BASIC ACCOUNTING CONCEPTS

The Entity Concept:

In accounting, the entity of business is considered separate from the

existence of its owners. Accounts are kept for the entity as distinct from
owners. When the owners invest money in the business or earn profits,
their capital accounts are credited and when they draw money or goods
from the business, their capital accounts are debited. This concept applies
to corporate bodies (entity is separate from the shareholders who own it)
and non-corporate bodies (proprietors and partnerships).

The Money Measurement Concept:

Money being a common unit of measurement for goods and services, all
transactions in account books are recorded in terms of money.
The Going Concern Concept:

The going concern concept is the backbone of accounting and is based on

the following assumptions:

i) Business has an indefinite life.

ii) Assets are depreciated on the basis of their expected life without caring
for their current values.

The Cost Concept:

According to this concept, all transactions and events are recorded in the
books of account at the actual price involved, i.e., cost. All assets are
carried in the books of account from year to year at their acquisition cost
(historical cost) irrespective of any change in their market value.
Acquisition cost is considered highly objective, reliable, definite and free
from bias. However, there are problems:
The Cost Concept:

i) When due to price rise, the prices of all commodities go up

substantially, the financial position of a firm depicted on cost concept
basis does not reflect true picture.

ii) Some assets reflect their immediate realisable value; e.g. marketable
securities, Sundry Debtors.

iii) Inventories are valued on cost or market price whichever is Lower.

Dual Aspect Concept:

Every transaction entered into by a firm has two aspects, debit and credit.
The total assets of a business are, therefore, always equal to its total
liabilities. Or
Assets = Liabilities + Capital
Materiality:

It states that the cost of data collection in terms of time, efforts, and
expense should not exceed the benefits to be derived from such an effort.
The convention emphasises that accounting should be concerned with
significant and material events for recording purposes.

Consistency:

According to this convention, an enterprise should be consistent in the

accounting policies from one accounting period to another period. This,
however, does not prevent adoption of changes in accounting policies and
practices if these are warranted by changed conditions. Reasons for such
changes and the implications of changed policies need to be disclosed in
the annual report.
Conservatism:

This concept states that “anticipate no profit and provide for all possible
losses”, i.e., all likely losses should be recognized even if they have not
yet occurred and profits should be recognized only when they have been
earned. In other words, the profits should never be overstated, though
they may be understated. For example, costing of inventory, investments
etc.
Accounting Equation

The accounting equation is a statement of equality between debit and

credit. It signifies that the assets of a business always equal the total
liabilities and capital (owner’s equity).

Assets = Liabilities + Capital

1.If a proprietor starts business with say, Rs. 30,000, the firm will have so
much money but the firm will also owe that amount to the proprietor, so that

Cash = Capital
Rs. 30,000 = Rs. 30,000
2.The proprietor purchases furniture for Rs. 3,000

Cash + Furniture = Capital

Rs. 27,000 + 3,000 = Rs. 30,000
3.Goods purchased on credit for Rs. 7,000
Cash + Furniture + Stock = Creditors + Capital
Rs. 27,000 + 3,000 + 7,000 = Rs. 7,000 + 30,000
4.Goods sold for cash for Rs. 6,000

Cash + Furniture + Stock = Creditors + Capital

Rs. 33,000 + 3,000 + 1,000 = Rs. 7,000 + 30,000
5.Creditors paid Rs. 3,000
Cash + Furniture + Stock = Creditors + Capital
Rs. 30,000 + 3,000 + 1,000 = Rs. 4,000 + 30,000
6.Assume rent paid Rs. 2,000.
Rent being an expense reduces Cash & Capital
Cash + Furniture + Stock = Creditors + Capital
Rs. 28,000 + 3,000 + 1,000 = Rs. 4,000 + 28,000
7.Furniture depreciated by Rs. 5,00
Cash + Furniture + Stock = Creditors + Capital
Rs. 28,000 + 2,500 + 1,000 = Rs. 4,000 + 27,500
8.Salary Rs. 2,000 remains outstanding
Cash + Furniture + Stock = Creditors + O/S Liability + Capital
Rs. 28,000 + 2,500 + 1,000 = Rs. 4,000 + 2,000 + 25,500
9.Goods costing Rs. 1,000 are sold for Rs. 1,500
Profit increases the Capital, Loss reduces it
Cash + Furniture = Creditors + O/S Liability + Capital
Rs. 29,500 + 2,500 = Rs. 4,000 + 2,000 + 26,000
10.Cash Withdrawn for personal use: Rs. 5,000
Cash + Furniture = Creditors + O/S Liability + Capital
Rs. 24,500 + 2,500 = Rs. 4,000 + 2,000 + 21,000
Thus after every transactions assets are equal to Liability and Capital.
 Accounting Process

Origination of the Transaction

Recording of the Transaction in the Journal

Posting to the Ledger

Preparation of Trial Balance

Preparation of Financial Statements

Accounting Data – Base System

Each transaction is first recorded in a book of original entry (also known

as book of prime entry) and later it is posted to the general ledger.
These books constitute the accounting data-base.

1. Journal

2. Cash Book

3. Special Form Journals

(a) Sales Day Book

(b) Purchase Day Book

4. General Ledger
Journal
The journal is the book of prime or original entry in which all transactions are
first recorded in a chronological order as and when they take place. It is also
called subsidiary book of account. From Journal, transactions are transferred
(posted) to Ledger.
The Journal is defined as a book that records all transactions. However, in
view of recording of transactions in special books like cash book,
Sales day book and purchases day book, the majority of transactions are
taken care of. Thus journal records only residual transactions of a non-
repetitive nature such as credit purchase of machinery. Since it is not a cash
transaction, nor is it a revenue purchase, it is recorded in journal proper. It
also serves some important purposes:
i) It provides a connecting link between two accounting periods (opening and
closing entries).
ii) It rectifies errors in books of accounts.
iii) It records adjustment entries, at the end of each year.
Cash Book
Since most of the transactions are in the form of cash receipts and cash
payments, a cash book is maintained to record such receipts and payments.
On the debit (left) side of the cash book, we record all receipts and on the
credit (right) side all payments.
Cash book is both a journal and a ledger. It is a journal since all transactions
are recorded chronologically, and a ledger since it also serves the purpose of
a T account by providing cash balance.
Special Form Journals
Since purchases and sales constitute a large number of repetitive
transactions, we keep special journals to record these transactions. For sales
transactions, there is sales day book or ‘sales journal’ and for purchase
transactions, there is ‘purchase day book’ or ‘purchase journal’.
These books record credit sales and credit purchases only (as cash sales
and cash purchases are recorded in the cash book). And these are recorded
by single entries that are totalled & posted to a ‘Control account’ in the
Ledger.
Thus the total of the sales day book is credited to sales account and debited
to accounts receivable. A separate A/cs Rec. Ledger is kept for separate
accounts of individual customers.

Similarly, all credit purchases are posted in the purchase day book, and the
creditors ledger contains the same information supplier-wise. The total of
purchase day book is debited to purchase a/c and credited to A/cs Payable.

Control Account: shows in a summary form the debits and credits that are
shown in detail in subsidiary ledgers. Thus Sales A/c, Purchase A/c, A/cs
Rec. and A/cs payable constitute the control accounts as their details can be
seen in sales day book, debtors ledger, purchase day book and creditors
ledger.
General Ledger:

The next stage in the accounting process after recording the transactions in
any one of the above books, is posting of the transactions to the debit and
credit sides of the respective accounts in the ledger. General Ledger
contains T accounts of:
1.Owner’s equity
2. Assets like buildings, furniture, stationery, plant and machinery, sundry
Drs., prepaid expenses, inventory etc.
3. Liabilities like Long-term Loans, Short-term Loans, bank overdraft, Crs.,
outstanding expenses, bills payable etc.
4. Revenue items like sales, interest earned, discount and commissions
recd.
5. Expense like depn., salaries, wages, insurance, rent, income tax etc.
Each folio in the Ledger is serially numbered and is devoted to one
specific account only. Whenever a number of accounts of similar nature
are required, a special ledger is opened. For example, a Sundry Drs.
Ledger may be maintained which will contain the individual A/cs of all
credit customers. Then only total Drs. a/c will appear in the General
Ledger representing all credit customers. A creditors ledger can also be
maintained likewise.
Summary
Journal Proper : Misc. & residual transactions and opening &
closing entries
Cash Book : Cash transactions including those involving
Bank A/c.
Purchase Day Book : Credit-purchases of revenue nature
Sales Day Book : Credit Sales Transactions
General Ledger : Owner’s equity, Assets & Liability A/c, Rev.&
Expense A/cs
Creditors Ledger : A/cs of individual creditors
Debtors Ledger: : Individual A/cs of customers to whom credit had
been granted
 Rules of Debit and Credit
Business transactions are classified into three categories:
i) Transactions relating to persons
ii) Transactions relating to properties and assets
iii) Transactions relating to incomes and expenses.
On this basis, it becomes necessary for the business to keep an account of:
i) Each person with whom it deals: Personal Accounts
ii) Each property or asset which the business owns. Real Accounts
iii) Each item of income or expense. Nominal Accounts
Personal Accounts: Three categories
i. Natural Personal Accounts: Mohan’s or Asha’s A/c
ii. Artificial Personal Accounts: Accounts of corporate bodies or
institutions which are recognized as persons in business dealings e.g. a
Ltd. Co., the A/c of a Coop. Society or that of a club, Govt. or a PSU.
iii. Representative Personal A/c: These are accounts which represent a
certain person or group of persons e.g. outstanding rent A/c or
outstanding salaries A/c. These A/cs represent the A/cs of the persons to
whom rent, salaries etc. have to be paid.

The rule is
DEBIT the Receiver
CREDIT the Giver

For example, if cash has been paid to Ram,the account of Ram will
have to be debited. If cash has been received from Keshav, the A/c of
Keshav will have to be credited.
Real Accounts:
i. Tangible Real A/cs are those which relate to such things which can be
touched felt, measured etc., e.g. Cash A/c, building A/c, furniture A/c,
Stock A/c etc. But, Bank A/c is a personal A/c. since it represents the
banking co-an artificial person.
ii. Intangible Real A/cs. These cannot be touched but can be measured,
e.g. goodwill A/c, Patent A/c etc.
The rule is
DEBIT what comes in
CREDIT what goes out

If building has been purchased for cash, building a/c should be debited
(since it is coming in the business) while Cash A/c should be credited since
cash is going out of the business. Similarly, when furniture is purchased for
cash, furniture A/c should be debited and cash A/c should be credited.
Nominal Accounts:
These include A/cs of all Expenses, Losses, Incomes and Gains; examples
are A/c for rent, rates, lighting, insurance, dividends, loss by fire etc.

The rule is
DEBIT All Expenses and Losses
CREDIT All Gains and Incomes

Note: When some prefix or suffix is added to a nominal A/c, it becomes a

personal A/c.
The table below explains:
Nominal A/c Personal A/c

Rent A/c Rent Pre-paid A/c, Outstanding rent A/c

Interest A/c Outstanding Interest A/c, Prepaid Interest A/c,
Interest recd. in advance A/c
Salary A/c Outstanding Salaries A/c, Prepaid Salaries
A/c, etc.
Rules of Debit and Credit:ACCOUNTING EQUATION
The rules of debit and credit are based on the nature of an account derived
from the Accounting Equation. For this purpose, accounts are classified as
follows:

i) Assets
ii) Liabilities
iii) Owner’s Equity
iv) Revenues
v) Expenses
The rules are:

i. When –there is an increase in the amount of an asset, its account is

debited and when there is a decrease, its account is credited. An asset may
increase due to purchase of new asset and decrease due to sale or
depreciation.
ii). When there is an increase in the amount of Liability, its account is
credited and when there is a decrease, its account is debited.
iii) When there is an increase in the owner’s equity its account (capital
account) is credited; the account is debited when there is a reduction in the
amount of owner’s equity.
iv) When there is an increase in revenues, the concerned revenues account
is credited e.g. Sales A/c, Rent Recd. etc.
v) When there is an increase in expenses or expense is incurred, the
concerned expenses A/c is debited and when there is decrease, the same
A/c is credited. Salaries paid to employees are debited to salaries A/c.
Illustration: From the following transactions, find out the nature of account
and also state which account should be debited and which A/c credited.

a. Rent paid
b. Salaries paid
c. Interest recd.
d. Dividends recd.
e. Furniture purchased for cash
f. Machinery sold
g. Outstanding for salaries
h. Telephone charges paid
i. Paid to Suresh
j. Recd. From Mohan (the proprietor)
k. Lighting
S# Transaction Accounts Nature of DEBIT/
involved A/cs CREDIT
a. Rent Paid Rent A/c Nominal A/c Debit
Cash A/c Real A/c Credit
b. Salaries Paid Salaries A/c Nominal A/c Debit
Cash A/c Real A/c Credit
c. Interest recd. Cash A/c Real A/c Debit
Interest A/c Nominal A/c Credit
d. Dividends recd. Cash A/c Real A/c Debit
Dividend A/c Nominal A/c Credit
e. Furniture Purchased Furniture A/c Real A/c Debit
Cash A/c Real A/c Credit
f Machinery Sold Cash A/c Real A/c Debit
Machinery A/c Real A/c Credit
S# Transaction Accounts Nature of DEBIT/
involved A/cs CREDIT
g. Outstanding Salaries Salaries A/c Nominal A/c Debit
Outstanding Personal A/c Credit
Salaries A/c
h. Telephone charges Telephone Nominal A/c Debit
paid Charges A/c

Cash A/c Real A/c Credit

i. Suresh Personal A/c Debit
Paid to Suresh Real A/c Credit
Cash A/c
j. Cash A/c Real A/c Debit
Recd. from Mohan (the
proprietor) Capital A/c Personal A/c Credit
k. Lighting A/c Nominal A/c Debit
Lighting Real A/c Credit
Cash A/c
Illustration:

Lal starts a business with capital of Rs. 20,000 on January 1, 1995. In this
case, there are two A/cs involved. These are:

i) The A/c of Lal

ii) Cash A/c

Lal is a natural person and, therefore, his A/cs is a personal A/c. Cash A/c is
a tangible asset and therefore, it is a Real A/c. As per the rules of Debit and
Credit applicable to personal A/c, Lal is the giver and therefore, his A/c, the
capital A/c. should be credited. Cash is coming in the business, and,
therefore, as per the rule, it should be debited. The transaction will now be
entered in the journal as follows:
 Journal
Date Particulars L.F. Debit Credit
Rs. Rs.
1995 Cash A/c Dr. 20,000
Jan, 1 To Capital A/c 20,000
*(Being commencement of
business)

* These words constitute narration for the entry passed, since these
narrated the transaction.
2. He purchased furniture for cash for Rs. 5,000 on Jan 5, 1995.

Both the furniture A/c & Cash A/c are Real A/cs. Furniture is coming in
& should be debited. Cash is going out and it should be credited.

Journal

Date Particulars L.F. Debit Credit

Rs. Rs.
1995 Furniture A/c Dr. 5,000
Jan, 5 To Cash A/c 5,000
*(Being purchase of furniture)
3. He paid rent for business premises Rs. 2,000 on Jan 10, 1995
The A/cs involved are Rent A/c & Cash A/c.
Rent A/c is a nominal A/c. It is an expense and, therefore, it should be
debited. Cash A/c is a Real A/c. Since cash is going out, it should be
credited.

Journal

Date Particulars L.F. Debit Credit

Rs. Rs.
1995 Rent A/c Dr. 2,000
Jan, To Cash A/c 2,000
10
*(Being Rent for premises)
4. He purchased goods on credit of Rs. 2,000 from Suresh on January
20, 1995
The A/c of Suresh is a personal A/c, while that of goods is a real A/c.
Suresh is the giver of goods and, therefore, his A/c should be credited
while goods are coming in the business and, therefore, Goods A/c should
be debited.
Journal

Date Particulars L.F. Debit Credit

Rs. Rs.
1995 Goods A/c Dr. 2,000
Jan, To Suresh 2,000
20
*(Being purchase of goods on
credit)
Purchases Account: records all purchases of goods. Goods “come in”
on purchasing of goods and therefore, the Purchases A/c is debited on
purchase of goods.

Sales Account: records goods sold. The goods “go out” on selling of
goods, and, therefore, the Sales A/c is credited.

Purchase Return Account: The goods “go out” on returning of goods to

the suppliers and, therefore, the A/c should be credited on the return of
goods purchased.

Sales Return Account: The goods “come in” and, therefore, the sales
Returns A/c should be debited on return of goods.
Goods Account

Purchases Sales Account Purchases Sales Return

Account (Goods go Return A/c A/c (Goods
(Goods Come out ………. (Goods go out Come in
in ………...Dr.) …..Cr.) …………..Cr.) …………..Dr.)
Ledger Accounts
Business transactions of a financial nature are recorded in the books of
original record. These books are cash book, purchases book, sales book,
purchase return book, sales return book, bills receivable book, bills
payable book, journal.
The proprietor may, however, like to know the position of individual
debtors and creditors. Or, the value of assets and liabilities separately.
Collection of requisite information concerning a particular account and
presenting them under one head is known as ledger posting.
We may sell goods to Ram or purchase goods from him. We may return
goods to Ram or Ram may return goods. Payments may be made to him
or may be received from him. All these transactions regarding dealings
with Ram must have been recorded in different books such as purchases
book or sales book or returns books or cash book.
Recording transactions in different books concerning Ram does not
present the picture of Ram’s account. We are not in a position to know if
Ram is a debtor or a creditor and to what extent.
In order to show Ram’s A/c under one heading at one glance, only a
ledger account will show the collective picture. Information from different
books is collected and presented under one heading known as a Ledger
A/c
Dr Format of Ledger Account Cr
Date Particulars Folio Amount Date Particulars Folio Amount

(1) (2) (3) (4) (5) (6) (7) (8)

To-------A/c By-------A/c

The left hand side is the debit side and the right hand side is credit side.
Preparation of Assets Account
Assets have a debit balance. Asset accounts are debited for increases and credited
for decreases. The debit side of an asset account records purchases and the credit
side records the sale and depreciation of the asset.
Illustration: Prepare Furniture A/c with the following information.:
1998 Rs.
Jan 1 Furniture in hand 1,000
Jan 1 Purchased furniture 2,000
June 30 Sold furniture 200
Dec 31 Depreciate furniture
including addition @10% 290
Solution: Depn. on furniture calculated @ 10% on 1000 + 2000 = 3000 for
six months and on 3000 – 200 = 2800 at the same rate for another six
months. Depn. will amount to Rs. 150 + 140 = 290
 Dr Furniture Account Cr
Date Particulars J.F. Amount Date Particulars J.F Amount
.

1998 To Balance b/d 1000 1998 By Cash A/c 200

Jan 1 Jun 30 By Depn. A/c 290

Jan 1 To cash A/c 2000 Dec 31 By Balance c/d 2510

3000 3000

1999 To Balance b/d 2510

Jan 1
•Explanation: Furniture as an asset shows debit balance, so its opening
balance has been shown as ‘To Balance b/d .’ Purchase of furniture on 1st
January will increase furniture, so it will be shown on the debit side of
Furniture A/C. As a general principle pf accounting, we do not show the
name of the same account either at the debit side or the credit side of the
account being prepared, so we shall be writing ‘To Cash A/c’ for the
purchase of furniture. In the same way, sale and depreciation of furniture
will decrease the value of furniture and will be posted at the credit side of
the furniture A/c and will be shown as ‘By Cash A/c’ for sales and by
depreciation A/c for depreciation on furniture.

•While balancing furniture A/C we find that the total of the debit side i.e,
Rs.3000 is more than the credit side, so the total of the debit and credit
side must be made equal, Rs.3000 and posted parallel to each other.
The total of the credit side is short by Rs.2510. This difference of
Rs.2510 will be written as ‘By Balance c/d’ on the closing date of the
account period. The closing balance will be carried forward to the first
day of the next accounting period and will be written as Balance b/d on
the debit side.
Ledger Posting & Trial Balance
The term ‘Posting’ means transferring the debit and credit items from the
Journal to their respective accounts in the Ledger. Exact names of
accounts used in the Journal should be carried to the Ledger.
The Ledger Folio (LF) column in the Journal is used at the time when
debits and credits are posted to the Ledger. The page no. of the Ledger
on which the posting has been done is mentioned in the LF column of the
Journal.
i) The transactions are recorded first of all in the Journal and then they
are posted to the Ledger. Thus, the Journal is the book of first or original
entry, while the Ledger is the book of second entry.
Ii) Journal records transactions in a chronological order, while the Ledger
records transactions in an analytical order.
Iii) Journals is more reliable as compared to the Ledger since it is the
book in which the entry is passed first of all.
Iv) The process of recording transactions is termed “Journalizing” while
for Ledger It is called posting.
Rules Regarding Posting:
i) Separate accounts should be opened in the Ledger for posting
transactions relating to different accounts recorded in the Journal. For
example, separate accounts may be opened for sales, purchases, sales
returns, purchase returns, salaries, rent, cash etc.
Ii) The concerned account which has been debited in the journal should
also be debited in the Ledger. However, a reference should be made of
the other account which has been credited in the Journal. For example,
for salaries paid, the salaries A/c should be debited in the Ledger, but
reference should be given of the cash A/c which has been credited in the
journal.
Iii) The concerned A/c, which has been credited in the Journal should
also be credited in the Ledger, but reference should be given of the A/c,
which has been debited in the Journal. For example, for salaries paid,
cash A/c has been credited in the Journal. It would be credited in the
Ledger also, but reference will be given of the Salaries A/c in the Ledger.
Suppose, salaries of Rs 10,000 have been paid in cash, the following
entry will be passed in the Journal:
Salaries A/c Dr 10,000
To Cash A/c 10,000
In the Ledger two A/cs will be opened (i) Salaries A/c and (ii) Cash A/c.
Since salaries A/c has been debited in the Journal. It will also be debited
in the Ledger Salaries A/c

Dr. Rs. Particular Cr.

Cash A/c 10,000

Cash A/c

Dr. Rs. Particular Cr.

Particulars Salaries A/c 10,000

The use of words To (e.g. To Cash A/c) and By (e.g. By Salaries A/c) is
merely conventional and has no meaning. Modern accountants ignore
these words, To & By.
Journalize the following transactions and post them in to the Ledger:
1. Ram started business with a capital of Rs. 10,000
2. He purchased furniture for cash Rs. 4,000
3. He purchased goods from Mohan on credit Rs. 2000
4. He paid cash to Mohan Rs. 1000.
 Journal
Date Particular LF Debit Credit
(Rs.) (Rs.)
Cash A/c 10,000
To Capital A/c 10,000
Furniture A/c 4,000
To Cash A/c 4,000
Purchase A/c 2,000
To Mohan A/c 2,000
Mohan 1,000
To Cash A/c 1,000
 Dr. Ledger Cash A/c Cr.
To Capital A/c 10,000 By Furniture A/c 4,000
By Mohan 1,000

Dr. Capital A/c Cr.

By Cash A/c 10,000

Dr. Furniture A/c Cr.

To Cash A/c 4,000

Dr. Purchase A/c Cr.

To Mohan A/c 2,000

Dr. Mohan A/c Cr.

To Cash A/c 1,000 By Purchases A/c 2,000
Balancing of Accounts: At the end of each month or year, personal
and real accounts are balanced. Balancing means finding the
difference between the total debit amounts and the total credit amounts
of an account. If the total of the credit side is bigger than the total of the
debit side, the difference is known as the credit balance. In the reverse
case, it is called debit balance.
The credit balance is written on the debit side of the ledger account
against the words “To balance c/d” and the debit balance is written on
the credit side of the Ledger A/c against the words ‘By balance c/d’ in
the particulars column. By doing this, the two sides are made equal and
the total of the amounts column are written on a parallel line.
In the next period, first entry is ‘To balance b/d’ or ‘By balance b/d’ as
the case may be.
Nominal A/cs are not balanced. They are closed by transfer to the
trading and profit and loss a/c. For the purpose of preparing the Trial
Balance, nominal accounts are also totalled. In Ledger accounts, the
word a/c after the name of the account in the particulars column may
be omitted.
TRIAL BALANCE
After posting the Ledger, a statement called the trial balance is
prepared, It shows separately the debit and credit balances of all the
accounts in the ledger, on a particular date
i) It provides information about the arithmetical accuracy of posting and
provides a basis for preparation of financial statements. If the trial
balance agrees, it gives an indication that double entry aspect of every
transaction recorded in the books of account is complete and the
account books are arithmetically correct. However, inspite of an agreed
trial balance, there might he certain errors. For example, if a
transaction has been completely omitted from the books of accounts,
the two sides of trial balance will still agree, inspite of the books of
accounts being wrong.
ii) Trial balance forms the basis for preparing financial statements such
as the P&L A/c and the balance sheet.
iii) The entire Ledger is summarized in the form of a trial balance. The
position of a particular A/c can be judged simply by looking at the trial
balance
The format of the trial balance is similar to the Journal. For preparing
the trial balance, the debit balances of A/cs are placed in the debit
column and credit balances in the credit columns of the trial balance.
It should be noted that a debit balance is either an asset or expense,
and credit balance is in respect of an income, or liability or capital
Cash and bank columns in the cash book serve the purpose of prime
as well as final entries. In the Ledger. Cash and Bank A/cs are not
opened separately.
Cash A/c never shows a credit balance, since a person cannot spend
more than what he has. The Bank a/c may show a credit balance since
a bank may permit a customer to overdraw his account (i.e., withdraw
more money than what he has in his account). In such a case, the
customer has an overdraft with the bank.
Measurement of Business Income
One of the basic objectives of maintaining the books of accounts of a
business is to ascertain the amount of profit or loss made or suffered
during a particular period. This requires proper matching of expenses
with revenue.
Revenue: It means income of recurring nature from any source, like
sale of goods, performance of service, rental of property etc.
Expense: It denotes the cost of services and things used for
generating revenue.
Expenditure: means payment for an asset or an expense. If an asset
is acquired or an expense is incurred, an expenditure is said to have
been incurred.
Every expense is an expenditure while each expr. Is not necessarily an
expense.
Matching of an expense with revenue:
Expense may be matched with the revenue at the end of year. A period
of 12 months is considered an ideal accounting period. First of all,
revenue is determined and then the expense incurred for earning that
revenue is matched with that revenue for determination of net income or
net profit.
Measurement of revenue:
Revenue is measured according to the Accrual Concept. This means
revenue and cash are two different things. Earning of revenue does not
mean receipt of cash and vice versa.
Revenue earned in a particular year may be received in cash in the next
year. Similarly, cash received in a year may be the revenue of the next
year. If a firm receives interest in advance for the year 1997 in 1996, the
cash has been received but it will be taken as revenue of the year 1997,
and not 1996.
Revenue is considered earned on its being realized.Thus according to
Realization Concept, revenue is generally taken to have been realized
in that period in which goods or services are furnished to the
customers; e.g.
– if order is received in February,
– goods are delivered in March
– Payment is received in September
The revenue is considered earned in March when goods are delivered.
Thus revenue is recognized when the actual sale takes place and the
ownership in goods has been transferred to the customers.
There are, however, exceptions to this rule:
i) In the case of extractive industries like gold, silver, oil, etc revenue is
recognized in the accounting period in which these have been mined
or extracted out.
ii) In the case of Long term contracts (e.g.construction) a proportion of
the amount of revenue representing part of the contract completed by
the end of the year is treated as realized even before the completion of
the contract.
iii) In the case of hire purchase, or installment sale transactions, revenue
is considered realized only to the extent of the installments which have
been received in cash in cases where the seller has doubts about the
possibility of realizing the full amount of selling price from the buyer.

Cash Basis- Income is equal to cash recd. Expense is equal to cash paid
– Net Income- is the difference between Cash Receipts & Cash
Payments
– Application in case of small enterprises doing business only on cash
basis, also clubs, societies, other non-profit organizations.
– It credit terms allowed or recd.; cash basis is inappropriate.
Accrual Concept: Income is the difference between revenue & expenses. It
is, therefore, profit earned which is reflected by a net increase in Owner’s
Equity
– If losses are incurred, Owner’s Equity decreases.
– Receipt of Cash is not Income
– Payment of Cash is not Expense.
 Capital and Revenue
Capital income: the term capital income means an income which does not
grow out of or pertain to the running of the business proper. It is
synonymous to the term capital gain. For example if a building costing Rs.
10,000 purchased by a firm for its use is sold for Rs. 15,000, Rs. 5,000 will
be taken as a capital profit. However, only the profit realized over and
above the cost of the fixed asset should be taken as a capital profit. Any
profit over the book value is treated as revenue profit since depreciation
against the fixed asset has already been charged to the P & L A/c, of the
earlier years and any profit which is now made is simply recovery of excess
provision for depreciation made in the earlier years.
According to the I.T. rules, a plant originally purchased for Rs. 10,000
standing in the books at Rs. 6000 is sold for Rs. 12000, there is a profit of
Rs. 6000 on the sale of this plant. Out of this profit, Rs. 2,000 (i.e., the
amount over and above the cost of the asset) should be taken as capital profit
while the balance of Rs. 4,000 should be taken as revenue profit. Capital
profit is transferred to the Capital Reserve and is shown in the Balance Sheet
on the liabilities side while revenue profit is credited.to the P and L A/c.
Revenue Income: means an income which arises out of and in the course
of regular business transactions of a concern, e.g. sales, rental of
property, dividends recd. etc.
Capital Expenditure: means an expenditure which has been incurred for
the purpose of obtaining a long term advantage for the business. Such
expenditure is either incurred for acquisition of an asset (tangible &
intangible) which can later be sold and converted into cash or which
results in increasing the earning capacity of the business.
Examples:
i)Expr. incurred in increasing the quality of fixed assets, e.g. purchase of
additional furniture, plant, building for permanent use in the business.
ii)Expr. incurred for increasing the useful life or capacity or efficiency of
a fixed asset.
iii)Expr. for replacement of an asset by a new one.
iv.Expr. incurred for purchase, receipt, erection of a fixed asset, e.g.
cartage, erection, wages etc.
v.Purchase of patent rights, copy rights, goodwill etc.
vi.Expr. for incorporation of a firm, obtaining a license, legal & other
expr.
Revenue Expenditure: An expr. whose benefit accrues in the current
period is known as rev. expr.
An expr. would be rev. expr. if
i) It is incurred on day to day production or on running day to day
business.
ii)It provides any benefit of an immediate or/and non-recurring nature;
iii)It helps in keeping the assets in good working condition, e.g.
replacement of a worn out part etc.
Deferred Revenue Expr. Sometimes, the benefit of a rev. expr. may be
available beyond the current period. Such expr. is referred to as deferred rev.
expr. It is written off over a period of 3 to 4 years instead of charging it to
the P&L A/c of the period in which it is incurred. Examples:
•Heavy expr. on advertisement and publicity of a new product or the firm,
the benefit of which will be derived in future also.
•The amount representing loss of an exceptional nature, such as fire
earthquake etc.
 Exercise
Name: Indicate the classification of each of the items in the worksheet
indicating the items that cannot be classified
Items Income Expenses Assets Liabilities
Building
Share Capital
Cash
Debtors
Creditors
Equipment
Land revalued
Stock
Goodwill developed
Furniture
Delivery vehicle

Prepayment of
expenses.
Advances recd.
Exercise – A tallied Balance Sheet?

Assets (Rs. 0000)

Owners’ equity 22.1
Merchandise 35.7
Accounts payable 14.0
Interest payable 0.2
72.0
Liabilities
Taxes payable 11.7
Cash 4.0
Equipment 18.0
Loan payable 24.0
Accounts receivable
8.0
Vehicles
6.3
72.0
Using the data given above, prepare a proper balance sheet
Exercise – Ranjan Mahapatra prepared the following tallied balance sheet of
Balances Ltd. in a five minutes quiz administered in a Management Accounting
class.
Balance
AssetsSheet of Balances Ltd. for the period ending 31.3-93
(Rs. 0000)
Owners’ equity 22.1
Merchandise 35.7
Accounts payable 14.0
Interest payable 0.2
72.0
Liabilities
Taxes payable 11.7
Cash 4.0
Equipment 18.0
Loan payable 24.0
Accounts receivable 8.0
Vehicles 6.3
72.0
Using the data given in the “balance sheet” prepared by Ranjan Mohapatra,
prepare a proper balance sheet