.
Sundry creditors 5014 Cash in hand 200
Capital accounts Sundry debtors 3548
P 6000 Stock 2500
Q 3000 Fixture & fittings 300
Patents 987
Plant & machinery 2782
Lease hold factory 2897
R’s deficiency 100
S’s deficiency 700
14014 14014
The assets realized the following amounts:
Sundry debtors, Rs.2700/; stock Rs.1975/; fixture and fitting Rs.100/; plant and machinery
Rs.1850/- and leasehold factory Rs.2610/-. The patents proved worthless.

226
The creditors were paid Rs.5002/- in settlement. A contingent liability amounting Rs.273 -
not provided in the above balance sheet had to be met during realization. S is insolvent.
Show the final adjustment of accounts among the partners.
Solution: Realization account
Sundry assets 13014 Cash 9235
Cash a/c 5002 Sundry creditors 5014
Cash (contingent liabilitiy 273 Loss transferred to:
P 1010
Q 1010
R 1010
S 1010 4040
18289 18289
Capital account
P Q P Q
Realization loss 1010 1010 Balance b/d 6000 3000
S’s deficiency 1140 570 Cash 1010 1010
Cash 4860 2430

7010 4010 7010 4010

Cash Account
To balance 200 By realisation creditors 5002
To realization 9235 By realisation creditors Liability 273
To P’s capital 1010 By P’s capital 4860
To Q’s capital 1010 by Q’s capital 2430
To Rs, capital 1010
12565 12565
Capital account
R S R S
To balance B. F 100 700By cash 1110
To realisation loss 1010 1010By P's capital a/c 1140
B Q's capital a/c 570

1110 1710 1110 1710

4.5 When all Partners are Insolvent (IFRS 9 - Financial Instruments)
If all partners are insolvent, creditors cannot expect full payment. Instead of transferring creditors
to the realization account, all available cash is directly paid to them. The unpaid balance is
transferred to the profit & loss account, closing the partners’ capital accounts. This aligns with
IFRS principles of fair presentation and liability recognition in financial reporting.
Example-15: Saleem and Rashid were partners sharing profits in the ratio of 3:2. On 1st
July their balance sheet was as under:
Liabilities Rs. Assets Rs.
Sundry Creditors 20000 Stock 12000

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 Capitals: Debtors 15000
Saleem 5000 Furniture 600
Rashid 3000 400
28000 28000
The firm was dissolved on the above date. The assets realised only Rs.16000 expenses came
to Rs.500. Saleem's private estate could pay only Rs.1000 Rashid had no surplus, and close
the books of the firm by giving a ledger account.
Solution Realization Account
Date Liabilities Rs. Date Assets Rs.
July To sundry assets: July By cash account 16000
Stock 12000 By loss transferred to
Debtors 15000 Saleem 3/5, 7260
Furniture 600 Rashid 2.5, 4840
To cash a/c exp. 500 12100
28100 28100
Cash Account
Date Rs. Date Rs.
July I To balance b/d 400 July 1 By Realisation a/c exp. 500
To Realisation a/c 16000 By sundry creditors 169000
To Saleem’s capital a/c 1000
17400 17400
Sundry Creditors Account
Date Rs. Date Rs.
July 1 To cash account 16900 July 1 by balance b/d 20000
To PLS account 3100
(amount unpaid)
20000 20000
Profit and Loss Account
Date Liabilities Rs. Date Assets Rs.
July 1 To Saleem’s capital a/c 1260 July 1 By S. creditors transfer
To Rashid’s capital a/c 1840 3100
3100 3100
Rashid's Capital Account
Date Liabilities Rs. Date Assets Rs.
July 1 To realization a/c loss 4840 July 1 By balance b/d 3000
By PLS account 1840
4840 4840
Saleem’s capital account
4.6 Gradual Realization of Assets & Piecemeal Distribution
Under IFRS (IFRS 9 - Financial Instruments), during dissolution, assets are usually realized
gradually, and payments occur over time. The piecemeal distribution follows these steps:
1. Pay outside creditors first.
2. Settle partner loans proportionately.
3. Adjust partner capitals to align with profit-sharing ratios.

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 4. Distribute the remaining cash among partners in their profit-sharing ratio.
This approach ensures fair liability settlement and aligns with IFRS principles of financial
obligations and equity distribution.
Example-16: Following is the Balance sheet of M/s A, B and C who share profits and losses
in the ratio of 2:2:1
Liabilities Rs. Assets Rs.
Sundry creditors 1500 Cash in hand sundry debtors 200
Capitals: Stock 2200
A-1500 2200
B-1200
C- 400 3100
4600 4600
The firm was dissolved and the assets were realized gradually Rs.1000 were received once,
Rs. 15000 another time and Rs.900 finally. Show how each installment is to be distributed.
Solution: The profit-sharing ratio between A, B and C is 2:2:1. C's capital is Rs.400, hence
the proportionate capitals of A and B Rs.800 each. This means C receives nothing until the
capitals of A and B each are brought down to Rs.800. Now A and B being equal partners,
their capital ought to be equal. A's capital is Rs..300 more than B's and hence before B
receives anything A should be paid Rs.300. The following statement now shows the
distribution.

Distribution of Cash
Creditors A B C
Amount due 1500 1500 1200 400
Cash in hand paid to creditor 200 -- - --
Balance due 1300 1500 1200 400
First installment:
Rs. 1000/- to creditors 100 -- -- --
Balance due 300 1500 1200 400
Second installment:
Rs. 300/- paid to creditors 300 -- -- --
Rs. 300/- paid to A -- 300 -- --
Balance due -- 1200 1200 400
Rs. 400/- paid cash to A & B to bring down
their capitals to Rs. 800/-
Balance due 400 400 --
Rs. 100/- distributed among all partners 800 800 400
(2:2:1) Balance due Third installment

40 40 20
760 760 380
Rs.900/- distributed among all partners
(2:2:1) 360 360 180
Balance unpaid or loss 400 400 200

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5. CONVERSION OF PARTNERSHIP INTO A LIMITED
COMPANY
5.1 Accounting Procedure (IFRS 3 - Business Combinations), when a partnership is
converted into a limited company, the following accounting steps are followed:
1. Realization Account: Record assets and liabilities transferred to the new company.
2. Liabilities Transfer: Debit liabilities, credit Realization Account.
3. Purchase Price Entry: Debit purchasing company, credit Realization Account.
4. Realization Expenses: Debit Realization Account, credit cash.
5. Profit/Loss on Conversion: Transfer to partners' capital accounts.
6. Purchase Consideration: Debit cash/shares/debentures, credit purchasing company.
7. Outstanding Liabilities: Pay off remaining liabilities.
8. Share Distribution: Allocate shares/debentures among partners per agreement.
9. Final Settlement: Pay partners, closing partnership books.

This ensures compliance with IFRS guidelines for business combinations and fair
value adjustments.

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