Success Tree Accounting

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Accounting
Basics
EPFO
Accounting is the process of recording and
summarizing financial information in a useful
way.
Accounting consists of 2 parts:
1. Book-keeping
MEANING OF 2. Analysis
ACCOUNTING It gives information on-
1. The resources available
2. How the available resources have been
employed
3. The results achieved by their use.
IDENTIFICATION MEASURING THE RECORDING CLASSIFYING
OF FINANCIAL IDENTIFIED
Characteristics TRANSACTIONS
AND EVENTS
TRANSACTIONS
of Accounting
SUMMARISING ANALYSIS AND COMMUNICATING

INTERPRETATION
Functions of Accounting
➢Maintaining systematic accounting record
➢Preparation of financial statement
➢Meeting legal requirement
➢Communicating financial information
➢Assistance to management
Accounting Entity or Business Entity Principle- Business is considered to be separate from its
owners. Transactions are recorded in the books of accounts from the point of view of the
business and not from that of the owner.
Accounting is not fully exact
Unrealistic information
Limitations of
Accounting ignores the qualitative elements
Accounting
Accounting ignores the effect of price level changes
Accounting may lead to window dressing

Financial Accounting
Branches of
Cost Accounting
accounting
Management Accounting
1. Double Entry System- both debit
and credit aspects of accounting are
recorded
System of
2. Single Entry System- All
Accounting
transactions are not recorded on
double entry system.
1. Account- It is a record of transactions under a particular head of account or a
particular head.
It not only shows the amount but also their effect and direction.
2. Capital- It is the amount invested in an enterprise by the proprietor. It may be in
the form of money or assets having a monetary value.
3. Drawings- It is the amount withdrawn or goods taken by the proprietor or
partner for personal for personal use.
Basic Accounting 4. Liabilities- It means amount owed (payable) by the business.
Terms a. Internal Liability- Liability towards the owners of the business.

b. External Liability- Liability towards the outsiders.
5. Assets- These are the properties owned by an entity or enterprise.
a. Non-current Assets- Those assets are those assets which are held by an entity or
enterprise not with the purpose to resell but are held either as investment or to
facilitate business operations.
b. Current Assets- These are those assets which are held by an entity or enterprise
with the purpose of converting them into cash within a short period, i.e. one year.
6. Receipts- It is the amount received or receivable for
selling assets, goods or services.
A. Revenue Receipts- Amount receivable in the normal
course of business say against sale of goods or
rendering of services.
B. Capital Receipts- Amount received against
transactions which are not revenue in nature
7. Expenditure- an be defined as the amount spent for
a long-term on an asset which gives a long-term
benefit like building expenditure, furniture
expenditure, plant expenditure etc.
Expenses are those costs which are incurred to earn revenues whereas expenditures are
those costs which are incurred to purchase or increase the value of the fixed assets of the organization.
▪Prepaid expense- It is an expense that has been paid in
advance and the benefit of which will be available in the
following year or years.
▪Outstanding Expense- It is in an expense that has been
incurred but has not been paid yet.
▪Income vs. profit vs. Revenue
▪Income is the profit earned during the period
▪Profit means income earned by the business from its operating
activities.
▪Revenue- It is the amount received or receivable by the
enterprise from its operating activities
Trade Receivables – It is the amount
receivable for sale of goods and/or services
rendered in the ordinary course of
business.
Trade receivables is a sum total of debtors
and bill receivable.
Trade Payables- It is the amount payable
for purchase of goods or services taken in
ordinary course of business. Trade payables
is the sum total of creditors and bills
payables
Accounting Principles
➢ Accounting Principles, concepts and conventions commonly known as
Generally Accepted Accounting Principles or GAAPs are the basic rules that
define the parameters and constraints within which accounting operates.
➢ The Institute of Chartered Accountants of India (ICAI) has issued Accounting
Standards. They are presently applicable to non-corporate enterprises.
➢ The accounting standards notified under the Companies Act, 2013 are
applicable and mandatory on companies.
The following are recognised by AS-1, Disclosure of Accounting Policies
are-
Going Concern Assumption-
It is assumed that business shall continue for a foreseeable period and
there is no intention to close the business or scale down its operation
Fundamental significantly.
Accounting Consistency Assumption-
Assumptions Accounting practices once selected and adopted should be applied

consistently year after year. It helps in eliminating personal bias and helps
in showing results that are comparable.
Accrual Assumption-
A transaction is recorded in the books of account at the time when it is
entered into and not when the settlement takes place.
1.) A person who owes money to a firm against
goods sold is called a-
a) Creditor
MCQs b) Debtor
c) Both a and b
d) None of these
2. Revenue from operations refer to
a) Revenue earned from operating activities
b) Revenue earned from activities that are not
operating activities
c) Both a and b
d) None of the above
3. According to the Going Concern Concept-
a) Assets are recorded at cost and are depreciated
over their useful life
b) Assets are valued at their market value at the year-
end and are recorded in the books of account
c) Assets are valued at their market value. Recorded in
the books of accounts and depreciation is charged
on the market value.
4. According to the convention of consistency-
a) Accounting policies and practices once
adopted should be consistently followed
b) Accounting policies and practices adopted
may be changed under any circumstances.
c) Accounting policies and practices once
adopted cannot be changed under any
circumstances
5. X Ltd. Follows the written down method of depreciating machinery year
after year due to
a) Comparability
b) Convenience
c) Consistency
d) All of the Above
Success Tree
General Accounting Principles Lecture- 1

MEANING OF ACCOUNTING
Accounting is the process of recording and summarizing financial information in a useful way. Accounting consists of
2 parts:
1.Book-keeping
2. Analysis
It gives information on-
 The resources available

 How the available resources have been employed
 The results achieved by their use.
Accounting as a discipline records, classifies, summarizes and interprets financial information about the activities of
an enterprise so that intelligent decisions can be made about the enterprise. The American Institute of Certified Public
Accountants has defined financial accounting as” the art of recording, classifying and summarizing, in a significant
manner and in terms of money, transactions and events which are in part, at least, of a financial character, and
interpreting the results thereof”. Accounting can, therefore, be defined as the process of identifying, measuring,
recording and communicating the required information relating to the economic events of an organisation to the
interested users of the information. From the above, the following attributes of accounting emerge
(i) It is the art of recording and classifying business transactions and events
(ii) The transactions or events of a business must be recorded in monetary terms
(iii) It is the art of making summaries, analysis and interpretation of the business financial transactions.
(iv) The result of such analysis must be communicated to the persons who are to make decisions or form
judgments.
Characteristics of Accounting
 Identification of Financial Transactions and Events

 Measuring the Identified Transactions
 Recording
 Classifying
 Summarising
 Analysis and Interpretation
 Communicating
Functions of Accounting
 Maintaining systematic accounting record
 Preparation of financial statement
 Meeting legal requirement
 Communicating financial information
 Assistance to management
External users of accounting information

External users are those persons or groups who are outside the organisation for whom the accounting function is being
performed. Following are the important external users of accounting information.
(i) Investors: Those who are interested in investing money in an organisation are interested in knowing the
financial health of the organisation, how safe the investment already made is, and how safe the future
investment will be. Thus, investors, for making investment decisions, are dependent upon accounting
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information available in financial statements. They can know the profitability and financial position of the
enterprise by making a study of the accounting information given in the financial statements of the
enterprise.
(ii) Creditors: Suppliers of goods and services on credit, bankers and other lenders of money are creditors.
They are interested in knowing the short-term financial position of the enterprise before giving loans or
granting credit. They want to be sure that the enterprise will not experience difficulty in making their
payment in time i.e. the liquid position of the concern is satisfactory. To know the liquid position, they need
accounting information relating to current assets and current liabilities which is available in the financial
statements.
(iii) Government: Central and state governments are interested in accounting information since they want to
know the earnings or sales of a particular period for the purpose of taxation. Governments also require
accounting information for compiling statistics concerning business which, in turn, helps in compiling
national income account.
(iv) Consumers: Consumers need accounting information so as to know the cost of goods and to ascertain that
they are being charged reasonable price of the goods they are buying for their satisfaction.
Internal users of accounting information
Internal users of accounting information are those persons or groups which are within the enterprise. Following are the
important internal users of accounting information.
(i) Owners: Owners provide capital for the operations of the business and want to ascertain whether their funds
are being properly used or not. They need accounting information to know the profitability and the financial
position of the enterprise in which they have invested their funds. The financial statements provide such
information for better investment and future planning.
(ii) Management: The most important function of management is decision making. Management needs
accounting information in selecting alternative proposals, for e.g., whether to buy or produce a product. It
also requires the same for controlling acquisition and maintenance of inventories, receipts and payments of
cash, purchases of sales etc. Accounting information is also important for the management for planning or
budgeting for the future. Managers require it for appraising performance and devising remedial measures
for the deviations of the actual results from the budgeted targets.
(iii) Employees: Employees are interested in the financial position of the enterprise, particularly for the payment
of bonus when it depends upon the amounts of profits earned. They require accounting information for
settling disputes relating to their wages.
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Limitations of Accounting
 Accounting is not fully exact

 Unrealistic information
 Accounting ignores the qualitative elements
 Accounting ignores the effect of price level changes
 Accounting may lead to window dressing
Branches of accounting
Financial Accounting: The most important branch of accounting it is concerned with the recording, classifying,
summarizing and analysing of business transactions. It is directed towards the preparation of profit and loss account,
and balance sheet. With the help of these financial statements business results are communicated to the interested
parties or users for decision-making.
(ii)Cost Accounting: Cost accounting is the process of accounting for costs. It is a systematic procedure for determining
the unit cost of output produced or services rendered. The basic functions of cost accounting is to ascertain the cost of
a product and to help the management in the control of cost. It is that branch of accounting which deals with the
classification, recording, allocation, summarization and reporting of current and prospective costs. Through analysis of
the expenses of operating a business, it helps in controlling the cost of products or services provided.
(iii)Management Accounting: Management accounting is concerned with the supply of information which is useful to
management in decision-making for the efficient functioning of the enterprise and, thus, in maximising profits. It is the
reproduction of financial statements (Profit and Loss Account and Balance Sheet) in such a way as will enable the
management to take decisions and to control activities.
System of Accounting
1. Double Entry System- both debit and credit aspects of accounting are recorded.
2. Single Entry System- All transactions are not recorded on double entry system
Basic Accounting Terms

1. Account- It is a record of transactions under a particular head of account or a particular head. It not only shows
the amount but also their effect and direction.
2. Capital: It refers to the amount invested by the owner(s) in the enterprise. It may be brought by the owners in
cash or in the form of assets. It indicates the interest of the owner(s) in the assets of the enterprise.
3. Drawings- It is the amount withdrawn or goods taken by the proprietor or partner for personal for personal use.
4. Liabilities- It means amount owed (payable) by the business.
a. Internal Liability- Liability towards the owners of the business
b. External Liability- Liability towards the outsiders.
5. Assets- These are the properties owned by an entity or enterprise.
a. Non-current Assets- Those assets are those assets which are held by an entity or enterprise not with
the purpose to resell but are held either as investment or to facilitate business operations.
b. Current Assets- These are those assets which are held by an entity or enterprise with the purpose of
converting them into cash within a short period, i.e. one year.
6. Account- It is a record of transactions under a particular head of account or a particular head. It not only shows
the amount but also their effect and direction.
7. Drawings- It is the amount withdrawn or goods taken by the proprietor or partner for personal for personal use.
8. Liabilities- These are the obligations or debts that the enterprise must pay in money or services at some time in
the future. Liabilities are debts, for e.g, amount due to creditors, bank overdrafts, bills payable, loans etc. Like
assets, liabilities can also be broadly classified into two categories:
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a. Long-term liabilities are those that are payable after a period of one year, for e.g, a term loan from a
financial institution, debentures etc. issued by a company.
b. Short-term liabilities are such obligations of the enterprise that are payable within a year e.g. creditors
(accounts payables), bills payable (notes payable), cash credit, overdraft, short-term loans etc.
Internal Liability- Liability towards the owners of the business.
External Liability- Liability towards the outsiders.
9. Assets- These are economic resources of an enterprise that can be usefully expressed in monetary terms. Assets
consist of tangible objects or intangible rights owned by the enterprise and carrying probable future benefits.
Examples of tangible assets are cash, bank balance, inventories, machinery, furniture, and building. Examples
of intangible assets are goodwill, patents, copyrights, trademarks. Assets can also be broadly classified into two
types: fixed assets and current assets.
a. Fixed assets are held for long use in business itself for the purpose of providing or producing goods or
services and are not held for re-sale purpose in the normal course of business, for e.g., land, building,
machinery, furniture and fixtures.
b. Current assets are held on a short-term basis; normally short-term refers to an accounting year.
Examples of current assets are cash, bank balance, debtors, bills receivable, investment etc. These are
expected to be converted into cash or consumed in the production of goods or rendering of services in
the normal course of business.
10. Expenditure- can be defined as the amount spent for a long-term on an asset which gives a long-term benefit
like building expenditure, furniture expenditure, plant expenditure etc.
11. Expenses are those costs which are incurred to earn revenues whereas expenditures are those costs which are
incurred to purchase or increase the value of the fixed assets of the organization.
a. Prepaid expense- It is an expense that has been paid in advance and the benefit of which will be
available in the following year or years.
b. Outstanding Expense- It is in an expense that has been incurred but has not been paid yet.
12. Income vs. profit vs. Revenue
a. Income is the profit earned during the period
b. Profit means income earned by the business from its operating activities.
c. Revenue- It is the amount received or receivable by the enterprise from its operating activities
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13. Trade Receivables – It is the amount receivable for sale of goods and/or services rendered in the ordinary
course of business. Trade receivables is a sum total of debtors and bill receivable. Debtors are persons and/or
other entities to whom goods have been sold or services provided on credit and who thus owe certain amount
to the enterprise. They are also referred to as accounts receivable or trade debtors. Debtors are assets for an
enterprise and the total of debtors on the closing date is shown on the assets side of the balance sheet as “sundry
debtors”.
14. Trade Payables- It is the amount payable for purchase of goods or services taken in ordinary course of business.
Trade payables is the sum total of creditors and bills payables. Creditors are persons and/or other entities who
have to be paid by an enterprise an amount for providing goods and services on credit. They are also referred
to as accounts receivable or trade creditors. The total amount standing to the favour of creditors on the closing
date is shown in the balance sheet as ‘sundry creditors’ on the liability side.
 Accounting Principles, concepts and conventions commonly known as Generally Accepted Accounting
Principles or GAAPs are the basic rules that define the parameters and constraints within which
accounting operates.
 The Institute of Chartered Accountants of India (ICAI) has issued Accounting Standards. They are
presently applicable to non-corporate enterprises.
 The accounting standards notified under the Companies Act, 2013 are applicable and mandatory on
companies.
Fundamental Accounting Assumptions

The following are recognised by AS-1, Disclosure of Accounting Policies are-
Going Concern Assumption-
This concept assumes that a business entity will continue to operate indefinitely and that it will not be liquidated in the
immediate future and the financial statements are prepared on this assumption. The business is called ‘going concern’
which means that it will remaining operation in the foreseeable future unless it is to be liquidated in the near future.
Since this concept believes in the continuity of the business over an indefinite period, it is also known as continuity
concept. It is because of the going concern concept that distinction between
(a) fixed assets and current assets
(b) short-term and long-term liabilities and
(c) capital and revenue expenditure are made.
Consistency Assumption-
Accounting practices once selected and adopted should be applied consistently year after year. It helps in eliminating
personal bias and helps in showing results that are comparable. The consistency principle of accounting states that a
company should use the same accounting policies and methods for recording similar events or transactions from one
financial period to another. It is necessary that a company consistently apply its accounting methods and policies from
one financial year to another.
A company can change its accounting methods and policies only and only if there are one or more reasonable grounds
to do so and the change reflects a more accurate picture of financial performance and position of the business in
company’s financial statements.
Accrual Assumption-
The essence of accrual concept is that revenue is recognised when it is occurred or realised i.e. when sale is complete,
or services are given, and it is immaterial whether cash is received or not. Similarly, according to this concept, expenses
are recognised in the accounting period in which they help in earning the revenues whether cash is paid or not. Thus, to
ascertain correct profit or loss for an accounting period we must take into account all expenses and incomes relating to
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the accounting period whether actual cash has been paid or received or not. It is because of this concept that outstanding
expenses and accrued incomes are taken into account.
MCQs
1. A person who owes money to a firm against goods sold is called a-
a) Creditor
b) Debtor
c) Both a and b
d) None of these
Solution- b
2. Revenue from operations refer to

a) Revenue earned from operating activities
b) Revenue earned from activities that are not operating activities
c) Both a and b
Solution- a
3. According to the Going Concern Concept-

a) Assets are recorded at cost and are depreciated over their useful life
b) Assets are valued at their market value at the year-end and are recorded in the books of account
c) Assets are valued at their market value. Recorded in the books of accounts and depreciation is charged on the
market value.
Solution- a)
4. According to the convention of consistency-

a) Accounting policies and practices once adopted should be consistently followed
b) Accounting policies and practices adopted may be changed under any circumstances.
c) Accounting policies and practices once adopted can be changed as per the management’s decision.
Solution- a
5. 5. X Ltd. Follows the written down method of depreciating machinery year after year due to
a) Comparability
b) Convenience
c) Consistency
d) All of the Above
Solution- c
Accounting Principles- Lecture-2
1. Money Measurement Concept
The money measurement concept states that a business should only record an accounting transaction if it can be
expressed in terms of money. This means that the focus of accounting transactions is on quantitative information,
rather than on qualitative information. Thus, a large number of items are never reflected in a company's accounting
records, which means that they never appear in its financial statements. Examples of items that cannot be recorded
as accounting transactions because they cannot be expressed in terms of money include:
 Employee skill level

 Employee working conditions
 Expected resale value of a patent
 Value of an in-house brand
 Product durability
 The quality of customer support or field service
 The efficiency of administrative processes
All of the preceding factors are indirectly reflected in the financial results of a business, because they have an
impact on either revenues, expenses, assets, or liabilities. For example, a high level of customer support will likely
lead to increased customer retention and a higher propensity to buy from the company again, which therefore
impacts revenues. Or, if employee working conditions are poor, this leads to greater employee turnover, which
increases labor-related expenses.
The key flaw in the money measurement concept is that many factors can lead to long-term changes in the financial
results or financial position of a business (as just noted), but the concept does not allow them to be stated in the
financial statements. The only exception would be a discussion of pertinent items that management includes in the
disclosures that accompany the financial statements. Thus, it is entirely possible that key underlying advantages of a
business are not disclosed, which tends to underrepresent the long-term ability of a business to generate profits. The
reverse is typically not the case, since management is encouraged by the accounting standards to disclose all current
or potential liabilities of a business in the notes accompanying the financial statements. In short, the money
measurement concept can lead to the issuance of financial statements that may not adequately represent the future
upside of a business. However, if this concept were not in place, managers could flagrantly add intangible assets to
the financial statements that have little supportable basis.
2. Accounting period
 This concept helps in estimating the profit or loss and financial position of a business for a particular
 period. If there are different accounting periods then various problems can arise like in the calculation of
profits, comparability of various incomes & expenses etc. Thus, to study the results of a business, the life of
a business is divided into short periods of equal length. Each such period is known as accounting period.
 While true profit or loss of a business can only be determined when the business finally closes down, it
would be unwise to wait for that. Accounting information is needed by all concerned on a regular basis and
should, therefore, be prepared on an ongoing basis. For the purpose of having a reliable and comparable set
of financial statements, the performance and position of a business is measured at the end of
predetermined periods called accounting periods.
 Generally, an accounting period is one year. Hence, an income statement shows the financial performance
over one year while a balance sheet shows the financial position at the end of a year. This year may not
necessarily be a calendar year. It may run from January to December, or from July of one year to June of the
next, or from October to September.
 The fact that financial statements are prepared in relation to an accounting period necessitates certain
adjustments. For example, when a car is bought its cost must be apportioned over the various accounting
periods in which the said will be used. The accounting period principle requires that such adjustments be
judicially made and accounting record of them made accordingly.
3. Full Disclosure Principle
The full disclosure principle states that all information should be included in an entity's financial statements that
would affect a reader's understanding of those statements. The interpretation of this principle is highly judgmental,
since the amount of information that can be provided is potentially massive. To reduce the amount of disclosure, it is
customary to only disclose information about events that are likely to have a material impact on the entity's financial
position or financial results.
This disclosure may include items that cannot yet be precisely quantified, such as the presence of a dispute with a
government entity over a tax position, or the outcome of an existing lawsuit. Full disclosure also means that you
should always report existing accounting policies, as well as any changes to those policies (such as changing an asset
valuation method) from the policies stated in the financials for a prior period.
Several examples of full disclosure involve the following:
 The nature and justification of a change in accounting principle

 The nature of a non-monetary transaction
 The nature of a relationship with a related party with which the business has significant transaction volume
 The amount of encumbered assets
 The amount of material losses caused by the lower of cost or market rule
 A description of any asset retirement obligations
 The facts and circumstances causing goodwill impairment
You can include this information in a variety of places in the financial statements, such as within the line item
descriptions in the income statement or balance sheet, or in the accompanying disclosures.
The full disclosure concept is not usually followed for internally-generated financial statements, where management
may only want to read the "bare bones" financial statements.
4. Materiality Principle
Materiality is the threshold above which missing or incorrect information in financial statements is considered to
have an impact on the decision making of users. Materiality is sometimes construed in terms of net impact on
reported profits, or the percentage or dollar change in a specific line item in the financial statements. Examples of
materiality are as follows:
The materiality concept or principle is an accounting rule that dictates any transactions or items that significantly
impact the financial statements should be accounted for using GAAP exclusively. In other words, if a transaction or
event happened during the year that would affect how an investor would view the company, it must be accounted
for using GAAP on the financial statements.
Transactions or events that are deemed to be not material can be ignored because they won’t affect how investors
and creditors view the financial statements to make their decisions. Non-material transactions are usually small or
have very little impact on the overall company bottom line.
It might be helpful to look at a few examples.
Example
Assume Bill’s Dry Cleaning service has annual revenues of $40,000. He decides to upgrade his equipment during the
year and replaces one of his dryers for $15,000. This is a significant event in the company’s year because investors
and creditors will definitely want to know about a purchase that equals over 30 percent of annual revenues. This
asset should be capitalized and placed on the balance sheet. Based on the preceding examples, it should be clear
that sometimes even quite a small change in financial information can be considered material, as well as a simple
omission of information.
After a year of having the new dryer, Bill had a belt go out on it. It cost him $250 to have the machine repaired. This
is not a significant event. It doesn’t really matter how Bill records this transaction. He can expense it in the repairs
and maintenance account, or he can capitalize it and add it to the asset. It is not material. Either way investors or
creditors’ opinions of the financial statements and health of the company will not change no matter how he records
this transaction.
In short, the materiality concept is concerned about events that are significant in nature and affect how end users
view the financial statements.
5. Prudence or Conservatism Principle
The idea of conservatism suggests that you, as a business, should anticipate and record future losses rather than
future gains. The principle of conservatism in accounting gives guidance when recording cases of uncertainty or
estimates. In other words, you should always lean towards the most conservative side of any transaction.
In situations where uncertainty exists and there is doubt between two reasonable alternatives for recording an item,
according to the conservatism principle your accountant should always choose the “less favourable” outcome. This
could mean minimising profits by recording estimated expenses or losses, and not recording the estimated gains or
revenues.
 If there is uncertainty about a loss or potential loss - then you should record it.
 If there is uncertainty about a gain or potential gain - then you should not record it.
 And of course, if there is certainty about a gain - then you should record it.
Here is an example to show when the conservatism principle is used, and what situations it is relevant for:
A cosmetic company Beauty Pacific, Inc. is in the process of a patent lawsuit against another cosmetic company Pure
Pacific, Inc.
Beauty Pacific, Inc anticipate winning the patent claims as well as a large settlement.
Beauty Pacific, Inc. cannot report the gains in their financial statements as long as this gain is still uncertain. By
recording the large settlement win, their financial statements could mislead their users, so it should not be recorded
until it is certain.
If Beauty Pacific, Inc. anticipate losing the patent claims, and might also have to pay out a large settlement, then
they should record this loss in the notes of the financial statement. Whether they end up winning or losing the
lawsuit, Beauty Pacific, Inc. should take the most conservative approach. Their financial statement users should be
made aware of any potential large losses that the company might experience in the future.
This is also known as “playing it safe”, or taking the least optimistic approach to a situation, assuming that losses will
be incurred and therefore adjusting the financial statements accordingly. The purpose of this is to ensure that a
business’s financial statements are reliable.
Another way of looking at the conservatism principle is that losses or expenses are recorded as soon as they are
incurred, whereas profits or gains are recorded only when they have been received.
6. Historical Cost Concept
Historical cost is the original cost of an asset, as recorded in an entity's accounting records. Many of the
transactions recorded in an organization's accounting records are stated at their historical cost. This concept is
clarified by the cost principle, which states that you should only record an asset, liability, or equity investment at its
original acquisition cost.
A historical cost can be easily proven by accessing the source purchase or trade documents. However, historical cost
has the disadvantage of not necessarily representing the actual fair value of an asset, which is likely to diverge from
its purchase cost over time. For example, the historical cost of an office building was $10 million when it was
purchased 20 years ago, but its current market value is three times that figure.
According to the accounting standards, historical costs require some adjustment as time passes. Depreciation
expense is recorded for longer-term assets, thereby reducing their recorded value over their estimated useful lives.
Historical cost differs from a variety of other costs that can be assigned to an asset, such as its replacement cost
(what you would pay to purchase the same asset now) or its inflation-adjusted cost (the original purchase price with
cumulative upward adjustments for inflation since the purchase date).
Historical cost is still a central concept for recording assets, though fair value is replacing it for some types of assets,
such as marketable investments. The ongoing replacement of historical cost by a measure of fair value is based on
the argument that historical cost presents an excessively conservative picture of an organization.
7. Matching Concept
The matching principle simply states that related revenues and expenses should be matched in the same period. So,
an expense should be recorded in the same period as the corresponding revenue. The matching principle requires
that revenues and any related expenses be recognized together in the same reporting period. Thus, if there is a
cause-and-effect relationship between revenue and certain expenses, then record them at the same time. If there is
no such relationship, then charge the cost to expense at once. This is one of the most essential concepts in accrual
basis accounting, since it mandates that the entire effect of a transaction be recorded within the same reporting
period.
Here are several examples of the matching principle:

Commission. A salesman earns a 5% commission on sales shipped and recorded in January. The commission of
$5,000 is paid in February. You should record the commission expense in January.
Employee bonuses. Under a bonus plan, an employee earns a $50,000 bonus based on measurable aspects of her
performance within a year. The bonus is paid in the following year. You should record the bonus expense within the
year when the employee earned it.
Wages. The pay period for hourly employees ends on March 28, but employees continue to earn wages through
March 31, which are paid to them on April 4. The employer should record an expense in March for those wages.
The matching principle is an accounting principle that requires expenses to be reported in the same period as the
revenues resulting from those expenses. In other words, the matching principle recognizes that revenues and
expenses are related. Businesses must incur costs in order to generate revenues.
8. Revenue Recognition Concept
The revenue recognition principle is a cornerstone of accrual accounting together with the matching principle. They
both determine the accounting period in which revenues and expenses are recognized. According to the principle,
revenues are recognized when they are realized or realizable, and are earned (usually when goods are transferred or
services rendered), no matter when cash is received. In cash accounting – in contrast – revenues are recognized
when cash is received no matter when goods or services are sold.
Cash can be received in an earlier or later period than obligations are met (when goods or services are delivered) and
related revenues are recognized that results in the following two types of accounts:
Accrued revenue: Revenue is recognized before cash is received.
Deferred revenue: Revenue is recognized after cash is received.
Revenue realized during an accounting period is included in the income.
9. Verifiable Objective Concept
The Verifiable Objective Concept holds that accounting should be free from personal bias. Measurements that are
based on verifiable evidences are regarded as objectives. It means all accounting transactions should be evidenced
and supported by business documents.
These supporting documents are:
 Cash Memo
 Invoices
 Sales Bills, etc.
These supporting documents provide the basis for accounting and audit.
10. Dual aspect or Duality principle
The dual aspect concept of accounting relates to the idea of double entry bookkeeping. Every transaction affects the
business in at least two aspects. These two aspects are equal and opposite in nature.
To ensure a comprehensive and complete record, it is necessary to make two entries to record each transaction. This
concept is based on the assumption that business never truly owns anything. Anything that it has (namely assets), it
owes it either to outsiders (i.e., liabilities) or to the owner who is also a separate person (i.e., capital). Hence
whenever a business gets anything, it must record both facts – an increase in asset and an increase in liability or
capital.
The accounting equation is considered to be the foundation of the double-entry accounting system. The accounting
equation shows on a company's balance sheet whereby the total of all the company's assets equals the sum of the
company's liabilities and shareholders' equity.
Accounting Equation Formula

Accounting Principles Lecture- 3
Deferred Revenue Expenditure-
 It is an expenditure which is revenue in nature and incurred during an accounting period, but its benefits are
to be derived in multiple future accounting periods.
 These expenses are unusually large in amount and, essentially, the benefits are not consumed within the
same accounting period.
 Part of the amount which is charged to profit and loss account in the current accounting period is reduced
from total expenditure and rest is shown in the balance sheet as an asset (fictitious asset, i.e. it is not really
an asset).
Preliminary Expenses
 The expenses incurred when a company is formed and before the start of any business operations are
termed as preliminary expenses, they are a good example of fictitious assets which are written off every year
from the profits earned by the business.
 Some examples of such expenses incurred before business incorporation are; Legal cost, Professional fees,
Stamp duty, Printing fees, etc.
Purchases
The term purchases are used for an account to record purchase of goods or raw materials for resale or for
producing products which are also to be sold. The term purchases include both cash and credit purchase of
goods. Goods purchase for cash or termed as cash purchases and goods purchased on credit are termed as credit
purchases
Sales
The term sales is associated with or used for sale of goods. These goods may be purchased for resale or
manufactured by the enterprise. The term sales include both cash and credit sales. When goods are sold for cash
they are termed as cash sales and when sold on credit there termed as credit sales.
Stock/Inventory
Stock is a tangible asset held by an enterprise for the purpose of sale in the ordinary course of business or for the
purpose of using it in the production of goods meant for sale. Stock maybe opening stock and closing stock. Opening
stock is the stock in hand in the beginning of accounting year. In other words, it is a stock in hand at the end of the
previous accounting year. Closing stock is the stock in hand at the end of current accounting.
Discount
What is the reduction in the price of goods or from the amount to be paid to a customer by the enterprise. Discount
allowed maybe trade discount or cash discount.
Trade discount is the reduction in prices by the seller to the purchaser of goods when they buy goods of certain
quantity or value. Sales are recorded at net value that is sales minus trade discount. Similarly, purchases are
recorded by the purchaser at net value that is purchases minus discount.
Cash Discount- It is the discount allowed for timely payment of due amount. It is an expense for the party allowing
the discount and income for the party receiving cash discount. It is recorded in the books of account of both the
parties
Bad Debts
It is the amount owed to business that is return of because it has become irrecoverable. It is a loss for the business
and the debited to profit and loss account.
Cost of Goods Sold
It is direct cost attributable to the production of goods sold and/or services rendered.
Accounting Procedures- Rules of Debit or Credit
Account is a record of transactions under a particular head. It records not only the amount of transactions but also
their effect and direction.
Debit refers to the right side of the account and credit refers to the left side of the account. Both debit and credit
may represent either increase or decrease depending upon the nature of an account. The rules depend upon nature
of account.
Rules of Dr. and Cr.
 Double entry system of accounting

 One aspect is debit i.e. receiving or incoming aspect
 Other aspect is credit i.e. giving or outgoing aspect
Classifications of accounts-
1) Traditional Approach
2) Modern Approach
Representative Personal Accounts are accounts which represent a certain person or group
of people. Accounts relating to outstanding and prepaid items are called representative personal accounts. For
example, prepaid insurance, outstanding rent, outstanding wages/salaries etc. Outstanding salaries is one
such account.
Rule- Debit the receiver and Credit the giver
Impersonal Accounts
Rule- Debit what comes in and credit what goes out
If a prefix or suffix (outstanding, prepaid or accrued) is added to a nominal account, it becomes a personal
account.
ACCOUNTING
BASICS
UPSC-EPFO
INTERNATIONAL FINANCIAL REPORTING
STANDARDS (IFRS)
The International Accounting Improve financial IFRS are referred to as

Standards Board (2001) replaced reporting internationally. principle based accounting
They superseded the the International Accounting standards.
International Accounting Standards Committee(IASC)
Standards. (1973). It issues IFRS.
Difference between IFRS and Indian GAAP or Accounting standards
• IFRS are principle based while Indian GAAP are rule based. Under the Indian laws
Balance sheet is prepared according to schedule III of the Companies Act 2013 or in the
form as near thereto. It means a balance sheet item should be detected under the
prescribed head. IFRS doesn’t prescribe any form for the balance sheet.
• IFRS are based on Fair Value Concept while Indian GAAP or Accounting Standards are
based on Historical Cost Concept.
• India had 2 options i.e. either to adopt IFRS as they are or converge the Indian
Accounting Standards in line with IFRS. It decided to converge its existing accounting
standards with IFRS--- Ind-AS (can’t have same laws in every country)
• Indian GAAP issued by Council of the Institute of Chartered Accountants of India.
Ind-AS are notified under the Companies Act,2013. They converge with IFRS and are applicable to companies-
1. Listed on Stock Exchange in India
2. Having net worth of Rs. 250 crores or more
3. Their holding, subsidiary, associate and joint venture companies
a) Balance sheet as at the end of the period;

b) a statement of profit and loss for the period;
c) Statement of changes in equity for the period;
d) a statement of cash flows for the period;
e) notes, comprising significant accounting policies and other explanatory information;
f) comparative information in respect of the preceding period as specified in paragraphs 38 and 38A; and
• Ind-AS prescribes that every company shall value its financial assets (securities) at Fair Value whereas other
assets can be valued at historical cost or at fair value. But, whichever of the 2 are adopted, shall have to be
consistently followed.
• Fair Value is the price that would be received when an asset is sold or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.
• Ind-AS are principle based.
Q. Ind-AS are based on-
1. Rule based accounting standards
2. Principle based accounting standard
3. Partially rule based and partially principle based
4. None of the above
Journal- is a book in which transactions are recorded
in the order in which they are entered i.e. in
chronological order. It is called the Book of Original
Entry.
Rules of debit and credit are applied to each
transaction at the time of recording in the books of
account.
The transactions recorded are transferred into
ledger account- posting
Dinesh started business with 5000 capital

A book which contains, in a summarised and classified form, a permanent record of all transactions.
Trial Balance and Final Accounts are prepared from ledger.
Trial Balance- It is a statement, prepared with the debit and credit balances of the ledger accounts to
test the arithmetical accuracy of the books.
A complete set of financial statements is used to give readers an overview of the financial results and
condition of a business. Financial statements shall be prepared in the form provided in new schedule III of
Companies Act, 2013.The financial statements are comprised of the follows:
•Income statement. Presents the revenues, expenses, and profits/losses generated during the reporting
period. This is usually considered the most important of the financial statements, since it presents the
operating results of an entity.
•Balance sheet. Presents the assets, liabilities, and equity of the entity as of the reporting date. Thus, the
information presented is as of a specific point in time. The report format is structured so that the total of all
assets equals the total of all liabilities and equity (known as the accounting equation). This is typically
considered the second most important financial statement, since it provides information about the liquidity
and capitalization of an organization.
Cost of Goods Sold= Opening Stock+ Purchases(net) + Direct Expenses – Closing Stock
Q. In context of accounting, the term IFRS stands for-
a. International Financial Reporting Standards
b. Indian Financial Reporting Standards
c. Indian Financial Reporting System
d. International Financial Reporting System
Q. Under which Schedule of the Companies Act,2013, the formats of

financial statements are prescribes?
a. Schedule I
b. Schedule II
c. Schedule III
d. Schedule IV
General Accounting Principles
INTERNATIONAL FINANCIAL REPORTING STANDARDS AS GLOBAL STANDARDS
With a view of achieving convergence towards global reporting, the London based group namely the
International Accounting Standards Committee (IASC), responsible for developing International Accounting
Standards, was established in June, 1973. It is presently known as International Accounting Standards Board (IASB),
The IASC comprises the professional accountancy bodies of over 75 countries (including the Institute of Chartered
Accountants of India). Primarily, the IASC was established, in the public interest, to formulate and publish,
International Accounting Standards to be followed in the presentation of audited financial statements.
International Accounting Standards were issued to promote acceptance and observance of International
Accounting Standards worldwide. The members of IASC have undertaken a responsibility to support the standards
promulgated by IASC and to propagate those standards in their respective countries. Between 1973 and 2001, the
International Accounting Standards Committee (IASC) released International Accounting Standards. Between 1997
and 1999, the IASC restructured their organisation, which resulted in formation of International Accounting
Standards Board (IASB). These changes came into effect on 1st April, 2001. Subsequently, IASB issued
statements about current and future standards: IASB publishes its Standards in a series of pronouncements
called International Financial Reporting Standards (IFRS). However, IASB has not rejected the standards issued by the
ISAC. Those pronouncements continue to be designated as “International Accounting Standards” (IAS). The term
IFRS comprises IFRS issued by IASB; IAS issued by International Accounting Standards Committee (IASC);
Interpretations issued by the Standard Interpretations Committee (SIC) and the IFRS Interpretations Committee of
the IASB. International Financial Reporting Standards (IFRSs) are considered a "principles-based" set of
standards. In fact, they establish broad rules rather than dictating specific treatments. Every major nation is
moving toward adopting them to some extent. Large number of authorities requires public companies to use IFRS
for stock-exchange listing purposes, and in addition, banks, insurance companies and stock exchanges may
use them for their statutorily required reports. So over the next few years, thousands of companies will
adopt the international standards. This requirement will affect about 7,000 enterprises, including their subsidiaries,
equity investors and joint venture partners. The increased use of IFRS is not limited to public-company listing
requirements or statutory reporting. Many lenders and regulatory and government bodies are looking to IFRS to full
local financial reporting obligations related to financing or licensing.
What are Indian Accounting Standards (Ind AS)?
Indian Accounting Standards (Ind-AS) are the International Financial Reporting Standards (IFRS) converged standards
issued by the Central Government of India under the supervision and control of Accounting Standards Board
(ASB) of ICAI and in consultation with National Advisory Committee on Accounting Standards (NACAS).
National Advisory Committee on Accounting Standards (NACAS) recommend these standards to the Ministry of
Corporate Affairs (MCA). MCA has to spell out the accounting standards applicable for companies in India. The Ind
AS are named and numbered in the same way as the corresponding International Financial Reporting
Standards (IFRS).
Depreciation
It is the fall in the value of tangible fixed assets because of its usage or with efflux of time or due to obsolescence or
accident.
Depreciation is charged on all fixed assets except land because unlike other fixed assets such as machinery, it has
infinite economic life.
 It may be noted that Accounting Standards as well as the Companies Act, 2013 requires depreciation to be
charged on a component basis.
 Each part of an item of Property, Plant and Equipment with a cost that is significant in relation to the
total cost of the item should be depreciated separately.
 Example- Aircraft is a classic example of such an asset. The airframe (i.e. the body of the aircraft), the
engines and the interiors have different individual useful lives. If the life of the airframe (being the longest of
the individual lives of the three major types of components) is taken as the life of the aircraft, it is important
that other two major components i.e. engine and interiors are depreciated over their respective useful life
and not over the life of airframe. Other components (usually small and low value) which will require
replacement very frequently may be depreciated over the useful life of airframe and their frequent
replacement cost may be charged to expense as and when it is incurred.
 Here it is important to note that a part of Property, Plant & Equipment to be identified as a
separate component should have both (a) significant cost when compared to overall cost of item of
property, plant and equipment and(b) and estimated useful life or depreciation method different from rest
of the parts of the property plant and equipment. A significant part of an item of property, plant and
equipment may have a useful life and a depreciation method that are the same as the useful life and
the depreciation method of another significant part of that same item. Such parts may be grouped in
determining the depreciation charge.
 Further depreciation is a non-cash expense and unlike other normal expenditure (e.g. wages, rent, etc.) does
not result in any cash outflow. Further depreciation by itself does not create funds it merely draws attention
to the fact that out of gross revenue receipts, a certain amount should be retained for replacement of assets
used for carrying on operation.
FACTORS IN THE MEASUREMENT OF DEPRECIATION
 Cost of asset including expenses for installation, commissioning, trial run etc.
 Estimated useful life of the asset.
 Estimated scrap value (if any) at the end of useful life of the asset
For example, a machinery is purchased for Rs.1,10,000. The residual value is estimated at Rs.10,000. It is
estimated that the machinery will work for 5 years. The cost to be allocated as depreciation in the
accounting periods will be calculated as:
The Income Tax Rules, however, prescribe the Diminishing Balance Method (Written Down Value Method) except in
the case of assets of an undertaking engaged in generation and distribution of power.
Amortisation- It is a gradual and systematic writing off of intangible asset over its estimated useful life. For e.g.-
patents, copyright, goodwill.
Depletion- It is a measure of exhaustion of wasting asset such as extraction of material from quary, mine etc. Extraction
reduces the available quantity of material. E.g. extraction of coal from a coal mine is depletion of coal stock.
Accrual Assumption- When transactions are recorded in the books of accounts as they occur even if the payment for
that particular product or service has not been received or made, it is known as accrual based accounting. This method
is more appropriate in assessing the health of the organisation in financial terms.
An expense is occurred or recorded when the raw material is ordered and not when the actual payment is made to
the supplier by either cash or cheque. The only drawback of this type of accounting system is that you, as a firm, might
end up paying tax on revenues even when you might have not received it (credit).
Provisions- It is an amount set aside, by charging it to the Profit and Loss account, to provide for a known liability the
amount of which can’t be determined with accuracy. Provision differs from liability to the extent that provision is an
estimated amount while liability is determined amount.
Reserves- It is the amount set aside out of profits. Reserves are set to meet a known or unknown contingency that
may arise in future. The amount of reserve when invested in outside securities
Revenue reserve- - out of revenue profit. Can be General and Specific Reserve
Capital Reserve- out of capital profits

ACCOUNTING
BASICS
UPSC-EPFO
DEFINITION AND FEATURES OF PARTNERSHIP
As per Section 4 of the Partnership Act, 1932:“Partnership is the relation between persons who have
agreed to share the profit of a business carried on by all or any of them acting for all.”
Features of a partnership
(i) Existence of an agreement
(ii) Business
(iii) Sharing of profit
(iv) Mutual agency
Number of Partners:
Minimum Partners: Two
Maximum Partners: 50.
• The Partners are supposed to have the power to act in certain matters and not to have such
powers in others. In other words, unless a public notice has been given to the contrary,
certain contracts entered into by a partner on behalf of the partnership, even without
consulting other partners are binding and the provisions of the Act relating to the question
will apply.
• Partnership Act doesn’t specify any format for preparation of accounts of

Partnership Firm and thus accounts are prepared as per Basic rules of accounts.
The Profit and Loss Account will show the profit earned by the firm or loss suffered by it. This
profit or loss has to be transferred to the Capital Accounts of partners according to the terms
of the Partnership Deed or according to the provisions of the Indian Partnership Act (if there is
no Partnership Deed or if the Deed is silent on a particular point).
FIXED AND FLUCTUATING CAPITAL
There are two methods of accounting –

i) Fixed capital method- In Fixed capital method, generally initial capital contributions by the partners are
credited to partners’ capital accounts and all subsequent transactions and events are dealt with through
current accounts, Unless a decision is taken to change it, initial capital account balance is not changed.
ii) Fluctuating capital method- no current account is maintained. All such transactions and events are passed
through capital accounts. Naturally, capital account balance of the partners uctuates every time. So in xed capital
method a xed capital balance is maintained over a period of time while in uctuating capital method capital account
balances uctuate all the time.
Interest on Capital: A partner is not entitled to interest on his capital as a matter of right. But if
there is an agreement, that partner would receive interest on his capital it is paid at the agreed
rate only out of profits.
Net loss and Interest on Capital: Subject to contract between the partners, interest on
capitals is to be provided out of profits only. Thus in case of loss, no interest is provided. But
in case of insufficient profits (i.e., net profit less than the amount of interest on capital), the
amount of profits distributed in the ratio of capital as partners get profits by way of interest on
capital only.
Guarantee of Minimum - Sometimes, one partner can enjoy the right to have minimum amount
of profit in a year as per the terms of the partnership agreement. In such case, allocation of
profit is done in a normal way if the share of partner, who has been guaranteed minimum is more
than the amount of guaranteed profit.
However, if share of the partner is less than the guaranteed amount, he takes minimum profit
and the excess of guaranteed share of profit over the actual share is borne by the remaining
partners as per the agreement. There are three possibilities as far as share of deficiency by
other partners is concerned.
These are as follows:
• Excess is payable by one of the remaining partners.
• Excess is payable by at least two or all the partners in an agreed ratio.
• Excess is payable by remaining partners in their mutual profit sharing ratio.
If the question is silent about the nature of guarantee, the burden of guarantee is borne by the
remaining partners in their mutual profit sharing ratio.
LIMITED LIABILITY PARTNERSHIP
• The Indian Partnership Act of 1932 provides for a general form of partnership which has
inherent shortcoming of unlimited liability of all partners for business debts and legal
consequences, regardless of their holding or profit sharing ratio, as the firm is not a legal
entity. General partners are also jointly and severally liable for tortuous acts of co-partners. In
case of liquidation personal assets of partners can be liquidated to meet liabilities of the firm.
• In order to encourage Indian professionals to participate in the international business community
without apprehension of being subject to excessive liability, the need for having a legal structure like
the LLP is encouraged. Thus in convergence towards global scenario, Limited Liability Partnership
Act, 2008 was introduced.
• The LLP will be a separate legal entity, liable to the full extent of its assets, with the
liability of the partners being limited to their agreed contribution in the LLP which may
be of tangible or intangible nature or both tangible and intangible in nature.
• No partner would be liable on account of the independent or un-authorized actions of
other partners or their misconduct.
• The liabilities of the LLP and partners who are found to have acted with intent to
defraud Creditors or for any fraudulent purpose shall be unlimited for all or any of the
debts or other liabilities of the LLP.
UPSC- EPFO
• A non-profit organisation is a legal and accounting entity that is operated for the benefit of
the society as a whole, rather than for the benefit of a sole proprietor or a group of partners
or shareholders.
• Non-profit making organisations such as public hospitals, public educational institutions, clubs,
Temples, churches etc., conventionally prepare Receipts and Payments Account and Income
and Expenditure Account to show periodic performance and Balance Sheet to show financial
position at the end of the period.
• Income and Expenditure Account is just similar to Profit and Loss Account prepared for the
profit making organisations. In case of Income and Expenditure Account, the excess of
expenditure over income is treated as deficit. In non-profit making organisations, total cash
receipts and total cash payments are highlighted through Receipts and Payments Account.
• A Balance Sheet is the statement of assets and liabilities of an accounting unit at a given date.
• In not for profit organizations, the excess of total assets over total outside liabilities is known as
Capital Fund.
• The Capital fund represents the amount contributed by members, legacies, special donations,
entrance fees and accumulated surplus over the years.
• If however, members have not contributed any amount, the name should be Accumulated Fund.
• The surplus or deficit, if any, on the year's working as disclosed by the Income and Expenditure
Account is shown either as an addition to or deduction from the Capital / Accumulated Fund
brought forward from the previous period.
• Donations: These may have been raised either for meeting some revenue or capital expenditure; those
intended for the first mentioned purpose are credited directly to the Income and Expenditure Account
but others, if the donors have declared their specific intention, are credited to special fund account and
in the absence thereof, to the Capital Fund Account.
• Entrance and Admission Fees: Such fees which are payable by a member on admission to club or society
are normally considered capital receipts and credited to Capital Fund.
• Subscription: Subscriptions being an income should be allocated over the period of their accrual. The
Subscription Account is closed off by transferring its balance at the end of the year to the Income and
Expenditure Account.
• Life Membership Fee: Fees received for life membership is a capital receipt as it is of non-recurring
nature. It is directly added to capital fund or general fund.
UPSC-EPFO
CHAPTER 10
COMPANY ACCOUNTS
UNIT 1: INTRODUCTION TO COMPANY ACCOUNTS
LEARNING OUTCOMES
After studying this unit, you will be able to:
w Understand the reason for the existence and survival of a company.
w Learn the nature and types of companies.
w Explain the salient features of a company.
w Understand the purpose of preparing the financial statements of the company.
UNIT OVERVIEW Government

Company
Subsidiary Foreign
Company Company
Holding Private
Company Company
Company
limited by Types of Public
Guarantee Companies Company
Company
One Person
limited by
Company
Shares
Unlimited Small
Company Company
Listed
Company
© The Institute of Chartered Accountants of India

10.2 PRINCIPLES AND PRACTICE OF ACCOUNTING
Statement
of Profit
and Loss
Preparation
Balance of Financial Cash Flow
Sheet Statements Statement
Notes to
Accounts
1.1 INTRODUCTION
The never-ending human desire to grow and grow further has given rise to the expansion of business
activities, which in turn has necessitated the need to increase the scale of operations so as to provide goods
and services to the ever-increasing needs of the growing population of consumers. Large amount of money,
modern technology, large human contribution etc. is required for it, which is not possible to arrange under
partnership or proprietorship. To overcome this difficulty, the concept of ‘Company’ or ‘Corporation’ came
into existence.
While the invention of steam power ignited the human imagination to build big machines for the mass
production of goods, the need to separate the management from ownership gave birth to a form of
organisation today known as ‘company’.
Company form of organisation is one of the ingenious creations of human mind, which has enabled the
business to carry on its wealth creation activities through optimum utilisation of resources. In course of
time, company has become an important institutional form for business enterprise, which has carved out a
key place for itself in the field of business operations as well as in the wealth-generating functions of society.
1.2 MEANING OF COMPANY

The word ‘Company’, in everyday usage, implies an assemblage of persons for social purpose, companionship
or fellowship. As a form of organisation, the word ‘company’ implies a group of people who voluntarily agree
to form a company.
The word ‘company’ is derived from the Latin word ‘com’ i.e. with or together and ‘panis’ i.e. bread. Originally
the word referred to an association of persons or merchant men discussing matters and taking food together.
However, in law ‘company’ is termed as company which is formed and incorporated under the Companies
Act, 2013 or an existing company formed and registered under any of the previous company laws. As per
this definition of law, there must be group of persons who agree to form a company under the law and once

COMPANY ACCOUNTS 10.3
so formed; it becomes a separate legal entity having perpetual succession with a distinct name of its own
and a common seal. Its existence is not affected by the change of members.
Company begs its origin in law. It is an organisation consisting of individuals, called shareholders by virtue
of holding the shares of a company, who are authorised by law to elect a board of directors and, through
it, to act as a separate legal entity as regards its activities. Generally, the capital of the company consists of
transferable shares, and members have limited liabilities.
To get to the heart of the nature of the company, let us examine the concept of company propounded
under corporate jurisprudence.
According to Justice Marshal, “A corporation is an artificial being, invisible, intangible and existing only in
the contemplation of law”.
In the same manner, Lord Justice Hanay has defined a company as “an artificial person created by law with a
perpetual succession and a common seal”.
A common thread running through the various definitions of ‘company’ is that it is an association of
persons created by law as a separate body for a special purpose. At the same time, definitions have laid
down certain characteristics of a corporate organisation, which make it out as a separate and unique
organisation which enables the people to contribute their wealth to the capital of the company by
subscribing to its shares and appointing elected representatives to carry out the business.
1.3 SALIENT FEATURES OF A COMPANY

Following are the salient features of a company:
1. Incorporated Association: A company comes into existence through the operation of law. Therefore,
incorporation of company under the Companies Act is must. Without such registration, no company
can come into existence. Being created by law, it is regarded as an artificial legal person.
2. Separate Legal Entity: A company has a separate legal entity and is not affected by changes in its
membership. Therefore, being a separate business entity, a company can contract, sue and be sued in
its incorporated name and capacity.
3. Perpetual Existence: Since company has existence independent of its members, it continues to be in
existence despite the death, insolvency or change of members.
4. Common Seal: Company is not a natural person; therefore, it cannot sign the documents in the manner
as a natural person would do. In order to enable the company to sign its documents, it is provided with a
legal tool called ‘Common Seal’. The common seal is affixed on all documents by the person authorised
to do so who in turn puts his signature for and on behalf of the company. Companies Act, 2013 required
common seal to be affixed on certain documents (such as bill of exchange, share certificates, etc.) Now,
the use of common seal has been made optional. All such documents which required affixing the
common seal may now instead be signed by two directors or one director and a company secretary of
the company.
5. Limited Liability: The liability of every shareholder of a company is limited to the amount he has agreed
to pay to the company on the shares allotted to him. If such shares are fully paid-up, he is subject to no
further liability.
6. Distinction between Ownership and Management: Since the number of shareholders is very large and
may be distributed at different geographical locations, it becomes difficult for them to carry on the

operational management of the company on a day-to-day basis. This gives rise to the need of separation
of the management and ownership.
7. Not a citizen: A company is not a citizen in the same sense as a natural person is, though it is created by
the process of law. It has a legal existence but does not enjoy the citizenship rights and duties as are
enjoyed by the natural citizens.
8. Transferability of Shares: The capital is contributed by the shareholders through the subscription of
shares. Such shares are transferable by its members except in case of a private limited company, which
may have certain restrictions on such transferability.
9. Maintenance of Books: A limited company is required by law to keep a prescribed set of account books
and any failure in this regard attracts penalties.
10. Periodic Audit: A company has to get its accounts periodically audited through the chartered accountants
appointed for the purpose by the shareholders on the recommendation of board of directors.
11. Right of Access to Information: The right of the shareholders of a company to inspect its books of
account, with the exception of books open for inspection under the Statute, is governed by the Articles
of Association. The shareholders have a right to seek information from the directors by participating in
the meetings of the company and through the periodic reports.
1.4 TYPES OF COMPANIES

1. Government Company
According to Section 2(45) of the Companies Act, 2013, “Government company” means any company in
which not less than fifty-one per cent of the paid-up share capital is held by the Central Government, or
by any State Government or Governments, or partly by the Central Government and partly by one or more
State Governments, and includes a company which is a subsidiary company of such a Government company.
2. Foreign Company
According to Section 2 (42) of the Companies Act, 2013, “Foreign company” means any company or body
corporate incorporated outside India which –
(a) Has a place of business in India whether by itself or through an agent physically or through electronic
mode; and
(b) Conducts any business activity in India in any other manner.
3. Private Company
Section 2(68) of the Companies Act, 2013 defines ‘Private company’ as a company which by its articles,
i. Restrict the right to transfer its shares;
ii. Except in case of One Person Company limits the number of its members to two hundred: Provided
that where two or more persons hold one or more shares in a company jointly, they shall, for the
purposes of this sub-clause, be treated as a single member:
Provided further that—
(A) Persons who are in the employment of the company; and
(B) persons who, having been formerly in the employment of the company, were members of the
company while in that employment and have continued to be members after the employment ceased,
shall not be included in the number of members; and
(iii) Prohibits any invitation to the public to subscribe for any securities of the company. Shares of a
Private Company are not listed on Stock Exchange.
4. Public Company
Section 2(71) of the Companies Act, 2013 defines Public Company as a company which— (a) is not a private
company; provided that a company which is a subsidiary of a company, not being a private company,
shall be deemed to be public company for the purposes of this Act even where such subsidiary company
continues to be a private company in its articles.
A company which is a listed public company if it gets unlisted continues to be a public company.
No Minimum Paid-up Share Capital: The minimum paid-up share capital requirement of INR 1,00,000
(in case of a private company) and INR 5,00,000 (in case of a public company) has been done away with
under Companies Act, 2013. Accordingly, no minimum paid-up capital requirements will now apply for
incorporating private as well as public companies in India.
5. One Person Company

Section 2 (62) of the Companies Act, 2013 defines “One Person Company” as a company which has only one
person as a member.
6. Small Company
Section 2(85) of the Companies Act, 2013 defines “Small company” means a company, other than a public
company
(i) paid-up share capital of which does not exceed fifty lakh rupees or such higher amount as may be
prescribed which shall not be more than five crore rupees; or
(ii) turnover of which as per its last profit and loss account does not exceed two crore rupees or such higher
amount as may be prescribed which shall not be more than twenty crore rupees:
Note: The status of a company as a Small Company may change from year to year.
7. Listed Company
As per Section 2 (52) of the Companies Act, 2013,''listed company” means a company which has any of its
securities listed on any recognised stock exchange.
The company, whose shares are not listed on any recognised stock exchange, is called ‘‘Unlisted Company’’.
An unlisted company can be a public company or a private company.
8. Unlimited Company
Section 2 (92) of the Companies Act, 2013 defines ''Unlimited company” means a company not having any
limit on the liability of its members.
9. Company limited by Shares
As per Section 2(22) of the Companies Act, 2013, “Company limited by shares” means a company having
the liability of its members limited by the memorandum to the amount, if any, unpaid on the shares
respectively held by them.
10. Company limited by Guarantee
As per Section 2(21) of the Companies Act, 2013, “company limited by guarantee” means a company having
the liability of its members limited by the memorandum to such amount as the members may respectively
undertake to contribute to the assets of the company in the event of its being wound up.
11. Holding Company
According to Section 2 (46) of the Companies Act, 2103, “Holding company”, in relation to one or more other
companies, means a company of which such companies are subsidiary companies.
12. Subsidiary Company
Section 2(87) of the Companies Act, 2013 defines “subsidiary company” as a company in which the holding
company:
(i) Controls the composition of the Board of Directors; or
(ii) Exercises or controls more than one-half of the total share capital either at its own or together
with one or more of its subsidiary companies.
A company shall be deemed to be a subsidiary company of the holding company even if there is indirect
control through the subsidiary company (ies). The control over the composition of a subsidiary company’s
Board of Directors means exercise of some power to appoint or remove all or a majority of the directors of
the subsidiary company.
1.5 MAINTENANCE OF BOOKS OF ACCOUNT

As per Section 128 of the Companies Act, 2013, every company shall prepare and keep at its registered
office books of account and other relevant books and papers and financial statement for every financial year
which give a true and fair view of the state of the affairs of the company, including that of its branch office or
offices, if any, and explain the transactions effected both at the registered office and its branches and such
books shall be kept on accrual basis and according to the double entry system of accounting:
Provided further that the company may keep such books of account or other relevant papers in electronic
mode in such manner as may be prescribed.
1.6 PREPARATION OF FINANCIAL STATEMENTS

Under Section 129 of the Companies Act, 2013, the financial statements shall give a true and fair view of the
state of affairs of the company or companies, comply with the notified accounting standards and shall be in
the form or forms as may be provided for different class or classes of companies, as prescribed in Schedule
III. The Board of Directors of the company shall lay financial statements at every annual general meeting of
a company.
Financial Statements as per Section 2(40) of the Companies Act, 2013, inter-alia include -
i. A balance sheet as at the end of the financial year;
ii. A profit and loss account, or in the case of a company carrying on any activity not for profit, an income
and expenditure account for the financial year;
iii. cash flow statement for the financial year;

iv. A statement of changes in equity, if applicable; and
v. (any explanatory not annexed to, or forming part of, any document referred to in sub-clause (i) to sub-
clause (iv):
Provided that the financial statement, with respect to One Person Company, small company and
dormant company, may not include the cash flow statement.
Requisites of Financial Statements
It shall give a true and fair view of the state of affairs of the company as at the end of the financial year.
Provisions Applicable
(1) Specific Act is Applicable
For instance, any
(a) Insurance company
(b) Banking company or
(c) Any company engaged in generation or supply of electricity* or
(d) Any other class of company for which a Form of balance sheet or Profit and loss account has been
prescribed under the Act governing such class of company.
(2) In case of all other companies:
Balance Sheet as per Form set out in Part I of Schedule III and Statement of Profit and Loss as per Part II
of Schedule III:
Compliance with Accounting Standards
As per Section 129 of the Companies Act, it is mandatory to comply with accounting standards notified by
the Central Government from time to time.
Schedule III of the Companies Act, 2013
As per Section 129 of the Companies Act, 2013, Financial statements shall give a true and fair view of the
state of affairs of the company or companies and comply with the accounting standards notified under
Section133 and shall be in the form or forms as may be provided for different class or classes of companies
in Schedule III under the Act.

PART I – Form of BALANCE SHEET

Name of the Company…………………….
Balance Sheet as at………………………
(` in…………)
Particulars Notes Figures as Figures as at
No. at end of end of the
the current previous
reporting reporting
period period
EQUITY AND LIABILITIES
1. Shareholders’ funds
a. Share capital (A) xxx xxx
b. Reserves and Surplus (B) xxx xxx
c. Money received against share warrants xxx xxx
2. Share application money pending allotment xxx xxx
3. Non-current liabilities
a. Long-term borrowings (C) xxx xxx
b. Deferred tax liabilities (Net) xxx xxx
c. Other long term liabilities xxx xxx
d. Long-term provisions (D) xxx xxx
4. Current liabilities
a. Short-term borrowings (E) xxx xxx
b. Trade Payables xxx xxx
c. Other current liabilities (F) xxx xxx
d. Short-term provisions xxx xxx
Total xxx xxx
ASSETS
1. Non-current assets
a. Property, Plant and Equipment
i. Tangible assets (G) xxx xxx
ii. Intangible assets (H) xxx xxx
iii. Capital Work-in-progress xxx xxx
iv. Intangible assets under development xxx xxx
b. Non-current investments (I) xxx xxx
c. Deferred tax assets (Net) xxx xxx
d. Long-term loans and advances (J) xxx xxx
e. Other non-current assets xxx xxx
2. Current assets
a. Current investments (K) xxx xxx
b. Inventories (L) xxx xxx
c. Trade receivables xxx xxx
d. Cash and cash equivalents (M) xxx xxx
e. Short-term loans and advances xxx xxx
f. Other current assets xxx xxx
Total xxx xxx

Some items are to be explained as follows:

A. SHARE CAPITAL
For each class of share capital following points is to be kept in mind:
i. The number and amount of shares authorised.
ii. The number of shares which are issued, subscribed and fully paid and which are issued, subscribed but
not fully paid.
iii. The par value per share.
iv. Shares outstanding at the beginning and at the end of the reporting period should be reconciled.
v. Calls unpaid.
vi. Forfeited shares.
B. RESERVES AND SURPLUS

Reserves and surplus can be distributed among the following sub-heads:
i. Capital reserves
ii. Capital redemption reserves
iii. Securities Premium
iv. Debenture Redemption reserve
v. Revaluation reserve
vi. Surplus; the balance as per profit and loss statement
vii. Other reserves (specify the nature and purpose)
C. LONG TERM BORROWINGS

Long term borrowings can be classified under the following sub-heads:
i. Bonds/Debentures
ii. Term loans
iii. Deferred payment liabilities
iv. Deposits
v. Long term maturities of finance lease obligations
vi. Loans and advances from related parties
vii. Other loans and advances (specify nature)
D. LONG TERM PROVISIONS

This can be classified as follows:
i. Employee benefits provision like gratuity, provident fund etc.

ii. Other provisions (specify the nature)
E. SHORT TERM BORROWINGS

Short term borrowings can be classified among the following sub-heads:
i. Loans repayable on demand
ii. Loans and advances from related parties
iii. Deposits
iv. Other loans and advances (specify the nature)
F. OTHER CURRENT LIABILITIES

Some of the other current liabilities can be grouped as under:
i. Interest accrued but not/and due on borrowings
ii. Income received in advance
iii. Unpaid dividends
iv. Application money received for allotment of securities and due for refund and interest accrued thereon
v. Other current liabilities (specify the nature)
G. TANGIBLE ASSETS
Tangible assets can be classified as follows:
i. Land
ii. Buildings
iii. Plant and Equipments
iv. Furniture and Fixtures
v. Vehicles
vi. Office equipments
vii. Others (specify the nature)
A detailed report showing additions, disposals, acquisitions through business combinations and other
adjustments and amount related to depreciation, impairment losses, revaluation etc. should be provided
for each class of asset.
H. INTANGIBLE ASSETS
Intangible assets can be classified as follows:
i. Goodwill
ii. Brands/trademarks
iii. Computer software
iv. Mining rights
v. Publishing titles
vi. Copyrights, patents and other intellectual property rights, services and operating rights.
vii. Licence and franchise
viii. Recipes, models, designs, formulae and prototypes
ix. Others (specify the nature)
A detailed report showing additions, disposals, acquisitions through business combinations and other
adjustments and amount related to depreciation, impairment losses, revaluation etc. should be provided
for each class of asset.
I. NON-CURRENT INVESTMENTS
Investments can be classified as under:
i. Investments in property
ii. Investments in equity instruments
iii. Investments in preference shares
iv. Investments in governments or trust securities
v. Investments in debentures or bonds
vi. Investments in mutual funds
vii. Investments in partnership firms
viii. Other non-current investments (specify the nature)
J. LONG TERM LOANS AND ADVANCES

It can be classified under the following sub-groups:
i. Capital advances
ii. Security deposits
iii. Loans and advances to related parties
iv. Other loans and advances (specify nature)
The above shall also be sub-classified as follows:
i. Secured, considered goods
ii. Unsecured, considered goods
iii. Doubtful
K. CURRENT INVESTMENTS
It can be classified as follows:
i. Investments in equity instruments
ii. Investments in preference shares
iii. Investments in government or trust securities

iv. Investments in bonds or debentures
v. Investments in mutual funds
vi. Investments in partnership firms
vii. Other investments (specify the nature)
L. INVENTORIES
Inventories can be classified as:
i. Raw materials
ii. Work-in-progress
iii. Stores and spares
iv. Finished goods
v. Loose tools
vi. Stock in trade
vii. Goods in transit
viii. Others (specify the nature)
M. CASH AND CASH EQUIVALENTS

The following head can be classified as follows:
i. Balances with banks
ii. Cheques, drafts in hand
iii. Cash in hand
iv. Others (specify the nature)

PART II – Form of STATEMENT OF PROFIT AND LOSS

Name of the Company…………………….
Profit and Loss Statement for the year ended ………………………

(` in…………)
Particulars Note No. Figures for Figures for

the current the previous
reporting reporting
period period
I. Revenue from operations xxx xxx
II. Other income xxx xxx
III. Total Revenue (I + II) xxx xxx
IV. Expenses: xxx xxx
Cost of materials consumed xxx xxx
Purchases of Stock-in-Trade xxx xxx
Changes in inventories of finished goods Work-in- xxx xxx
Progress and Stock-in-Trade
Employee benefits expense
xxx xxx
Finance costs
xxx xxx
Depreciation and amortization expense
xxx xxx
Other expenses
xxx xxx
Total expenses xxx xxx
V. Profit before exceptional and extraordinary items and xxx xxx
tax (III-IV)
VI. Exceptional items xxx xxx
VII. Profit before extraordinary items and tax (V-VI) xxx xxx
VIII. Extraordinary Items xxx xxx
IX. Profit before tax (VII-VIII) xxx xxx
X. Tax expense:
(1) Current tax xxx xxx
(2) Deferred tax xxx xxx xxx xxx
XI. Profit (Loss) for the period from continuing operations xxx xxx
(VII-VIII)
XII. Profit/(Loss) from discontinuing operations xxx xxx
XIII. Tax expense of discontinuing operations xxx xxx

XIV. Profit/(Loss) from discontinuing operations (after tax) xxx xxx

(XII-XIII)
XV. Profit (Loss) for the period (XI + XIV) xxx xxx
XVI. Earnings per equity share:
(1) Basic xxx xxx
(2) Diluted xxx xxx
SUMMARY
1. Company’ is termed as an entity which is formed and incorporated under the Companies Act, 2013 or
an existing company formed and registered under any of the previous company laws.
2. Salient features of a company include: Incorporated Association; Separate Legal Entity; Perpetual
Existence; Common Seal; Limited Liability; Distinction between Ownership and Management; Not a
citizen; Transferability of Shares; Maintenance of Books; Periodic Audit; Right of Access to Information.
3. Types of companies: Government Company: Foreign Company; Private Company; Public Company;
One Person Company; Small Company; Listed Company; Unlimited Company; Company limited by
Shares; Company limited by Guarantee; Holding Company; Subsidiary Company.
4. The financial statements shall give a true and fair view of the state of affairs of the company or companies,
comply with the notified accounting standards and shall be in the form or forms as may be provided
for different class or classes of companies, as prescribed in Schedule III to the Companies Act, 2013.
Financial Statements as per Section 2(40) of the Companies Act, 2013, include balance sheet as at the
end of the financial year; profit and loss account, or in the case of a company carrying on any activity
not for profit, an income and expenditure account for the financial year; cash flow statement for the
financial year; statement of changes in equity, if applicable; and any explanatory note annexed to.
TEST YOUR KNOWLEDGE

MCQs
1. Which of the following statement is not a feature of a Company?
(a) Separate legal entity
(b) Perpetual Existence
(c) Members have unlimited liability
2. In a Government Company, the holding of the Central Government in paid-up capital should not be less
than
(a) 25% (b) 50 % (c) 51%

3. Which of the following statement is true in case of a Foreign Company?

(a) A Company incorporated in India and has place of business outside India.
(b) A Company incorporated outside India and has a place of business in India.
(c) A Company incorporated in India and has a place of business in India.
4. Which of the following statements is not a feature of a private company?

(a) Restricts the rights of members to transfer its shares.
(b) Does not restrict on the number of its members to any limit.
(c) Does not involve participation of public in general.
Theory Questions
1. Explain salient features of a company in brief.
2. Write short note on:
(i) Foreign company.
(ii) Small company.
(iii) Company limited by guarantee.
ANSWERS
MCQs
1. (c) 2. (c) 3. (b) 4. (b)

Theoretical Question
1. Refer para 1.3 of this unit for salient features of a company.
2. (i) Foreign Company
According to Section 2 (42) of the Companies Act, 2103, “Foreign company” means any company or body
corporate incorporated outside India which –
(a) Has a place of business in India whether by itself or through an agent physically or through electronic
mode; and
(b) Conducts any business activity in India in any other manner.
(ii) Small Company
Section 2(85) of the Companies Act, 2013 defines “Small company” means a company, other than a public
company.
(i) paid-up share capital of which does not exceed fifty lakh rupees or such higher amount as may be
prescribed which shall not be more than five crore rupees; or

(ii) turnover of which as per its last profit and loss account does not exceed two crore rupees or such
higher amount as may be prescribed which shall not be more than twenty crore rupees.
(iii) Company limited by Guarantee
As per Section 2(21) of the Companies Act, 2013, “company limited by guarantee” means a company
having the liability of its members limited by the memorandum to such amount as the members may
respectively undertake to contribute to the assets of the company in the event of its being wound up.

General
Accounting
Principles
UPSC-EPFO
On the basis of the above information, calculate-
a) Authorized capital
b) Issued capital
c) Subscribed capital
d) Called-up capital
e) Paid-up capital
f) Calls-in-arrears
g) Cash
• Public companies issue a ‘Prospectus’ and invite general public to subscribe for shares. A public company
issues a prospectus inviting general public to subscribe for its shares.
• On the basis of prospectus, applications are deposited in a scheduled bank by the interested parties
along with the amount payable at the time of application, in cash.
• First installment paid along with application is called ‘Application Money’.
• As per Section 39 of the Companies Act, 2013. Application money must be at least 5% of the nominal
value of shares.
• After the closing date of the issue (the last date for filing applications), company decides about allotment
of shares in consultation with the SEBI and stock exchange concerned. According to the Companies Act,
2013, a company cannot proceed to allot shares unless minimum subscription is received by the
company.
• As per guidelines of the Securities Exchange Board of India (SEBI), the minimum subscription to be
received in an issue shall not be less than ninety per cent of the offer through offer document
UPSC-EPFO
• With increasing and ever growing needs of the corporate expansion and growth, equity source
of financing is not sufficient. Hence corporates turn to debt financing through various means.
Issuing debt instruments by offering the same for public subscription is one of the sources of
financing the business activities.
• Debt financing does not only helps in reducing the cost of the capital but also helps in
designing appropriate capital structure of the company. Debenture is one of the most
commonly used debt instrument issued by the company to raise funds for the business.
GENERAL ACCOUNTING PRINCIPLES
Joint Venture
When some persons join hands to carry out a specific job or a project (called joint venture), each person (called co-
venturer) would like to ascertain his share of profit or loss from the joint venture business. For this purpose, they
record the transactions related to the joint venture business in their own books or prepare a separate set of books
altogether When two or more persons join together to carry out a specific business venture and share the profits on
an agreed basis it is called a 'joint venture'. Each one of them who join as a party to the joint venture is called 'Co-
venturer. 89No firm name is normally used for the joint venture business because its duration is limited to a short
period. During this period, the co-venturer are free to carry on their own business as usual unless agreed otherwise.
The business relationship amongst the co-venturer comes to an end as soon as the venture is completed. Thus, a
joint venture is some kind of a temporary partnership between two or more persons who have agreed to jointly
carry out a specific venture. The joint ventures are quite common in construction business, consignment, sale and
purchase of property, underwriting of shares and debentures, etc.
For example, A and B agreed to construct a college building for which they pooled their resources and skill. A
provided Rs. 6 lakh and B Rs. 4 lakh as capital. They completed the building and shared the profits in the ratio of their
contributions to capital. In this example, joining hands by A and B to construct a building is a joint venture. A and B
are co-venturer. They will share the profits in the ratio of 6 and 4 (same as the ratio of their capitals).
From the above discussion the essential features of a joint venture can be listed as follows:
1. It is formed by two or more persons.

2. The purpose is to execute a particular venture or project.
3. No specific firm name is used for the joint venture business.
4. It is of a temporary nature. Hence, the agreement regarding the venture automatically stands terminated as
soon as the venture is completed.
5. The co-venturers share profit and loss in the agreed ratio. However, in the absence of any other agreement
between the co-venturers, the profits and losses are to be shared equally.
6. During the tenure of .joint venture, the co-venturers are free to continue with their own business unless
agreed otherwise.
The main advantages of a joint venture are:
1. Sufficient Resources: Since two or more persons pool their resources, there is sufficient capital available:
2. Ability and Experience: In joint venture the different venturers may be having different skills and
experience. The benefit of their common wisdom will be available to the venture.
3. Spreading of Risk: The co-venturers agree to share the profits and losses in a particular ratio. This implies
that the risk is also borne by them in that ratio.
JOINT VENTURE AND CONSIGNMENT
Even though both consignment and joint venture are in the nature of an agreement between different parties, there
are many points of difference between the two. The main points of difference are as follows:
Consignment Joint Venture

Normally two persons are involved, the consignor and Number of co-venturers is usually two, but it may also
the consignee. be more than two.
The relationship between the consignor and the The relationship between co-venturers is that of
consignee is that of principal and agent. partnership.
The arrangement may continue for a long time. The relationship comes to an end as soon as the
venture is completed.
The funds are provided by the consignor. All the co-venturers contribute to a common pool.
The consignee acts merely as an agent and he has to The co-venturers have equal authority to take
follow the instructions of the consignor. decisions.
Consignment is generally concerned Joint venture may be for sale of goods or for carrying
with the sale of movable goods. on any other activity like construction of building,
investment in shares, etc.
The profit belongs to the consignor only. The consignee The profit is shared by all the co-venturers.
is entitled only to his commission.
The consignor owns the goods. There is joint ownership.
There is only one method of maintaining the accounts There are four methods of maintaining accounts for the
for consignment transactions. joint venture.
JOINT VENTURE AND PARTNERSHIP
Though joint venture is in the nature of a temporary partnership but in the strict legal sense it is not a partnership.
Both in joint venture and partnership some business is carried on by two or more persons and the profits are shared
by all of them. But there are some basic differences between the two. They are as follows:
Partnership Joint Venture

A partnership firm always has a name There is no need for firm name
It is of continuous nature It comes to an end as soon as the work is completed.
Separate set of books have to be maintained. There is no need for a separate set of books, the
accounts can be maintained even in one
of the co-venturer’s books only.
No partner can carry on a similar business. The co-venturers are free to carry on the business of a
similar nature.
Though the registration of partnership is not There is no need for registration at all.
compulsory, but it is considered desirable.
A minor can also be admitted to the benefits of the firm A minor cannot be a co-venturer as he is incompetent
to enter into a contract.
ACCOUNTING TREATMENT
Broadly speaking, accounts of a joint venture business can be kept in any one of the following four ways:
1. In the books of one co-venturer: In case the business is not very large, only one of the venturers may be
entrusted with the task of recording the transactions in his books. In that case all other co-venturers will
send their contributions to such venturer and he will open a Joint Venture Account and the personal
accounts of other co-venturers in his books.
2. In the books of all the co-venturers: When all co-venturers are working actively, each one of them shall
open a Joint Venture Account and the personal accounts of other CO- venturers in his books. In such a
situation, each co-venturer informs others about the transactions undertaken by him so that they can
incorporate them in their books.
3. Memorandum Joint Venture Account: Sometimes each co-venturer records only such transactions as are
directly concerned with him. In that case he cannot work out the profit or loss because his books do not
include all transactions of the joint venture. Hence, for calculating the profit or loss of the joint venture, a
Memorandum Joint Venture Account has to be prepared by incorporating all transactions related to the joint
venture. Thereafter the Joint Venture Account is completed and closed.
4. Separate Set of Books: Sometimes, for the sake of convenience, a separate set of books are maintained for
the joint venture. Under this system a Joint Bank Account, a Joint Venture Account and the personal
accounts of all the co-venturers are to be opened in the independent set of books of account.
Recording in the Books of one Co-venturer
If the joint venture business is not very large, the task of recording transactions can very well he entrusted to one of
the co-venturers. He will prepare a Joint Venture Account and the personal accounts of other co-venturers. The Joint
Venture Account prepared for ascertaining the profit or loss of the joint venture. The personal account of other co-
venturers are prepared to find out the amount due from them. As stated earlier, each co- venturer is also entitled to
carry on his own business and these transactions will be in addition to what he records in respect of his own
business. The following journal entries are passed in his books before preparing the necessary accounts of the joint
venture.
1. When the co-venturers send their contribution:
Cash/Bank A/c Dr.
To Co-venturer's Personal A/c
2. When the goods are purchased for the joint venture:
Joint Venture A/c Dr.
To Cash/Bank A/c
3. When the goods are supplied from his own stock by the co-venturer who is recording the transactions:
To Purchases A/c
Here We are crediting Purchases Account because he is supplying the goods from his own stock at cost. But if the
goods are supplied by him at a price other than the cost price, we shall credit the Sales Account instead of the
Purchases Account.
4. When the goods are supplied by other co-venturers:
5. When some expenditure is incurred on account of the joint venture:
To Cash/Bank A/c
But if expenses are paid by a co-venturer other than the one who is recording the transactions, then the entry will
be:
Here we have debited the Joint Venture Account because it is an expenditure on account of the joint venture
business.
6. When the co-venturer recording the transactions sells the goods:
a) For cash sales:
Cash/Bank A/c Dr.
To Joint Venture A/c
b) For credit sales:
Debtor's Personal A/c
7. When cash is received from debtors:
Cash/Bank A/c Dr.
To Debtor's Personal A/c
8. When some cash discount is allowed to the debtor making payment, or some bad debts are incurred:
9. When sales are made by other co-venturers:
Co-venturer's Personal A/c Dr.
10. When some cash or bills receivable are received from other co-venturers on account of sales made by them:
Cash/Bank/Bills Receivable A/c Dr.
11. When the co-venturers recording the transactions is entitled to some commission or salary:
To Commission/Salary A/c
Joint Venture Account is debited as it is an expenditure related to the joint venture business.
12. When the unsold stock of joint venture is taken over by the co-venturer recording the transactions:
Purchases A/c Dr.

If the unsold stock is taken over by some other co-venturer, the journal entry will be :
After passing the above entries, the Joint Venture Account is prepared. The balance of this account will show either
profit or loss which is to be shared by all the co-venturers in their profit sharing ratio. This will require the following
further entries:
a) If it shows profit:
To Profit & Loss A/c
(his own share)
To Co-venturer’s Personal A/cs (individually for their shares)
b) If it results in loss:
Profit & Loss A/c Dr.
(his own share of loss)
Co-venturer’s Personal A/cs Dr.
(individually for their shares)
After closing the Joint Venture Account, we have to find out the amount due to other co- venturers. When this
amount is sent to them, we record the following entry.
Co-venturer’s Personal A/c Dr.
To Cash/Bank A/c
Recording in the Books of all Co-venturers
Under the second method, all transactions relating to the joint venture are recorded in the books of all the co-
venturers. In order to complete the Joint Venture Account in the books of all co-venturers, each co-venturer sends
the necessary information about his dealings to the other co-venturers. There is not much of a difference in the
recording of transactions between the first and the second method. We will be having similar entries in the joint
venture accounts in each co-venturer's books who shall all open the personal accounts of other co-venturers.
Memorandum Joint Venture Account Method
In the methods discussed above each co-venturer records all transactions relating to the joint venture in the Joint
Venture Account opened in his books, But under the Memorandum Joint Venture Account Method each co-venturer
will record only those transactions relating to the joint venture which are directly concerned with him, and not those
of others. Under this method each co-venturer opens a Joint Venture Account including the name of the other co-
venturer. For example, if A and B are partners in a joint venture, then in the books of A it will be termed as 'Joint
Venture with B Account' in the books of B it will be termed its 'Joint Venture with A Account': Each co-venturer will
record only such transactions which are actually effected by him. For example, if goods are purchased by A for the
joint venture, it will be recorded only by A and not by other co-venturers. Similarly, if goods are sold by B, it will be
recorded in the books of B only. This account is in the nature of a personal account and, therefore, will not disclose
the profit or loss of the venture. For that purpose we prepare an additional account called 'Memorandum Joint
Venture Account'. This is like Profit and Loss A/c.
Let us say A and B enter into a joint venture and certain transactions have taken place for which the following entries
will be passed in each co-venturer's books.
1. A purchases goods for cash:
This transaction shall be recorded in the books of A only. The entry will be:
Joint Venture with B A/c Dr.
To Cash A/c
2. A incurs some expenditure on account of the joint venture:
It shall be recorded in A's books only. The entry will be:
To Cash A/c
3. B sells goods for cash:
No entry will be nude in A's books. But the following entry will be made in B's books:
Cash Account Dr.
To Joint Venture with A A/c
4. B sends money to A:
a. It shall be recorded in B's books as follows:
Joint Venture with A A/c Dr.
To Cash/Bank A/c
b. It shall be recorded in A's books as follows:

Cash/Bank A/c Dr.
To Joint Venture with B A/c
As stated earlier, for ascertaining the profit or loss on the joint venture, we prepare a Memorandum Joint Venture
Account. This account is prepared exactly on the pattern of Profit & Loss Account. Since this account does not form
part of the double entry system, the word 'Memorandum is prefixed. The method of preparing this account is very
simple. It is prepared on the basis of information supplied by all the co-venturers. The debit entries appearing in the
personal accounts of all co-venturers are written on the debit side of the Memorandum Account and the entries
appearing on the credit side of those accounts are shown on the credit side of the Memorandum Joint Venture
Account. However, you should remember that the transactions which do not relate to an item of expense or income
are to be excluded from this Memorandum Account. The difference in the totals of the debit side and the credit side
represents profit or loss. The profit or loss thus calculated is then shared by the co-venturers in the agreed profit
sharing ratio. Each co-venturer will record only his share of profit or loss.
In the event of profit, the entries shall be:
In the books of A
In the books of B
Joint Venture with A A/c Dr.
In the event of Loss the entries shall be reversed as follows:
In the books of A
Profit and Loss A/c Dr.
To Joint Venture with B A/c
In the books of B
Profit and Loss A/c Dr.
To Joint Venture with A A/c
In the end each venturer balances the 'Joint Venture with .................... Account' in his books and settles the account
by paying or receiving cash.
Separate set of Books
So far you have studied the methods of recording joint venture transactions where no separate set of books were
maintained. Now we shall study another method where co-venturers agree to keep separate set of books for
recording the joint venture transactions.
When separate set of books are maintained, the joint venture transactions are recorded as a separate accounting
entity on the basis of double entry principles. Under this method the following accounts are opened:
1. Joint Bank Account

2. Joint Venture Account
3. Personal accounts of each co-venturer
Joint Bank Account is a real account like the ordinary Bank Account. All the co-venturers pay or deposit their
contribution in this account, The Joint Venture Account is like a profit and loss account which shows all the expenses
and incomes of the joint venture.
The personal accounts of the co-venturers simply show their contributions in the form of goods, cash or expenses
and the amounts received by them.
Let us now see the various journal entries which are normally recorded under this method.
1. Joint Bank A/c Dr.
To Co-venturers Personal A/cs
2. When n co-venturer contributed in the form of goods:
Joint Venture A/c
3. When purchases are made for joint venture:
a) If on cash:
To Joint Bank A/c
b) If on credit:
To Creditor's Personal A/c
Note that when goods are purchased for the joint venture business, you will debit the joint venture Account not the
Purchases Account,
4. When expenses are incurred on account of joint venture:
a) If paid out of Joint Bank Account
To Joint Bank A/c
b) If paid by a co-venturer
5. When goods are sold:
a) For cash sales:

Joint Bank A/c
b) For credit sales:
Debtor's Personal A/c
6. When creditors are paid:
Creditors' Personal A/c
To Joint Bank Account
1. When amounts are received from debtors:
Joint Bank A/C
2. Any commission, interest, etc. payable to a co-venturer:
Joint Venture A/c
3. Unsold stock taken over by a co-venturer:
Now if we balance the Joint Venture Account, it will disclose the amount of profit or loss made on the joint venture
which is to be shared by the co-venturers in their profit sharing ratio, The entries for the distribution of profit and
loss will be as follows:
a) In ease of profit:
To Co-venturers Personal A/cs
b) In case of loss:
Co-venturers Personal A/cs Dr.
This closes the Joint Venture Account. After transferring the amount of profit or loss to the co-venturer's personal
accounts, you can find out the amount payable to each one of them. When the payment is made, the journal entry
will be as follows:
Co-venturers Personal A/c Dr.
To Joint Bank A/c
Your will notice that the balance in the Joint Bank Account will be sufficient to pay-off all the co-venturers, and when
the above entries are passed all accounts will be closed.
Rectification of Errors
ACCOUNTING PROCESS 2.85
UNIT 6 : RECTIFICATION OF ERRORS

LEARNING OUTCOMES
After studying this unit, you will be able to:
w Understand different types of errors which may occur in course of recording transactions and events.
w Be familiar with the steps involved in locating errors.
w Learn the nature of one-sided errors and two-sided errors.
w Understand why suspense account is opened for rectification of errors.
w Understand the technique of correcting errors of one period in the next accounting period.
Errors of
Principle
UNIT OVERVIEW Errors of Types of Errors of

Omission Commission
Errors
Compensating
Errors
6.1 INTRODUCTION
Unintentional omission or commission of amounts and accounts in the process of recording the transactions
are commonly known as errors. These various unintentional errors can be committed at the stage of
collecting financial information/data on the basis of which financial statements are drawn or at the stage of
recording this information. Also errors may occur as a result of mathematical mistakes, mistakes in applying
accounting policies, misinterpretation of facts, or oversight. To check the arithmetic accuracy of the journal
and ledger accounts, trial balance is prepared. If the trial balance does not tally, then it can be said that
there are errors in the accounts which require rectification thereof. Some of these errors may affect the Trial
Balance and some of these do not have any impact on the Trial Balance although such errors may affect the
determination of profit or loss, assets and liabilities of the business.
Illustrative Case of Errors and their Nature

We have seen that after preparing ledger accounts a trial balance is taken out where debit and credit
balances are separately listed and totalled. If the two totals do not agree, it is definite that there have been
some errors We shall now study the types of errors which may be committed and how they may be rectified.
For this purpose, the working of the following illustrative cases should be carefully seen.
Illustrative Cases of Errors
(a) Wrong Entry: Let us start from the first phase in the accounting process. Wrong entry of the value of
transactions and events in the subsidiary books, Journal Proper and Cash Book may occur.
Example 1: Credit purchases `17,270 are entered in the Purchases Day Book as `17,720. Credit sales of
`15,000 gross less 1% trade discount are wrongly entered in Sales Day Book at `15,000. Cheque issued
`19,920 are wrongly entered in the credit of bank column in the Cash Book as `19,290.
(b) Wrong casting of subsidiary books: Subsidiary books are totalled periodically and posted to the
appropriate ledger accounts. There may arise totalling errors. Totalling errors may arise due to wrong
entry or simply these may be independent errors.
Example 2: For the month of January, 2016 total of credit sales are `1,75,700, this is wrongly totalled as
`1,76,700 and posted to sales account as `1,76,700.
(c) In case of cash book, wrong castings result in wrong calculation of the balance c/d.
Example 3: The following cash transactions of M/s. Tularam & Co. occurred:
2017
Jan. 1 Balance - cash `1,200 bank `16,000;

Jan. 2 Cheque issued to M/s. Bholaram & Co., a supplier, for `22,500;
Jan. 6 Cheque collected from M/s. Scindia & Bros. `42,240 and deposited for clearance;
Jan. 7 Cash sales `27,200 paid wages `12,400;
Jan. 8 Cash sales ` 37,730 cash deposited to bank ` 35,000.
The following Cash Book entries are passed:
Dr. Cash Book Cr.
Date Particulars Cash Bank Date Particulars Cash Bank

2017 ` ` 2017 ` `
Jan. 1 To Balance b/d 1,200 16,000 Jan. 2 By M/s Bholaram & Co. A/c 22,500
Jan. 6 To M/s. Scindia & Bros. A/c 42,420 By Wages A/c 12,200
Jan. 7 To Sales A/c 27,200 By Bank A/c 34,500
Jan. 8 To Sales A/c 37,370 By Balance c/d 19,070 71,420
Jan. 8 To Cash A/c 34,500

65,770 93,920 65,770 93,920

Wrong entries and wrong casting are shown in bold prints. However, errors of cash entries generally are not
carried. Usually cash balances are tallied daily. So errors are identified at an early stage. But bank balance
cannot be checked daily and thus errors may be carried until bank reconciliation is made. In the above
example, there are four wrong entries and one wrong casting. Bank and cash balances are affected by these
errors.
(d) Wrong posting from subsidiary books: In this case, the wrong amount may be posted to the ledger
account or the amount may posted to the wrong side or to the wrong account. For example, purchases
from A may be posted to B’s account.
(e) Wrong casting of ledger balances: Likewise Cash Book, any ledger account balance may be cast
wrongly. Obviously wrong postings make the balance wrong; but that is not wrong casting of balances.
Whenever there arises independent casting error as in the case of bank column in the Cash Book of
example (4), that is called wrong casting of ledger balances.
Example 4: The following are the credit purchases of M/s. Ballav Bros.:
2017
Jan. 1 Purchases from M/s. Saurabh & Co.- gross `1,00,000 less 1% trade discount.
Jan. 3 Purchases from M/s. Netai & Co.- gross ` 70,000 less 1% trade discount.
Jan. 6 Purchases from M/s. Saurabh & Co.- gross ` 60,000 less 1% trade discount
Let us cast M/s. Saurabh & Co.’s Account:
Dr. M/s Saurabh & Co. Account Cr.
Date Particulars Amount ` Date Particulars Amount `

2017 2017
Jan. 1 To Balance c/d 1,55,000 Jan. 1 By Purchases A/c 99,000
Jan. 6 By Purchases A/c 59,400
1,55,000 *1,55,000
*While casting the credit side an error has been committed and so the account is wrongly balanced.
Example 5: Goods are purchased on credit from M/s. Saurabh & Co. for ` 27,030 and from M/s. Karnataka
Suppliers for ` 28,050. The following Day Book is prepared:
Purchases Day Book
Date Particulars Amount

`
M/s. Saurabh & Co. 27,050
M/s. Karnataka Suppliers 28,030
55,080
In the Day Book both the transactions are entered wrongly but the first error has been compensated by the
second. Even if these errors are not rectified Trial Balance would tally.

Trial Balance
Particulars Dr. Cr.

` `
M/s. Saurabh & Co. 27,050
M/s. Karnataka Suppliers 28,030
Purchases Account 55,080
55,080 55,080
6.2 STAGES OF ERRORS

Errors may occur at any of the following stages of the accounting process:
AT THE STAGE OF RECORDING THE TRANSACTIONS IN JOURNAL
Following types of errors may happen at this stage:
(i) Errors of principle,
(ii) Errors of omission,
(iii) Errors of commission.
AT THE STAGE OF POSTING THE ENTRIES IN LEDGER
(i) Errors of omission:
(a) Partial omission,
(b) Complete omission.
(ii) Errors of commission:
(a) Posting to wrong account,
(b) Posting on the wrong side,
(c) Posting of wrong amount.
AT THE STAGE OF BALANCING THE LEDGER ACCOUNTS
(a) Wrong Totalling of accounts,
(b) Wrong Balancing of accounts.
AT THE STAGE OF PREPARING THE TRIAL BALANCE
(a) Errors of omission,
(b) Errors of commission:
1. Taking wrong account,
2. Taking wrong amount,
3. Taking to the wrong side.
On the above basis, we can classify the errors in four broad categories:
1. Errors of Principle,
2. Errors of Omission,
3. Errors of Commission,
4. Compensating Errors.
6.3 TYPES OF ERRORS

Basically errors are of two types:
(a) Errors of principle: When a transaction is recorded in contravention of accounting principles, like
treating the purchase of an asset as an expense, it is an error of principle. In this case there is no effect on
the trial balance since the amounts are placed on the correct side, though in a wrong account. Suppose
on the purchase of a computer, the office expenses account is debited; the trial balance will still agree.
(b) Clerical errors: These errors arise because of mistake committed in the ordinary course of the accounting
work. These are of three types:
(i) Errors of Omission: If a transaction is completely or partially omitted from the books of account, it
will be a case of omission. Examples would be: not recording a credit purchase of furniture or not
posting an entry into the ledger.
(ii) Errors of Commission: If an amount is posted in the wrong account or it is written on the wrong side
or the totals are wrong or a wrong balance is struck, it will be a case of “errors of commission.”
(iii) Compensating Errors: If the effect of errors committed cancel out, the errors will be called
compensating errors. The trial balance will agree. Suppose an amount of `10 received from A is not
credited to his account and the total of the sales book is `10 in excess. The omission of credit to A’s
account will be made up by the increased credit to the Sales Account.
From another point of view, error may be divided into two categories:
(a) Those that affect the trial balance - because of these errors ,trial balance does not agree; these are the
following:
(i) Wrong casting of the subsidiary books.
(ii) Wrong balancing of an account.
(iii) Posting an amount on the wrong side.
(iv) Posting the wrong amount.
(v) Omitting to post an amount from a subsidiary book.
(vi) Omitting to post the totals of subsidiary book.
(vii) Omitting to write the cash book balances in the trial balance.
(viii) Omitting to write the balance of an account in the trial balance.
(ix) Writing a balance in wrong column of the trial balance.
(x) Totalling the trial balance wrongly.

(b) The errors that do not affect the trial balance are the following:
(i) Omitting an entry altogether from the subsidiary book.
(ii) Making an entry with the wrong amount in the subsidiary book .
(iii) Posting an amount in a wrong account but on the correct side, e.g., an amount to be debited to A
is debited to B, the trial balance will still agree.
Errors
Errors of Principle (Treating a revenue Clerical Errors

expenses as capital expenditure or vice versa
or the sale of a fixed asset as ordinary sale).
Trial Balance will agree. Errors of Omission Errors of Commission Compensating Errors
Trial Balance will
agree.
Omitting an Entry completely Omitting to post the ledger account

from the subsidiary books. from the subsidiary books. Trial
Trial Balance will agree. Balance will not agree.
Writing the wrong Wrong casting of Posting the wrong Posting an amount on Wrong balancing of
amount in the subsidiary books. amount in the ledger. the wrong side. an account.
subsidiary books. Trial
Balance will agree.
Types Balance will not agree
6.4 STEPS TO LOCATE ERRORS

Even if there is only a very small difference in the trial balance, the errors leading to it must be located and
rectified. A small difference may be the result of a number of errors. The following steps will be useful in
locating errors :
(i) The two columns of the trial balance should be totalled again. If in place of a number of accounts,
only one amount has been written in the trial balance the list of such accounts should be checked and
totalled again. List of Trade receivables is the example from which Trade receivable balance is derived.
(ii) It should be seen that the cash and bank balances have been written in the trial balance.
(iii) The exact difference in the trial balance should be established. The ledger should be gone through; it is
possible that a balance equal to the difference has been omitted from the trial balance. The difference
should also be halved; it is possible that balance equal to half the difference has been written in the
wrong column.
(iv) The ledger accounts should be balanced again.
(v) The casting of subsidiary books should be checked again, especially if the difference is
` 1, ` 100 etc.

(vi) If the difference is very big, the balance in various accounts should be compared with the corresponding
accounts in the previous period. If the figures differ materially the cases should be seen; it is possible
that an error has been committed. Suppose the sales account for the current year shows a balance of
` 32,53,000 whereas it was ` 36,45,000 last year; it is possible that there is an error in the Sales Account.
(vii) Postings of the amounts equal to the difference or half the difference should be checked. It is possible
that an amount has been omitted to be posted or has been posted on the wrong side.
(viii) If there is still a difference in the trial balance, a complete checking will be necessary. The posting of all
the entries including the opening entry should be checked. It may be better to begin with the nominal
accounts.
6.5 RECTIFICATION OF ERRORS

Errors should never be corrected by overwriting. If immediately after making an entry it is clear that an error
has been committed, it may be corrected by neatly crossing out the wrong entry and making the correct
entry. If however the errors are located after some time, the correction should be made by making another
suitable entry, called rectification entry. In fact the rectification of an error depends on at which stage it is
detected. An error can be detected at any one of the following stages:
(a) Before preparation of Trial Balance.
(b) After Trial Balance but before the final accounts are drawn.
(c) After final accounts, i.e., in the next accounting period.
6.5.1 Before preparation of Trial Balance

There are some errors which affect one side of an account or which affect more than one account in such a
way that it is not possible to pass a complete rectification entry. In other words, there are some errors which
can be corrected, if detected at this stage, by making rectification statement in the appropriate side(s) of
concerned account(s). It is important to note here that such errors may involve only one account or more
than one account. Read the following illustrations:
(i) The sales book for November is undercast by ` 200. The effect of this error is that the Sales Account has
been credited short by ` 200. Since the account is posted by the total of the sales book, there is no error
in the accounts of the customers since they are posted with amounts of individual sales. Hence only the
Sales Accounts is to be corrected. This will be done by making an entry for ` 200 on the credit side: “By
undercasting of Sales Book for November ` 200”.
(ii) While posting the discount column on the debit side of the cash book the discount of
` 10 allowed to Ramesh has not been posted. There is no error in the cash book, the total of discount
column presumably has been posted to the discount account on the debit side. The error is in not
crediting Ramesh by ` 10. This should now be done by the entry “By omission of posting of discount on
----- `10”.
(iii) ` 200 received from Ram has been entered by mistake on the debit side of his account. Since the cash
book seems to have been correctly written, the error is only in the account of Ram - he should have
been credited and not debited by ` 200. Not only is the wrong debit to be removed but also a credit of
` 200 is to be given. This can be done now by entering ` 400 on the credit side of his account. The entry
will be “By Posting on the wrong side - ` 400”.

(iv) ` 50 was received from Mahesh and entered on the debit side of the cash book but was not posted to
his account. By the error, which affects only the account of Mahesh, ` 50 has been omitted from the
credit side of his account. The rectification will be by the entry. “By Omission of posting on the ` 50.”
(v) ` 51 paid to Mohan has been posted as `15 to the debit of his account. Mohan has been debited short
by ` 36. The rectifying entry is “To mistake in posting on ` 36”.
(vi) Goods sold to Ram for `1,000 was wrongly posted from sales day book to the debit of purchase account.
Ram has however been correctly debited. Here the error affects two accounts, viz., purchases account
and sales account but we cannot pass a journal entry for its rectification because both the accounts
need to be credited. The rectification will be by the entry “By wrong posting on ` 1,000” in the credit of
purchases account and also “By omission of posting on - ` 1,000” in the credit sales account.
(vii) Bills receivable from Mr. A of ` 500 was posted to the credit of Bills payable Account and also credited to
A account. Here also although two accounts are involved we cannot pass a complete journal entry for
rectification. The rectification will be by the entry “To wrong posting on ` 500” in debit of Bills payable
Account and also “To omission of posting on ` 500” in the debit of Bills Receivable Account.
(viii) Goods purchased from Vinod for ` 1,000 was wrongly credited to Vimal account by ` 100. Again we
cannot pass a complete journal entry for rectification even though two accounts are involved. The
rectification will be done by the entry “To wrong posting on `100” in the debit of Vimal account and “By
omission of posting on ` 1,000” in the credit of Vinod account.
Thus, from the above illustrations we are convinced that the general rule that errors affecting two accounts
can always be corrected by a journal entry is not always valid.
? ILLUSTRATION 1
How would you rectify the following errors in the book of Rama & Co.?
1. The total to the Purchases Book has been undercast by `100.
2. The Returns Inward Book has been undercast by ` 50.
3. A sum of ` 250 written off as depreciation on Machinery has not been debited to Depreciation Account.
4. A payment of ` 75 for salaries (to Mohan) has been posted twice to Salaries Account.
5. The total of Bills Receivable Book ` 1,500 has been posted to the credit of Bills Receivable Account.
6. An amount of `151 for a credit sale to Hari, although correctly entered in the Sales Book, has been posted as
` 115.
7. Discount allowed to Satish ` 25 has not been entered in the Discount Column of the Cash Book. the amount
has been postedcorrectly to the credit of his personal account.
 SOLUTION
1. The Purchases Account should receive another debit of `100 since it was debited short previously:
“To Undercasting of Purchases Book for the month of --- `100.”
2. Due to this error the Returns Inward Account has been posted short by ` 50 : the correct entry will be:
“To Undercasting of Returns Inward Book for the month of --- `50.”
3. The omission of the debit to the Depreciation Account will be rectified by the entry:
“To Omission of posting on ` 250”.
4. The excess debit will be removed by a credit in the Salaries Account by the entry:
“By double posting on ` 75”.
5. `1,500 should have been debited to the Bills Receivable Account and not credited. To correct the
mistake, the Bills Receivable Account should be debited by ` 3,000 by the entry:
“To Wrong posting of B/R received on ` 3,000”
6. Hari’s personal A/c is debited ` 36 short. The rectification entry will be:
“To Wrong posting ` 36”.
7. Due to this error, the discount account has been debited short by ` 25. The required entry is :
“To Omission of discount allowed to Satish on ` 25.”
So far we have discussed the correction of errors which affected only one Account or more than one account
but for which rectifying entries were not complete journal entries.We shall now take up the correction of
errors which affect more than one account in such a way that complete journal entries are possible for their
rectification. Read the following illustrations:
(i) The purchase of machinery for ` 2,000 has been entered in the purchases book. The effect of the entry
is that the account of the supplier Ram & Co. has been credited by ` 2,000 which is quite correct. But the
debit to the Purchases Account is wrong : the debit should be to Machinery Account. To rectify the error,
the debit in the purchases Account has to be transferred to the Machinery Account. The correcting
entry will be to Credit Purchases Account and debit the Machinery Account. Please see the three entries
made below: the last entry rectifies the error:
Wrong Entry: ` `
Purchases Account Dr. 2,000
To Ram & Co. 2,000
Correct Entry:
Machinery Account Dr. 2,000
To Ram & Co. 2,000
Rectifying Entry:
Machinery Account Dr. 2,000
To Purchases Account 2,000
(ii) `100 received from Kamal Kishore has been credited in the account of Krishan Kishore. The error is that
there is a wrong credit in the account of Krishan Kishore and omission of credit in the account of Kamal
Kishore; Krishan Kishore should be debited and Kamal Kishore be credited. The following three entries
make this clear:
Wrong Entry: ` `
Cash Account Dr. 100
To Krishan Kishore 100
Correct Entry:
Cash Account Dr. 100
To Kamal Kishore 100
Rectifying Entry:
Krishan Kishore Dr. 100
To Kamal Kishore 100

(iii) The sale of old machinery, `1,000 has been entered in the sales book. By this entry the account of
the buyer has been correctly debited by `1,000. But instead of crediting the Machinery Account. Sales
Account has been credited. To rectify the error this account should be debited and the Machinery
Account credited. See the three entries given below:
Wrong Entry: ` `
Buyer’s Account Dr. 1,000
To Sales Account 1,000
Correct Entry:
Buyer’s Account Dr. 1,000
To Machinery Account 1,000
Rectifying Entry:
Sales Account Dr. 1,000
To Machinery Account 1,000
? ILLUSTRATION 2
The following errors were found in the book of Ram Prasad & Sons. Give the necessary entries to correct them.
(1) ` 500 paid for furniture purchased has been charged to ordinary Purchases Account.
(2) Repairs made were debited to Building Account for ` 50.
(3) An amount of `100 withdrawn by the proprietor for his personal use has been debited to Trade Expenses
Account.
(4) `100 paid for rent debited to Landlord’s Account.
(5) Salary `125 paid to a clerk due to him has been debited to his personal account.
(6) `100 received from Shah & Co. has been wrongly entered as from Shaw & Co.
(7) ` 700 paid in cash for a typewriter was charged to Office Expenses Account.
 SOLUTION
Journal
Particulars L.F. Dr. Cr.

` `
(1) Furniture A/c Dr. 500
To Purchases A/c 500
(Correction of wrong debit to Purchases A/c for furniture
purchased)

(2) Repairs A/c Dr. 50

To Building A/c 50
(Correction of wrong debit to building A/c for repairs made)
(3) Drawings A/c. Dr. 100
To Trade Expenses A/c 100
(Correction of wrong debit to Trade Expenses A/c for cash
withdrawn by the proprietor for his personal use)
(4) Rent A/c Dr. 100
To Landlord’s Personal A/c 100
(Correction of wrong debit to landlord’s A/c for rent paid)
(5) Salaries A/c Dr. 125
To Clerk’s (Personal) A/c 125
(Correction of wrong debit to Clerk’s personal A/c for salaries paid)
(6) Shaw & Co. Dr. 100
To Shah & Co. 100
(Correction of wrong credit to Shaw & Co. Instead of Shah & Co.)
(7) Typewriter A/c Dr. 700
To Office Expenses A/c 700
(Correction of wrong debit to Office Expenses A/c for purchase of
typewriter)
? ILLUSTRATION 3
Give journal entries to rectify the following:
(1) A purchase of goods from Ram amounting to `150 has been wrongly entered through the Sales Book.
(2) A Credit sale of goods amounting `120 to Ramesh has been wrongly passed through the Purchase Book.
(3) On 31st December, 2016 goods of the value of `300 were returned by Hari Saran and were taken inventory
on the same date but no entry was passed in the books.
(4) An amount of ` 200 due from Mahesh Chand, which had been written off as a Bad Debt in a previous year,
was unexpectedly recovered, and had been posted to the personal account of Mahesh Chand.
(5) A Cheque for `100 received from Man Mohan was dishonoured and had been posted to the debit of Sales
Returns Account.

 SOLUTION
Journal
` `
(1) Purchases A/c Dr. 150
Sales A/c Dr. 150
To Ram 300
(Correction of wrong entry in the sales Book for a purchases of
goods from Ram)
(2) Ramesh Dr. 240
To Purchases A/c 120
To Sales A/c 120
(Correction of wrong entry in the Purchases Book of a credit sale
of goods to Ram)
(3) Returns Inwards A/c Dr. 300
To Hari Saran 300
(Entry of goods returned by him and taken in inventory omitted
from records)
(4) Mahesh Chand Dr. 200
To Bad Debts Recovered A/c 200
(Correction of wrong credit to Personal A/c in respect of recovery
of previously written off bad debts)
(5) Man Mohan Dr. 100
To Sales Return A/c 100
(Correction of wrong debit to Sales Returns A/c for dishonour of
cheque received from Man Mohan)
Thus it can be said that errors detected before the preparation of trial balance can be rectified either through
rectification statements (not entries) or through rectification entries.
6.5.2 After Trial Balance but before Final Accounts
The method of correction of error indicated so far is appropriate when the errors have been located before
the end of the accounting period. After the corrections the trial balance will agree. Sometimes the trial
balance is artificially made to agree inspire of errors by opening a suspense account and putting the
difference in the trial balance to the account - the suspense account will be debited if the total of the credit
column in the trial balance exceeds the total of the debit column; it will be credited in the other case.
One must note that such agreement of the trial balance will not be real. Effort must be made to locate the
errors.
The rule of rectifying errors detected at this stage is simple. Those errors for which complete journal entries
were not possible in the earlier stage of rectification (i.e., before trial balance) can now be rectified by way
of journal entry(s) with the help of suspense account, for it these errors which gave rise to the suspense
account in the trial balance. The rectification entry for other type of error i.e. error affecting more than one
account in such a way that a complete journal entry is possible for its rectification, can be rectified in the
same way as in the earlier stage (i.e. before trial balance).
In a nutshell, it can be said that each and every error detected at this stage can only be corrected by a
complete journal entry. Those errors for which journal entries were not possible at the earlier stage will now
be rectified by a journal entry(s), the difference or the unknown side is being taken care of by suspense
account. Those errors for which entries were possible even at the first stage will now be rectified in the same
way.
Suppose, the sales book for November, 2015 is cast `100 short; as a consequence the trial balance will not
agree. The credit column of the trial balance will be `100 short and a Suspense Account will be credited by
`100. To rectify the error the Sales Account will be credited (to increase the credit to the right figure. Since
now one error remains, the Suspense Account must be closed- it will be debiting the Suspense Account. The
entry will be:
Suspense Account Dr. `100
To Sales Account `100
(Correction of error of undercasting the sales
Book for November 2015)
? ILLUSTRATION 4
Correct the following errors (i) without opening a Suspense Account and (ii) opening a Suspense Account:
(a) The Sales Book has been totalled `100 short.
(b) Goods worth `150 returned by Green & Co. have not been recorded anywhere.
(c) Goods purchased `250 have been posted to the debit of the supplier Gupta & Co.
(d) Furniture purchased from Gulab & Bros, `1,000 has been entered in Purchases Day Book.
(e) Discount received from Red & Black `15 has not been entered in the Discount Column of the Cash Book.
(f) Discount allowed to G. Mohan & Co. `18 has not been entered in the Discount Column of the Cash Book. The
account of G. Mohan & Co. has, however, been correctly posted.
 SOLUTION
If a Suspense Account is not opened.

(a) Since sales book has been cast `100 short, the Sales Account has been similarly credited `100 short. The
correcting entry is to credit the Sales Account by `100 as “By wrong totalling of the Sales Book `100”.
(b) To rectify the omission, the Returns Inwards Account has to be debited and the account of Green & Co.
credited. The entry:
Returns Inward Account Dr. `150
To Green & Co. `150
(Goods returned by the firm, previously
omitted from the Returns Inward Book)

(c) Gupta & Co. have been debited `250 instead of being credited. This account should now be credited by
500 to remove the wrong debit and to give the correct debit. The entry will be on the credit side... “By
errors in posting `500”.
(d) By this error Purchases Account has to be debited by `1,000 whereas the debit should have been to the
Furniture Account. The correcting entry will be:
Furniture Account Dr. `1,000

To Purchases Account `1,000
(Correction of the mistake by which of the
Furniture Account)
(e) The discount of `15 received from Red & Black should have been entered on the credit side of the cash
book. Had this been done, the Discount Account would have been credited (through the total of the
discount column) and Red & Black would have been debited. This entry should not be made:
Red & Black Dr. `15

To Discount Account `15
(Rectification of the error by which the
discount allowed by the firm was not entered
in Cash Book)
(f ) In this case the account of the customer has been correctly posted; the Discount Account has been
debited `18 short since it has been omitted from the discount column on the debit side of the cash
book. The discount account should now be debited by the entry; “To Omission of entry in the Cash Book
`18.”
If a Suspense Account is opened :

` `
(a) Suspense Account Dr. 100
To Sales Account 100
(Being the correction arising from undercasting of Sales Day
Book)
(b) Return Inward Account Dr. 150
To Green & Co . 150
(Being the recording of unrecorded returns)
(c) Suspense Account Dr. 500
To Gupta & Co. 500
(Being the correction of the error by which Gupta & Co. was
debited instead of being credited by ` 250).

(d) Furniture Account Dr. 1,000

(Being the correction of recording purchase of furniture as
ordinary purchases)
(e) Red & black Dr. 15

To Discount Account 15
(Being the recording of discount omitted to be recorded)
(f ) Discount Account Dr. 18
To Suspense Account 18
(Being the correction of omission of the discount allowed
from Cash Book customer’s account already posted correctly).
Suspense Account
Dr. Particulars Amount Date Particulars Cr.

Date ` Amount
`
To Sales A/c 100 By Difference in
To Gupta & Co. 500 Trial Balance 582
By Discount A/c 18
600 600
Notes:
(i) One should note that the opening balance in the Suspense Account will be equal to the difference in
the trial balance.
(ii) If the question is silent as to whether a Suspense Account has been opened, the student should make
his assumption, state it clearly and then proceed.
? ILLUSTRATION 5
Correct the following errors found in the books of Mr. Dutt. The Trial Balance was out by ` 493 excess credit. The
difference thus has been posted to a Suspense Account.
(a) An amount of `100 was received from D. Das on 31st December, 2015 but has been omitted to enter in the
Cash Book.
(b) The total of Returns Inward Book for December has been cast `100 short.
(c) The purchase of an office table costing ` 300 has been passed through the Purchases Day Book.
(d) ` 375 paid for Wages to workmen for making show-cases had been charged to “Wages Account”.
(e) A purchase of ` 67 had been posted to the trade payables’ account as ` 60.
(f) A cheque for ` 200 received from P. C. Joshi had been dishonoured and was passed to the debit of “Allowances
Account”.

(g) ` 1,000 paid for the purchase of a motor cycle for Mr. Dutt had been charged to “Miscellaneous Expenses
Account”.
(h) Goods amounting to `100 had been returned by customer and were taken in to inventory, but no entry in
respect there of, was made into the books.
(i) A sale of ` 200 to Singh & Co. was wrongly credited to their account. Entry was made correctly made in sales
book.
 SOLUTION
(a) Journal Entries
Particulars L.F. ` `
(a) Cash Account Dr. 100
To D. Das 100
(Being the amount received)
(b) Returns Inward Account Dr. 100
(Being the mistake in totalling the Returns Inward Book
corrected)
(c) Furniture Account Dr. 300
To Purchases Account 300
(Being the rectification of mistake by which purchase of
furniture was entered in Purchases book and hence debited
to Purchases Account)
(d) Furniture Account Dr. 375
To Wages Account 375
(Being the wages paid to workmen for making show-cases
which should be capitalised and not to be charged to Wages
Account)
(e) Suspense Account Dr. 7
To Creditors (personal) Account 7
(Being the mistake in crediting the Trade payables Account
less by ` 7, now corrected)
(f ) P.C. Joshi Dr. 200
To Allowances Account 200
(Being the cheque of P.C. Joshi dishonoured, previously
debited to Allowances Account)

(g) Drawings Account Dr. 1,000

To Miscellaneous Expenses 1,000
(Being the motor cycle purchased for Mr. Dutt debited to
his Drawings Account instead of Miscellaneous Expenses
Account as previously done by mistake)
(h) Returns Inward Account Dr. 100
To Debtors (Personal) Account 100
(Correction of the omission to record return of goods by
customers)
(i) Singh & Co. Dr. 400
(Being the correction of mistake by which the account of
Singh & Co. was credited by ` 200 instead of being debited)
Suspense Account
Dr. Cr.
Date Particulars Amount Date Particulars Amount
2015 ` 2015 `
Dec.31 To Difference in Dec. 31 By Returns
Trial Balance 493 Inwards A/c 100
““ To Trade Payables A/c 7 ““ By Singh & Co. 400
500 500
? ILLUSTRATION 6
The following errors, affecting the account for the year 2015 were detected in the books of Jain Brothers, Delhi:
(1) Sale of old Furniture `150 treated as sale of goods.
(2) Receipt of ` 500 from Ram Mohan credited to Shyam Sunder.
(3) Goods worth `100 brought from Mohan Narain have remained unrecorded so far.
(4) A return of `120 from Mukesh posted to his debit.
(5) A return of ` 90 to Shyam Sunder posted as ` 9 in his account.
(6) Rent of proprietor’s residence, ` 600 debited to rent A/c.
(7) A payment of ` 215 to Mohammad Sadiq posted to his credit as `125.
(8) Sales Book added ` 900 short.
(9) The total of Bills Receivable Book ` 1,500 left unposted.
You are required to pass the necessary rectifying entries and show how the trial balance would be affected by the
errors.

 SOLUTION
Journal

Amount Amount
` `
(1) Sales Account Dr. 150
To Furniture Account 150
(Rectification of sales of furniture treated as sales of
goods)
(2) Shyam Sunder Dr. 500
To Rama Mohan 500
(Rectification of a receipt from Ram Mohan credited
to Shyam Sunder)
(3) Purchases Account Dr. 100
To Mohan Narain 100
(Purchases of goods from Mohan Narain unrecorded)
(6) Drawing Account Dr. 600
To Rent Account 600
(Rectification of Payment of rent of proprietor’s
residence treated as payment of office rent)
N.B. : For 4, 5, 7, 8, 9 no journal entry can be passed as they affect a single account. The correction will be as
under:
(4) Credit Mukesh’s Account with ` 240.
(5) Debit the account of Shyam Sunder by ` 81.
(7) Debit the account of Mohammad Sadiq by ` 340.
(8) Credit Sales Account by ` 900.
(9) Debit Bills Receivable Account with `1,500.
Effect of the Errors on Trial Balance
1. No effect
2. No effect
3. No effect
4. Trial Balance credit total short by ` 240.
5. Trial Balance debit total short by ` 81.
6. No effect
7. Trial Balance debit total short by ` 340.
8. Trial Balance credit total short by ` 900.
9. Trial Balance debit total short by ` 1,500.

? ILLUSTRATION 7
Write out the Journal Entries to rectify the following errors, using a Suspense Account.
(1) Goods of the value of `100 returned by Mr. Sharma were entered in the Sales Day Book and posted therefrom
to the credit of his account;
(2) An amount of `150 entered in the Sales Returns Book, has been posted to the debit of Mr. Philip, who returned
the goods;
(3) A sale of ` 200 made to Mr. Ghanshyam was correctly entered in the Sales Day Book but wrongly posted to
the debit of Mr. Radheshyam as ` 20;
(4) Bad Debts aggregating `450 were written off during the year in the Sales ledger but were not adjusted in the
General Ledger; and
(5) The total of “Discount Allowed” column in the Cash Book for the month of September, 2015 amounting to
` 250 was not posted.
 SOLUTION
Journal
` `
(1) Sales Account Dr. 100
Sales Returns Account Dr. 100
(The value of goods returned by Mr. Sharma
wrongly posted to Sales and omission of debit to
Sales Returns Account, now rectified)
(2) Suspense Account Dr. 300
To Mr. Philip 300
(Wrong debit to Mr. Philip for goods returned by
him, now rectified)
(3) Mr. Ghanshyam Dr. 200
To Mr. Radheshyam 20
(Omission of debit to Mr. Ghanshyam and wrong
credit to Mr. Radhesham for sale of ` 200, now
rectified)
(4) Bad Debts Account Dr. 450
(The amount of Bad Debts written off not adjusted
in General Ledger, now rectified)
(5) Discount Account Dr. 250
(The total of Discount allowed during September,
2015 not posted from the Cash Book; error now
rectified)

6.5.3 Correction in the next Accounting Period

Rectification of errors discussed so far assumes that it was carried out before the books were closed for
the concerned year. However, sometimes, the rectification is carried out in the next year, carrying forward
the balance in the Suspense Account or even transferring it to the Capital Account. Suppose, the Purchase
Book was cast short by `1,000 in December, 2015 and a Suspense Account was opened with the difference
in the trial balance. If the error is rectified next year and the entry passed is to debit Purchase Account (and
credit Suspense Account), it will mean that the Purchases Account for year 2016 will be `1,000 more than
the amount relating to year 2016 and thus the profit that year 2016 will be less than the actual for that year.
Thus, correction of errors in this manner will ‘falsify’ the Profit and Loss Account.
To avoid this, correction of all amounts concerning nominal accounts, i.e., expenses and incomes should
be through a special account styled as “Prior Period Items” or “Profit and Loss Adjustment Account”. The
balance in the account should be transferred to the Profit and Loss Account. However, these Prior Period
Items should be charged after deriving net profit of the current year. ‘Prior Period items’ are material income
or expenses which arise in the current period as a result of errors or omissions in the preparation of the
financial statements of one or more periods. Prior Period Items should be separately disclosed in the current
statement of profit and loss together with their nature and amount in a manner that their impact on current
profit or loss can be perceived.
? ILLUSTRATION 8
Mr. Roy was unable to agree the Trial Balance last year and wrote off the difference to the Profit and Loss Account
of that year. Next Year, he appointed a Chartered Accountant who examined the old books and found the
following mistakes:
(1) Purchase of a scooter was debited to conveyance account `3,000.
(2) Purchase account was over-cast by `10,000.
(3) A credit purchase of goods from Mr. P for `2,000 entered as a sale.
(4) Receipt of cash from Mr. A was posted to the account of Mr. B `1,000.
(5) Receipt of cash from Mr. C was posted to the debit of his account, `500.
(6) ` 500 due by Mr. Q was omitted to be taken to the trial balance.
(7) Sale of goods to Mr. R for `2,000 was omitted to be recorded.
(8) Amount of `2,395 ofpurchase was wrongly posted as `2,593.
Mr. Roy used 10% depreciation on vehicles. Suggest the necessary rectification entries.

 SOLUTION
Journal Entries in the books of Mr. Roy
Date Particulars Dr. Cr.
` `
(1) Motor Vehicles Account Dr. 2,700
To Profit and Loss Adjustment A/c 2,700
(Purchase of scooter wrongly debited to conveyance
account now rectified-capitalisation of ` 2,700, i.e.,
` 3,000 less 10% depreciation)
(2) Suspense Account Dr. 10,000
To Profit & Loss Adjustment A/c 10,000
(Purchase Account overcast in the previous year; error
now rectified).
(3) Profit & Loss Adjustment A/c Dr. 4,000
To P’s Account 4,000
(Credit purchase from P ` 2,000, enteredas sales last
year; now rectified)
(4) B’s Account Dr. 1,000
To A’s Account 1,000
(Amount received from A wrongly posted to the
account of B; now rectified)
(5) Suspense Account Dr. 1,000
To C’s Account 1,000
(` 500 received from C wrongly debited to his account;
now rectified)
(6) Trade receivables Dr. 500
(` 500 due by Q not taken into trialbalance; now
rectified)
(7) R’s Account Dr. 2,000
(Sales to R omitted last year; now adjusted)
(8) Suspense Account Dr. 198
To Profit & Loss Adjustment A/c 198
(Excess posting to purchase account last year, ` 2,593,
instead of ` 2,395, now adjusted)
(9) Profit & Loss Adjustment A/c Dr. 10,898
To Roy’s Capital Account 10,898
(Balance of Profit & Loss Adjustment A/c transferred to
Capital Account)
(10) Roy’s Capital Account Dr. 10,698
To Suspense Account 10,698
(Balance of Suspense Account transferred to the
Capital Account)
Note : Entries No. (2) and (8) may even be omitted; but this is not advocated.
Profit and Loss Adjustment Account

(Prior Period Items)
` `
To P 4,000 By Motor Vehicles A/c 2,700
To Roy’s Capital (transfer) 10,898 By Suspense A/c 10,000
By R 2,000
By Suspense Account 198
14,898 14,898
Suspense Account
` `
To Profit & Loss Adjustment Account 10,000 By Trade Receivables (Q) 500
To C 1,000 By Roy’s Capital Account (Transfer) 10,698
To Profit & Loss Adjustment Account 198
11,198 11,198
SUMMARY
w Unintentional omission or commission of amounts and accounts in the process of recording the
transactions are commonly known as errors.
w Accounting errors are generally of four types-
(a) Errors of Principle;
(b) Errors of Omission;
(c) Errors of Commission;
(d) Compensating Errors.
w Some errors may affect the Trial Balance and some of these do not.
w The method of rectification of errors depends on the stage at which the errors are detected. If the error
is detected before the preparation of trial balance, rectification is carried out by making the statement
in the appropriate side of the concerned account.
w In case of the errors detected after the preparation of the trial balance, we open a suspense account
with the amount of difference in the trial balance. Then complete journal entries can be passed for
rectifying the errors.
w For rectifying the errors detected in the next accounting period, a special account ‘Profit and Loss
Adjustment Account’ is opened for correction of amounts relating to expenses and incomes.

TEST YOUR KNOWLEDGE

Multiple Choice Questions
1. Goods purchased from A for `10,000 passed through the sales book. The error will result in
(a) Increase in gross profit.
(b) Decrease in gross profit.
(c) No effect on gross profit.
2. If a purchase return of `1,000 has been wrongly posted to the debit of the sales returns account, but has
been correctly entered in the suppliers’ account, the total of the
(a) Trial balance would show the debit side to be `1,000 more than the credit.
(b) Trial balance would show the credit side to be `1,000 more than the debit.
(c) The debit side of the trial balance will be `2,000 more than the credit side.
3. If the amount is posted in the wrong account or it is written on the wrong side of the account, it is called
(a) Error of omission.
(b) Error of commission.
(c) Error of principle.
4. `200 paid as wages for erecting a machine should be debited to
(a) Repair account.
(b) Machine account.
(c) Capital account.
5. On purchase of old furniture, the amount of `1,000 spent on its repair should be debited to
(a) Repair account.
(b) Furniture account.
(c) Cash account.
6. Goods worth `50 given as charity should be credited to
(a) Charity account.
(b) Sales account.
(c) Purchase account.
7. Goods worth `100 taken by proprietor for domestic use should be credited to
(a) Sales account.
(b) Proprietor’s personal expenses.
(c) Purchases account.

8. Sales of office furniture should be credited to

(a) Sales Account.
(b) Furniture Account.
(c) Purchase Account.
9. The preparation of a trial balance is for:
(a) Locating errors of commission.
(b) Locating errors of principle.
(c) Locating clerical errors.
10. `200 received from Smith whose account, was written off as a bad debt should be credited to:
(a) Bad Debts Recovered account.
(b) Smith’s account.
(c) Cash account.
11. Purchase of office furniture `1,200 has been debited to General Expense Account. It is:
(a) A clerical error.
(b) An error of principle.
(c) An error of omission.
Theory Questions
1. How does errors of omission differ from errors of commission?
2. What is error of principle and how does it affect Trial Balance?
3. When and how is Suspense account used to rectify errors?
Practical Questions
1. The trial balance of Mr. W & H failed to agree and the difference `20,570 was put into suspense pending
investigation which disclosed that:
(i) Purchase returns day book had been correctly entered and totalled at `6,160, but had not been
posted to the ledger.
(ii) Discounts received `1,320 had been debited to discounts allowed.
(iii) The Sales account had been under added by `10,000.
(iv) A credit sale of `1,470 had been debited to a customer account at `1,740.
(v) A vehicle bought originally for `7,000 four years ago and depreciated to `1,200 had been sold for
`1,500 in the beginning of the year but no entries, other than in the bank account had been passed
through the books.
(vi) An accrual of `560 for telephone charges had been completely omitted.

(vii) A bad debt of `1,560 had not been written off and provision for doubtful debts should have been
maintained at 10% of Trade receivables which are shown in the trial balance at `23,390 with a credit
provision for bad debts at `2,320.
(viii) Tools bought for `1,200 had been inadvertently debited to purchases.
(ix) The proprietor had withdrawn, for personal use, goods worth `1,960. No entries had been made in
the books.
Required:
(i) Pass rectification entries without narration to correct the above errors before preparing annual accounts.
(ii) Prepare a statement showing effect of rectification on the reported net profit before correction of these
errors.
2. On going through the Trial balance of Ball Bearings Co. Ltd. you find that the debit is in excess by `150.
This was credited to “Suspense Account”. On a close scrutiny of the books the following mistakes were
noticed:
(1) The totals of debit side of “Expenses Account” have beeen cast in excess by ` 50.
(2) The “Sales Account” has been totalled in short by `100.
(3) One item of purchase of `25 has been posted from the day book to ledger as `250.
(4) The sale return of `100 from a party has not been posted to that account though the Party’s account
has been credited.
(5) A cheque of `500 issued to the Suppliers’ account (shown under Trade payables) towards his dues
has been wrongly debited to the purchases.
(6) A credit sale of `50 has been credited to the Sales and also to the Trade receivables Account.
You are required to
(i) Pass necessary journal entries for correcting the above;
(ii) Show how they affect the Profits; and
(iii) Prepare the “Suspense Account” as it would appear in the ledger.
3. Mr. A closed his books of account on September 30, 2016 in spite of a difference in the trial balance.
The difference was `830 the credits being short; it was carried forward in a Suspense Account. In 2017
following errors were located:
(i) A sale of `2,300 to Mr. Lala was posted to the credit of Mrs. Mala.
(ii) The total of the Returns Inward Book for July, 2016 `1,240 was not posted in the ledger.
(iii) Freight paid on a machine `5,600 was posted to the Freight Account as `6,500.
(iv) White carrying forward the total in the Purchases Account to the next page, `65,590 was written
instead of `56,950.
(v) A sale of machine on credit to Mr. Mehta for `9,000 on 30th sept. 2016 was not entered in the books
at all. The book value of the machine was `6,750.
Pass journal entries to rectify the errors. Have you any comments to make?

4. A merchant’s trial balance as on June 30, 2017 did not agree. The difference was put to a Suspense
Account. During the next trading period, the following errors were discovered:
(i) The total of the Purchases Book of one page, `4,539 was carried forward to the next page as `4,593.
(ii) A sale of `573 was entered in the Sales Book as `753 and posted to the credit of the customer.
(iii) A return to a creditor, `510 was entered in the Returns Inward Book; however, the creditor’s account
was correctly posted.
(iv) Cash received from C. Dass, `620 was posted to the debit of G. Dass.
(v) Goods worth `840 were despatched to a customer before the close of the year but no invoice was
made out.
(vi) Goods worth `1,000 were sent on sale or return basis to a customer and entered in the Sales Book.
At the close of the year, the customer still had the option to return the goods. The sale price was
25% above cost.
You are required to give journal entries to rectify the errors in a way so as to show the current year’s
profit or loss correctly.
ANSWERS/HINTS
MCQs
1. (a) 2. (c) 3. (b) 4. (b) 5. (b) 6. (c)

7. (c) 8. (b) 9. (c) 10. (a) 11. (b)
Theoretical Questions
1. (i) Errors of Omission: If a transaction is completely or partially omitted from the books of account, it
will be a case of omission. Examples would be: not recording a credit purchase of furniture or not
posting an entry into the ledger.
(ii) Errors of Commission: If an amount is posted in the wrong account or it is written on the wrong side
or the totals are wrong or a wrong balance is struck, it will be a case of “errors of commission.”
2. Errors of principle: When a transaction is recorded in contravention of accounting principles, like
treating the purchase of an asset as an expense, it is an error of principle. In this case there is no effect on
the trial balance since the amounts are placed on the correct side, though in a wrong account. Suppose
on the purchase of a typewriter, the office expenses account is debited; the trial balance will still agree.
The method of correction of error indicated so far is appropriate when the errors have been located
before the end of the accounting period. After the corrections the trial balance will agree. Sometimes
the trial balance is artificially made to agree inspite of errors by opening a suspense account and
putting the difference in the trial balance to the account - the suspense account will be debited if the
total of the credit column in the trial balance exceeds the total of the debit column; it will be credited in
the other case. Each and every error detected can only be corrected by a complete journal entry. Those
errors for which journal entries were not possible at the earlier stage will now be rectified by a journal
entry(s), the difference or the unknown side is being taken care of by suspense account. Those errors for
which entries were possible even at the first stage will now be rectified in the same way.

Practical Questions
Answer 1
Particulars Dr. Cr.

(i) Suspense Account Dr. 6,160
To Return Outward A/c 6,160
(ii) Suspense Account Dr. 2,640
To Discount Allowed Account 1,320
To Discount Received Account 1,320
(iii) Suspense Account Dr. 10,000
(iv) Suspense Account Dr. 270
To Customer Account 270
(v) Suspense Account Dr. 1,500
To Vehicle Account 1,200
To Profit on Sale of Vehicle Account 300
(vi) Telephone Charges Account Dr. 560
To Outstanding Expenses Account 560
(vii) Bad Debts Account Dr. 1,560
To Trade receivables Account 1,560
Provision for Doubtful Debts Account Dr. 1,642
To Profit and Loss Account 1,642
(viii) Loose Tools Account Dr. 1,200
(ix) Drawings Account Dr. 1,960
1. Bad debts will be debited in the profit and loss account.
2. Provision @ 10% of `21,560 i.e. 2,156; Excess provision `164 (2320 - 2156 = 164).
Working Notes :
(i) Trade receivables as per books 23,390

Deduction vide item (iv) 270 270
Bad Debts 1,560 1,830

21,560

(ii) Suspense Account
` `
To Return outward Account 6,160 By balance b/d 20,570
To Discount allowed Account 1,320
To Discount Received Account 1,320
To Customers Account 270
To Vehicles Account 1,200
To Profit on Sale of Vehicle 300
20,570 20,570
Answer 2
Journal Entries

` `
Suspense Account Dr. 50
To Expenses Account 50
(Being the mistake in totalling of Expenses Account,
rectified)
Suspense Account Dr. 100
To Sales Account 100
(Being the mistake in totalling of Sales Accounts rectified)
Supplier Dr. 225
(Being the mistake in posting from Day Book to Ledger
rectified)
Sales Returns Account Dr. 100
(Being the sales return from a party not posted to “Sales
Returns” now rectified)
Trade payables Account Dr. 500
To Purchases Account 500
(Being the payments made to supplier wrongly posted to
purchases now rectified)

Trade receivables Account Dr. 100

(Being the sales wrongly credited to Customer’s Account
now rectified)
Suspense Account
Dr. ` Cr.
`
To Expenses Account 50 By Difference in Trial Balance 150
To Sales Account 100 By Trade payables 225
To Balance c/d 425 By Sales Returns Account 100
By Trade receivables 100
575 575
By Balance b/d 425
Since the Suspense Account does not balance, it is clear that all the errors have not been traced. As a result
of the above corrections the Net Profit will be:
Increased by Decreased by
` `
Mistake in totalling in “Expenses” 50
Mistake in totalling in “Sales” 100
Mistake in posting from day book to Ledger under
“Purchases” 500
Omission in posting under “Sales Returns” 100
650 100
Net Increase 550
As a result of these adjustments, the Profits will be increased by `550.

Answer 3
Journal of Mr. A
Date Particulars L.F. Dr. Cr.

` `
2017 (i) Mrs. Mala Dr. 2,300
Mr. Lala Dr. 2,300
To Suspense A/c 4,600
(Correction of error by which a sale of ` 2,300

to Mr. Lala was posted to the Credit of Mrs. Mala)

(ii) Profit and Loss Adjustment A/c Dr. 1,240
To Suspense A/c 1,240
(Rectification of omission to post the total of
Returns Inward Book for July, 2016)
(iii) (a) Machinery A/c Dr. 5,600
Suspense A/c Dr. 900
(Correction of error by which freight paid for
a machine ` 5,600 was posted to Freight
Account at ` 6,500 instead of capitalising it)
(b) Profit & Loss Adjustment A/c Dr. 560 560
To Plant and Machinery A/c
(Depreciation @ 10% charged on freight paid
on a machine capitalised)
(iv) Suspense A/c Dr. 8,640
(Correction of wrong carry forward of total in
the purchase Account to the next page ` 65,590
instead of ` 56,950)
(v) Mr. Mehta Dr. 9,000
To Plant & Machinery A/c 6,750
(Correction of omission of a sale of machine on
credit to Mr. Mehta for ` 9,000 )
Comments
The Suspense Account will now appear as shown below:
Suspense Account
Dr. Cr.
` `
2017 To Profit and Loss 2016 By Balance b/d 830
Adjustment A/c 900 Oct. 1 By Sundries
To Profit and Loss Mrs. Mala 2,300
Adjustment A/c 8,640 Mr. Lala 2,300

By Profit and Loss

Adjustment A/c 1,240
By balance c/d 2,870
9,540 9,540
Since the Suspense Account still shows a balance, it is obvious that there are still some errors left in the
books.
Profit & Loss Adjustment A/c
(For Prior Period Items)
Dr. Cr.
2017 ` 2017 `
To Suspense A/c 1,240 By Machinery A/c 5,600
To Plant and Machinery A/c 560 By Suspense A/c 900
To Balance c/d 15,590 By Suspense A/c 8,640
By Mr. Mehta 2,250
17,390 17,390
Answer 4
Journal Entries

` `
(i) Suspense Account Dr. 54
To Profit and Loss Adjustment A/c 54
(Correction of error by which Purchase Account
was over debited last year- `4,593 carried forward
instead of `4,539)
(ii) Profit & Loss Adjustment A/c Dr. 180
Customer’s Account Dr. 1,326
To Suspense Account 1,506
(Correction of the entry by which (a) Sales A/c was
over credited by `180 (b) customer was credited
by `753 instead of being debited by `573)
(iii) Suspense Account Dr. 1,020
(Correction of error by which Returns Inward
Account was debited by `510 instead of Returns
Outwards Account being credited by ` 510)

(iv) Suspense Account Dr. 1,240

To C. Dass 620
To G. Dass 620
(Removal or wrong debit to G. Dass and giving
credit to C. Dass from whom cash was received).
(v) Customer’s Account Dr. 840
To Profit & Loss Adjustment A/c 840
(Rectification of the error arising from non-
preparation of invoice for goods delivered)
(vi) Profit & Loss Adjustment A/c Dr. 200
Inventory Account Dr. 800
To Customer’s Account 1,000
(The Customer’s A/c credited with `1,000 for
goods not yet purchased by him; cost of the
goods debited to inventory and “Profit” debited
to Profit & Loss Adjustment Account)
(vii) Profit & Loss Adjustment A/c Dr. 1,534
To Capital Account 1,534
(Transfer of Profit & Loss Adjustment A/c balance
to the Capital Account)

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SUMMARISING ANALYSIS AND COMMUNICATING

Accounting ignores the effect of price level changes

Accounting may lead to window dressing

Terms a. Internal Liability- Liability towards the owners of the business.

Assumptions Accounting practices once selected and adopted should be applied

General Accounting Principles Lecture- 1

 The resources available

 Identification of Financial Transactions and Events

External users of accounting information

 Accounting is not fully exact

Basic Accounting Terms

Fundamental Accounting Assumptions

2. Revenue from operations refer to

3. According to the Going Concern Concept-

4. According to the convention of consistency-

Accounting Principles- Lecture-2

1. Money Measurement Concept

 Employee skill level

3. Full Disclosure Principle

Several examples of full disclosure involve the following:

 The nature and justification of a change in accounting principle

It might be helpful to look at a few examples.

5. Prudence or Conservatism Principle

Here are several examples of the matching principle:

8. Revenue Recognition Concept

Accrued revenue: Revenue is recognized before cash is received.

Deferred revenue: Revenue is recognized after cash is received.

Revenue realized during an accounting period is included in the income.

9. Verifiable Objective Concept

These supporting documents are:

10. Dual aspect or Duality principle

Accounting Equation Formula

Accounting Principles Lecture- 3

Deferred Revenue Expenditure-

Cost of Goods Sold

Accounting Procedures- Rules of Debit or Credit

Rules of Dr. and Cr.

 Double entry system of accounting

Rule- Debit the receiver and Credit the giver

Rule- Debit what comes in and credit what goes out

The International Accounting Improve financial IFRS are referred to as

a) Balance sheet as at the end of the period;

Dinesh started business with 5000 capital

Q. Under which Schedule of the Companies Act,2013, the formats of

INTERNATIONAL FINANCIAL REPORTING STANDARDS AS GLOBAL STANDARDS

What are Indian Accounting Standards (Ind AS)?

FACTORS IN THE MEASUREMENT OF DEPRECIATION

Capital Reserve- out of capital profits

• Partnership Act doesn’t specify any format for preparation of accounts of

FIXED AND FLUCTUATING CAPITAL

There are two methods of accounting –

w Understand the reason for the existence and survival of a company.

w Learn the nature and types of companies.

w Explain the salient features of a company.

w Understand the purpose of preparing the financial statements of the company.

UNIT OVERVIEW Government

© The Institute of Chartered Accountants of India

1.2 MEANING OF COMPANY