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Final » Accounts/Accounting

Final
Meaning
Occurring at or forming an end or termination
Conclusive in a process or progression
Synonyms
last, concluding, finishing, closing, ending
» Final Accounts/Accounting
In its simplest sense, final accounts/accounting should be understood as the accounting activity that is
carried on generally towards the end of a period called accounting period.

Basic Purpose of Accounting


The basic purpose of accounting is derivation of information. The double entry system of accounting
enables an organisation to derive the information that it needs in relation to accounting elements
called account heads or ledger accounts. This double entry system of accounting, enables the
collection of all the information relating to an element (account) at a single place.
For example
To know the value of Furniture with the organisation a "Furniture a/c" is maintained.
...
...
To know the amount of expenditure incurred on account of salaries a "Salaries a/c" is maintained.
...
The organisation's informational need defines the
elements in the accounting system of the organisation.
The more the information needed by the organisation
the more the elements (accounting heads) that are to be
maintained by the organisations'.

Journal (Recording) » Ledger (Posting) : Regular


Tasks

The place where the information relating to an element is collected/available is a Ledger. Each
accounting element has a specific identity in the ledger and is known as a ledger account.
Every Ledger posting should have a journal support i.e.
the information flows into the ledger from/through a
journal. There is no ledger without a journal.
Recording the accounting transactions into the journal
and posting them into the ledger form the core tasks
carried on regularly in relation to the accounting
process. However these are not the only tasks that exist
in relation to an accounting system/process.
Tasks Involved in the accounting process

f
Including the tasks of recording the transactions and i
n
posting them into the ledger, these are the tasks that a
l
we generally come across and assume to be the tasks ,
involved in accounting. a
c
c
• Creating a Proof of the Transaction o
Whenever a transaction takes place in an organisation, more so, in the case of transactions u
relevant to accounting, a proof is created in the form of either a voucher or a receipt or an n
invoice or any other document that gives the details relating to the transaction. t
s
Strictly speaking, this task is not a part of the ,
accounting process. It is only a task which would f
i
enable the accomplishment of the accounting process n
a
or tasks. n
• Actual Accounting Tasks c
i
» Recording a
The first accounting task is "Preparing the Journal based on the proof of the transaction". This is l
called Recording the transaction. ,
» Posting a
The second accounting task is "Preparing the Ledger based on the information in the Journal". c
This is called Posting the Journal Entry into the Ledger. c
o
» Preparing a Trial Balance u
Preparing a trial balance is one other task that we come across in accounting. A trial balance is a n
statement of ledger account balances as at a particular instance. It can be prepared at any t
instance as and when needed. It is a statement and not a ledger account. i
• Purpose!! n
A Trial Balance is prepared to check the mathematical/arithmetic accuracy of accounting. This is g
the main and most important purpose of preparation of the Trial Balance and nothing else. ,
t
However, since it is anyhow prepared for an important r
purpose, it is used for other purposes wherever a
d
possible. Just because it is being used for other i
n
purposes (like in the preparation of final accounts), we g
cannot say that the trial balance is prepared for those ,
p
other purposes. r
o
• Trial Balance » Not a part of the actual Accounting Process!! f
True, the trial balance enables the organisation to ensure the mathematical/arithmetic accuracy
i
of accounting. However, preparation of a Trial Balance is not a necessity, unlike the Journal and
t
the Ledger.
,
The Ledger gives the information that we need and we l
o
cannot prepare a ledger without a journal (No Journal s
No Ledger). But, we can think of the existence of the s
,
accounting system and process without the trial a
c
c
balance.

Additional Information Needed by the


Organisation

f
Apart from the information relating to the various elements (ledger accounts) that an i
organisation collects, there is other information that is needed by the organisation. In general, in n
accounting we can identify two important pieces of information that the organisation needs. a
l
,
The ledger accounts collect information relating to a
each element. All the elements (account heads) are c
c
classified into three types. Personal accounts (relating o
u
to persons and organisations), Real accounts (relating n
to tangible aspects) and Nominal accounts (relating to t
s
incomes/gains and expenses/losses). ,
f
• Profits made by the organisation i
As and when an element is effected by a transaction, the ledger account is posted to with the n
information. This keeps on happening continuously. The information thus collected in the form of a
ledger accounts does not say anything about the profits made by the organisation. n
The organisation periodically would be interested in c
i
knowing the amount of profit that it has made over the a
period. l
,
» Involvement of a Period a
When it comes to thinking about profits there is a period involved in the thought. We think of c
profits made over a period and not at a particular instance. c
o
For example, We think of Profits made u
From 1st April to 31st April or n
During April or t
During the 6 months ending 30th June i
For the year from 1st April, 2005 to 31st March 2006. n
• Position of the Organisation g
The ledger accounts are periodically balanced to obtain the balances in the accounts. ,
t
The act of balancing is done at such periods as is r
needed by the organisation. For example, where the a
d
organisation needs the information relating to cash i
n
balance daily, therefore Cash a/c is balanced daily. g
» Assets and Liabilities indicate a persons Position ,
What is it that comes to our mind when we think of a persons position? It is the value of his/her p
property and the liabilities he/she has. r
o
Even in accounting, in trying to ascertain the position f
of a business entity, this is what we think of. The i
t
position of a business is indicated by the value of its ,
l
assets and liabilities. o
s
The organisation at times would be interested in
knowing its position as at a particular point of time.
» Position at an instance
When it comes to thinking about the position there is an instance involved in the thought. We think
of the position as at a point of time and not a period.
For example, We think of the position
As on 24th June or
As at the end of a period i.e. on the last day of the period

How is the Additional Information obtained?


f
The organisational accounting system provides information in the form of ledger accounts i
maintained in the books of accounts. The additional information that is needed is obtained by n
deriving it from the information that is existing in these ledger accounts. a
• Information relating to Profits l
The ledger accounts relating to the organisation are classified into three types. Personal, Real ,
and Nominal. a
c
» Nominal Accounts c
Nominal accounts are related to expenses, losses, incomes and gains. o
Since ascertaining profits or losses involves dealing with incomes, gains, expenses and losses we u
can conclude that all the nominal accounts together would give us the information relating to the n
profits or losses made by the organisation. t
s
» Trading and Profit and Loss Accounts ,
f
To derive the information relating to profits from these nominal accounts a ledger account by
i
name "Trading and Profit & Loss a/c" is prepared.
n
a
Almost in all cases, we use two separate ledger accounts "Trading a/c" and
n
"Profit and Loss a/c" to derive information relating to profits with a greater
c
detail. [The more the information we need, the more the accounting heads
i
we need to maintain].
a
l
Preparation of these ledger accounts requires us to think beyond just transferring the
,
information in the nominal accounts into these accounts. a
• The Position of the organisation c
The ledger accounts maintained within an organisational accounting system are classified into c
three as Personal, Real and Nominal. o
» Real Accounts u
n
Real accounts are related to tangible aspects. In general we can identify that all asset accounts
t
are real accounts.
i
» Personal Accounts n
Personal accounts are related to persons and organisations. These are persons/organisation g
which owe the organisation or to whom the organisation owes. In effect they either form ,
creditors (liabilities) or debtors (assets). t
Since all the nominal accounts have been dealt with in deriving the information relating to profits r
and we are left with only the real and personal accounts which represent either assets or a
liabilities we can conclude that all the real and personal accounts together give us the d
information relating to the position of the organisation. i
» Balance Sheet n
To derive the information relating to the position of the organisation from these real and g
personal accounts a statement by name "Balance Sheet" is prepared. ,
However preparing the Balance sheet need us to think a bit beyond just listing out the p
information relating to the personal and real accounts in the statement. r
o
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Debtors (Assets) and Creditors
(Liabilities)

• Assets
Real accounts and Personal accounts are capable of being called assets. Any element (account) that
is capable of being liquidated (that is capable of being converted to cash by giving it away)
indicates an asset. Machinery, Furniture, Cash, etc are real accounts that can be called assets.
» Debtors represent Assets
Debtors represent the persons and organisation who owe to the organisation. They would clear
their dues by paying out either in cash or in some other form. Thus Debtors get liquidated and as
such can be called assets.
• Liabilities
All elements representing liabilities are Personal accounts. An element that is capable of being
cleared by paying out indicates a liability.
» Creditors represent Liabilities
Creditors represent the persons and organisation to whom the organisation owes. The organisation
would clear its due by paying them either in cash or in some other form. Thus creditors are cleared
by paying out and as such can be called liabilities.

When is the information relating to profits & position


collected/derived
f
Information needs vary from organisation to organisation. Even the information relating to i
profits and position would also be derived for such periods and on such dates respectively n
depending on the organisations need or this information. a
» Period for which profits are ascertained l
,
a
The information relating to profits is something that is needed by the organisation periodically.
c
For what period do we try to ascertain profits. Do we think of profits made every day or over a
c
week or over a month or over a six month period or over a year? This is dependent on the
o
information needs of the organisation.
u
Though theoretically it is possible to derive this information's for any time period, conventionally
n
it is derived for a year. That is in most cases, information relating to profits is derived over a
t
year. We think of profits made over a year.
s
» Day on which position is ascertained ,
The information relating to the position may be needed by the organisation at many points of f
time. Theoretically this is also capable of being derived at any point of time we need it. i
However, conventionally it is derived at a point which indicates the end of the period for which n
the profits are ascertained. Say if we think of profits made for the period from 1st April 2005 to a
31st March 2006, we think of deriving the position as on 31st March 2006. n
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Accounting b
a
Period l
a
n
c
Accounting Period is that period for which the organisation ascertains the profit or loss. If the e
organisation is trying to ascertain the profits made over a year, then the accounting period is a ,
year. If it is trying to ascertain the profits made over a six months period, then the accounting w
period is six-months. o
There are two aspects relating to an accounting period. The length of the period as well as the r
being/end dates of the period. These can be ascertained from the way the accounting period is
stated.
For example, where the accounting period of an organisation is stated as
From 1st July to 31st December,
This implies that the length of the accounting period is 6 months.
One year and starts on 1st January every year.
This implies that the accounting period is from 1st January to 31st December and is one year long.
• What Accounting Period to Follow?
What accounting period an organisation follows is dependent on the informational as well as
statutory needs of the organisation. The most common period followed all over the world is a period
of 1 year which starts from either 1st January or 1st April.
» Statutory Requirements
The need of the organisation to comply with the various laws that it has to adhere to would also
influence the decision relating to the accounting period.
Say in India, the Income Tax Act, needs organisations to calculate and present their business
profits for the period from 1st April to the following 31st March. Therefore, the organisations would
follow the same accounting period so that their accounting would serve their informational needs as
well as enable them to easily present the information that has to be presented to the Income Tax
Department.

Ascertaining the how much of Profit/Loss

• Profit = Total (Incomes + Gains) − Total (Expenses + Losses)


Using this relation, a positive profit figure indicates a profit and a negative profit figure indicates a
loss.
• Math of Ascertainment of Profit/Loss
Nominal accounts are related to incomes/gains and expenses/losses. Thus the information relating
to the aspects that would define the profit or loss made by the organisation is contained in the
Nominal accounts.
» Nominal Accounts with Debit balances
Those ledger accounts which have a debit balance in them represent expenses or losses
The total (sum) of balances in all the nominal (ledger) accounts with a debit balance indicates the
total (expense + losses).
» Nominal Accounts with Credit balances
Those ledger accounts which have a credit balance in them represent incomes or gains.
The total (sum) of balances in all the nominal (ledger) accounts with a credit balance indicates the
total (incomes + gains).
If the total of (expense + losses) and (incomes + gains) are set off, we would be able to arrive at
the profit or loss made.

Thus the relation to ascertain the profit or loss can be written as


Profit = Sum of balances in Nominal accounts with a Credit
Balance
− Sum of balances in Nominal accounts with a Debit Balance .

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Preparation of Trading and Profit and Loss


account (a/c)

The "Trading and Profit & Loss a/c" is a ledger account. Like all ledger accounts, the postings in this
ledger account also flow from the journal. "No Journal No Ledger".
• Transactions making up the Trading and Profit & Loss a/c
The transactions relating to the journal entries that would go into the "Trading and Profit & Loss
a/c" are not ones that are take place in the ordinary course of business. These are transactions that
are specifically meant to create this "Trading and Profit & Loss a/c".
Consider the above formula for ascertaining the profit or loss,
Profit = Sum of balances in Nominal accounts with a Credit Balance
− Sum of balances in Nominal accounts with a Debit Balance .
» For Ascertaining the sum of balances in Nominal Accounts with a
Debit Balance
This is done by transferring the balances in the nominal accounts with a debit balance, to an
account by name "Trading and Profit & Loss a/c".

Transferring a debit balance from one account to a second results in the


second account being debited and the first account being credited.

Therefore the Journal Entry would be

Journal in the books of M/s __ for the period from ____ to _____

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

March 31st – Trading and Profit & Loss a/c D – xxx


To Nominal a/c [with a r x xxxx
debit balance] –

[For the debit balances in the


nominal accounts transferred to
the "Trading and Profit & Loss
a/c" for the purpose of
ascertaining the profits on the
last day of the accounting
period ]

» For Ascertaining the sum of balances in Nominal Accounts with a


Credit Balance
This is done by transferring the balances in the nominal accounts with a credit balance to an
account by name "Trading and Profit & Loss a/c".

Transferring a credit balance from one account to a second results in the


second account being credited and the first account being debited.

Therefore the Journal Entry would be

Journal in the books of M/s __ for the period from ____ to _____

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

March 31st – Nominal a/c [with a credit D – xxx


balance] r x xxxx
To Trading and Profit & –
Loss a/c

[For the credit balances in the


nominal accounts transferred on
the last day of the accounting
period to the "Trading and Profit
& Loss a/c" for the purpose of
ascertaining the profits.]

• Trading and Profit and Loss Account (a/c)


Thus the "Trading and Profit & Loss a/c" would appear as follows

Dr Trading and Profit & Loss a/c Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

31/03/0 – xxx 31/03/0 By Nominal a/c – xxx


6 To Nominal a/c – xxx 6 1 [Cr] xxx
31/03/0 1 [Dr] – xxx 31/03/0 By Nominal a/c xxx
6 To Nominal a/c – xx 6 2 [Cr] xxx
31/03/0 2 [Dr] – xxx 31/03/0 ... xxx
6 To Nominal a/c 6 ...
31/03/0 3 [Dr] 31/03/0
6 ... 6
31/03/0 ... 31/03/0
6 6

sub-total 3,24,000 sub-total 5,80,000

31/03/0
To Bal (Profit) – 2,56,000
6

Total 5,80,000 Total 5,80,000

Thus the "Trading and Profit & Loss a/c", is nothing but a consolidated account formed by
transferring the balances in the nominal accounts.

Nature of Trading and Profit & Loss


a/c
Since the "Trading and Profit & Loss a/c" is prepared by transferring the ledger account balances in
all the nominal accounts in the books of accounts it is appropriate to consider it to be a nominal
account.

Any Ledger account prepared to ascertain the profits or losses out of a set of
transactions is a nominal account. Thus, "Trading and Profit & Loss a/c" is a
nominal account.

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

When are the entries


recorded?

Accounting period is the period for which we wish to ascertain the profits or losses. The "Trading
and Profit & Loss a/c" is prepared at the end of the accounting period.
Say if the accounting period is a year from 1st April 2005 to 31st March 2006, the journal entry for
transferring the amounts to the "Trading and Profit & Loss a/c" is recorded at the end of the
accounting period i.e. on 31st March 2006.

What happens to the Nominal


a/c's?

To ascertain the profits, we transfer the balances in the Nominal accounts (with debit balances as
well as credit balances) to the "Trading and Profit & Loss a/c", thus creating that ledger account.
• Nil Balance
When the total balance in a nominal account is transferred to the "Trading and Profit & Loss a/c",
its balance becomes Nil.

Dr Rent Paid a/c Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

01/04/0
5
To Cash a/c – 8,000
01/05/0
To Cash a/c – 8,000
5
.. – ..
..
.. – ..
..
To Cash a/c – 8,000
01/03/0
6

sub-total 96,000 sub-total 96,000

31/03/0 By Trdg and P/L


– 96,000
6 a/c
Total 96,000 Total 96,000

• Closing the Nominal Account at the end of the accounting period


The act of transferring the balance in a nominal account to the Trading and Profit and Loss Account
and thereby making its balance Nil is identified as Closing the Nominal Account at the end of the
accounting period.

All the nominal accounts are closed at the end of the accounting period by
transfer to the "Trading and Profit and Loss Account.

• How do Nominal a/c's appear in every accounting period if they


are closed
The nominal accounts are closed at the end of the accounting period. But we see the same nominal
accounts being used in accounting in all the accounting periods. Say, the "Rent Paid a/c" would
appear in the accounting books in all the accounting periods.
This is for the reason that all the nominal accounts are closed at the end of the accounting period
and are opened afresh at the beginning of the next accounting period for being used in that
accounting period.
Therefore, the "Rent Paid a/c" appearing in the books in a particular accounting period is different
from the "Rent Paid a/c" appearing in the same books in any other accounting period.

All the nominal accounts are opened anew at the beginning of the accounting
period.

Illustration » Problem

To get an understanding and feel of the process of final accounting, let us go through an example of
an organisations accounting consisting of a few transactions during an accounting period.
Following are the transactions relating to M/s Trinity Foods, over an accounting period from 1st
June 2005 to 30th June 2006.
Started business with Capital Rs. 1,00,000
Paid into Bank Rs. 10,000
Bought Furniture and paid cash Rs. 25,000
Bought goods for cash Rs. 50,000
Bought goods from Ram on Credit Rs. 15,000
Sold a part of the goods for Rs. 75,000 and paid the proceeds into bank directly
Sold the remaining goods on credit for Rs. 50,000 to Rahim
Paid Salaries and Wages Rs. 5,000
Paid rent by cheque Rs. 8,000

Illustration » Solution [Journal and


Ledger]
Journal Entries » Hide/Show

Journal in the books of M/s Trinity Foods for the period from 1st June 2005
to 30th June 2005

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

1st to 30th – Cash a/c D – 1,0


To Capital a/c r 0,0 1,00,000
– 00

[For the amount brought in by


the proprietor towards his capital
contribution.]

1st to 30th – Bank a/c D – 10,


To Cash a/c r 00 10,000
– 0

[For the amount paid into bank.]

1st to 30th – Furniture a/c D – 25,


To Cash a/c r 00 25,000
– 0

[For the amount paid towards


purchase of Furniture.]

1st to 30th – Purchases a/c D – 50,


To Cash a/c r 00 50,000
– 0

[For the amount paid towards


purchase of goods/stock.]

1st to 30th – Purchases a/c D – 15,


To Ram a/c r 00 15,000
– 0

[For the value of goods bought


from Ram on credit.]

1st to 30th – Bank a/c D – 75,


To Sales a/c r 00 75,000
– 0

[For the sales made for cash and


the proceeds paid into bank
directly.]

1st to 30th – Rahim a/c D – 50,


To Sales a/c r 00 50,000
[For the value of goods sold on – 0
credit to Rahim.]

1st to 30th – Salaries and Wages a/c D – 5,0


To Cash a/c r 00 5,000

[For the amount paid in cash


towards salaries and wages.]

1st to 30th – Rent Paid a/c D – 8,0


To Bank a/c r 00 8,000

[For the amount paid towards


rent by cheque.]

Ledger Accounts » Hide/Show

Dr Cash a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st-30th To Capital a/c – 1,00,000 1st-30th By Bank a/c – 10,000


" By Furniture a/c – 25,000
" By Purchases – 50,000
" a/c – 5,000
By Sal. & Wages
30/06/05 a/c – 10,000

By Balance c/d

Total 1,00,000 Total 1,00,000

30/06/05 To Balance b/d – 10,000

Dr Capital a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

30/06/05 To Bal c/d – 1,00,000 01/06/05 By Cash a/c – 1,00,000

Total 1,00,000 Total 1,00,000

30/06/05 By Balance b/d – 1,00,000

Dr Bank a/c Cr
Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st-30th To Cash a/c – 10,000 1st-30th By Rent Paid a/c – 8,000


To Sales a/c – 75,000
30/06/05 By Bal c/d – 77,000

Total 85,000 Total 85,000

30/06/05 To Balance b/d – 77,000

Dr Furniture a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st-30th To Cashl a/c – 25,000 30/06/05 By Bal c/d – 25,000

Total 25,000 Total 25,000

30/06/05 To Balance b/d – 25,000

Dr Purchases a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st-30th To Cash a/c – 50,000 30/06/05 By Bal c/d – 65,000


" To Ram a/c – 15,000

Total 65,000 Total 65,000

30/06/05 To Balance b/d – 65,000

Dr Ram a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

30/06/05 To Bal c/d – 15,000 1st-30th By Purchases – 15,000


a/c

Total 15,000 Total 15,000

30/06/05 By Balance b/d – 15,000


Dr Sales a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

30/06/05 To Bal c/d – 1,25,000 1st-30th By Bank a/c – 75,000


– " By Rahim a/c – 50,000

Total 1,25,000 Total 1,25,000

30/06/05 By Balance b/d – 1,25,000

Dr Rahim a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st-30th To Sales a/c – 50,000 30/06/05 By Bal c/d – 50,000

Total 50,000 Total 50,000

30/06/05 To Balance b/d – 50,000

Dr Salaries and Wages a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st-30th To Cash a/c – 5,000 30/06/05 By Bal c/d – 5,000

Total 5,000 Total 5,000

30/06/05 To Balance b/d – 5,000

Dr Rent Paid a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st-30th To Bank a/c – 8,000 30/06/05 By Bal c/d – 8,000

Total 8,000 Total 8,000

30/06/05 To Balance b/d – 8,000


final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Illustration » Solution [Trial


Balance]

The trial balance is nothing but a statement of ledger account balances as on a particular instance.

Trial Balance of M/s Trinity Foods" as on 30th June 2005

De
bit
A
L m
Credit Amount
Particulars / ou
(in Rs)
F nt
(in
Rs
)

Cash a/c 10,


Capital a/c — 00
Bank a/c 0
Furniture a/c —
Purchases a/c 77,
Ram a/c — 00
Sales a/c 0
Rahim a/c — 25,
Salaries and Wages a/c 00 1,00,000
Rent Paid a/c —0
65,
— 00
0 15,000
— 1,25,000

— 50,
00
—0
5,0
— 00
8,0
00

2,4
Total 0,0 2,40,000
00

Preparing Trading and Profit and Loss Account :


Journal & Ledger
Consider the above Trial Balance. There are a total of 4 nominal accounts with either debit or credit
balances.
Purchases a/c [Debit Balance]
Sales a/c [Credit Balance]
Salaries and Wages a/c [Debit Balance]
Rent Paid a/c [Debit Balance]
To ascertain the profit or loss made by the organisation, the balance in these accounts should be
transferred to the "Trading and Profit & Loss a/c". The journal entries for these transfers would be:
» Journal Entries Hide/Show

Journal in the books of M/s Trinity Foods for the period from 1st June 2005
to 30th June 2005

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

June 30th – Trading and Profit & Loss a/c D – 78,


To Purchases a/c r 00 65,000
To Salaries & Wages a/c – 0 5,000
To Rent Paid a/c 8,000

[For the transfer of debit –


balances in nominal accounts at
the end of the accounting period
to the Trading and Profit & Loss
a/c for the purpose of
ascertaining profits.]

June 30th – Sales a/c D – 1,2


To Trading and Profit & r 5,0 1,25,000
Loss a/c – 00

[For the transfer of credit


balances in nominal accounts at
the end of the accounting period
to the Trading and Profit & Loss
a/c for the purpose of
ascertaining profits.]

» Trading and Profit & Loss a/c


The "Trading and Profit & Loss a/c" would be

Dr Trading and Profit & Loss a/c Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

30/06/0 To Purchases – 65,000 30/06/0 By Sales a/c – 1,25,000


5 a/c – 5,000 5
" To Salaries & – 8,000
" Wages a/c
To Rent Paid a/c
sub-total 78,000 sub-total 1,25,000

30/06/0
To Bal (Profit) – 47,000
5

Total 1,25,000 Total 1,25,000

Since the credit side total is greater, the account has a credit balance. Since a credit balance in a
nominal account indicates a gain, we can say that there is a profit.
» Other Ledger Accounts Affected Hide/Show

Dr Purchases a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st-30th To Cash a/c – 50,000 30/06/05 By Bal c/d – 65,000


" To Ram a/c – 15,000

Total 65,000 Total 65,000

30/06/05 To Balance b/d – 65,000 30/06/05 By Trdg. P/L a/c – 65,000

Total 65,000 Total 65,000

Dr Sales a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

30/06/05 To Bal c/d – 1,25,000 1st-30th By Bank a/c – 75,000


– " By Rahim a/c – 50,000

Total 1,25,000 Total 1,25,000

To Trdg, & By Balance


– 1,25,000 30/06/05 – 1,25,000
P/L a/c b/d

Total 1,25,000 Total 1,25,000

Dr Salaries and Wages a/c Cr

Date Particulars J/F Amount Date Particulars J/F Amount


(in Rs) (in Rs)

1st-30th To Cash a/c – 5,000 30/06/05 By Bal c/d – 5,000

Total 5,000 Total 5,000

30/06/05 To Balance b/d – 5,000 30/06/05 By Trdg. P/L a/c – 5,000

Total 5,000 Total 5,000

Dr Rent Paid a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st-30th To Bank a/c – 8,000 30/06/05 By Bal c/d – 8,000

Total 8,000 Total 8,000

30/06/05 To Balance b/d – 8,000 30/06/05 By Trdg. P/L a/c – 8,000

Total 8,000 Total 8,000

The balance in these nominal accounts becomes zero after the balances are transferred to the
"Trading and Profit & Loss a/c". Thus, nominal accounts are closed at the end of the accounting
period by transfer to the "Trading and Profit & Loss a/c".
In the subsequent accounting period, if the same nominal account heads are used, they are opened
anew. Thus these accounts pertaining to the current accounting period are independent of the
nominal accounts with the same name in any other accounting period.

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Trial Balance
Redrawn/Remade

The trial balance is a list of ledger account balances at an instance when it is drawn. If we consider
the instance after having prepared the "Trading and Profit & Loss a/c", we do not find a balance in
any nominal account. All the nominal accounts are closed by transfer to the "Trading and Profit &
Loss a/c", thereby leaving a nil balance in all of them.
The "Trading and Profit & Loss a/c" is also a nominal account and has a credit balance if there is a
profit and a debit balance if there is a loss. If we make a trial balance after having prepared the
"Trading and Profit & Loss a/c" we will find only real and personal accounts in it apart from the
nominal account "Trading and Profit & Loss a/c".
Trial Balance of M/s Trinity Foods" as on 30th June 2005
[After closing Nominal accounts]

De
bit
A
L m
Credit Amount
Particulars / ou
(in Rs)
F nt
(in
Rs
)

Cash a/c — 10,


Capital a/c 00 1,00,000
Bank a/c —0
Furniture a/c
Ram a/c — 77, 15,000
Rahim a/c 00
Trading and Profit & Loss a/c —0 47,000
25,
— 00
0

50,
— 00
0

1,6
Total 2,0 1,62,000
00

What indicates the Position of an Organisation

What is it that comes to our mind when we think of a person's position? It is the value of his/her
property and the liabilities he/she has.
Even in accounting, in trying to ascertain the position of a business entity, this is what we think of.
The position of an organisation is indicated by the value of the assets and liabilities held by the
organisation.

Information relating to the Assets and


Liabilities

The information relating to the assets and liabilities of an organisation is available in the Real and
Personal Accounts.
» Real Accounts
Real accounts are related to tangible aspects. In general we can identify that all asset accounts are
real accounts.
» Personal Accounts
Personal accounts are related to persons and organisations. These are persons/organisation which
owe the organisation or to whom the organisation owes. In effect they either form creditors
(liabilities) or debtors (assets).
Since all the nominal accounts have been dealt with in deriving the information relating to profits
and we are left with only the real and personal accounts which represent either assets or liabilities
we can conclude that all the real and personal accounts together give us the information relating to
the position of the organisation.
• Where to obtain the information relating to assets and liabilities
The value of the assets and liabilities of an organisation is revealed by the balances in the real and
personal accounts.
Therefore, if we need the information relating to the assets and liabilities, we just need to collect
the ledger account balances relating to real and personal accounts in the books of accounts.
» Utility of Trial Balance
The Trial balance is a statement that gives the ledger account balances as at a particular point of
time. Therefore, we can find the balances in those accounts which are capable of being identified as
assets and liabilities from the trial balance.
Thus, if there is a Trial Balance, it would provide the information relating to the assets and liabilities
as on the date of the trial balance ready hand.

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

When does the organisation need the information


relating to its position?

The organisation may need this information at many points of time during the course of the conduct
of the business.
Theoretically, the information may be derived as and when needed by collecting the ledger account
balances relating to the real and personal accounts, but is conventionally derived at a point which
indicates the end of the accounting period (i.e. the period for which the profits are ascertained).
Say if the organisation ascertains the profits made for the period from 1st April 2005 to 31st March
2006, it would ascertain the position as on 31st March 2006.
The ending day for an accounting period would be the beginning day for the subsequent accounting
period and as such the information relating to the position of the organisation as on the last day of
a particular accounting period would be the information relating to its position as on the first day of
the subsequent accounting period. Thus we can say that the information relating to position is
derived in relation to the opening and closing days of the accounting periods.

Ascertainment of the Position vs Ascertainment of


Profits

Practically, in deriving the information relating to the correct position of the organisation, there are
a number of aspects to be taken care of. It is not as simple as collecting the ledger account balances
of the real and personal accounts as and when we intend to ascertain the position.
For example, the information relating to profits is also necessary to arrive at the position of an
organisation. We know that profits increase capital and loss decreases capital. Capital is a liability.
Therefore, the balance in capital account cannot be used to reflect the correct position of the
business unless the profits or losses (up to that point of time) are adjusted in the capital account.
And for this the profits till that point of time are to be ascertained.
This should explain the reason why the ascertainment of the position generally goes along with the
ascertainment of the profits of the business.
Balance Sheet » Statement for Presenting the
information relating to Position

The information relating to the position of an organisation is presented in the form of a statement
titled "Balance Sheet".
• Format of the Balance Sheet
The "Balance Sheet" is a statement and is made in a "T" format. It has two sides named the
"Assets" side and the "Liabilities" side put side by side. The Liabilities side is placed to the left and
the assets side to the right.

Balance Sheet of M/s Trinity Foods as on 30th June 2005

A
Amou m
Liabilities Assets
nt ou
nt

To
Total ta
l

• Preparation of the Balance Sheet


In its simplest form this statement is nothing but a statement of ledger account balances remaining
after ascertainment of the profits of the organisation, arranged in a such a way that all the ledger
accounts with a debit balance on the assets side and all the ledger accounts with a credit balance on
the liabilities side.

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Illustration » Preparation of Balance


Sheet

Consider the Trial Balance after having ascertained the profits (from the illustration relating to
ascertainment of profits)

Trial Balance of M/s Trinity Foods" as on 30th June 2005


(after closing Nominal accounts)

Particulars L De Credit Amount


/ bit (in Rs)
FA
m
ou
nt
(in
Rs
)

Cash — 10,
Capital 00 1,00,000
Bank —0
Furniture
Ram — 77, 15,000
Rahim 00
Trading and Profit & Loss —0 47,000
25,
— 00
0

50,
— 00
0

1,6
Total 2,0 1,62,000
00

• Note
After getting accustomed to accounting we avoid using the word a/c in the Ledger accounts, Trial
Balance, Balance Sheet and other places where we do not find it essential, just to make the
statements and the ledger accounts look more appealing.
• Preparation of the Balance Sheet
The Balance sheet is obtained by arranging the figures in the trial balance (ledger accounts left
after having ascertained the profits) in an order. One simple rule of arrangement is "The accounts
with debit balances on the assets side and the accounts with credit balances on the liabilities side".
[As you move forward you will notice that we violate this rule at times to derive additional
information.]
The Balance Sheet drawn from the above Trial Balance would be:

Balance Sheet of M/s Trinity Foods as on 30th June 2005

A
Amou m
Liabilities Assets
nt ou
nt

Capital 1,00, Cash 1


Ram 000 Bank 0,
Trading& Profit/Loss 15,00 Furniture 0
0 Rahim 0
47,00 0
00 7
7,
0
0
0
2
5,
0
0
0
0
5
0,
0
0
0

1,
6
1,62, 2,
000 0
0
0

Be conscious of the fact that the Balance Sheet is just a statement and not a ledger account.
We are not transferring the balances in the real and personal accounts into the balance sheet. We
are only showing them here.

Combined Trading and Profit and Loss Account (a/c)

The "Trading and Profit & Loss a/c" is prepared by transferring the balances in all the nominal
accounts to it. This amounts to setting off all the debit balances and the credit balances to obtain
the profit/loss made. Thus the "Trading and Profit & Loss a/c" gives us the information relating to
the profits available after setting off all expenses/losses with all incomes/gains.
» Information obtained from the Trading and Profit and Loss a/c
The "Trading and Profit & Loss a/c" that is prepared to ascertain the profits or losses made by the
organisation gives us the information relating to the overall profit or loss made by the organisation.
» Illustrative Explanation
The following is the information relating to the Nominal accounts in an organisation for four
accounting periods (calendar year being its accounting period)

Account Head 2002 2003 2004 2005

Purchases 2,00,00 2,40,000 3,25,000 4,00,000


Salaries 0 18,000 28,000 32,000
Rent 15,000 18,000 24,000 30,000
Interest 12,000 96,000 1,35,000 1,65,000
Sales 80,000 3,60,000 4,87,500 6,00,000
3,00,00
0

If we are making a single "Trading and Profit & Loss a/c" the profits/losses made by the
organisation would be:

Account Head 2002 2003 2004 2005

Incomes:
Sales 3,00,000 3,60,000 4,87,500 6,00,000
Total 3,00,000 3,60,000 4,87,500 6,00,000
Expenses:
Purchases 2,00,000 2,40,000 3,25,000 4,00,000
Salaries 15,000 18,000 28,000 32,000
Rent 12,000 18,000 24,000 30,000
Interest 80,000 96,000 1,35,000 1,65,000
Total 3,07,000 3,72,000 5,12,000 6,27,000
Profit/Loss:
Income − Expenditure − 7,000 − 12,000 − 24,500 − 27,000
The profits ascertained through this method indicate a growing loss over the years. If, the
organisation should take a decision to whether to continue with the business or not, it has to opt for
moving out of the business.
» Combined Trading and Profit & Loss a/c
The same information pertaining to a particular year presented in the Trading and Profit and Loss
account would be

Dr Trading and Profit & Loss a/c (for the year 2003) Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

31/12/0 To Purchases – 2,40,000 31/12/0 By Sales a/c – 3,60,000


3 To Salaries – 18,000 3
" To Rent – 18,000 By Bal (Loss) – 12,000
" To Interest – 96,000

Total 3,72,000 Total 3,72,000

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Limitations of the Combined Account »


Remedy

The combined Trading and Profit and Loss Account gives an overall comprehensive view of the
profits or losses.
» Profits influenced by Events not related to Operations
The expenses/losses that are to be borne by the organisation may not be directly related to its
operations.
For example, where the organisation has incurred a loss on account one of its vehicles getting
damaged because of an accident, it has to absorb this loss as it is related to the organisation. This
loss is also considered in ascertaining the overall profit or loss made by the organisation.
But, this loss is not directly related to the business operations of the organisation. This loss is not
on account of conducting the business in the normal course, but an abnormal one.
» Information used in Decision Making
Profits/Losses are figures based on which a number of business decisions are taken.
Since, the overall profit/loss is a figure that is influenced by a number of factors which may not be
directly related to the business operations, any decisions made based on that figure may be
detrimental to the organisation.
» Remedy : Segregating Trading and Profit & Loss accounts
To arrive at a profit/loss figure that would take into consideration only the basic business
operations, the nominal accounts that are considered in the process of preparation of the "Trading
and Profit &Loss a/c" are grouped into two.
The first set of accounts are related to a ledger account by name "Trading a/c" and the remaining
accounts are related to another ledger account by name "Profit and Loss a/c".

The basic purpose of accounting is derivation of information and the more the
information we need, the more the accounting heads we need to maintain.
Breaking the Combined Trading and Profit & Loss
account into two Accounts

The same information relating to profits is broken down into two and derived at two different
stages. At the first stage, the profit from the core operations relating to the business is derived and
in the next stage the overall profits are derived.
» Segregating the Information
The information in the above statement giving the overall profit, segregated into two

Account Head 2002 2003 2004 2005

Direct Incomes:
Sales 3,00,000 3,60,000 4,87,500 6,00,000
Total 3,00,000 3,60,000 4,87,500 6,00,000
Direct Expenses:
Purchases 2,00,000 2,40,000 3,25,000 4,00,000
Total 2,00,000 2,40,000 3,25,000 4,00,000
Core Profit:
Direct Income − Direct 1,00,000 1,20,000 1,62,500 2,00,000
Exp.
Indirect Expenses: 18,000 18,000 28,000 32,000
Salaries 12,000 18,000 24,000 30,000
Rent 80,000 96,000 1,35,000 1,65,000
Interest 1,07,000 1,32,000 1,87,000 2,27,000
Total
Overall Profit: − 7,000 − 12,000 − 24,500 − 27,000
Core Profit − Indirect
Expenses.

If we look at the remade statement, we will be able to identify that the organisation is conducting a
business which is generating reasonably good amount of profits (50% on cost or around 33% on
sales). The turnover has been increasing, the core profit has been increasing, but the organisation
is ultimately making an overall loss.
The segregation of information also indicates that the business is good enough to be conducted, but
the indirect expenses are a reason for the loss being made by the organisation. This should make
the organisation think as to the real reason for the loss being made and take corrective steps or
actions if possible.
The organisation would be able to arrive at such conclusions only if the information is presented a
manner so as to reveal the basic/core profit and the overall profit figures separately.

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Trading and Profit & Loss


Accounts
Almost in all cases, there are two ledger accounts used in the exercise of ascertaining the profits
made by the organisation, (1) "Trading a/c" and (2) "Profit & Loss a/c". The information contained
in the combined "Trading and Profit & Loss a/c" is spread over the two accounts.
» Journal Entries » Preparation of "Trading a/c", "P/L a/c" Hide/Show
The journal entries relating to the preparation of separate "Trading a/c" and "Profit and Loss a/c"
would thus be as follows:

Journal in the books of M/s ___ for the period from ____ to ____

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

31st Dec – Trading a/c D – xxx


To Direct Expenses a/c r x xxxx

[For the transfer of debit balances


in the direct expenses accounts to
the Trading a/c.]

31st Dec – Direct Incomes a/c D – xxx


To Trading a/c r x xxxx

[For the transfer of credit


balances in the direct incomes
accounts to the Trading a/c.]

31st Dec – Trading a/c D – xxx


To Profit and Loss a/c r x xxxx

[For the transfer of Gross Profit to


the Profit and Loss a/c.]

31st Dec – Profit and Loss a/c D – xxx


To Trading a/c r x xxxx

[For the transfer of Gross Loss to


the Profit and Loss a/c.]

31st Dec – Profit and Loss a/c D – xxx


To Indirect r x xxxx
Expenses/Losses a/c –

[For the transfer of debit balances


in the indirect expenses accounts
and accounts indicative of losses
to the Profit and Loss a/c.]

31st Dec – Indirect Incomes/Gains a/c D – xxx


To Profit and Loss a/c r x xxxx
[For the transfer of credit –
balances in the indirect incomes
accounts and accounts indicative
of gains to the Profit and Loss
a/c.]

The two ledger accounts would therefore be

Dr Trading a/c [For the year 2003] Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Purchases 2,40,000 By Sales a/c 3,60,000


To Gross Profit 1,20,000

3,60,000 3,60,000

Dr Profit & Loss a/c [For the year 2003] Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Salaries 18,000 By Gross Profit 1,20,000


To Rent 18,000 By Net Loss 12,000
To Interest 96,000

1,32,000 1,32,00

The Trading and Profit and Loss accounts are generally shown together to indicate the flow of
information from one to another.

Dr Trading and Profit and Loss a/c [For the year 2003] Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Purchases 2,40,000 By Sales a/c 3,60,000


To Gross Profit 1,20,000

3,60,000 3,60,000

To Salaries 18,000 By Gross Profit 1,20,000


To Rent 18,000 By Net Loss 12,000
To Interest 96,000

1,32,000 1,32,00

• Note
Though the heading used here seems to indicate that it is a single account, it is in effect two
different accounts.
Trading Account : Gross Profit » Profit & Loss
Account : Net Profit

• Trading a/c : Gross Profit


The profit that is indicated as the Core/Basic Profit is what is called Gross Profit and that
information is provided by the "Trading a/c".
The "Trading a/c" is prepared to ascertain the Core (Gross) Profit relating to the business. It is
debited with the Direct Expenses and Credited with Direct Incomes, i.e. the balances of all the
nominal accounts representing Direct expenses and Direct Incomes are transferred to the Trading
a/c.
» Gross Profit
The profit/loss revealed by the "Trading a/c" is called "Gross" Profit/Loss.
The "Gross" Profit/Loss is transferred from the "Trading a/c" to the "Profit and Loss a/c" to enable
the ascertainment of the overall profit/loss.
• Profit and Loss a/c : Net Profit
The profit that is indicated as the overall profit is what is called Net Profit and that information is
provided by the "Profit and Loss a/c".
The "Profit and Loss a/c" is prepared to ascertain the Overall (Net) Profit relating to the business.
This account is created by transferring the Gross Profit/Loss from the "Trading a/c". It is also
debited with the Indirect Expenses and losses and Credited with Indirect Incomes i.e. the balances
of all the nominal accounts representing Indirect expenses, losses and Indirect Incomes are
transferred to the "Profit and Loss a/c".
» Net Profit
The profit/loss revealed by the "Profit and Loss a/c" is called "Net" Profit/Loss.
The "Net" Profit/Loss is transferred to the "Capital a/c" or the "Profit and Loss Appropriation a/c",
thereby closing the "Profit and Loss a/c".

Nature of Trading Account & Profit and Loss


Account

» Nominal Accounts
The "Trading a/c" and "Profit and Loss a/c" are ledger accounts derived by breaking up the
information in the "Trading and Profit & Loss a/c" i.e. these accounts together replace the "Trading
and Profit & Loss a/c". Since the "Trading and Profit & Loss a/c" is a nominal account, these two
accounts are also nominal accounts.

Any ledger account made to ascertain the profits or losses


made out of a set of transactions is a nominal account.

Balances in Trading a/c, Profit and Loss a/c

All the nominal accounts are closed at the end of the accounting period by
transfer to either the Trading a/c or the Profit and Loss a/c as the case may
be.
• Balance in Trading a/c
The "Trading a/c" is a nominal account. It is closed at the end of the accounting period by
transferring its balance (Gross profit/loss) to the "Profit and Loss a/c".
Thus the trading account can be placed on par with any other nominal account.
• Balance in Profit and Loss a/c
The Profit and Loss a/c is a nominal account. It is closed at the end of the accounting period by
transferring its balance to either the Capital a/c or the Profit and Loss Appropriation a/c (or
Retained Earnings a/c).
The "Trading a/c" and "Profit and Loss a/c" relating to a particular accounting period are
independent of similar accounts relating to any other accounting period.

Transfer of Profit and Loss a/c balance : To


Capital a/c

» Influence of Profits on Capital


Profits (including losses which can be understood as negative profits) are the returns for the risk
that Capital takes in business. Profits increase capital and losses decrease capital.
» Transfer to Capital a/c
The net profit belongs to the ownership of the business which is represented by the Capital account.
Therefore, the net profits or losses are ultimately transferred to the Capital account.
The Profit and Loss a/c is closed by transferring the balance to either the "Capital a/c".

Transfer of Profit and Loss a/c balance : To Profit and


Loss Appropriation a/c

At the time of starting the business, the owner invests certain amount as his capital contribution for
the business either in the form of cash or any other assets.
As time goes by, the organisation would be making profits or losses over the various accounting
periods that it passes through.
When profits or losses are transferred to the Capital account, the balance in that account increases
when there are profits and decreases when there are losses. Thus, the capital account balance is a
figure that gets altered by the amounts of profits and losses made over the years.
• Distinct Information
If the organisation intends to have the information relating to the contribution made by the owners
towards capital as well as the addition/shortage of capital that has accumulated in the business on
account of the profits/losses made by over the years (through its operations) separately, it would
transfer the profits or losses to a separate account by name "Profit and Loss appropriation a/c" or
"Retained Earnings a/c" instead of to the "Capital a/c".

The basic purpose of accounting is derivation of information and the more the
information we need, the more the accounting heads we need to maintain.

Transferring Profits » Illustration : Trading a/c, Profit


and Loss a/c
Consider the following ledger account balances relating to an accounting period

Trial Balance of M/s Razmataz Chemicals" as on 31st December


2005

De
bit
A
L m
Credit Amount
Particulars / ou
(in Rs)
F nt
(in
Rs
)

Opening Stock a/c – 20,


Purchases a/c 00
Salaries a/c – 0
Rent a/c 1,2
Wages a/c – 0,0
Carriage Inwards a/c 00
Cash a/c – 25,
Furniture a/c 00
Capital a/c – 0 1,84,000
Bank a/c 18,
Creditors a/c – 50 37,300
Sales a/c 0 3,32,000
Debtors a/c – 47,
Machinery a/c 00
Bank Loan a/c – 0 72,100
12,
– 40
0
– 24,
60
– 0
44,
– 00
0

75,
– 00
0

62,
90
0
1,7
6,0
00

6,2
Total 5,4 6,25,400
00
Trading a/c
Dr [of M/s Razmataz Chemicals for the period ending Cr
31st December 2005]

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000 By Sales a/c 3,32,000


To Purchases 1,20,000
To Wages a/c 47,000
To Carriage Inwards 12,400
a/c 1,32,600
To Gross Profit

3,32,000 3,32,000

Profit & Loss a/c


Dr [of M/s Razmataz Chemicals for the period ending Cr
31st December 2005]

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Salaries 25,000 By Gross Profit 1,32,600


To Rent 18,500
To Net Profit 89,100

1,32,600 1,32,600

Transfer of Net Profit : To


Capital a/c

The P/L a/c shows a credit balance when there are profits.
Transferring a credit balance from one account to a second would result in the second account
being credited and the first account being debited.
» Journal
The journal entry for transfer of the net profit from P/L a/c to the Capital a/c would therefore be

Journal in the books of M/s Razmataz Chemicals for the period from __ to
31st December 2005

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

1st to 30th – Profit and Loss a/c D – 89,


To Capital a/c r 10 89,100
– 0

[For the transfer of the net profit


to the capital account.]

» Ledger
Dr Capital a/c Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

30/06/0 To Bal c/d – 2,73,100 __-31st By bal b/d – 1,84,000


5 31/12/0 By Net Profit – 89,100
5

Total 2,73,100 Total 2,73,100

01/01/0
By Balance b/d – 2,73,100
6

• Trial Balance and Balance Sheet » Hide/Show

» Trial Balance
The "Trial Balance" redrawn after closing the "Profit and Loss a/c"

Trial Balance of M/s Razmataz Chemicals" as on 31st December


2005

De
bit
A
L m
Credit Amount
Particulars / ou
(in Rs)
F nt
(in
Rs
)

Cash a/c – 24,


Furniture a/c 60
Capital a/c – 0 2,73,100
Bank a/c 44,
Creditors a/c – 00 37,300
Debtors a/c 0
Machinery a/c –
Bank Loan a/c 75, 72,100
– 00
0

62,
– 90
0
– 1,7
6,0
00

3,8
Total 2,5 3,82,500
00

» Balance Sheet
Balance Sheet of M/s Razmataz Chemicals" as on 31-12-2005

A
Amou m
Liabilities Assets
nt ou
nt

Capital 2,73, Cash 2


Creditors 100 Bank 4,
Bank Loan 37,30 Furniture 6
0 Debtors 0
72,10 Machinery 0
0 7
5,
0
0
0
4
4,
0
0
0
6
2,
9
0
0
1,
7
6,
0
0
0

3,
8
3,82, 2,
500 5
0
0

Transfer of Net Profit : To Profit and Loss


Appropriation a/c
The P/L a/c shows a credit balance when there are profits.
Transferring a credit balance from one account to a second would result in the second account
being credited and the first account being debited.
» Journal
The journal entry for transfer of the net profit from P/L a/c to the "Profit and Loss Appropriation
a/c" would be

Journal in the books of M/s Trinity Foods for the period from 1st June 2005
to 30th June 2005

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

1st to 30th – Profit and Loss a/c D – 47,


To Profit and Loss r 00 47,000
Appropriation a/c – 0

[For the transfer of the net profit


to the profit and loss
appropriation account.]

» Ledger
Dr Profit and Loss Appropriation a/c Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

30/06/0 To Bal c/d – 47,000 30/06/0 By Net Profit – 47,000


5 5

Total 47,000 Total 47,000

30/06/0
By Balance b/d – 47,000
5

• Trial Balance and Balance Sheet » Hide/Show

» Trial Balance
The "Trial Balance" redrawn after closing the "Profit and Loss a/c" in this case would be

Trial Balance of M/s Razmataz Chemicals" as on 31st December


2005

De
L bit
Credit Amount
Particulars / A
(in Rs)
Fm
ou
nt
(in
Rs
)

Cash a/c – 24,


Furniture a/c 60
Capital a/c – 0 1,84,000
Bank a/c 44,
Creditors a/c – 00 37,300
Debtors a/c 0
Machinery a/c –
Bank Loan a/c 75, 72,100
Profit and Loss Appropriation a/c – 00 89,100
0

62,
– 90
0
– 1,7
6,0
– 00

3,8
Total 2,5 3,82,500
00

» Balance Sheet
Balance Sheet of M/s Razmataz Chemicals" as on 31-12-2005

A
Amou m
Liabilities Assets
nt ou
nt

Capital 1,84, Cash 2


P & L Appropriation 000 Bank 4,
Creditors 89,10 Furniture 6
Bank Loan 0 Debtors 0
37,30 Machinery 0
0 7
72,10 5,
0 0
0
0
4
4,
0
0
0
6
2,
9
0
0
1,
7
6,
0
0
0

3,
8
3,82, 2,
500 5
0
0

• Alternative
Balance Sheet of M/s Razmataz Chemicals" as on 31-12-2005

A
Amou Amo mo
Liabilities Assets Amount
nt unt un
t

Capital 1,84,0 Cash 24,600


(Add:) P & L 00 2,73, Bank 75,000
Appropriation 89,10 100 Furniture 44,000
Creditors 0 37,3 Debtors 62,900
Bank Loan 00 Machinery 1,76,000
72,1
00

3,82,
3,82,500
500

The basic purpose of accounting is derivation of information. Where the organisation feels that in
addition to having the information relating to the Capital a/c and the accumulated profits separately,
it also needs to know the total amount of capital available with it (including accumulations), the two
accounts are clubbed and shown in the Balance Sheet.
Since here both the accounts lie on the same side of the balance sheet, the two amounts are added
up.

Transferring Net Loss » Trading a/c, Profit and


Loss a/c

Consider the following ledger account balances relating to an organisations accounting

Trial Balance of M/s Razmataz Chemicals" as on 31st December


2005

Particulars L De Credit Amount


/ bit (in Rs)
FA
m
ou
nt
(in
Rs
)

Opening Stock a/c – 50,


Purchases a/c 00
Salaries a/c – 0
Postage & Stationary a/c 2,3
Wages a/c – 5,0
Carriage Outwards a/c 00
Rent & Insurance a/c – 48,
Cash a/c 00
Furniture a/c – 0
Capital a/c 8,5 2,50,000
Bank a/c – 00
Creditors a/c 15, 58,250
Sales a/c – 00 2,63,400
Debtors a/c 0
Land and Buildings a/c – 24,
Debenture Loan a/c 40 2,02,100
– 0
18,
– 25
0
– 86,
00
– 0
24,
– 00
0

61,
– 00
0

58,
60
0
1,4
5,0
00

7,7
Total 3,7 7,73,750
50

Trading a/c
Dr [of M/s Razmataz Chemicals for the period ending Cr
31st December 2005]

Amount Amount
Particulars Particulars
(in Rs) (in Rs)
To Opening Stock 50,000 By Sales 2,63,400
To Purchases 2,35,000 36,600
To Wages a/c 15,000 By Gross Loss
To Gross Profit

3,00,000 3,00,000

Profit & Loss a/c


Dr [of M/s Razmataz Chemicals for the period ending Cr
31st December 2005]

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Gross Loss 36,600 By Net Loss 1,35,750


To Salaries 48,000
To Postage and 8,500
Stationery 24,400
To Carriage Outwards 18,250
To Rent and Insurance

1,35,750 1,35,750

Transfer of Net Loss : To


Capital a/c

The P/L a/c shows a debit balance when there are losses.
Transferring a debit balance from one account to a second would result in the second account being
debited and the first account being credited.
» Journal
The journal entry for transfer of the net loss from P/L a/c to the Capital a/c would be

Journal in the books of M/s _____ for the period ending 32st December 2005

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

1st to 30th – Capital a/c D – 1,3


To Profit and Loss a/c r 5,7 1,35,750
– 50

[For the transfer of the net loss


to the capital account.]

» Ledger
Dr Capital a/c Cr
J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

31/12/0 To Net Loss – 1,35,750 31/12/0 By Balance b/d – 2,50,000


5 To Bal c/d – 1,14,250 5
31/12/0
5

Total 2,50,000 Total 2,50,000

01/07/0
By Balance b/d – 1,14,250
5

• Trial Balance and Balance Sheet » Hide/Show

» Trial Balance
The "Trial Balance" redrawn after closing the "Profit and Loss a/c"

Trial Balance of M/s Razmataz Chemicals" as on 31st December


2005

De
bit
A
L m
Credit Amount
Particulars / ou
(in Rs)
F nt
(in
Rs
)

Cash a/c – 86,


Furniture a/c 00
Capital a/c – 0 1,14,250
Bank a/c 24,
Creditors a/c – 00 58,250
Debtors a/c 0
Land and Buildings a/c –
Debenture Loan a/c 61, 2,02,100
– 00
0

58,
– 60
0
– 1,4
5,0
00

3,7
Total 4,6 3,74,600
00

» Balance Sheet
Balance Sheet of M/s Razmataz Chemicals" as on 31-12-2005

A
Amou m
Liabilities Assets
nt ou
nt

Capital 1,14, Cash 8


Creditors 250 Bank 6,
Debenture Loan 58,25 Furniture 0
0 Debtors 0
2,02, Land and 0
100 Buildings 6
1,
0
0
0
2
4,
0
0
0
5
8,
6
0
0
1,
4
5,
0
0
0

3,
7
3,74, 4,
600 6
0
0

Transfer of Net Loss : To Profit and Loss


Appropriation a/c
The P/L a/c shows a debit balance when there are losses.
Transferring a debit balance from one account to a second would result in the second account being
debited and the first account being credited.
» Journal
The journal entry for transfer of the net loss from P/L a/c to Profit and Loss Appropriation a/c
would be

Journal in the books of M/s _____ for the period ending 32st December 2005

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

1st to 30th – Profit and Loss Appropriation D – 1,3


a/c r 5,7 1,35,750
To Profit and Loss a/c – 50

[For the transfer of the net loss


to the profit and loss
appropriation account.]

» Ledger
Dr Profit and Loss Appropriation a/c Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

31/12/0 To Net Loss – 1,35,750 31/12/0 By Balance c/d – 1,35,750


5 5

Total 1,35,750 Total 1,35,750

30/06/0
To Balance b/d – 1,35,750
5

• Trial Balance and Balance Sheet » Hide/Show

» Trial Balance
The "Trial Balance" redrawn after closing the "Profit and Loss a/c"

Trial Balance of M/s Razmataz Chemicals" as on 31st December


2005

De
bit
L A
Credit Amount
Particulars / m
(in Rs)
F ou
nt
(in
Rs
)

Cash a/c – 86,


Furniture a/c 00
Capital a/c – 0 2,50,000
Bank a/c 24,
Creditors a/c – 00 58,250
Debtors a/c 0
Land and Buildings a/c –
Debenture Loan a/c 61, 2,02,100
Profit and Loss Appropriation a/c – 00
0

58,
– 60
0
– 1,4
5,0
– 00

1,3
5,7
50

5,1
Total 0,3 5,10,350
50

» Balance Sheet
Balance Sheet of M/s Razmataz Chemicals" as on 31-12-2005

A
Amou m
Liabilities Assets
nt ou
nt

Capital 2,50, Cash 8


Creditors 000 Bank 6,
Debenture Loan 58,25 Furniture 0
0 Debtors 0
2,02, Land and 0
100 Buildings 6
P&L 1,
Appropriatio 0
n 0
0
2
4,
0
0
0
5
8,
6
0
0
1,
4
5,
0
0
0
1,
3
5,
7
5
0

5,
1
5,10, 0,
350 3
5
0

• Alternative
Balance Sheet of M/s Razmataz Chemicals" as on 31-12-2005

Am
Amou Amo
Liabilities Assets ou Amount
nt unt
nt

Capital 2,50,0 Cash 86,000


(Less:) P & L Appropr. 00 1,14, Bank 61,000
Creditors 1,35,7 250 Furniture 24,000
Debenture Loan 50 2,02, Debtors 58,600
100 Land and 1,45,000
Buildings

3,74,
3,74,600
600

The basic purpose of accounting is derivation of information. Where the organisation feels that in
addition to having the information relating to the Capital a/c and the accumulated profits separately,
it also needs to know the total amount of capital available with it (including accumulations), the two
accounts are clubbed and shown in the Balance Sheet.
Since here both the accounts lie on different sides of the balance sheet, the two amounts are set off.

Showing an item on a particular side and deducting the item from another item
on the opposite side of the balance sheet would give the same effect.

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Using the phrases Net Profit, Net Loss in Ledger


Postings
If we post the Journal entry for transferring
The profit from the "Profit & Loss a/c"
To Capital a/c
The posting on
The debit side of Profit and Loss a/c should read "To Capital a/c"
The credit side of Capital a/c should read "By Profit and Loss a/c"
To Profit and Loss Appropriation a/c
The posting on
The debit side of Profit and Loss a/c should read "To Profit and Loss Appropriation a/c"
The credit side of Profit and Loss Appropriation a/c should read "By Profit and Loss a/c"
The loss from the "Profit & Loss a/c"
To Capital a/c
The posting on
The credit side of Profit and Loss a/c should read "By Capital a/c"
The debit side of Capital a/c should read "To Profit and Loss a/c"
To Profit and Loss Appropriation a/c
The posting on
The credit side of Profit and Loss a/c should read "By Profit and Loss Appropriation a/c"
The debit side of Profit and Loss Appropriation a/c should read "To Profit and Loss a/c"
» Postings only indicate transfer of balances
These postings only give us an idea that there is a transfer from the "Profit and Loss a/c" to the
"Capital a/c" or "Profit & Loss Appropriation a/c". They do not indicate the reason (idea of why the
posting is being made) for the transfer and the direction of transfer.
Consider the journal entry for transfer of net profit from the profit and loss account to the capital
account

Journal in the books of M/s Razmataz Chemicals for the period from __ to
31st December 2005

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

1st to 30th – Profit and Loss a/c D – 89,


To Capital a/c r 10 89,100
– 0

This can be interpreted as


Transfer of Credit balance From Profit and Loss a/c To Capital a/c
Transferring a credit balance from one account to a second would result in the second account
being credited and the first account being debited.
Transfer of Debit balance From Capital a/c To Profit and Loss a/c
Transferring a debit balance from one account to a second would result in the second account being
debited and the first account being credited.
• Deriving Additional Information
The basic purpose of accounting is derivation of information. The more the
information we need, the more the accounting heads we need to maintain.

Therefore, to give us the additional information relating to the reason and direction of transfer, we
create and use additional ledger accounts by name "Net Profit a/c" and "Net Loss a/c".
» To/By Net Profit
The Net Profit from the Profit and Loss a/c is transferred to the Net Profit a/c and from there to the
Capital a/c or the Profit and Loss Appropriation a/c.
By using this additional account we can ensure that the postings would read To Net Profit in the
Profit and Loss account and By Net Profit in the Capital or Appropriation accounts.
Journal/Ledger » Hide/Show

Journal in the books of M/s Razmataz Chemicals for the period from ___ to
31st December 2005

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

1st to 30th – Profit and Loss a/c D – 47,


To Net Profit a/c r 00 47,000
– 0

[For the transfer of the net profit


to the Net Profit account.]

1st to 30th – Net Profit a/c D – 89,


To Profit and Loss r 10 89,100
Appropriation a/c – 0
(Or) Capital a/c

[For the transfer of the net profit


from the Net Profit account to
the capital account or the profit
and loss appropriation account.]

Dr Net Profit a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Capital a/c – 89,100 31/12/05 By Profit & Loss – 89,100


(Or) a/c
To P/L Appropr.
a/c

Total 89,100 Total 89,100

The Profit and Loss a/c would straight away reveal the information that there is Net Profit and has
been transferred. The Capital a/c or the Profit and Loss Appropriation a/c would reveal the
information that Net Profit has been received by transfer.
» To/By Net Loss
The Net Loss from the Profit and Loss a/c is transferred to the Net Loss a/c and from there to the
Capital a/c or the Profit and Loss Appropriation a/c.
By using this additional account we can ensure that the postings would read By Net Loss in the
Profit and Loss a/c and To Net Loss in the Capital or Profit and Loss Appropriation accounts.
Journal/Ledger » Hide/Show
Journal in the books of M/s Razmataz Chemicals for the period from ___ to
31st December 2005

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

1st to 30th – Net Loss a/c D – 1,3


To Profit & Loss a/c r 5,7 1,35,750
– 50

[For the transfer of the net loss


to the Net Loss account.]

1st to 30th – Profit and Loss Appropriation D – 1,3


a/c r 5,7 1,35,750
To Net Loss a/c – 50

[For the transfer of the net loss


from the Net Loss account to the
profit and loss appropriation
account.]

Dr Net Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Profit & Loss – 1,35,750 31/12/05 By P/L Appropr. – 1,35,750


a/c a/c

Total 1,35,750 Total 1,35,750

The Profit and Loss a/c would straight away reveal the information that there is Net Loss and has
been transferred. The Capital a/c or the Profit and Loss Appropriation a/c would reveal the
information that Net Loss has been received by transfer.

Net Profit a/c, Net Loss a/c » Control


accounts

• Control Accounts
Accounts which are created and closed instantaneously and whose sole purpose is to enable the
derivation of greater information are called "Control Accounts".
Use of Controlling accounts is a procedure that we adopt frequently in accounting.
• Manual Accounting
In manual accounting, we just assume the presence of such accounts and use the useful phrases
wherever needed. We do not record the journal entries relating to these and carry on posting as if
we have recorded the journal.
• Computerised Accounting
If you intend to make use of such a facility in computerised accounting, care should be taken to
ensure that all the relevant controlling accounts are created and the required journal entries are
passed.

Profit & Loss Appropriation a/c » Special Nominal


account

• A Nominal Account
If Profit & Loss Appropriation a/c is maintained, the Net profit or loss revealed by the Profit and
Loss a/c in every accounting period is transferred to that account. Thus the accumulated balance in
the Profit & Loss Appropriation a/c also indicates either a profit or loss which qualifies it to be
called a nominal account.

All the nominal accounts are closed at the end of the accounting period by
transfer to either the Trading a/c or the Profit and Loss a/c as the case may
be.

However, the Profit & Loss Appropriation a/c, though a nominal account is not closed. The balance
in that account is carried over to the subsequent accounting periods just like balances in the case of
Real or Personal accounts.
With regard to this characteristic, the Profit & Loss Appropriation a/c is a special account.
• Special Nominal Accounts
Nominal accounts which are not closed at the end of the accounting period and whose balances are
carried forward from one accounting period to another as "Special Nominal accounts". Balances of
these accounts, appear in the balance sheet along with the other Real and Personal account
balances.

Trial Balance » What? Why? When?


• What is a Trial Balance
The Trial Balance is a statement of ledger account balances as on a particular instance.

Trial Balance of M/s Wearall Textlies as on 31st March 2006

De
bit
A
L m
Credit Amount
Particulars / ou
(in Rs)
F nt
(in
Rs
)

Opening Stock – 63,


Textile Purchases 65
Wages – 0
Octroi 22,
Salaries – 56,
Rent 00
Printing and Stationery – 0
Advertisements 3,2
Cash – 5,0
Office Building 00
Capital – 1,7 2,50,000
Bank 8,2
Motor Vehicles – 00
Sundry Creditors 1,0 1,80,000
Sales – 4,0 36,86,000
P/L Appropriation 00 6,52,950
Sundry Debtors – 1,2
Machinery 6,0
– 00
74,
– 65
0
– 86,
00
– 0
26,
– 00
0
– 4,2
3,4
– 50

– 1,1
9,0
– 00
2,1
0,0
00

2,0
8,0
f
00 i
5,6 n
9,0 a
00 l
,
a
47, c
68, c
Total 95
47,68,950 o
0 u
n
• Why is a Trial Balance prepared? t
s
The trial balance is prepared to check/ensure the arithmetical accuracy of accounting. Though
,
not a conclusive proof, the agreement of the trial balance is a prima facie evidence of the
f
absence of mathematical errors.
i
This is the most important purpose for which the trial balance is prepared.
n
» Isn't Trial Balance made for enabling preparation of Final a
Accounts? n
No, not at all. c
Preparation of Trial Balance is not an act that forms a part of the activities involved in the regular i
accounting cycle. Since Final Accounting can be completed without the preparation of the Trial a
Balance, we can say that enabling the preparation of final accounts is not the purpose of the trial l
balance. ,
a
c
• When is a Trial Balance prepared? c
The trial balance is generally prepared at a time when all the ledger accounts are balanced like at o
the end of the accounting period. u
Theoretically, the trial balance can be prepared as and when needed. n
The practical difficulty in preparing the trial balance as and when needed is the requirement of t
the balances of all the ledger accounts within the organisational accounting system. Different i
ledger accounts are balanced at different time intervals based on the information needs of the n
organisation. Say in a typical organisation Cash a/c is balanced daily, Expenses, Creditor and g
Debtor accounts are balanced on a monthly basis, Asset accounts are balanced annually etc. ,
The ledger account balances relating to all ledger accounts would not be available ready hand at t
any given instance. Year ending is one such instance when the balances are derived. r
a
» Computerised Accounting d
In mechanised (computerised) accounting systems, trial balance is a statement that can be
i
automatically derived as and when needed.
n
g
,
p
r
o
f
i
t
,
l
o
s
s
,
a
c
c
o
u
n
t
,
b
a
l
a
n
c
e
,
s
Accounting Cycle » Absence of Preparation of Trial
Balance

Preparation of a trial balance is not an act which forms a part of the activities involved in the
accounting cycle.
The Accounting Cycle (activities involved)
Begins with opening the books of accounts for an accounting period by recording the opening entry;

Journal in the books of M/s Amonaya Metals for the period from 1st January
2007 to ____

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

1st January – Assets a/c D – –


To Liabilities a/c r –
To Capital a/c – –


[For bringing the balances in the
various ledger accounts at the
end of the previous accounting
period into books.]

This is the journal entry that supports the posting To Balance b/d and By Balance b/d in the various
ledger accounts.
Recording the various transactions all through out the accounting period;
Balancing the ledgers as and when needed and finally at the end of the accounting period;
Recording the transactions for making up the final accounts
Making the Trading a/c
Closing the Trading a/c by transferring the balance in it to Profit & Loss a/c
Making the Profit and Loss a/c
Closing the Profit and Loss a/c by transferring the balance in it to Capital a/c (or Profit and Loss
Appropriation a/c)
Preparing the Balance sheet (A statement of balances in all the ledger accounts that remain after
making up and closing the Trading and Profit & Loss a/c.)
The accounting cycle ends with recording the closing entry for closing the books of accounts.

Journal in the books of M/s Amonaya Metals for the period from 1st Jan to
31st Dec 2007

Debit
Amo
V/R L/ Credit Amount
Date Particulars unt
No. F (in Rs)
(in
Rs)

31st – Liabilities a/c D – –


December Capital a/c r –
To Assets a/c – –


[For carrying the balances in
the various ledger accounts
at the end of the accounting
period to the subsequent
accounting period.]

This is the journal entry that supports the posting To Balance c/d and By Balance c/d in the various
ledger accounts.

Final Accounting : Use of


Journal/Ledger

Final Accounting deals with all the ledger account balances at the end of the accounting period in
one way or the other.
All the Nominal accounts that represent direct expenses and direct incomes are closed by transfer
to the Trading a/c.
For this at least two journal entries are recorded.
The Trading a/c is closed by transferring its balance to the Profit and Loss a/c.
For this a journal entry is recorded.
All the Nominal accounts that represent indirect expenses, losses and indirect Incomes are closed
by transfer to the Profit and Loss a/c.
For this at least two journal entries are recorded.
The Profit & Loss a/c is closed by transferring its balance to either the Capital a/c or Profit & Loss
Appropriation a/c.
For this a journal entry is recorded.
All the remaining accounts are listed out in the Balance Sheet.
A closing entry is recorded in relation to this, though it is not directly related to preparing the
balance sheet.
If the Final Accounting is to be done in a systematic manner, then all the journal entries mentioned
above are to be recorded and all the ledger accounts that are affected by those transactions are to
be posted to and updated. That would result in the making up of the Trading a/c and Profit and Loss
a/c. The balance sheet is prepared by drawing up a statement of ledger account balances carried
forward through the closing entry.

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Final Accounting : Use of Trial Balance : Avoiding


Journal/Ledger

In manual accounting, the Trading a/c, Profit & Loss a/c and the Balance Sheets can also be
prepared using the information in the Trial Balance avoiding the act of journalising the transactions
involved in final accounting.
This is done by showing each item in the ledger accounts (Trading, P/L a/c) or the statement
(Balance Sheet) where it would be ultimately appearing had the actual procedure been adopted.
This would have the same affect as recording the journal and posting into the ledger.
» Example
The balance in the Carriage Inwards a/c (direct expenditure) is transferred to the Trading a/c by
recording a Journal entry. By this, the Carriage Inwards a/c would get closed (its balance becomes
zero) and the Trading a/c would get debited with that balance. In preparing the Trading a/c the
balance in the Carriage Inwards a/c can be ascertained from the Trial Balance and shown on the
debit side of Trading a/c.
» Reduction of Work involved in Manual Accounting
Since not recording the related journal entries makes no difference as far as final accounting is
concerned, in almost all cases in manual accounting, the process of recording the journal entries
required for final accounting and updating the ledger is bypassed to reduce the burden of the work
involved.

Information in Trial Balance » To be dealt with


only once

In making up final accounts using the information in the Trial Balance, we should ensure that each
item of information (representing a ledger account balance) should be dealt with only once.
In final accounting each piece of information can appear either on the debit or credit sides of the
Trading a/c or "Profit & Loss a/c" or on the assets or liabilities side of the "Balance Sheet".

Each item from the Trial Balance should be dealt with only once in Final Accounting.

• Interpreting the items in the Trial Balance


A statement for interpretation of the various ledger account balances in the above trial balance

Trial Balance of M/s Wearall Textlies as on 31/03/06 » Statement of Analysis

Ba
la
W
nc
Acco hi
Descriptio e Wh
Account unt ch Amount
n N ere
Type Si
at
de
ur
e

Opening Stock Direct Nomin De Trad De 63,650


Textile Purchases Expenses al bit ing bit 22,56,000
Wages Direct Nomin De a/c De 3,25,000
Octroi Expenses al bit Trad bit 1,78,200
Salaries Direct Nomin De ing De 1,04,000
Rent Expenses al bit a/c bit 1,26,000
Printing and Direct Nomin De Trad De 74,650
Stationery Expenses al bit ing bit 86,000
Advertisements Indirect Nomin De a/c De 26,000
Cash Expenses al bit Trad bit 4,23,450
Office Building Indirect Nomin De ing De 2,50,000
Capital Expenses al bit a/c bit 1,19,000
Bank Indirect Nomin De P/L De 2,10,000
Motor Vehicles Expenses al bit a/c bit 1,80,000
Sundry Creditors Indirect Nomin De P/L De 36,86,000
Sales Expenses al bit a/c bit 6,52,950
P/L Appropriation Asset Real De P/L As 2,08,000
Sundry Debtors Asset Real bit a/c se 5,69,000
Machinery Liability Person De P/L ts
Liability/Ass al bit a/c As
et Person Cr B/S se
Asset al edi B/S ts
Liability Real t B/S Li
Direct Person De B/S ab
Incomes al bit B/S ilit
Accumulatd Nomin De B/S ie
Profit al bit Trad s
Asset Spl. Cr ing As
Asset Nomin edi a/c se
al t B/S ts
Person Cr B/S As
al edi B/S se
Real t ts
Cr Li
edi ab
t ilit
De ie
bit s
De Cr
bit ed
it
Li
ab
ilit
ie
s
As
se
ts
As
se
ts

• Making up the Final Accounts


Final Accounting using the information in a Trial Balance involves nothing more than putting the
right items in the right places i.e. on the appropriate side of Trading a/c, Profit and Loss a/c or the
Balance Sheet.

Trading and Profit & Loss a/c [For the year ending
Dr Cr
31/03/06]

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 63,650 By Sales 36,86,000


To Textile Purchases 22,56,000
To Wages 3,25,000
To Octroi 1,78,200
To Gross Profit 8,63,150

36,86,000 36,86,000

To Salaries 1,04,000 By Gross Profit 8,63,150


To Rent 1,26,000
To Printing and 74,650
Stationery 86,000
To Advertisements 4,72,500
To Net Profit

8,63,150 8,63,150

Balance Sheet of M/s Wearall Textlies as on 31st March 2006

Liabilities Amou Assets A


nt m
ou
nt

Capital 2,50, Cash 2


Sundry Creditors 000 Bank 6,
P/L Appropriation 1,80, Office 0
[6,52,950 + 4,72,500] 000 Building 0
11,25 Motor 0
,450 Vehicles 4,
Sundry 2
Debtors 3,
Machinery 4
5
0
1,
1
9,
0
0
0
2,
1
0,
0
0
0
2,
0
8,
0
0
0
5,
6
9,
0
0
0

1
5,
5
15,55
5,
,450
4
5
0

Care in dealing with Profit and Loss Appropriation a/c


(or Capital a/c)

The balance in the "Profit & Loss Appropriation a/c" as shown in the Trial Balance represents the
balance carried forward from the previous accounting period (i.e. year ending 31st March 2005).
The Profit and Loss a/c relating to the current period is closed by transfer its balance to the "Profit
& Loss Appropriation a/c"

Dr Profit and Loss Appropriation a/c Cr


J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

31/03/0 To Bal c/d – 11,25,450 31/03/0 By Bal b/d – 6,52,950


6 6 By Net Profit – 4,72,500
31/03/0
6

Total 11,25,450 Total 11,25,450

01/04/0
By Balance b/d – 11,25,450
6

Therefore, while showing the information (balance) relating to the Profit & Loss Appropriation a/c
in the Balance sheet, care should be taken to make appropriate adjustment to the balance on
account of the transfer of balance from the Profit and Loss a/c.
The balance that appears in the balance sheet is not the one that appears in the trial balance, but
the one that takes into consideration the adjustment on account of current periods profit or loss
also.
If the balance in Profit and Loss a/c is transferred to the Capital a/c, then such a care should be
taken with regard to the Capital a/c balance.

Trial Balance used in Final Accounting : When


Prepared?

The Trial Balance is a statement of ledger account balances as on a particular date (instance).
Final Accounting is done towards the end of the accounting period.
The trial balance that we consider in the preparation of final accounts is the one that is prepared
towards the end of the accounting period i.e. on the last day of the accounting period.

Transactions after the Trial Balance


Date

There might be a number of accounting transactions which might not have been taken into
consideration by the time the Trial Balance has been prepared.
Some of the reasons for the presence of such transactions are
• Transactions which do not occur in the normal course of
business
There are a number of transactions relating to the business which do not occur in the normal course
of business. These transactions unless deliberately recorded do not get into the books of accounts.
Examples for such transactions
Stock taken away by the proprietor for personal use
Abnormal loss of stock
• Transactions which have to be recorded only towards the end
There are a number of transactions relating to the business which have to be recorded only at the
end of the accounting period. If the trial balance has been prepared before all such transactions into
consideration have been taken into consideration, then they stay unrecorded in the books of
accounts.
Depreciation on Assets
Expenses - Outstanding/Prepaid
Incomes - Outstanding/Pre-received
• Transactions relating to Error Rectifications
The agreement of a Trial Balance is not a conclusive proof of absence of errors in accounting. Even
in case where the trial balance agrees, there may still be errors existing in the books of accounts.
These errors if identified subsequent to the preparation of the Trial Balance, need to be rectified
which needs journal entries to be passed for rectification.

What are
Adjustments?

The transactions which have not yet been journalised, appended to the trial balance are what we
call adjustments.
Thus we can say that Adjustments are transactions relating to the business which have not been
journalised by the end of the accounting period.
• Illustration
Trial Balance of M/s Azaya Traders" as on 30th June 2006.

De
bit
A
L m
Credit Amount
Particulars / ou
(in Rs)
F nt
(in
Rs
)

Opening Stock – 86,


Purchases 00
Salaries – 0
Wages 11,
Carriage Inwards – 36,
Trading Charges 00
Carriage Outwards – 0
Rent received 1,5 1,78,300
Cash – 3,0
Capital 00 3,44,700
Bank (Overdraft) – 18, 37,980
Comission 00
Creditors – 0 2,68,000
Sales 26, 15,48,700
Debtors – 90
Machinery 0
– 64,
00
– 0
52,
– 50
0

62,
– 50
0

– 42,
78
– 0

2,5
6,0
00
4,8
0,0
00

23,
77,
Total 68
23,77,680
0

» Adjustments
The following additional information is available
A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet recorded
in the books.
Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.
The additional information presented after the trial balance contains information relating to
accounting transactions, which are to be identified from the wordings.

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Why are they called Adjustments? Why not


Additional Transactions?

Since adjustments are also transactions relating to the business, we need to bring them into the
accounting books by journalising them.
The trial balance is used for final accounting, so as to eliminate a lot of physical work (in manual
accounting) in the form of recording transactions for making up final accounts, posting them into
respective ledger accounts, balancing of ledger accounts effected by these transactions.
Therefore even for the purpose of bringing the transactions represented by the adjustments into
books a method has been designed which would not require us to record these transaction, post
them and balance the ledger accounts affected. This method incorporates the effect of the
transactions into the final accounts without having to go through the regular process of recording,
posting, balancing etc.
• Accounting for the Transactions
Recording the transactions represented by adjustments normally would result in the existing
balance in the affected ledger accounts to either increase or decrease.
» Transaction
Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.
This represents an error of principle whereby an expenditure that was to be debited in a particular
account has been debited to another account.
To bring the effect of this transaction into books, the journal entry to rectify this error has to be
recorded.
» Journal/Ledger Hide/Show
Journal in the books of M/s Azaya Traders for the year ending 30th June
2006

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

30/06/06 – Wages a/c D – 2,0


To Salaries a/c r 0,0 2,00,000
– 00

[For the transfer of wages


erroneously treated as salaries
from the "salaries a/c" to the
"Wages a/c".]

The transaction posted into the relevant ledger accounts

Dr Salaries a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

30/06/06 To Bal b/d – 1,53,000 30/06/06 By Wages – 43,000


– 30/06/06 Bal c/d 1,10,000

1,53,000 1,53,000

01/07/06 To Balance b/d – 1,10,000

Dr Wages a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

30/06/06 To Salaries a/c – 43,000 30/06/06 By Bal c/d – 43,000

43,000 43,000

01/07/06 To Balance b/d – 43,000

• The Method of Adjustment


This method involves identification of the effect and making mathematical adjustments in the
figures that we consider in final accounting (i.e. at the time of showing them in the Trading a/c or
Profit & Loss a/c or the Balance Sheet.).
» Effect of the Transaction
The effect of the journal entry to be recorded in the above case can be analysed as
(−) From Salaries on the debit side of P/L a/c
The Salaries a/c which already has a debit balance is credited which will result in a decrease in the
existing debit balance.
To bring the effect of this transaction, the amount involved in the transaction (Rs. 43,000) is
deducted from the Salaries a/c balance (Rs. 1,53,000) shown on the debit side of the "Profit & Loss
a/c".
(+) To Wages on the debit side of Trading a/c
The Wages a/c which already has a debit balance is debited resulting in an increase in the existing
debit balance.
To bring the effect of this transaction, the amount involved in the transaction (Rs. 43,000) is added
to the Wages a/c balance (Rs. 18,000) shown on the debit side of the "Trading a/c".
These are the adjustments to be made to bring the affect of the above transaction into the books of
accounts.
• Why call them Adjustment? Why not Additional Transactions?
Since the affect of these transactions is incorporated by mathematical adjustments, they are called
Adjustments rather than just Additional Transactions.

To make the Adjustment » Know the Journal


Entry

Adjustments are transactions relating to business which have not yet been
journalised.

Therefore, to make the adjustments one should have an idea of the journal entry related to the
transaction indicated by the adjustment.
If we know the Journal entry, we can identify the effect of the same on the ledger accounts and
thus be able to identify the adjustments to be made.
The adjustments are made at the time of making up the final accounts within the three parts that
make up the final accounting, i.e. the "Trading a/c", "Profit & Loss a/c" and the "Balance Sheet".

Illustration »
Problem

Draw up the final accounts from the following trial balance and the additional information that
follows it.

Trial Balance of M/s Azaya Traders" as on 30th June 2006.

De
bit
A
L m
Credit Amount
Particulars / ou
(in Rs)
F nt
(in
Rs
)

Opening Stock – 86,


Purchases 00
Salaries – 0
Wages 11,
Carriage Inwards – 36,
Trading Charges 00
Carriage Outwards – 0
Rent received 1,5 1,78,300
Cash – 3,0
Capital 00 3,44,700
Bank (Overdraft) – 18, 37,980
Comission 00
Creditors – 0 2,68,000
Sales 26, 15,48,700
Debtors – 90
Machinery 0
– 64,
00
– 0
52,
– 50
0

62,
– 50
0

– 42,
78
– 0

2,5
6,0
00
4,8
0,0
00

23,
77,
Total 68
23,77,680
0

The following additional information is available


A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet recorded
in the books.
Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.

Illustration » Working
Notes
An analysis of the various ledger accounts in the trial balance would enable us to decide what to be
done with each item in the trial balance.

Trial Balance of M/s Azaya Traders as on 30/06/06 » Statement of Analysis

Ba
Acc la W
oun nc ha
Wh
Account Description t e t Amount
ere
Typ Na Si
e tu de
re

Opening Stock Direct Nom De Tradi De 86,000


Purchases Expenses inal bit ng bit 11,36,000
Salaries Direct Nom De a/c De 1,53,000
Wages Expenses inal bit Tradi bit 18,000
Carriage Inwards Indirect Nom De ng De 26,900
Trading Charges Expenses inal bit a/c bit 64,000
Carriage Direct Nom De P/L De 52,500
Outwards Expenses inal bit a/c bit 1,78,300
Rent received Direct Nom De Tradi De 62,500
Cash Expenses inal bit ng bit 3,44,700
Capital Indirect Nom De a/c De 37,980
Bank (Overdraft) Expenses inal bit Tradi bit 42,780
Comission Indirect Nom De ng De 2,68,000
Creditors Expenses inal bit a/c bit 15,48,700
Sales Indirect Nom Cre P/L Cr 2,56,000
Debtors Incomes inal dit a/c ed 4,80,000
Machinery Asset Real De P/L it
Liability Pers bit a/c As
Liability onal Cre P/L se
Indirect Pers dit a/c ts
Expense onal Cre B/S Li
Liability Nom dit B/S ab
Direct inal De B/S ilit
Incomes Pers bit P/L ie
Asset onal Cre a/c s
Asset Nom dit B/S Li
inal Cre B/S ab
Pers dit B/S ilit
onal De B/S ie
Real bit s
De De
bit bit
Li
ab
ilit
ie
s
Cr
ed
it
As
se
ts
As
se
ts
An analysis of the additional transactions would enable us to identify what is to be done to
incorporate their effect in accounting.
A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet recorded
in the books.
Entry Effect

Dr. Machinery a/c 1. (+) To Machinery a/c on the Assets side of the Balance Sheet
Cr. Ramsay Machine Tools 2. (+) To Ramsay Machine Tools a/c on the Liabilities side of the
a/c Balance Sheet
Detailed Explanation Hide/Show

» Transaction
A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet
recorded in the books.
This represents an error of omission whereby a transaction has been omitted from being
recorded in the books.
To bring the effect of this transaction into books, the relevant journal entry has to be
recorded.
» Journal/Ledger
Journal in the books of M/s Azaya Traders for the year ending 30th June
2006

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

30/06/06 – Machinery a/c D – 2,0


To M/s Ramsay Machine r 0,0 2,00,000
Tools a/c – 00

[For the value of machine


purchased on credit.]

The transaction posted into the relevant ledger accounts

Dr Machinery a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

30/06/06 To Bal b/d – 4,80,000 30/06/06 By Bal c/d – 6,80,000


To Ramsay – 2,00,000
Machine
Tools

6,80,000 6,80,000

To Balance
01/07/06 – 6,80,000
b/d

Dr Ramsay Machine Tools a/c Cr


Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

30/06/06 To Bal c/d – 2,00,000 30/06/06 By Machine – 2,00,000


a/c

2,00,000 2,00,000

By Balance
01/07/06 – 2,00,000
b/d

» Effect of the Transaction


The effect of the journal entry to be recorded in the above case can be analysed as
(+) To Machinery a/c on the assets side of the Balance Sheet
The Machinery a/c which already has a debit balance is debited resulting in an increase in the
existing debit balance.
To bring the effect of this transaction, the amount involved in the transaction (Rs. 2,00,000)
is added to the Machinery a/c balance (Rs. 4,80,000) shown on the assets side of the
"Balance Sheet".
(+) To Ramsay Machine Tools a/c on the Liabilities side of the
Balance Sheet
Ramsay Machine Tools a/c (which is not present in the books i.e. it has no balance in it) is
credited resulting in the "Ramsay Machine Tools a/c" being created anew resulting in a credit
balance in the account.
Ramsay Machine Tools a/c is a personal account since it relates to an organisation. It has a
credit balance and therefore is an equivalent of a creditor. Thus it is to be shown on the
liabilities side of the Balance Sheet.
To bring the effect of this transaction, the amount involved in the transaction (Rs. 2,00,000)
is shown on the name of Ramsay Machine Tools on the liabilities side of the balance sheet.
We can also interpret this as adding the amount to the existing nil balance.
These are the adjustments to be made to bring the affect of the above transaction into the
books of accounts.

Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.


Entry Effect

Dr. Wages a/c 1. (+) To Wages a/c on the Debit side of the Trading a/c
Cr. Salaries a/c 2. (−) From Salaries a/c on he Debit side of the Profit an Loss a/c
Detailed Explanation Above

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Illustration »
Solution

Making up the final accounts would involve nothing more than putting the items from the trial
balance in the right places i.e. in either the "Trading a/c" or "Profit and Loss a/c" or the "Balance
Sheet" and making subsequent adjustments.

Trading and Profit & Loss a/c of M/s Azaya Traders for the year
Dr Cr
ending 30/06/06
Amount Amount Amount Amount
Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)

To Opening Stock 86,000 By Sales 15,48,700


To Purchases 11,36,000
To Wages 18,000
(+) Salary (Tr) 43,000 61,000
To Carriage 26,900
Inwards 2,38,800
To Gross Profit

15,48,700 15,48,700

To Salaries 1,53,000 By Gross Profit 2,38,800


(−) Tr. to 43,000 1,10,000 By Rent Received 1,78,300
Wages 64,000
To Trading 52,500
Charges 42,780
Carriage Outwards 1,47,820
To Comission
To Net Profit

4,17,100 4,17,100

Balance Sheet of M/s Azaya Tradrs as on 30th June 2006

A
Amou Amo mo
Liabilities Assets Amount
nt unt un
t

Capital 3,44,7 Cash 62,500


(+) Net Profit 00 4,92, Debtors 2,56,000
Bank (Overdraft) 1,47,8 520 Machinery 4,
Creditors 20 37,98 (+) New 80 6,80,000
(+) Due to M/s 0 Machine ,0
Ramsay 2,68,0 00
00 4,68, 2,
2,00,0 000 00
00 ,0
00

9,98,
9,98,500
500

The effect of the additional transactions (adjustments) are incorporated into the accounts by
mathematical adjustments wherever needed.

Adjustments to be Dealt with at least


Twice
• Dual Entity Concept
Every transaction relating to business has its effect on two elements.
Adjustments are transactions relating to the business which are yet to be journalised. We call them
adjustments for the reason that they are dealt with by making mathematical adjustments to the
figures of ledger account balances instead of passing the regular journal entries.
Therefore, in making mathematical adjustments we have to ensure that we are adjusting the two
elements that are affected by the transaction.

Each item from the adjustments should be dealt with at least twice in Final Accounting.

Where an item appears in the trial balance it is to be dealt with only once and where an adjustment
is being dealt with it is to be dealt with at two or more places depending on the number of elements
effected by the transaction.
» Adjusting more than two accounts
In most of the cases, the journal entry for recording the transaction given as adjustments is a
simple entry involving two accounts (one being debited and the other being credited). However, in
some cases, a complex entry involving more than two elements (accounts) is needed to record the
additional transactions. In such cases more than two accounts may have to be adjusted.

Valuation of Assets » Direct Expenses

• Asset Valuation Principle


The value of an asset includes all the expenses incurred before bringing the asset into usable
condition.
• Direct Expenditure
In financial accounting, we use the term Direct Expense in relation to assets.
Any expenditure that goes into the value of an asset is
identified as Direct Expenditure for that asset.
• Assets » Treatment of Direct Expenses
All the expenses incurred in relation to an asset before bringing the asset into usable condition
would form direct expenses for the asset
All the direct expenses in relation to an asset are to be
made part of the value of the asset i.e. are to be
capitalised.
» Example
If a machine is purchased at Delhi and brought to Tenali for use, then all the expenses incurred
before bringing the machine into working mode (usable condition) like transportation charges from
Delhi to Tenali, Unloading Charges at Tenali, Installation Charges etc., should be considered to be
part of the value of the machine.
These expenses should not be debited to the respective
expenditure accounts, but should be debited to the
Machinery a/c. The Machinery a/c balance which
indicates the value of the asset would be the sum of the
cost of the machine, the transportation charges,
unloading charges, installations charges, etc..
Is Stock an
Asset?

• Dual nature of Stock


» Purchases : During the Accounting Period
Whenever we purchase stock/goods we debit the Purchases a/c (Nominal account). This implies
that we treat the amount spent on purchasing stock as an expenditure.
Such a treatment is adopted all throughout the year.
» Asset : At the end of the Accounting Period
At the end of the accounting period, while preparing the final accounts we treat stock an asset and
show it in the Balance Sheet on the assets side.
Thus we can say that stock has dual nature. All
throughout the year the amount spent on it is
expenditure and only for the moment the balance sheet
is prepared it is an asset.
• Valuation of Stock » Based on the Principle for Valuation of
Assets
Since Stock is an asset, its valuation should also be made based on the principle for valuation of
assets.
The value of stock should include all the expenses
incurred before bringing stock into usable condition.
• Usable Condition for Stock » Being ready for Sale
Considering the Stock used in sale, the usable condition for stock would mean getting it ready for
sale i.e. it being finally set up in the show case or sale area.
• Value of Stock
All the expenses incurred on the stock till it is placed in the sales area would form direct expenses
for the stock and should be treated as a part of the value of stock.
In situations where it would be difficult/impossible to
collect all the expenses in detail, this idea is modified to
mean the expenses incurred before that stage till which
point it would be convenient to collect information.

Direct Expenses for Stock used in Trading


Business

In relation to a trading business, the stock used for sale would be an asset.
The usable condition for that stock would be, it being
placed ready for sale in the showroom.
Therefore, the direct expenses in relation to this stock
would be all the expenses incurred before placing it in
the show room or any other relevant place ready for
sale.
Conventionally, expenses like Wages, Carriage Inwards
(carriage on purchases), Octroi, Excise, Duties etc.,
Stock purchased, etc. are treated as direct expenses
apart from the actual cost of the goods purchased which
is revealed by the "Purchases a/c".
It is not a rule that only these form direct expenses. Any
expenditure that would have been incurred in relation to
stock before it is made ready for sale would form direct
expenditure for the stock.
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Cost of Goods
Sold

• Cost of Goods Sold = Value of the Goods Sold


The cost of goods sold is a term used to indicate the value of the goods sold.
This value is needed to identify the amount of basic/core
(gross) profit made by the organisation
» Gross Profit = Sales − Cost of Goods Sold
» Illustrative Explanation
Consider the following data relating to an organisation.
Opening Stock at the beginning of the accounting period, Rs. 20,000.
Purchases of goods/stock during the accounting period : Rs. 2,48,000.
Direct expenses incurred :Rs. 54,000.
Unsold stock at the end of the accounting period valued at Rs. 36,000.
Value of Stock used for other purposes Rs. 14,000.

A
mo
Particulars Amount
un
t

Opening Stock 20,000


(+) a) Purchases (Cost Value) 2
b) Direct Expenses , 3,02,000
Total Value of Goods 4 3,22,000
(−) a) Closing Stock (Value) 8
b) Stock Unused for Trading , 50,000
Cost of Goods Sold 0 2,72,000
0
0

5
4
,
0
0
0

3
6
,
0
0
0

1
4
,
0
0
0

The formula for calculating the value of Cost of Goods


Sold based on the above calculations can be written as
Cost of Goods Sold = Opening Stock + Purchases + Direct
Expenses
− Closing Stock − Stock Unused for trading
• Stock Unused for Trading
Stock with the organisation may have been used for purposes other than trading. The value of such
stock unused for trading purposes has to be deducted from the total value of stock so as to arrive at
the value of cost of goods sold.
Some such instances
Goods being taken away by the proprietor for personal purposes;
Stock used in building up an asset;
Stock used for advertisement purposes;
Normal loss of stock;
Abnormal loss of stock;
Stock used up for other types of businesses (like consignments, branches, joint ventures etc)

Do we need Cost of Goods Sold to find Gross


Profit

• Gross Profit = Sales − Cost of Goods Sold


By definition Gross Profit = Sales − Cost of Goods Sold ← (1)
⇒ To obtain the value of gross profit we need the figures of cost of goods sold and sales.
• Bypassing finding Cost of Goods Sold
Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses − Closing Stock − Stock Unused
for trading
Substituting this in (1) we get,
• Gross Sales − (Opening Stock + Purchases + Direct Expenses − Closing Stock − Stock Unused
=
Profit for trading)
Sales − Opening Stock − Purchases − Direct Expenses + Closing Stock + Stock Unused
=
for trading

(Sales + Closing Stock + Stock Unused for trading) − (Opening Stock + Purchases +
=
Direct Expenses)

Thus we do not specifically need to calculate the value


of cost of goods sold for finding gross profit, only its
affect is to be brought into account.
Such an ascertainment of Gross Profit is done in the
Trading and Profit and Loss account.
Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock – By Sales –


To Purchases – By Stock Unused –
To Direct Expenses – By Closing Stock –

"Purchases a/c" is a nominal account with a debit balance and is a direct expenditure (for stock).
Since Purchases a/c is closed by transfer to the Trading
a/c, it appears on the debit side of Trading a/c.
Transferring a debit balance from one account to a second results in the
second account being debited and the first account being credited.

Thus, all the accounts representing the figures that are


added to purchases appear on the debit side
"Sales a/c" is a nominal account with a credit balance and is a direct income.
Since Sales a/c is closed by transfer to the Trading a/c, it
appears on the credit side of Trading a/c.
Transferring a credit balance from one account to a second results in the
second account being credited and the first account being debited.

Thus, all the accounts representing the figures that are


added to sales appear on the credit side
» Finding Cost of Goods Sold in such cases
Cost of goods sold is a figure that is not straight away available in the books of accounts used in
financial accounting. That figure can be obtained either from the "Trading a/c" or by preparing a
separate ledger account to specific account which gives the information relating to the cost of
goods sold.

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments
Ascertaining Cost of Goods Sold from
Trading a/c

Each ledger account serves one or more informational needs of the organisation. The Trading a/c
gives the information relating to the Gross Profit made by the organisation. It can also be used to
derive the information relating to the "Cost of Goods Sold".
» Ascertaining Cost of Goods Sold
Cost of Goods Sold = (Opening Stock + Purchases + Direct Expenses) − (Closing Stock + Stock
Unused for trading)
The "Trading a/c" with this information posted to it
would be
Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000 By Closing Stock 36,000


To Purchases 2,48,000 By Stock Unused 14,000
To Direct Expenses 54,000

sub-total 3,22,000 sub-total 50,000

The trading account before crediting sales would have a


greater total on the debit side and thus has a debit
balance. That debit balance represents the cost of goods
sold.
Thus, to ascertain the cost of goods sold, we need to
balance the "Trading a/c" without crediting sales.
The Sales a/c can be subsequently transferred to the
Trading a/c to ascertain the Gross Profit.
Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000 By Closing Stock 36,000


To Purchases 2,48,000 By Goods Unused 14,000
To Direct Expenses 54,000 By Cost of Goods Sold 2,72,000
c/d

3,22,000 3,22,000
To Cost of Goods Sold 2,72,000 By Sales 3,80,000
b/d 1,08,000
To Gross Profit

3,80,000 3,80,000

If such a two stage Trading a/c is prepared, we would be


able to ascertain the Cost of Goods Sold as well as Gross
Profit from the Trading a/c itself.
» Ascertaining Cost of Goods Sold by Mathematical Calculations
The Trading a/c is generally prepared only as a single stage account as follows

Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000 By Sales 3,80,000


To Purchases 2,48,000 By Goods Unused 14,000
To Direct Expenses 54,000 By Closing Stock 36,000
To Gross Profit 1,08,000

4,30,000 4,30,000

To obtain the value of cost of goods sold from this we


use the definition for gross profit.
=
• Cost of Goods Sold Sales − Gross Profit [Since Gross Profit = Sales − Cost of Goods Sold]

=
Rs. 3,80,000 − Rs. 1,08,000

=
Rs. 2,72,000

Finding Cost of Goods Sold using Goods


Consumed a/c

The value of Cost of Goods Sold can also be obtained specifically, by maintaining a separate account
for the purpose. This may be named "Goods Consumed a/c" (any other indicative name may be
used).

The basic purpose of accounting is derivation of information and


the more the information we need, the more the accounting
heads we need to maintain.

The Goods Consumed a/c is nothing but the first part of


the trading account where it was balanced twice.
Dr Goods Consumed a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000 By Goods Unused 14,000


To Purchases 2,48,000 By Closing Stock 36,000
To Direct Expenses 54,000 By Trading a/c 2,72,000

3,22,000 3,22,000

The balance in the Goods Consumed a/c represents Cost


of Goods sold. This account is closed by transferring the
balance to the Trading a/c.
Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Goods Consumed 2,72,000 By Sales 3,80,000


To Gross Profit 1,08,000

3,80,000 3,80,000

• Cost of Goods Consumed


If the balances in the ledger accounts representing direct expenses are not transferred to the
"Goods Consumed a/c" but are transferred to the "Trading a/c", then the balance from the "Goods
Consumed a/c" cannot be called cost of goods sold (value of goods sold).
It just represents the cost of goods consumed. To obtain
the cost of goods sold from this, the direct expenses
have to be added to this.

Goods used within the Organisation have to be


valued at Cost

The stock that is used within the organisation (stock drawn by the proprietor for own purposes,
stock used for building an asset, stock used for advertisement purposes, etc.,) have to be valued at
cost.
This is for the reason that if such usages are recorded at
a value which includes an element of profit, the
transaction when recorded would generate a profit,
which would amount to making a profit out of a
transaction with oneself.
Principle of Mutuality » One cannot make a profit out of a transaction with
oneself

» Illustrative Explanation
Consider the following data relating to an organisation which started its operations on 28th
December 2006:
Opening Stock :: Nil;
Purchases :: Rs. 1,20,000;
Direct Expenses :: Rs. 30,000
Sales :: Nil
Stock used by the organisation internally Rs. 20,000 (Valued at Cost).
Generally Sales are made by adding 25% profit to cost
Closing Stock :: ?
The accounting period ends on 31st December 2006.
=
Value of Closing Stock with the Organisation Total Value of Stock − Value of Stock used up internally

=
Purchases + Direct Expenses − Rs. 20,000

=
(Rs. 1,20,000 + Rs. 30,000) − Rs. 20,000

=
Rs. 1,30,000

=
Sales value of the stock used within the organisation Cost + 25% of Cost

=
Rs. 20,000 + 25% of Rs. 20,000

=
Rs. 20,000 + Rs. 5,000

=
Rs. 25,000

• Stock used up internally recorded at Sales Value


Dr Trading a/c Cr

Amount Amount Amount Amount


Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)

To Purchases 1,20,000 By Sales –


To Direct Exp. 30,000 By Stock used 25,000
To Gross Profit 5,000 By Closing Stock 1,30,000

1,55,000 1,55,000
There is no commercial activity (no sales), there is no
scope for earning profits. But the Trading a/c reveals a
Gross Profit of Rs. 5,000 which is on account of the stock
used up internally being recorded at sales value.
Such profit generation is inappropriate for the reason
that in using up stock within the organisation, the
organisation is not conducting a transaction with an
outside party.
Thus to avoid profit generation in such cases, the stocks
so used are to be valued at cost.
• Stock used up internally recorded at Cost
Dr Trading a/c Cr

Amount Amount Amount Amount


Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)

To Purchases 1,20,000 By Sales –


To Direct Exp. 30,000 By Stock used 20,000
To Gross Profit Nil By Closing Stock 1,30,000

1,50,000 1,50,000

The Trading a/c would reveal no profit when the stock


used up internally is valued at cost.

Finding Value of Closing Stock from Sales

We may be able to ascertain what is left out if we know what has been sold. This logic may be
applied in finding the value of closing stock. However, to know this, we need to ascertain the value
of cost of goods sold.
Gross Profit = Sales − Cost of Goods Sold
Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses − Closing Stock
Gross Profit = Sales − (Opening Stock + Purchases + Direct Expenses − Closing Stock) [From (i)
and (ii)]
= Sales − Opening Stock − Purchases − Direct Expenses + Closing Stock
Closing Stock = Opening Stock + Purchases + Direct Expenses + Gross Profit − Sales [From (iii)]
To use this relation to obtain the value of closing stock,
we need the information relating to Gross Profit. All
other information in this relation is readily available
from the accounting records.
Gross Profit
Ratio

• Ratio : Percentage
Ratio is a comparison between two numerical quantities of the same kind.

a
Ratio between two quantities is expressed in the form , where "a" and "b" do not have a common
a : b or factor.
b

Percentage = Ratio × 100


• Gross Profit Ratio
Gross Profit Ratio is the ratio of Gross Profit to Net Sales Value or Cost of Goods Sold.
» To Sales
Gross Profit
=
Gross Profit Ratio
Net Sales

Gross Profit
=
Gross Profit as a % of Sales × 100
Net Sales

=
(Or) Gross Profit Ratio (to Sales) × 100

» To Cost of Goods Sold


Gross Profit
=
Gross Profit Ratio
Cost of Goods Sold

Gross Profit
=
Gross Profit as a % of Cost of Goods Sold × 100
Cost of Goods Sold

=
(Or) Gross Profit Ratio (to Cost) × 100

• Inter-Relationship between the two Ratios


The Gross Profit Ratio (to Sales) and Gross Profit Ratio (to Cost of Goods Sold) are interrelated and
one can be obtained if the other is known.
» Finding GP Ratio (to Cost) when GP Ratio (to Sales) is known
Show/Hide
The data relating to the Gross Profit as a % of Sales given
can be considered in three different forms. The formula
used for conversion (expressing the interrelationship)
varies depending on the form of the data considered.
• Data on 1 Scale
Expressing the data on 1 scale, amounts to expressing the value either in decimals or as a fraction.
Consider the following data:
Sales = x
Gross Profit Ratio (to Sales) = y (one scale)
=
Gross Profit Sales × Gross Profit Ratio (to Sales)

=
x×y

=
xy

=
Cost of Goods Sold Sales − Gross Profit

=
x − xy

=
x (1 − y)

Gross Profit
=
Gross Profit Ratio (to Cost)
Cost of Goods Sold

xy
=
x (1 − y)

y
=
(1 − y)

» Example
Given » Gross Profit Ratio (to Sales) is 0.25 ⇒ y =
0.25

y
=
Therefore, Gross Profit Ratio (to Cost)
(1 − y)

=
0.25
(1 − 0.25)

0.25
=
0.75

1
=
3

=
0.33

=
Gross Profit (as a % to Cost) Gross Profit Ratio (to Cost) × 100

=
0.33 × 100

1
=
33 %
3

• Data on 100 Scale


Expressing the data on 100 scale implies expressing the % without using the denominator 100.
[42% is taken as 42 for calculation purposes if it is taken on a 100 scale.]

m
Let the data on 100 scale be represented by 'm'. ⇒ y =
100

Substituting this value for 'y' in the above formula we


get,
y
=
Gross Profit Ratio (as a % of Cost) × 100
(1 − y)

100
=
× 100
m
(1 − )
100

100
=
× 100
100 − m

100

=m × 100 100
100 100 − m

m
=
× 100
100 − m

» Example
Given » Gross Profit is 25% of Sales ⇒ m =25
m
=
Therefore, Gross Profit as % of Cost × 100
100 − m

25
=
× 100
100 − 25

25
=
× 100
75

100
=
3

1
=
33
3

• Data as a ratio with numerator 1


In some cases, for some common values that we use in problem solving, we use a formula based on
the Gross Profit Ratio expressed as a ratio with a numerator 1.

1⇒ 1

Let the data be represented by ay a


=

Substituting this value for 'y' in the formula in (1) we get,


y
=
Gross Profit Ratio (to Cost)
(1 − y)

a
=

1
(1 − )
a
1

a
=
a−1

1 a
= ×
a a−1

1
=
a−1

» Example
1
=
Given » Gross Profit Ratio (to Sales) ⇒a=4
4

1
=
Gross Profit Ratio (to Cost)
a−1

1
=
4−1

1
=
3

=
Gross Profit (as a % to Cost) Gross Proft Ratio (to Cost) × 100

1
=
× 100
3

1
=
33 %
3

» Finding GP Ratio (to Sales) when GP Ratio (to Cost) is known


Show/Hide
The data relating to the Gross Profit as a % of Cost of
Goods Sold given can be considered in three different
forms. The formula used for conversion (expressing the
interrelationship) varies depending on the form of the
data considered.
• Data on 1 Scale
Expressing the data on 1 scale, amounts to expressing the value either in decimals or as a fraction.
Consider the following data:
Cost of Goods Sold = p
Gross Profit (to Cost of Goods Sold) = q (one scale)
=
Gross Profit Cost of Goods Sold × Gross Profit (to Cost of Goods Sold)

=
p×q

=
pq

Sales = Cost of Goods Sold + Gross Profit

= p + pq

= p (1 + q)

Gross Profit
=
Gross Profit Ratio (to Sales)
Net Sales

pq
=
p (1 + q)

q
=
(1 + q)

» Example
Given » Gross Profit Ratio (to Cost) is 0.2 ⇒ p = 0.2
q
=
Therefore, Gross Profit Ratio (to Sales)
(1 + q)

0.2
=
(1 + 0.2)
0.2
=
1.2

1
=
6

=
Gross Profit (as a % to Sales) Gross Profit Ratio (to Cost) × 100

1
=
× 100
6

2
=
16 %
3

• Data on 100 Scale


Expressing the data on 100 scale implies expressing the % without using the denominator 100.
[35% is taken as 35 for calculation purposes if it is taken on a 100 scale.]

n
Let the data on 100 scale be represented by 'n'. ⇒ q =
100

Substituting this value for 'q' in the above formula we


get,
q
=
Gross Profit as a % of Sales × 100
(1 + q)

100
=
× 100
n
(1 + )
100

100
=
× 100
100 + n

100

=n × 100
× 100
100 100 + n

n
=
× 100
100 + n

» Example
Given » Gross Profit is 20% of Cost ⇒ n =20
n
=
Therefore, Gross Profit as a percentage of Saes × 100
100 + n

20
=
× 100
100 + 20

20
=
× 100
120

1
=
× 100
6

=
16 2/3%

• Data as a ratio with numerator 1


In some cases, for some common values that we use in problem solving, we use a formula based on
the Gross Profit Ratio expressed as a ratio with a numerator 1.

1⇒ 1

Let the data be represented by bq b


=

Substituting this value for 'q' in the formula in (1) we get,


q
=
Gross Profit Ratio (to Sales)
(1 + q)

b
=

1
(1 + )
b
1

b
=

b+1

1 b
= ×
b b+1

1
=
b+1

» Example
1
Given » Gross Profit Ratio (to Sales) is ⇒ b = 5
5

1
=
Gross Profit Ratio (to Sales)
b+1

1
=
5+1

1
=
6

=
Gross Profit Ratio (as a % to Sales) Ratio × 100

1
=
× 100
6

2
=
16 %
3
» Frequently used conversions
• Hundred Scale
1 2
2 5
As a % of Cost 20 33 66 100
5 0
3 3

2 1
2
As a % of Sales16 25 33 40 50
0
3 3

• One Scale
0
0.
0. .
3 0.
As a % of Cost 0.2 2 6 1
3 5
5 6
3
6

0.
0. 0. 0
0.1 3
As a % of Sales 2 2 . 0.5
66 3
0 5 4
3

• Inverse
1 1 1 12 1
As a % of Cost
5 4 3 23 1

1 1 1 12 1
As a % of Sales
6 5 4 35 2

final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Gross Profit is generally Non-


Uniform

The gross profit earned by an organsation is in almost all cases not a figure that can be easily
derived (without the availability of the value of closing stock). Deriving the value of closing stock
would be far easier than deriving the value of gross profit made (based on sales).
• Variety of Products being Sold
The organisation may be selling a number of products with different selling prices and different
rates of gross profits.
In such cases, if the gross profit figure is to be
ascertained from the sales figure, sales records should
be maintained so as to give the sales details relating to
each product with a distinct Gross Profit %. This would
involve a lot of work and would be impractical, more so
where there are a large number of products being dealt
with.
• Variations in Sale Prices
The prices charged to customers are dependent on a number of factors like the market conditions,
the immediate competition existing in the market, the loyalty of the customers etc.
Depending on the market conditions, some times the
prices may be varied instantaneously.
Depending on the customer to whom the product is
being sold, the prices may be varied (a discount may be
given to loyal customers) etc.
In such a situations there would not be uniformity in the
Gross profit percentage and it would be near to
impossible to ascertain the gross profit made using the
sales figures.
Since using the figure of gross profit to ascertain the
value of closing stock available in the organisation is not
a feasible idea, we look at other methods for finding out
the value of closing stock.

How is the Value of Closing Stock


Ascertained?

• Physical Stock
Closing stock is the stock/goods unsold at the end of the accounting period.
The details relating to the physical stock would be
readily available with the organisation only if the
inventory records are being maintained by the
organisation. In other cases the physical stock would
have to be ascertained by stock taking.
• Stock Value
There is no specific ledger account in financial accounting that would give us the information
relating to the value of closing stock ready hand.
The value of closing stock is available ready hand only if
inventory records are being maintained that too from
the inventory records.
The value of Closing Stock is ascertained by Physical Verification of Stock on the
last day of the accounting period and its valuation at Cost or Market Price (Net
Realisable Value) whichever is lesser
This is the most common method for valuing the closing
stock.
The information relating to the value of closing stock is
not regularly required by the organisation. It is however
required at the end of the accounting period for the
purpose of evaluation of the Cost of Goods Sold.

Convention of
Conservatism

• Net Realisable Value of Stock


For the purpose of Valuation of closing Stock, Market Price implies Net Realisable Value/Rate and
not the Selling Price.
Net Realisable Value of stock is the net sale realisation
excluding all the expenses directly and exclusively
relatable to the sale (Sale commission, Brokerage etc)
from the Sale Realisation.
Therefore, in trying to ascertain the Market Price to be
used for valuation, care should be taken to ensure that
such expenses are deducted from the sales price to
ascertain the net realisable value of stock.
• Convention of Conservatism
By the Convention of Conservatism we take into consideration all
those expenses and losses of which we are aware, even if they
relate to the subsequent accounting periods.

The act of valuing closing stock at cost or market price


is based on the "Convention of Conservatism".

Convention of Conservatism : Valuation of Closing


Stock : Illustration

Following is the "Trading a/c" relating to an organisation, wherein the Closing Stock has been
recorded at cost.

Dr Trading a/c Cr
f
Amount Amount i
Particulars Particulars
(in Rs) (in Rs) n
a
l
To Opening Stock 20,000 By Sales 3,80,000 ,
To Purchases 2,48,000 By Closing Stock 36,000 a
To Direct Expenses 54,000 c
To Gross Profit 94,000 c
o
4,16,000 4,16,000 u
n
t
s
» Closing Stock details ,
The closing stock is made up of f
Batch N :: 600 units valued at Rs. 36/unit with a total value of Rs. 21,600 i
Batch M :: 600 units valued at Rs. 24/unit with a total value of Rs. 14,400 n
Total 1,200 units with a total value of Rs. 36,000 a
Value here implies cost + direct expenses n
c
The selling prices and the related expenses are i
Batch N :: Rs. 50/unit a
Batch M :: Rs. 50/unit [Regular price] l
Batch M :: Rs. 25/unit [Current price] ,
a
This stock represents an outdated model of the c
product and the present market conditions would c
o
enable the stock to be sold only at a price of Rs. 25 per u
n
unit. t
The sales of all stocks are made through a dealer who would charge a commission of 10% of the i
sale proceeds. n
» Cost and Net Realisable Values of Closing Stock g
From the available data, Closing stock can be valued at two different rates. Cost and Market Price ,
(Net Realisable Rate). t
r
600 units [Batch N] a
Cost = Rs. 36/unit. d
Market Price = Rs. 50/unit. i
Expenses directly relatable to sale = Rs. 5/unit n
(10% of selling price = Rs. 50/unit × 10%). g
Net Realisable Value = Rs. 45/unit ,
[Market Price (Rs. 50/unit) − Expenses relatable to sale (Rs. 5/unit)] p
600 units [Batch M] r
Cost = Rs. 24/unit. o
Market Price = Rs. 25/unit. f
Expenses directly relatable to sale = Rs. 2.50/unit i
(10% of selling price = Rs. 25/unit × 10%). t
Net Realisable Value = Rs. 22.50/unit ,
[Market Price (Rs. 25/unit) − Expenses relatable to sale (Rs. 2.50/unit)]. l
o
» Valuation of Closing Stock based on Convention of s
Conservatism s
600 units [Batch N] ,
a
Cost = Rs. 36/unit. Net Realisable Rate = Rs. 45/unit. c
c
Since Cost < Net Realisable Value, the goods are to be o
valued at cost. u
n
⇒ Value of 600 units is Rs. 21,600 (600 units × Rs. t
,
36/unit) b
a
600 units [Batch M]
Cost = Rs. 24/unit. Net Realisable Rate = Rs. 22.50/unit.
Since Net Realisable Value < Cost, the goods are to be
valued at the net realisable value.
⇒ Value of 600 units is Rs. 13,500 (600 units × Rs.
22.50/unit)
Value of Closing stock if valued at cost = Rs. 14,400 (600
units × Rs. 24/unit)
The Closing Stock should be valued therefore at Rs.
35,100 (Rs. 21,600 + 13,500).
» Trading a/c
If value of Closing Stock is taken based on the Convention of Conservatism, the Trading a/c would
be

Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000 By Sales 3,80,000


To Purchases 2,48,000 By Closing Stock 35,100
To Direct Expenses 54,000
To Gross Profit 93,100

4,15,100 4,15,100

The Gross profit has gone down by Rs. 900 since closing
stock is considered at a lesser value.

Role of Convention of
Conservatism

The convention of conservatism asks us to take into consideration all those expenses and losses
relating to the subsequent periods of which we are aware.
» Future Losses
Where the Net realisable value of stock is less than its cost, the organisation may incur a loss.
In the above case, the organisation may have to incur a
loss of Rs. 900 [Rs. 14,400 (cost) − Rs. 13,500 (net
realisable value)].
• When?
This loss would have to be borne by the organisation if it sells the stock at the net realisable rate.
Since it is the end of the accounting period, such a sale
at such a price, if at all it takes place, would be in the
subsequent accounting period.
Thus, the organisation may have to incur this loss in the
future.
• Is the loss for sure?
The loss may have to be incurred in the future only if the stock has to be sold at Rs. 25 per unit
(which gives a net realisation of Rs. 22.50).
We may consider such a loss a certainty in cases where
the stock is required to be sold at the lower price on
account of it becoming obsolete, losing demand etc.
Bu where the lower market rate is on account of normal
market fluctuation and if the rates go up in the
subsequent period and the product can be sold at a
higher price, this loss need not be incurred.

How is the loss


absorbed?

Based on the Convention of Conservatism, the loss though it may have to be incurred in the future
period, is absorbed in the current period itself, since its information is known.
This will be the case where the lower valuation is on
account of conditions which are certain (obsolete goods,
demand going down etc).
» Crediting a Nominal a/c implies gain
The value of closing stock is credited to the "Trading a/c". By the principle of credit in relation to
nominal accounts (Credit all Incomes and Gains), we can assume the value to indicate a gain.
Reducing the value of closing stock would therefore
amount to reducing the credit made to the Trading a/c,
which would be reducing the gain. Debiting an amount is
an equivalent of deducting the amount from the
opposite side i.e. the credit side. Therefore, reducing
the gain is the same as taking in additional loss.
Therefore, the loss is absorbed by considering the value
of closing stock at a lesser value i.e. the net realisable
value. [In the above example, by considering the closing
stock at the lower value, the estimated loss of Rs. 900
relating to the subsequent accounting periods has been
absorbed in the current period itself.]
Value of Closing Stock = Value of Opening Stock of the
Subsequent Period

The Closing Stock a/c relating to an accounting period and the Opening Stock a/c relating to the
subsequent accounting period represent the same account. Therefore, the value of the closing stock
at the end of the accounting period and the opening stock at the beginning of the subsequent
accounting period are the same.
• Closing Stock a/c
The "Closing Stock a/c" is a real account and is created at the last moment of the accounting
period.
It represents Stock as an asset. The balance in the
"Closing Stock a/c" is carried forward to the next
accounting periods.
• Opening Stock a/c
The account that we name "Closing Stock a/c" is renamed "Opening Stock a/c" at the beginning of
the next accounting period while bringing the values of assets and liabilities into the books of
accounts with the help of an "Opening Entry".
This "Opening Stock a/c" is treated as an equivalent of a
Nominal account.
Like other nominal accounts it is closed at the end of the
accounting period. It is closed by transfer to the
"Trading a/c" since it goes into the value of cost of
goods sold.
» Note
The value of Opening and Closing stocks relating to a particular accounting period do not mean the
same. They are two indicated by distinct ledger accounts - Opening stock by "Opening Stock a/c"
which is a nominal account and Closing stock by "Closing Stock a/c" which is a Real account.
They may or may not have the same values.

Recording the Value of Closing Stock

The valuation of closing stock and recording of the value of closing stock in the books are two
different aspects.
After ascertaining the value of the closing stock, it is to
be brought into the books of accounts.
The basic purpose of accounting is derivation of information and the more
information we need the more the accounting heads we need to maintain.

For each additional piece of information that we intend


to derive from the books of accounts, we create and use
an additional ledger account.
Thus, to derive the information relating to Closing Stock
we maintain a real account by name "Closing Stock a/c".
The "Closing Stock a/c" gives the information relating to
the value of the stock (as an asset) unsold at the end of
the accounting period.
• Recording
The value of closing stock is not available ready hand in the books of accounts. It is specifically
ascertained at the end of the accounting period by physical verification of stock and its valuation at
cost or market price whichever is lower.
Thus, by recording the journal entry for Closing Stock,
we are in effect bringing the value of Closing Stock into
books.
» Debit : Closing Stock a/c
Accounts representing assets are real accounts and show a debit balance. Since by recording the
journal entry for bringing the value of closing stock into books, we are creating an asset by name
"Closing Stock a/c" we debit that account.
[Closing Stock a/c – Real a/c – Debit what comes in.]
» Credit :
There are three possible variations in the account to be credited for recording the value of closing
stock.
Trading a/c
Goods Consumed a/c
Purchases a/c
The ledger account to be credited is dependent on which
account is used to reflect the value of cost of goods sold
as well as the time of recording the entry.

Recording Closing Stock » Crediting


Trading a/c

Total value of goods = Opening Stock + Purchases +


Direct Expenses.
A
mo
Particulars Amount
un
t

Opening Stock 20,000


(+) a) Purchases (Cost Value) 2
b) Direct Expenses , 3,02,000
Total Value of Goods 4 3,22,000
(−) a) Closing Stock (Value) 8
b) Stock Unused for Trading , 50,000
Cost of Goods Sold 0 2,72,000
0
0

5
4
,
0
0
0

3
6
,
0
0
0

1
4
,
0
0
0

» Direct Incomes/Expenses transferred to Trading a/c


At the end of the accounting period, the balances (amounts) in all the ledger accounts which
represent expenses which go into the value of goods/stock (direct expenses), are closed by
transfer to the "Trading a/c".
This would result in the "Trading a/c" being debited with
the total value of goods/stock. Show/Hide
Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000


To Purchases 2,48,000
To Direct Expenses 54,000

3,22,000 3,22,000

» Revealing/Reflecting Cost of Goods Sold


To reflect/reveal the cost of goods sold, the value of closing stock is to be deducted from the total
value of goods.
Thus the value of closing stock has to be credited to the
"Trading a/c" which has the total value of goods/stock
existing in it as a debit balance. Show/Hide
Dr Trading a/c Cr

Particulars Amount Particulars Amount


(in Rs) (in Rs)

To Opening Stock 20,000 By Cost of Goods Sold 2,86,000


To Purchases 2,48,000 c/d 36,000
To Direct Expenses 54,000 By Closing Stock

3,22,000 3,22,000

To Cost of Goods Sold 2,86,000


b/d

• Journal/Ledger
The Journal entry for recording the value of closing stock in such a case would be

Journal in the books of M/s ___ for the period from ____ to ____

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

31st Dec – Closing Stock a/c D – 36,


To Trading a/c r 00 36,000
– 0

[For recording the value of


Closing Stock in the books.]

Dr Closing Stock a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Trading a/c 36,000 By Bal c/d 36,000

36,000 36,000

Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000 By Sales 3,80,000


To Purchases 2,48,000 By Closing Stock 36,000
To Direct Expenses 54,000
To Gross Profit 94,000

4,16,000 4,16,000
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Recording Closing Stock » Crediting Goods


Consumed a/c

Where the organisation intends to specifically identify the cost of goods consumed, a separate
ledger account by name "Goods Consumed a/c" may be created and used for that purpose.
» Direct Expenses transferred to Goods Consumed a/c
At the end of the accounting period, the balances (amounts) in all the ledger accounts which
represent expenses which go into the value of goods/stock (direct expenses), are closed by
transfer to the "Goods Consumed a/c".
This would result in the "Goods Consumed a/c" being
debited with the total value of goods/stock. Show/Hide
Dr Goods Consumed a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000


To Purchases 2,48,000
To Direct Expenses 54,000

3,22,000 3,22,000

» Revealing/Reflecting Cost of Goods Sold


To reflect/reveal the cost of goods sold, the value of closing stock is to be deducted from the total
value of goods.
Thus the value of closing stock has to be credited to the
"Goods Consumed a/c" which has the total value of
goods/stock existing in it as a debit balance. Show/Hide
Dr Goods Consumed a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000 By Trading a/c (?) 2,86,000


To Purchases 2,48,000 By Closing Stock 36,000
To Direct Expenses 54,000

3,22,000 3,22,000

The amount transferred to the Trading account


represents the Cost of Goods Sold
• Journal/Ledger
The Journal entry for recording the value of closing stock in the books would be
Journal in the books of M/s ___ for the period from ____ to ____

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

31st Dec – Closing Stock a/c D – 36,


To Goods Consumed a/c r 00 36,000
– 0

[For recording the value of


Closing Stock in the books.]

Dr Goods Consumed a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000 By Trading a/c (?) 2,86,000


To Purchases 2,48,000 By Closing Stock 36,000
To Direct Expenses 54,000

3,22,000 3,22,000

The balance in the "Goods Consumed a/c" represents the


cost of goods sold and is transferred to the "Trading a/c"
to ascertain the Gross Profit.
Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Goods Consumed 2,86,000 By Sales 3,80,000


To Gross Profit 94,000

3,80,000 3,80,000

Balance in Goods Consumed a/c not representing


Cost of Goods Sold
The balancing figure in the "Goods Consumed a/c" transferred to the "Trading a/c" does not
represent cost of goods sold, in the following cases
• Direct Expenses Transferred to Trading a/c
Where the direct expenses have been transferred to the Trading a/c instead of the Goods Consumed
a/c, the balancing figure in Goods Consumed a/c does not represent cost of goods sold.

Dr Goods Consumed a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000 By Trading a/c (?) 2,32,000


To Purchases 2,48,000 By Closing Stock 36,000

2,68,000 2,68,000

Cost of Goods Sold implies the total value of goods sold


which includes both cost of the goods (represented by
purchases a/c balance) and direct expenses related to
the goods.
Since Direct Expenses have not been debited to Goods
Consumed a/c, the balancing figure represents the value
of goods sold excluding direct expenses thereon.
Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Direct Expenses 54,000 By Sales 3,80,000


To Goods Consumed 2,32,000
To Gross Profit 94,000

3,80,000 3,80,000

» Recording Closing Stock


Valuation of closing stock is independent of the accounting treatment. Closing Stock can be credited
to either the Trading a/c or the Goods Consumed a/c.
The only precaution to be taken would be in interpreting
the balancing figure value. It should not be considered
as Cost of Goods Sold.
However, in such cases, it would be more appropriate to
record the value of closing stock through the Trading a/c
where the value includes both cost and direct expenses.
• Exception
Recording Closing Stock through Goods Consumed a/c would be rational if its value does not
include any part of the direct expenses incurred during the current period which have been debited
to the Trading a/c.
• Opening Stock transferred to Trading a/c
Where the balance in "Opening Stock a/c" has been transferred to the Trading a/c instead of the
Goods Consumed a/c, the balancing figure in Goods Consumed a/c may not represent Cost of Goods
Sold.

Dr Goods Consumed a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Purchases 2,48,000 By Trading a/c (?) 2,66,000


To Direct Expenses 54,000 By Closing Stock 36,000

3,12,000 3,12,000

The balance in the Goods Consumed a/c transferred to


the Trading a/c represents the value of goods that have
been purchased and sold away during the current
period.
This does not include the value of opening stock that
might also have been sold away. Thus this balance,
cannot be called "cost of goods sold" though it
represents value.
Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000 By Sales 3,80,000


To Goods Consumed 2,66,000
To Gross Profit 94,000

3,80,000 3,80,000

» Recording Closing Stock


Valuation of closing stock is independent of the accounting treatment. Closing Stock can be credited
to either the Trading a/c or the Goods Consumed a/c.
The only precaution to be taken would be in interpreting
the balancing figure value. It should not be considered
as Cost of Goods Sold.
However, in such cases, it would be more appropriate to
record the value of closing stock through the Trading a/c
where the total value is debited ultimately.
• Exception
Recording Closing Stock through Goods Consumed a/c would be rational closing stock includes only
that stock which has been purchased during the current accounting period.
This would be the case where the quantity of closing
stock is less than the quantity purchased during the
current period and stock is being used up on FIFO basis.

Recording Closing Stock » Crediting


Purchases a/c

Where the following conditions exist, we can credit "Purchases a/c" with the value of closing stock.
Closing stock is physically relatable to the stock that has been purchased during the current period.
[This would be the case where FIFO method is adopted for physical usage of stock]
There are no direct expenses in relation to the stock purchased during the current period
(Or)
The value of closing stock does not include the direct expenses incurred during the current period
• Journal/Ledger
The Journal entry for recording the value of closing stock in the books would be

Journal in the books of M/s ___ for the period from ____ to ____

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

31st Dec – Closing Stock a/c D – 36,


To Purchases a/c r 00 36,000
– 0

[For recording the value of


Closing Stock in the books.]

Dr Purchases a/c Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

1st- To Cash/Bank/Crs – 2,48,000 31/12/0 By Closing Stock – 36,000


31st 5 By Trading a/c – 2,12,000
31/12/0
5

2,48,000 2,48,000
Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 20,000 By Sales 3,80,000


To Purchases 2,12,000
To Direct Expenses 54,000
To Gross Profit 94,000

3,80,000 3,80,000

• Conventional use
Technically we can credit the value of closing stock to Purchases a/c only when the above
conditions are satisfied.
The use of "Trading a/c" or "Goods Consumed a/c" for
crediting the value of closing stock, is possible only if
the journal entry for brining the value of closing stock
into books is being recorded at the time of preparation
of final accounts.
Where we are recording the value of closing stock in the
accounting books before the preparation of final
accounts, it is a convention that we credit "Purchases
a/c" (on account of the absence of "Trading a/c" or
"Goods Consumed a/c" for use).
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Closing Stock a/c : Opening Stock


a/c

The "Closing Stock a/c" and the end of an accounting period and the "Opening Stock a/c" at the
beginning of the subsequent accounting period represent the same account.
• At the End of an Accounting Period
The closing balances in all the ledger accounts are carried forward to the subsequent accounting
periods.
Every ledger posting should have a journal support.
The journal entry that supports the carry forward of
balances in ledger accounts is called the "Closing Entry".
» Closing Entry
The journal entry for closing the books of accounts during an accounting period

Journal in the books of M/s ___ for the period from ____ to ____
Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

31st Dec – Creditors a/c D – 48,


Bank Loan a/c r 00
Profit & Loss Appropriation a/c D – 0
Capital a/c r 63,
To Closing Stock a/c D – 00 36,000
To Cash a/c r 0 42,000
To Debtors a/c D – 54, 1,26,000
To Furniture a/c r 00 61,000
– 0
1,0
[For the balances in the ledger – 0,0
accounts carried forward to the 00
next accounting period.] –

» Closing Balance Sheet


The closing Balance Sheet is a statement of balances that are carried forward to the subsequent
accounting periods.

Balance Sheet of M/s ______ as on the Last Day

A
Amo m
Liabilities Assets
unt ou
nt

Capital 1,00, Cash 4


Profit & Loss Appropriation 000 Closing 2,
Creditors 54,00 Stock 0
Bank Loan 0 Debtors 0
48,00 Furniture 0
0 3
63,00 6,
0 0
0
0
1,
2
6,
0
0
0
6
1,
0
0
0

2,65, 2,
000 6
5,
0
0
0

• At the beginning of the Subsequent Accounting Period


The opening balances in all the ledger accounts are brought forward from the previous accounting
periods. Every ledger posting should have a journal support and the journal entry that supports the
brining forward of balances in ledger accounts is called the "Opening Entry".
» Opening Balance Sheet
The opening balance sheet of an accounting period and the closing balance sheet of the previous
period are the same. This is something that is not specifically prepared.

Balance Sheet of M/s ______ as on the First Day

A
Amo m
Liabilities Assets
unt ou
nt

Capital 1,00, Cash 4


Profit & Loss Appropriation 000 Closing 2,
Creditors 54,00 Stock 0
Bank Loan 0 Debtors 0
48,00 Furniture 0
0 3
63,00 6,
0 0
0
0
1,
2
6,
0
0
0
6
1,
0
0
0

2,
6
2,65, 5,
000 0
0
0

» Opening Entry
The opening entry is based on the opening balance sheet.

Journal in the books of M/s ___ for the period from ____ to ____

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)
31st Dec – Cash a/c D – 42,
Opening Stock a/c r 00
Debtors a/c D – 0
Furniture a/c r 36,
To Capital a/c D – 00 1,00,000
To Profit & Loss r 0 54,000
Appropriation a/c D – 1,2 63,000
To Bank Loan a/c r 6,0 48,000
To Creditors a/c – 00
61,
– 00
[For the opening balances in the 0
various ledger accounts brought –
forward into the books of
accounts from the previous –
accounting period.]

Where the Opening Entry is being recorded, the phrase


"Closing Stock" is replaced by the phrase "Opening
Stock".

Closing Stock » Adjustment during Final


Accounting

The value of closing stock is ascertained through physical verification of the stock and its valuation
at cost or market price whichever is lesser.
Thus recording the entries for brining in the value of
closing stock into books may not be complete by the
time trial balance is drawn up.
If the value of closing stock is not available (or is not
recorded) by the time of making up the trial balance at
the end of the accounting period, it would appear as a
part of the transactions appended to the trial balance
which are to be adjusted.
Adjustment is bringing in the effect of the transactions
through mathematical operations of addition and
subtraction. The adjustments to be made can be found
out by ascertained the net effect of the journal entries
to be recorded.
In adjusting the value of closing stock we consider the
entry for recording the same to be the one where the
Trading a/c or Purchases a/c is credited.
Where the closing stock is recorded by crediting its value to the Trading a/c
Entry Effect

Dr. Closing Stock a/c 1. (+) Show the Value of Closing Stock on the Assets side of the Balance
Sheet
Cr. Trading a/c 2. (+) Show the Value of Closing Stock on the Credit side of Trading a/c
Where the closing stock is recorded by crediting its value to Purchases a/c
Entry Effect

1. (+) Show the Value of Closing Stock on the Assets side of the Balance
Dr. Closing Stock a/c
Sheet
2. (−) Deduct the Value of Closing Stock from Purchases on th Debit side
Cr. Purchases a/c
of Trading a/c
Where the closing stock is recorded by crediting Goods Consumed a/c
Entry Effect

Dr. Closing Stock a/c 1. (+) Show the Value of Closing Stock on the Assets side of the
Balance Sheet
Cr. Goods Consumed 2. (+) Show the Value of Closing Stock on the Credit side Goods
a/c Consumed a/c

This assumption is generally avoided, where the value of


closing stock has to be dealt with as an adjustment.

Closing Stock in Trial Balance »


Interpretation

Where "Closing Stock a/c" is present in the Trial Balance, it is an indication of the Journal entry for
recording the value of closing stock has already been recorded.
• Dealing with Closing Stock a/c
The "Closing Stock a/c" represents an asset and is thus a Real account.
Since an item appearing in the "Trial Balance" has to be
dealt with only once based on its nature, the Closing
Stock a/c appearing in the trial balance is shown on the
assets side of the Balance Sheet.
The balance in all the real accounts is carried forward to
the subsequent accounting periods. All such accounts
whose balances are carried forward to the subsequent
accounting periods are listed in the Balance Sheet as at
the end of the accounting period. Thus all the real
account balances are shown on the assets side of the
balance sheet.
• What was the Journal Entry used?
The Journal entry used for recording the value can be identified/assumed depending on what ledger
accounts are present in the Trial Balance
» Trading a/c appears in the Trial Balance
Trial Balance of M/s ___ " as on 30th June 2005

De
bit
A
L m
Credit Amount
Particulars / ou
(in Rs)
F nt
(in
Rs
)

Opening Stock a/c — 20,


Purchases a/c 00
– —0
Closing Stock a/c 2,4
– — 8,0
Trading a/c 00 36,000
– —
– 36,
— 00
0

xx
Total x
xxx

Where Closing Stock a/c and Trading a/c appear in Trial Balance

Dr. Closing Stock a/c


← The entry used for recording the value of closing stock.
Cr. Trading a/c

» Trading a/c does not appear, but Purchases a/c appears in the
Trial Balance
Trial Balance of M/s ___ " as on 30th June 2005

Particulars L De Credit Amount


/ bit (in Rs)
FA
m
ou
nt
(in
Rs
)

Opening Stock a/c — 20,


Purchases a/c 00
– —0
Closing Stock a/c 2,1
– — 2,0
– 00
– —
– 36,
— 00
0

xx
Total x
xxx

Where Closing Stock a/c and Purchases a/c appear in Trial Balance

Dr. Closing Stock a/c


← The entry used for recording the value of closing stock.
Cr. Purchases a/c

» Both Trading a/c and "Purchases a/c" do not appear in the Trial
Balance
Trial Balance of M/s ___ " as on 30th June 2005

De
bit
A
L m
Credit Amount
Particulars / ou
(in Rs)
F nt
(in
Rs
)


Goods Consumed 2,3
– — 2,0
Closing Stock a/c 00
– —
– 36,
– — 00
– 0


xx
Total x
xxx

Where Purchases a/c and Trading a/c do not appear in


the Trial Balance and
Where Closing Stock a/c and Goods Consumed a/c appear in Trial Balance

Dr. Closing Stock a/c


← The entry used for recording the value of closing stock.
Cr. Goods Consumed a/c

Purchases and Sales » Return a/c's

Each ledger account provides one or more pieces of information. To enable derivation of additional
information relating to returns of goods/stock, we record the transactions relating to purchase
returns as well as sales returns using Purchase Returns a/c and Sales Returns a/c respectively.
• Purchases Returns a/c
Purchase Returns a/c is a nominal account. It provides the information relating to the value of
goods/stock returned to the seller from whom the stock has been purchased.
Being a nominal account, this account is closed at the
end of the accounting period.
• Sales Returns a/c
Sales Returns a/c is a nominal account. It provides the information relating to the value of
goods/stock returned by the buyers to whom the stock has been sold.
Being a nominal account, this account is closed at the
end of the accounting period.
• Gross Purchases and Gross Sales
The Purchase Returns a/c and the Sales Returns a/c provide information relating to returns only.
Since returns are recorded separately using these
accounts, the Purchases a/c and Sales a/c give the
information relating to the Gross Purchases and Gross
Sales.
• Need for information relating to Net Values
Along with the information relating to the returns and the gross values, the organisation needs the
information relating to the net values i.e. the net purchases and net sales made by it.
There are two methods adopted for deriving the
information relating to Net Purchases and Net Sales.
By Setting off related Ledger account balances.
By Transferring the balance in the returns accounts to Trading a/c and making adjustments
thereon.
This information is generally derived at the end of the
accounting period. However, it can be derived as and
when needed, by deducting the balance in the returns
account from the balance in the main account.
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Finding Net Purchases/Sales by Setting off related


Ledger Account Balances

SET OFF » Setting off of ledger accounts is clubbing two accounts with opposite
balances. In setting off ledger account balances, we close the account with the
lower balance by transferring it to the account with a higher balance.

• Finding Net Purchases


The Purchases a/c carries a debit balance and the Purchase Returns a/c carries a credit balance. At
the end of the accounting period, the two accounts are set off i.e. the Purchase Returns a/c is
closed by transfer to the Purchases a/c.

Transfer of a credit balance from one account to a second would result in the
second account being credited and the first account being debited.

The balance remaining in the Purchases a/c would thus


represent net purchases. While closing the purchases
account at the end of the accounting period, this
balance is transferred to the Trading a/c
• Journal/Ledger Show/Hide
The journal entry for recording the transfer would be

Journal in the books of M/s __ for the period from ____ to _____

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

March 31st – Purchase Returns a/c D – 80,


To Purchases a/c r 00 80,000
– 0

[For transferring the balance in


the purchase returns account to
the purchases account to derive
the net purchases]

Dr Purchase Returns a/c Cr


Amount Amount
Particulars Particulars
(in Rs) (in Rs)

By – –
To Purchases a/c 80,000 By – –

80,000 80,000

Dr Purchases a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To – – By Purchase Returns 80,000


To – – a/c 5,00,000
By Trading a/c

5,80,000 5,80,000

• Finding Net Sales


The Sales a/c carries a credit balance and the Sales Returns a/c carries a debit balance. At the end
of the accounting period, the two accounts are set off i.e. the Sales Returns a/c is closed by transfer
to the Sales a/c.

Transfer of a debit balance from one account to a second would result in the
second account being debited and the first account being credited.

The balance remaining in the Sales a/c would thus


represent net sales. While closing the Sales account at
the end of the accounting period, this balance is
transferred to the Trading a/c
• Journal/Ledger Show/Hide
The journal entry for recording the transfer would be

Journal in the books of M/s __ for the period from ____ to _____

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

March 31st – Sales a/c D – 72,


To Sales Returns a/c r 50 72,500
– 0

[For transferring the balance in


the sales returns account to the
sales account to derive the net
sales]
Dr Sales Returns a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To – –
To – – By Sales a/c 72,500

72,500 72,500

Dr Sales a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Sales Returns a/c 72,500 By – –


To Trading a/c 7,51,500 By – –

8,24,000 8,24,000

• Information in Trading a/c


If this method is adopted for deriving the value of net purchases and sales, the Trading a/c would
not display information relating to returns and would contain postings as To Purchases a/c on the
debit side and the By Sales a/c on the credit side.

Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 40,000 By Sales 7,51,500


To Purchases 5,00,000 Closing Stock 76,000
To Wages 45,000
To Octroi 32,000
To Carriage Inwards 15,000
To Gross Profit 2,40,500

8,27,500 8,27,500

Transferring balances in Purchases/Sales Returns a/c


to Trading a/c
The Purchase Returns a/c and the Sales Returns a/c being nominal accounts are closed at the end
of the accounting period by transfer to the Trading a/c (instead of to the Purchases a/c and Sales
a/c respectively).
The Purchase Returns a/c carries a credit balance and
the "Sales Returns a/c" carries a credit balance.
• Journal
The journal entries for closing these accounts by transfer to the trading account would be

Journal in the books of M/s __ for the period from ____ to _____

Debit
Amou
V/R L/ Credit Amount
Date Particulars nt
No. F (in Rs)
(in
Rs)

March 31st – Purchase Returns a/c D – 80,


To Trading a/c r 00 80,000
– 0

[For transferring the balance in


the purchase returns account at
the end of the accounting period
to the trading account]

March 31st – Trading a/c D – 72,


To Sales Returns a/c r 50 72,500
– 0

[For transferring the balance in


the sales returns account at the
end of the accounting period to
the trading account]

• Posting in Trading a/c


The "Trading a/c" with these journal entries posted:

Dr Trading a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock 40,000 By Sales 8,24,000


To Purchases 5,80,000 By Purchase Returns 80,000
To Sales Returns 72,500 Closing Stock 76,000
To Wages 45,000
To Octroi 32,000
To Carriage Inwards 15,000
To Gross Profit 2,40,500

9,80,000 9,80,000

We cannot derive the information relating to Net


Purchases and Net Sales by just Posting the entries to
the Trading a/c.
final,accounts,financial,accounting,trading,profit,loss,account,balance,sheet,trial,balance,work,sheet,a
djustments

Adjustment in Trading a/c : Information relating to Net


Purchases/Sales

Since the information relating to Net Purchases and Net Sales is not revealed by just transferring
the balances in the returns accounts to the Trading a/c we need to make adjustments to derive that
information.
• Net Purchases
Posting (showing) an amount on the credit side of an account is an equivalent of
deducting the amount from an item on the debit side.

Thus the Purchase Returns a/c balance instead of being


shown on the credit side is deducted from Purchases a/c
balance on the debit side of the Trading a/c, thereby
giving the figure of Net Purchases in the Trading a/c
itself.
• Net Sales
Posting (showing) an amount on the debit side of an account is an equivalent of
deducting the amount from an item on the credit side.

Thus, the Sales Returns a/c balance instead of being


shown on the debit side would be deducted from Sales
a/c on the credit side of the Trading a/c, thereby giving
us the figure of Net Sales in the Trading account itself.
• Deriving from the Trading a/c
Dr Trading a/c Cr

Amount Amount Amount Amount


Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)

To Opening Stock 40,000 By Sales 8,24,000


To Purchases 5,80,000 (−) Sales 72,500 7,51,500
(−) Pur. 80,000 5,00,000 Returns 76,000
Returns 45,000 Closing Stock
To Wages 32,000
To Octroi 15,000
To Carriage 2,40,500
Inwards
To Gross Profit

8,27,500 8,27,500
f
Such an adjustment would not affect the figure of gross i
profit. n
a
l
,
Revenue a
Income, turnover, revenue are terms used synonymously to mean the amount of money that an c
organisation receives from its activities like sale of products, providing services to customers etc. c
Depending on the nature of the organisation and the type of activity it is involved in the revenue o
streams are varied u
Sale or Products, Providing Services are the activities most common to business organisations. n
Taxes, Duties, Fees etc are the major sources of revenue for Governments. Donations, Grants, t
Subscriptions, etc are some of the sources of revenue for non-profit organisations. s
The terms Revenue and Sales or Turnover are interchangeably used. This makes sense only when ,
sales are expressed in terms of value and not in terms of quantity. f
Gross Revenue and Net Revenue are terms which are indicative of Gross Sales and Net Sales after i
setting off sales returns n
Revenue would be meaningful only when it is expressed in relation to a period. Say the revenue is a
Rs. 5 crores is would not make much sense unless we express the period involved. n
c
Saying the revenue for the last month is Rs. 5 Crores does sound meaningful. i
a
Top Line and Bottom Line l
Revenue is often referred to as top line since it is the first item that we consider in preparing the ,
income statements or accounts. On the Credit Side of the Trading account we find sales generally a
towards the top as the first or second item. c
Similarly Net Profit (revenue left after deducting all expenses) is termed "Bottom Line". In the Profit c
and Loss account, Net Profit/Loss is the last item that appears towards the end. o
Even in an income statement (which is nothing but the Trading and Profit & Loss a/c prepared in a u
form suitable for financial analysis) we start by considering the gross sales (i.e. gross revenue) and n
end with arriving at the net profit. t
Revenue Recognition i
Revenues are n
realized when goods and services are exchanged for cash or receivables (debtors). g
realizable when assets received in exchange for goods and services are readily convertible to cash ,
or receivables (debtors). t
earned when the duties to be entitled to compensation are performed. r
Recognising revenue implies the act that would make the organisation consider that they have a
earned the revenue involved in the transaction. Based on when the d
revenue is recognised there are two types of accounting systems (1) i
Cash Basis of Accounting and (2) Accrual Basis or Mercantile System final,accounts,financial,acco n
of Accounting unting,trading,profit,loss,ac g
count,balance,sheet,trial,ba ,
lance,work,sheet,adjustme p
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Cash Basis Accounting
Under cash basis accounting revenues are recognized and earned only when cash is received
irrespective of when and how the services were performed or goods delivered.
To put it in different terms, the cash basis of accounting asks you to take into consideration all those
incomes/gains that have been received in cash or other assets and expenses/losses that have been
paid out in cash or other assets during the accounting period in consideration.
Accrual or Mercantile Basis Accounting
Under accrual or mercantile basis accounting, revenues are recognized and earned when they are
realized or realizable irrespective of when the cash is received.
To put it in different terms, the accrual basis of accounting asks you to take into consideration all those
incomes/gains and expenses/losses pertaining to the accounting period for which you are trying to
ascertain the profits and losses irrespective of whether the incomes are received in cash or not and the
expenses are paid out in cash or not.
Hybrid System of Accounting
This is not a system of accounting on its own. It is a combination of the Cash Basis Accounting and
Accrual Basis Accounting. This system is based on the concept of conservatism.
Under the hybrid system of accounting, incomes are recognised as in Cash Basis Accounting i.e. when
they are received in cash and expenses are recognised on accrual basis i.e. during the accounting
period in which they arise irrespective of when they are paid.
What Basis/system to follow?
The basis of accounting to be followed is dependent on the attitude and outlook of the organisation. If
organisations have a conservative attitude, they may adopt the hybrid system of accounting.
The traditional accounting systems used to adopt the cash basis of accounting. Organisations which are
to abide by the various regulations imposed by the various acts under which they are regulated are
mostly required to adopt the Mercantile System of Accounting which is supposed to reveal the
information relating to the organisation in a more appropriate manner than the cash basis of
accounting.
Conversion from One System to Another
In practice we consider only the Cash and Accrual bases as the systems of accounting. As such,
conversion implies converting from cash basis of accounting to the mercantile basis of accounting and
vice versa.
For the purpose of deriving each piece of information, a ledger account is created. The more the
information we need, the more the accounting heads we need to maintain.
Conversion
From Cash Basis to Accrual/Mercantile Basis would require the following
information to be brought into the books of accounts.
From Mercantile/Accrual Basis to Mercantile Basis would require the final,accounts,financial,acco
following information to be written off from the books of accounts. unting,trading,profit,loss,ac
count,balance,sheet,trial,ba
lance,work,sheet,adjustme
nts
Expenses Outstanding [≡ Creditors]
The amount of expenses that have been incurred but have not yet been paid out.
Separate ledger accounts may be used for each distinct expenditure (like outstanding salaries a/c,
Rent payable a/c, Interest unpaid a/c etc.) or a single account may be used in place of all these (like
outstanding expenses a/c or creditors for expenses a/c).
Creditors !!! (for expenses)
When an expenditure is outstanding it amounts to a liability for the organisation. It may have to be
paid to a person or an organisation. Any person or organisation to whom we owe money is called a
creditor. As such, the "outstanding expenditure a/c" is a personal account in the nature of a creditor.
Since it is indicative of a creditor, it carries a credit balance and has to be shown on the liabilities side
of the balance sheet.
The creditors for expenses are cleared in the subsequent periods by paying them out.
Expenses Prepaid [≡ Debtors]
The amount of expenses that have not yet been incurred but have been paid out in advance.
Separate ledger accounts may be used for each distinct expenditure (like Advance salaries a/c, Rent
prepaid a/c, Interest paid in advance a/c etc.) or a single account may be used in place of all these
(like Prepaid expenses a/c or expenses paid in advance a/c).
Incomes Receivable [≡ Debtors]
The amount of incomes (revenue) that have arisen and have not yet been received.
Separate ledger accounts may be used for each such income (like Interest Receivable a/c, Commission
Due a/c, etc.) or a single account may be used in place of all these (like Incomes Still Receivable a/c).
Incomes Pre-received [≡ Creditors]
Incomes that have not yet arisen but have been received in advance.
Separate ledger accounts may be used for each such income (like Interest received in advance a/c,
Commission Pre received a/c, etc.) or a single account may be used in place of all these (like Pre-
received Incomes a/c or Incomes received in advance a/c).

Any Nominal Account Head prefixed or


suffixed by the terms outstanding,
prepaid, pre-received, still receivable,
etc., indicates a personal account and
not a nominal account. Depending on
the nature of the balance in the
account, it is an equivalent of either a
creditor or a debtor.

Conversion from Cash Basis to Accrual Basis


To convert the accounting system from cash basis to accrual basis from a particular point of time, one
needs to identify the values attributable to the accounts of the nature as described above and bring
them into the books of accounts, which would take care of the adjustments to be made in the books for
the incomes/expenses relating to the past periods. From thereon, the incomes and expenses have to
be recorded on accrual basis.
The ledger accounts to be brought into the books of accounts are personal accounts and are an
equivalent of either debtors or creditors. Brining the ledger accounts equivalent to debtors would
amount to brining in an undisclosed asset into the books, which would result in a gain. Brining the
ledger accounts equivalent to creditors would amount to brining in an undisclosed liabilities into the
books, which would result in a loss. A ledger account by name "Profit and Loss Adjustment a/c" is used
to record thess gains or losses.
Journal Entries » Hide/Show

Journal in the books of M/s _____ for the period from _____ to _____
Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

31/12/05 – Profit & Loss Adjustment a/c Dr – 26,000


To Expenses Outstanding a/c – 26,000

[For brining the expenses outstanding to


be paid into the books of accounts.]

31/12/05 – Expenses Prepaid a/c Dr – 16,400


To Profit & Loss Adjustment a/c – 16,400

[For brining the expenses paid in advance


into the books of accounts.]

31/12/05 – Profit & Loss Adjustment a/c Dr – 11,100


To Incomes Pre-received a/c – 11,100

[For brining in the amount of incomes


received in advane into books of accounts.]

31/12/05 – Incomes Receivable a/c Dr – 5,200


To Profit & Loss Adjustment a/c – 5,200

[For brining the incomes receivable into


the books of accounts.]

Ledger Accounts » Hide/Show

Dr Expenses Outstanding a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Bal c/d – 26,000 31/12/05 By P/L – 26,000


Adjustment.

26,000 26,000

31/12/05 By Balance b/d – 26,000

Dr Expenses Prepaid a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To P/L – 16,400 31/12/05 By Bal c/d – 16,400


Adjustment
16,400 16,400

31/12/05 To Balance b/d – 16,400

Dr Incomes Pre-received a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Bal c/d – 11,100 31/12/05 By P/L – 11,100


Adjustment.

11,100 11,100

31/12/05 By Balance b/d – 11,100

Dr Incomes Receivable a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To P/L – 5,200 31/12/05 By Bal c/d – 5,200


Adjustment

5,200 5,200

31/12/05 To Balance b/d – 5,200

Dr Profit & Loss Adjustment a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Out. Exp. – 26,000 31/12/05 By Prepaid Exp. – 16,400


31/12/05 To Pre-rec. – 11,100 31/12/05 By Inc. – 5,200
Inc. receivable 15,500
By P/L
Appropr.

37,100 37,100
The overall gain or loss revealed by the "P/L Adjustment a/c" is written off to the "P/L
f
Appropriation a/c" or the "Capital a/c", depending on where the accumulated profits of the previous
i
periods have been transferred.
n
These would bring in all the adjustments needed for the various accruals, outstandings and prepaids
a
that have not been taken into consideration in the previous periods on account of not having
l
received the cash relating to the same.
,
Conversion from Accrual Basis to Cash Basis a
c
c
To convert the accounting system from accrual/mercantile basis to cash basis from a particular
o
point of time, one needs to identify the accounts of the nature as described above and write them off
u
from the books of accounts, which would take care of the adjustments to be made in the books for
n
the incomes/expenses relating to the past periods. From thereon, the incomes and expenses have to
t
be recorded on cash basis.
s
The ledger accounts to be written off from the books of accounts are personal accounts and are an
,
equivalent of either debtors or creditors. Writing off the ledger accounts equivalent to debtors would
f
amount to writing off an existing asset in the books, which would result in a loss. Writing off the
i
ledger accounts equivalent to creditors would amount to writing off an existing liability in the books,
n
which would result in a gain. A ledger account by name "Profit and Loss Adjustment a/c" is used to
a
record these losses or gains.
n
Journal Entries » Hide/Show c
i
a
Journal in the books of M/s _____ for the period from _____ to _____ l
,
Credit a
V/R Debit Amount c
Date Particulars L/F Amount
No. (in Rs) c
(in Rs)
o
u
31/12/05 – Expenses Outstanding a/c Dr – 31,650 n
To Profit & Loss Adjustment a/c – 31,650 t
i
n
[For writing off the expenses outstanding
g
to be paid, recorded as a liability, from the
,
books of accounts.]
t
r
31/12/05 – Profit & Loss Adjustment a/c Dr – 18,700 a
To Expenses Prepaid a/c – 18,700 d
i
n
[For writing off the expenses paid in g
advance, recorded as an asset, from the ,
books of accounts.] p
r
o
31/12/05 – Incomes Pre-received a/c Dr – 13,650
f
To Profit & Loss Adjustment a/c – 13,650
i
t
[For writing off the amount of incomes ,
received in advance, recorded as a liability, l
from books of accounts.] o
s
s
31/12/05 – Profit & Loss Adjustment a/c Dr – 8,750 ,
To Incomes Receivable a/c – 8,750 a
c
c
[For writing off the incomes receivable,
o
recorded as an asset, from the books of
u
accounts.]
n
t
,
b
a
Ledger Accounts » Hide/Show

Dr Expenses Outstanding a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To P/L – 31,650 31/12/05 By Bal b/d – 31,650


Adjustment.

31,650 31,650

Dr Expenses Prepaid a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Bal b/d – 18,700 31/12/05 By P/L – 18,700


Adjustment

18,700 18,700

Dr Incomes Pre-received a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To P/L – 13,650 31/12/05 By Bal b/d – 13,650


Adjustment.

13,650 13,650

Dr Incomes Receivable a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Bal b/d – 8,750 31/12/05 By P/L – 8,750


Adjustment

8,750 8,750
Dr Profit & Loss Adjustment a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Prepaid Exp. – 18,700 31/12/05 By Out. Exp. – 31,650


31/12/05 To Inc. – 8,750 31/12/05 By Pre-rec. – 13,650
31/12/05 receivable – 17,850 Inc.
To P/L
Appropr.

45,300 45,300
The overall gain or loss revealed by the "P/L Adjustment a/c" is written off to the "P/L Appropriation
a/c" or the "Capital a/c", depending on where the accumulated profits of the previous periods have
been transferred.
These would bring in all the adjustments needed for the various accruals, outstandings and prepaids
that have been taken into consideration in the previous periods on account of not having received the
cash relating to the same.
Income/Profits
The profits relating to a particular accounting period are revealed by the "Profit & Loss a/c" relating to
that period. The profits are derived by transferring the ledger account balances in the nominal accounts
to the "Trading a/" or "Profit & Loss a/c" as the case may be.
The basis of accounting followed i.e. cash basis or mercantile basis would decide the amount of
incomes/expenses in relation to the accounting period. Since the figure of profit is dependent on the
incomes/expenses, we can say that the figure of profit would vary depending on the method of
accounting being followed by the organisation.
Finding Income under a System given Income under the
other
Many a times, in problem solving, we would be required to identify the income under the Mercantile
basis accounting from the income under cash basis account.
We know that the information relating to outstanding expenses, expenses paid in advance, pre-
received incomes, outstanding incomes receivable is to be dealt with in changing the accounting
system from Cash to Mercantile or vice versa from a particular point of time. The same accounts are to
be dealt with in finding the income under one system given the income under the other system of
accounting. Moreover, we should understand that these accounts are to be dealt along with the
respective income/expenses accounts and not in isolation.
Adjusting Expenditure
Consider an expenditure like Salary. Within an accounting period, salary is expended as well as paid.
The amount of salary paid can be identified from the amount of cash paid or cheques issued towards
salaries. The amount of salary expended i.e. the expenditure on account of salary relating to the
current accounting period can be identified by making appropriate adjustments for outstanding and
prepaid salaries both at the beginning and ending of the accounting period.
Opening Expenses Outstanding
This represents the amount of expenditure that has been outstanding at the beginning of the
accounting period.
This would have to be cleared by paying out the amount in the current period. Therefore, the cash paid
in the current period towards the expenditure is assumed to include this outstanding amount also
(unless there is an indication to the contrary).
Thus to find the expenditure relating to the current period only, this amount has to be deducted from
the Cash Paid for the expense during the current period.
Opening Expenses Prepaid
This represents the amount of expenditure that has been paid in advance during the previous period.
The prepaid expenses account shows a debit balance at the end of the previous accounting period. It is
an equivalent of a debtor and is treated as an asset. During the current accounting period, this account
is closed by transferring the balance to the expenditure account.
Thus to find the expenditure relating to the current period only, this amount has to be added to the
Cash Paid for the expense during the current period.
Closing Expenses Outstanding
This represents the amount of expenditure relating to the current accounting period that has not yet
been paid.
Thus to find the expenditure relating to the current period only, this amount has to be added to the
Cash Paid for the expense during the current period.
Closing Expenses Prepaid
This represents the amount of expenditure relating to the subsequent accounting periods that has been
paid in advance during the current accounting period.
Thus to find the expenditure relating to the current period only, this amount has to be deducted from
the Cash Paid for the expense during the current period.

Particulars Amount Amount

Expenditure paid in Cash during the Current Period 2,48,000


15,425
(+) Opening Expenses Prepaid 45,300 60,725
Closing Expenses Outstanding 3,08,725
18,200
(−) Opening Expenses Outstanding 23,750 45,300
Closing Expenses Prepaid 2,66,775
Expenditure incurred in the current period

The adjustment relating to expenses can be summarised as follows:


Cash Paid + Opening Expenditure Prepaid − Opening Expenditure Outstanding
+ Closing Expenditure Outstanding − Closing Expenditure Prepaid = Expenditure Incurred.
Using the above relation, either the cash paid (which would be the expenditure to be considered in
cash basis accounting) or the expenditure pertaining to the current period (which would be the
expenditure to be considered under the mercantile basis accounting) can be found.
Deriving the Information using the Ledger a/c's » Hide/Show

The information relating to the cash paid and the expenditure incurred can also be obtained
using a ledger account instead of a statement. For this the relevant expenditure account is used.

Dr Expenditure Prepaid a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 To Bal b/d – 15,425 01/01/05 By Expenditure – 15,425


31/12/05 To Expenditure – 23,750 31/12/05 a/c – 23,750
a/c By Bal c/d

39,175 39,175

31/12/05 To Balance b/d – 23,750

The balance in the "Expenditure Prepaid a/c" at the beginning of the accounting period is
transferred to the "Expenditure a/c". At the end of the accounting period, a new asset equal to
the amount of expenditure that is paid in advance is created by transferring the debit from the
"Expenditure a/c"

Dr Expenditure Outstanding a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 To Expenditure – 18,200 01/01/05 By Bal b/d – 18,200


31/12/05 a/c – 45,300 31/12/05 By Expenditure – 45,300
To Bal c/d a/c

63,500 63,500

31/12/05 By Balance b/d – 4,300

The balance in the "Expenditure Outstanding a/c" at the beginning of the accounting period is
transferred to the "Expenditure a/c". At the end of the accounting period, a new liability equal to
the amount of expenditure that is outstanding to be paid is created by transferring the credit
from the "Expenditure a/c"

Dr Expenditure a/c Cr

Date Particulars J/F Amount Date Particulars J/F Amount


(in Rs) (in Rs)

01/01/05 To Exp. – 15,425 01/01/05 By Exp. Out. – 18,200


1st_31st Prepaid a/c – 2,48,000 1st_31st a/c – 2,66,775
31/12/05 To Cash/Bank – 45,300 31/12/05 By P/L a/c – 23,750
a/c By Exp.
To Exp. Out Prepaid a/c
a/c

3,08,725 3,08,725

The details relating to the opening and closing outstanding and prepaid expenditures being
known, the cash paid or the expenditure relatable to the current period (under mercantile
system) can be identified as the balancing figure when the data relating to the other is available.
Deriving the Information using only the Expenditure
a/c
The information relating to outstandings and prepaids is some times maintained using the
nominal account itself. In the above "Expenditure a/c", we can notice that the amount of
outstanding expenditure is to be debited and the prepaid expenditures is to be credited at the
end of the account period to derive the actual expenditure that is relatable to the current period.

Dr Expenditure a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 To Bal b/d – 15,425 01/01/05 By Bal b/d – 18,200


1st_31st To Cash/Bank – 2,48,000 1st_31st By P/L a/c – 2,66,775
31/12/05 a/c – 45,300 31/12/05 By Bal c/d – 23,750
To Bal c/d

3,08,725 3,08,725

01/01/06 To Bal b/d – 23,750 01/01/06 By Bal b/d – 45,300

This effect is brought about by carrying forward the amounts as balances to the subsequent
accounting periods within the same ledger accounts.
Outstanding Expenditure
The "Expenditure Outstanding a/c", if at all it is maintained would have a credit balance.
Therefore, instead of creating a separate account the same effect is brought about by carrying
forward a credit balance in the nominal account itself.

Dr Expenditure a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

– 01/01/05 By Bal b/d – 18,200


– –
31/12/05 To Bal c/d – 45,300 –

3,08,725 3,08,725
01/01/06 By Bal b/d – 45,300

Closing
The posting relevant to creating the closing outstanding balance would read "To Bal c/d"
towards the end of the ledger account. This indicates a credit balance being carried forward to
the subsequent accounting period.
Opening
Since a credit balance is brought forward from the previous accounting period, the posting
relevant to bringing in the opening outstanding balance would read "By Bal b/d" at the
beginning of the ledger account.
Expenditure Prepaid
The "Expenditure Prepaid a/c", if at all it is maintained would have a debit balance. Therefore,
instead of debiting a separate account the same effect is brought about by carrying forward a
debit balance in the nominal account itself.

Dr Expenditure a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 To Bal b/d – 15,425

31/12/05 By Bal c/d – 23,750

3,08,725 3,08,725

01/01/06 To Bal b/d – 23,750

Closing
The posting relevant to creating the closing prepaid balance would read "By Bal c/d" towards
the end of the ledger account. This indicates a debit balance being carried forward to the
subsequent accounting period.
Opening
Since a debit balance is brought forward from the previous accounting period, the posting
relevant to bringing in the opening prepaid balance would read "To Bal b/d" at the beginning of
the ledger account.
Opening » Outstanding vs Prepaid
The "Expenditure Outstanding a/c" is a personal account with a credit balance and is an equivalent of a
creditor (a liability). Creditors are cleared by paying out the amount due. Thus the oustandings of the
previous periods may be paid out in full or in part during the subsequent periods.
The "Expenditure Prepaid a/c" is a personal account with a debit balance and is an equivalent of a
debtor (an asset). Debtors are normally liquidated by paying realising the amounts due from them. But,
the prepaid expenditure is not an asset that is liquidated by realising it in cash. It is liquidated by
absorbing (writing off) the asset as an expenditure during the subsequent periods.
Adjusting Incomes
Consider an income like Interest. Within an accounting period, interest is earned as well as received in
cash. The amount of interest received can be identified from the amount of cash/cheques received
towards interest. The amount of interest earned i.e. the income on account of salary relating to the
current accounting period can be identified by making appropriate adjustments for outstanding and
pre-received interest both at the beginning and ending of the accounting period.
Opening Income Receivable
This represents the amount of income that has been outstanding and still receivable at the beginning of
the accounting period.
This would be cleared by realising the amount in the current period. Therefore, the cash received in the
current period towards the income is assumed to include this outstanding amount also (unless there is
an indication to the contrary).
Thus to find the income relating to the current period only, this amount has to be deducted from the
Cash received towards the income during the current period.
Opening Income Pre-received
This represents the amount of income that has been received in advance during the previous period.
The pre-received income account shows a credit balance at the end of the previous accounting period.
It is an equivalent of a creditor and is treated as a liability. During the current accounting period, this
account is closed by transferring the balance to the income account.
Thus to find the income relating to the current period only, this amount has to be added to the Cash
received for the income during the current period.
Closing Income Receivable
This represents the amount of income relating to the current accounting period that has not yet been
received.
Thus to find the income relating to the current period only, this amount has to be added to the Cash
received towards the income during the current period.
Closing Income Pre-received
This represents the amount of income relating to the subsequent accounting periods that has been
received in advance during the current accounting period.
Thus to find the income relating to the current period only, this amount has to be deducted from the
Cash received towards the income during the current period.

Particulars Amount Amount

Cash Received during the Current Period 1,32,500


8,125
(+) Opening Income Pre-received 5,245 13,370
Closing Income Receivable 1,45,870
6,850
(−) Opening Income Receivable 3,750 10,600
Closing Income Pre-received 1,35,270
Income relating to the current period
The adjustment relating to the incomes can be summarised as follows:
Cash Received + Opening Income Pre-received − Opening Income Receivable
+ Closing Income Receivable − Closing Income Pre-received = Income.
Using the above relation, either the cash received (which would be the income to be considered in cash
basis accounting) or the income pertaining to the current period (which would be the income to be
considered under the mercantile basis accounting) can be found.
Deriving the Information using the Ledger a/c's » Hide/Show

The information relating to the cash received and the income accrued can also be obtained using
a ledger account instead of a statement. For this the relevant income account is used.

Dr Income Pre-received a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 To Income a/c – 8,125 01/01/05 By Bal b/d – 8,125


31/12/05 To Bal c/d – 3,750 31/12/05 By Income a/c – 3,750

11,875 11,875

01/01/06 By Balance b/d – 3,750

The balance in the "Income Pre-received a/c" at the beginning of the accounting period is
transferred to the "Income a/c". At the end of the accounting period, a new liability equal to the
amount of income that is received in advance is created by transferring the credit from the
"Income a/c"

Dr Income Receivable a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 To Bal b/d – 6,850 01/01/05 By Income a/c – 6,850


31/12/05 To Income a/c – 5,245 31/12/05 By Bal b/d – 5,245

12,095 12,095

01/01/06 To Balance b/d – 5,245

The balance in the "Income Receivable a/c" at the beginning of the accounting period is
transferred to the "Income a/c". At the end of the accounting period, a new asset equal to the
amount of income that is still to be received is created by transferring the debit from the
"Income a/c"

Dr Income a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 To Inc. Rec – 6,850 01/01/05 By Inc. Pre. – 8,125


1st_31st a/c – 1,35,270 1st_31st a/c – 1,32,500
31/12/05 To P/L a/c – 3,750 31/12/05 By Cash/Bank – 5,245
To Inc. Pre. a/c
a/c By Inc. Rec.
a/c
1,45,870 1,45,870

The details relating to the opening and closing receivable and pre-received income being known,
the cash received or the income relatable to the current period (under mercantile system) can
be identified as the balancing figure when the data relating to the other is available.
Deriving the Information using only the Income a/c
The information relating to receivable and pre-received incomes is some times maintained using
the nominal account itself. In the above "Income a/c", we can notice that the amount of income
receivable is to be credited and the pre-received income is to be debited at the end of the
account period to derive the actual income that is relatable to the current period.

Dr Income a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 To Bal b/d – 6,850 01/01/05 By Bal b/d – 8,125


1st_31st To P/L a/c – 1,35,270 1st_31st By Cash/Bank – 1,32,500
31/12/05 To Bal c/d – 3,750 31/12/05 a/c – 5,245
By Bal c/d

1,45,870 1,45,870

This effect is brought about by carrying forward the amounts as balances to the subsequent
accounting periods within the same ledger accounts.
Income Receivable a/c
The "Income Receivable a/c", if at all it is maintained would have a debit balance. Therefore,
instead of creating a separate account the same effect is brought about by carrying forward a
debit balance in the nominal account itself.

Dr Income a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 To Bal b/d – 6,850

31/12/05 By Bal c/d – 5,245

01/01/06 To Bal b/d – 5,245

Closing
The posting relevant to creating the closing balance receivable would read "By Bal c/d" towards
the end of the ledger account. This indicates a debit balance being carried forward to the
subsequent accounting period.
Opening
Since a debit balance is brought forward from the previous accounting period, the posting
relevant to bringing in the opening outstanding balance would read "To Bal b/d" at the
beginning of the ledger account.
Pre-received Incomes
The "Income Pre-received a/c", if at all it is maintained would have a credit balance. Therefore,
instead of debiting a separate account the same effect is brought about by carrying forward a
credit balance in the nominal account itself.

Dr Income a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 By Bal b/d – 8,125

31/12/05 To Bal c/d – 3,750

01/01/06 By Bal b/d – 3,750

Closing
The posting relevant to creating the closing pre-received balance would read "To Bal c/d"
towards the end of the ledger account. This indicates a debit balance being carried forward to
the subsequent accounting period.
Opening
Since a credit balance is brought forward from the previous accounting period, the posting
relevant to bringing in the opening prepaid balance would read "By Bal b/d" at the beginning of
the ledger account.

Opening » Receivable vs Received in Advance


The "Income Receivable a/c" is a personal account with a debit balance and is an equivalent of a
debtor (an asset). Debtors are normally liquidated by realising the amounts due from them. Thus the
Incomes receivable relating to the previous periods may be realised in full or in part during the
subsequent periods.
The "Income Pre-received a/c" is a personal account with a credit balance and is an equivalent of a
creditor (a liability). Creditors are cleared by paying out the amount due to them. But, the pre-received
income is not a liability that is cleared by paying out in cash. It is cleared by absorbing (writing off) the
liability as an income during the subsequent periods.

A Nominal Account with a balance


represents a personal account. It is an
equivalent of a debtor (debit balance)
or a creditor (credit balance)
depending on the nature of balance.

Statement for Finding Income under Mercantile System


Particulars Amount Amount

Profit/Income under Cash Basis Accounting 2,48,000


(+) Opening Expenses Outstanding 18,200
Opening Incomes Pre-received 8,125
Closing Expenses Prepaid 23,750
Closing Incomes Receivable 5,245 55,320
3,03,320
(−) Opening Expenses Prepaid 15,425
Opening Incomes Receivable 6,850 f
Closing Expenses Outstanding 45,300 i
Closing Incomes Pre-received 3,750 49,775 n
Profit/Income under Mercantile/Accrual Basis Accounting 2,53,545 a
l
,
Statement for Finding Income under Cash System a
This statement is just the converse of the above statement. c
c
Particulars Amount Amount o
u
n
Profit/Income under Mercantile/Accrual Basis Accounting 2,53,545
t
15,425
s
(+) Opening Expenses Prepaid 6,850
,
Opening Incomes Receivable 45,300
f
Closing Expenses Outstanding 3,750 49,775
i
Closing Incomes Pre-received 3,03,320
n
18,200
a
(−) Opening Expenses Outstanding 8,125
n
Opening Incomes Pre-received 23,750
c
Closing Expenses Prepaid 5,245 55,320
i
Closing Incomes Receivable 2,48,000
a
Profit/Income under Cash Basis Accounting l
,
• Adjustments a
c
c
o
Adjustments are nothing but transactions relating to the business which have not been journalised. u
Therefore, to deal with adjustments one needs to understand the journal entry to be recorded if the n
transaction representing the adjustment is to be recorded in the books of accounts. t
The adjustments relating to outstanding/prepaid expenses and pre-received/receivable incomes are i
dealt with here. n
g
,
Outstanding Expenses t
At the end of the accounting period, there may be expenses which have become due but have not r
yet been paid. If the organisation is following the mercantile system of accounting, these expenses a
are to be brought into account. d
i
Debit » Expenditure a/c n
"Expenditure a/c" is a nominal account with a debit balance. The balance in the "Expenditure a/c" g
generally indicates the total amount paid on account of the expenditure during the current ,
accounting period. p
To bring the expenditure that has not yet been brought into account into the books, the relevant r
expenditure account has to be debited. o
[Expenditure a/c – Nominal a/c – Debit all Expenses and Losses.] f
Credit » Expenses Outstanding a/c i
t
"Expenses Outstanding a/c" is a personal account with a credit balance. The balance in the
,
"Expenses Outstanding a/c" indicates the amount that is owed by the organisation on account of the
l
expenditure unpaid.
o
The amount of expenditure that has not yet been paid is a liability for the organisation. The persons
s
to whom the organisation owes is its creditor. As such, the amount of expenditure outstanding that
s
has not yet been taken into the books is credited to the "Expenditure Outstanding a/c."
,
[Outstanding Expenditure a/c – Personal a/c – Credit the benefit giver.]
a
c
Journal in the books of M/s ____ for the period from 1st July 2005 to 30th c
June 2006 o
u
Credit n
V/R Debit Amount t
Date Particulars L/F Amount
No. (in Rs) ,
(in Rs)
b
a
1st to 30th – Expenditure a/c Dr – xxx
To Expenditure Outstanding a/c – xxx

[For the amount expenditure relating to


the current period, not yet paid brought in
to the books.]
Adjustment
The amount of expenditure outstanding is to be
Added to the relevant expenditure on the debit side of the "Trading a/" or "Profit & Loss a/c".
Shown as a liability on the liabilities side of the balance sheet.
Explanation/Illustration » Hide/Show
Trial Balance of M/s ___ as on 1st July 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Expenditure a/c –

Expenditure Outstanding a/c 13,500

Total

The "Expenditure a/c" being a nominal account is created anew in every accounting period. Thus it has
no balance on the opening day of the accounting period.
Cash paid towards the expenditure
» Rs. 4,500/month for 13 months (includes payment for 2 months outstanding dues)
For the Current Period Rs. 49,500 (Rs. 4,500/month × 11 months) and
For the previous period Rs. 9,000 (Rs. 4,500/month × 2 months).
Outstanding : (?) Rest of the Period
Since the accounting period consists of 12 months, the amount of expenditure outstanding would be for 1
month.
[Total payment for 13 months − Payment made for previous dues 2 months = Payment made for 11
months]
Method I :: "Expenditure Outstanding a/c" exists all
throughout
"Expenditure Outstanding a/c" is treated as a separate liability and the amount paid towards the
previous period dues are recorded through this account.

Journal in the books of M/s ____ for the period from 1st July 2005 to 30th
June 2005

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

1st to 30th – Expenditure a/c Dr – 49,500


Expenditure Outstanding a/c Dr – 9,000
To Cash/Bank a/c – 58,500

[For the amount paid towards the


expenditure relating to the current period
as well as the previous period dues.]

Dr Expenditure a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st-30th To Cash/Bank a/c – 49,500 30/06/06 By bal c/d – 49,500

49,500 49,500
Expenses Prepaid f
At the end of the accounting period, there may be expenses which have been paid in advance. These i
are expenses which are paid in advance and would be adjusted in the relevant expenditure during n
the subsequent accounting periods. a
Advances paid are treated in a different manner from expenses prepaid, the difference l
,
a
being that the advances are recoverable whereas expenditure prepaid are realised by adjusted them
c
in the amounts to be paid in the future towards the expenditure.
c
Credit » Expenditure a/c o
"Expenditure a/c" is a nominal account with a debit balance. The balance in the "Expenditure a/c" u
generally indicates the total amount paid on account of the expenditure during the current n
accounting period. t
On the assumption that the payments towards the expenditure include the expenditure prepaid, the s
expenditure has to be adjusted (reduced) to ascertain the actual expenditure chargeable for the ,
current period. f
"Expenditure a/c" shows a debit balance and as such to reduce it, the "Expenditure a/c" has to be i
credited. n
[Expenditure a/c – Nominal a/c – Credit all Incomes& Gains.] a
n
Debit » Expenses Prepaid a/c c
The prepaid expenditure is indicative of an amount that is owed to the organisation by the person or i
organisation to whom it has been prepaid. The persons who owe to the organisation are its debtors. a
Thus amount of expenditure prepaid is debited to the "Expenses Prepaid a/c". l
[Expenditure Prepaid a/c – Personal a/c – Debit the benefit receiver.] ,
a
Journal in the books of M/s ____ for the period from 1st July 2005 to 30th c
June 2006 c
o
u
Credit n
V/R Debit Amount
Date Particulars L/F Amount t
No. (in Rs)
(in Rs) i
n
1st to 30th – Expenditure Prepaid a/c Dr – xxx g
To Expenditure a/c – xxx ,
t
r
[For the amount expenditure relating to a
the subsequent periods paid in advance d
being adjusted from the current period i
expenditure.] n
g
,
p
r
o
f
i
t
,
l
o
s
s
,
a
c
c
o
u
n
t
,
b
a
Adjustment
The amount of expenditure prepaid is to be
Deducted from the relevant expenditure on the debit side of the "Trading a/" or "Profit & Loss a/c".
Shown as an asset on the assets side of the balance sheet.
Explanation/Illustration » Hide/Show

Trial Balance of M/s ___ as on 1st Jan 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Expenditure a/c –

Expenditure Prepaid a/c 8,000

Total

The "Expenditure a/c" being a nominal account is created anew in every accounting period. Thus it has
no balance on the opening day of the accounting period.
Cash paid towards the expenditure
» Rs. 86,000 (includes Rs. 6,000 pre paid)
Method I :: "Expenditure Prepaid a/c" exists all through out
This method of treating prepaid expenditure is not possible since the prepaid expenditure is not realised
in cash and is adjusted to the relevant expenditure only.
Method II :: "Expenditure Prepaid a/c" is raised and written
off
The "Expenditure Prepaid a/c" is created at the end of the accounting period and is written off by
transfer to the "Expenditure a/c" at the beginning of the accounting period.

Trial Balance of M/s ___ as on 1st Jan 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Expenditure a/c –

Expenditure Prepaid a/c – 8,000

Total
The balance in the "Expenditure Prepaid a/c" at the beginning of the accounting period represents the
expenditure prepaid at the end of the previous period brought forward. This balance is transferred to the
"Expenditure a/c" at the beginning of the accounting period.

Dr Expenditure Prepaid a/c Cr


Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 To Bal b/d – 8,000 01/01/05 By Expenditure a/c – 8,000

8,000 8,000

The amount that is paid during the current period, whether towards the current period dues or for the
subsequent period is recorded through the "Expenditure a/c".

Journal in the books of M/s ____ for the period from 1st Jan 2005 to 31st Dec
2005

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

1st to 31st – Expenditure a/c Dr – 86,000


To Cash/Bank a/c – 86,000

[For the amount paid towards the


expenditure relating to the current period
as well as the expenditure prepaid.]

Dr Expenditure a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 To Exp. Prep. a/c – 8,000 31/12/05 By Bal c/d – 94,000


1st-31st To Cash/Bank a/c – 86,000

94,000 94,000

31/12/05 To bal b/d – 94,000

Trial Balance of M/s ___ as on 31st Dec 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Expenditure a/c – 94,000

Expenditure Prepaid a/c – –


Total
The "Expenditure Prepaid a/c" does not carry any balance till the entry for recording the total
expenditure prepaid is recorded at the end of the accounting period.

Journal in the books of M/s ____ for the period from 1st Jan 2005 to 31st Dec
2005

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

31/12/05 – Expenditure Prepaid a/c Dr – 6,000


To Expenditure a/c – 6,000

[For the amount expenditure prepaid at the


end of the accounting period.]

Dr Expenditure a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Bal b/d – 94,000 31/12/05 By Exp. Prep. a/c – 6,000


31/12/05 By P/L a/c – 88,000

94,000 94,000

Dr Expenditure Prepaid a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Expenditure a/c – 6,000 31/12/05 By Bal c/d – 6,000

6,000 6,000

31/12/05 To Bal b/d – 6,000

Dr Trading and Profit & Loss a/c Cr

Amount Amount Amount Amount


Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)

Expenditure 88,000
Balance Sheet of M/s ______ as on 31st Dec 2005

Liabilities Amount Amount Assets Amount Amount

Expenditure Prepaid 6,000

Method II (alternative): Using Only "Expenditure a/c"


The prepaid expenditure is shown as a balance in the "Expenditure a/c" itself, thereby treating the
"Expenditure a/c" as a personal account for the purpose of making up the balance sheet. The
"Expenditure a/c" appearing in the Balance Sheet is a personal account and for all other purposes it is a
nominal account.

Trial Balance of M/s ___ as on 1st Jan 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Expenditure a/c – 8,000

Total
The "Expenditure a/c" is a personal account for the purpose of preparation of the opening balance sheet
and is treated a nominal account all throughout the accounting period.
Thus, the debit balance shown in the account on the opening day is indicative of a prepaid expenditure at
the end of the previous period.

Dr Expenditure a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/01/05 To Bal b/d – 8,000 31/12/05 By P/L a/c – 88,000


1st-31st To Cash/Bank a/c – 84,000 By Bal c/d – 6,000

94,000 94,000

01/01/06 To bal b/d – 6,000

The closing debit balance in the "Expenditure a/c" indicates the total expenditure pre-paid at the end of
the accounting period. Even in this case, the total amount paid during the current period is to be treated
as paid for the expenditure (without segregating between payment for the current period and payment
for the subsequent periods.)
The postings in the "Trading a/c" or "Profit and Loss a/c" would be the same as above with the only
difference being in the name of the account head that is shown in the balance sheet. "Expenditure a/c"
would appear in the balance sheet instead of the "Expenditure Prepaid a/c".
Adjustment during Final Accounting
Adjustment is bringing in the effect of the transactions through mathematical operations of addition and
subtraction. The adjustments to be made can be found out by ascertained the net effect of the journal
entries to be recorded.
Adjustments are generally required for transactions which are not yet recorded at the time of making up
the final accounts i.e. towards the end of the accounting period.
For the prepaid expenditure to be recorded at the end of the accounting period.

Regular Entries Net Effect

1) Expenditure Prepaid a/c Dr


To Expenditure a/c Expenditure Prepaid a/c Dr
2) Expenditure a/c Dr To Trading a/c (Or) Profit & Loss
To Trading a/c (Or) Profit & Loss a/c
a/c

The net effect would give an understanding on where the amounts are to be adjusted.
The amount of expenditure prepaid at the end of the accounting period is to be
deducted from the relevant expenditure on the debit side of the "Trading a/" or "Profit & Loss a/c".
Shown as an asset on the assets side of the balance sheet.

Dr Trading and Profit & Loss a/c Cr

Amount Amount Amount Amount


Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)

Expenditure 94,000
(−) Pre paid (cl). 6,000
Total Exp 88,000

Balance Sheet of M/s ______ as on 31st Dec 2005

Liabilities Amount Amount Assets Amount Amount

Expenditure Prepaid 6,000


Incomes » Receivable and Prereceived
Adjustments are nothing but transactions relating to the business which have not been journalised.
Therefore, to deal with adjustments one needs to understand the journal entry to be recorded if the
transaction representing the adjustment is to be recorded in the books of accounts.
The adjustments relating to prereceived/receivable incomes are dealt with here.
Incomes Receivable
At the end of the accounting period, there may be incomes which have become due but have not yet
been received. If the organistion is following the mercantile system of accounting, these incomes are
to be brought into account.
Credit » Income a/c
"Income a/c" is a nominal account with a credit balance. The balance in the "Income a/c" generally
indicates the total amount received on account of the income during the current accounting period.
To bring the income that has not yet been brought into account into the books, the relevant income
account has to be credited.
[Income a/c – Nominal a/c – Credit all Incomes and Gains.]
Debit » Income Receivable a/c
The income receivable is indicative of an amount that is owed to the organisation by a person or
organisation. The persons who owe to the organisation are its debtors.
Thus amount of income receivable is debited to the "Income Receivable a/c".
[Income Receivable a/c – Personal a/c – Debit the benefit receiver.]

Journal in the books of M/s ____ for the period from 1st April 2005 to 31st
March 2006

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

1st to 30th – Income Receivable a/c Dr – xxx


To Income a/c – xxx

[For the amount income relating to the


current period, not yet received brought
into the books.]
Adjustment
The amount of income receivable is to be
Added to the relevant income on the credit side of the "Trading a/" or "Profit & Loss a/c".
Shown as an asset on the assets side of the balance sheet.
Explanation/Illustration » Hide/Show

Trial Balance of M/s ___ as on 1st April 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Income a/c –

Income Receivable a/c – 6,800

Total

The "Income a/c" being a nominal account is created anew in every accounting period. Thus it has no
balance on the opening day of the accounting period.
Cash received towards the income
» Rs. 1,02,000 (includes past dues Rs. 5,200)
Income is to be received @ Rs. 9,000/month
Income Receivable relating to the current period = Rs. 11,200 {(Rs. 9,000 × 12) − (Rs. 1,02,000 −
5,200)}
Method I :: "Income Receivable a/c" exists all throughout
"Income Receivable a/c" is treated as a separate asset and the amount received towards the past dues
are recorded through this account.

Journal in the books of M/s ____ for the period from 1st July 2005 to 30th
June 2005

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

1st to 31st – Cash/Bank a/c Dr – 1,02,000


To Income a/c – 96,800
To Income Receivable a/c – 5,200

[For the amount received towards the


income relating to the current period as
well as the past period dues.]

Dr Income a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/03/06 To Bal c/d – 96,800 1st-31st By Cash/Bank a/c – 96,800


96,800 96,800

31/03/06 By Bal b/d – 96,800

Dr Income Receivable a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/04/05 To Bal b/d – 6,800 1st-31st By Cash/Bank a/c – 5,200


31/03/06 By Bal c/d – 1,600

6,800 6,800

01/04/06 To bal b/d – 1,600

Trial Balance of M/s ___ as on 31st March 2006

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Income a/c – 96,800



Income Receivable a/c 1,600

Total

Journal in the books of M/s ____ for the period from 1st April 2005 to 31st
March 2006

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

30/06/06 – Income Receivable a/c Dr – 11,200


To Income a/c – 11,200

[For the amount of income relating to the


current period, not yet received, brought
into the books.]

Dr Income a/c Cr

Date Particulars J/F Amount Date Particulars J/F Amount


(in Rs) (in Rs)

31/03/06 To P/L a/c – 1,08,000 31/03/06 By Bal b/d – 96,800


31/03/06 By Inc. Rec a/c – 11,200

1,08,000 1,08,000

Dr Income Receivable a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/03/06 To Bal b/d – 1,600 31/03/06 By Bal c/d – 12,800


31/03/06 To Income a/c – 11,200

12,800 12,800

01/04/06 To bal b/d – 12,800

Dr Trading and Profit & Loss a/c Cr

Amount Amount Amount Amount


Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)

Income a/c 1,08,000

Balance Sheet of M/s ______ as on 30th June 2006

Liabilities Amount Amount Assets Amount Amount

Income Receivable 12,800

Method II :: "Income Receivable a/c" is raised and written


off
The "Income Receivable a/c" is created at the end of the accounting period and is written off by transfer
to the "Income a/c" at the beginning of the accounting period.
Trial Balance of M/s ___ as on 1st April 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Income a/c – –

Income Receivable a/c – 6,800

Total
The balance in the "Income Receivable a/c" at the beginning of the accounting period represents the
income receivable at the end of the previous period brought forward. The balance in the "Income
Receivable a/c" at the beginning of the accounting period is transfered to the "Income a/c".

Dr Income Receivable a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/04/05 To Bal b/d – 6,800 01/04/05 By Income a/c – 6,800

6,800 6,800

The amount that is received during the current period, whether towards the current period dues or the
previous period dues is recorded through the "Income a/c", as that is the only account that is available.

Journal in the books of M/s ____ for the period from 1st Arpil 2005 to 31st
March 2006

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

1st to 30th – Cash/Bank a/c Dr – 1,02,000


To Income a/c Dr – 1,02,000

[For the amount received towards the


income relating to the current period as
well as the previous period dues.]

Dr Income a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

01/04/05 To Inc. Rec. a/c – 6,800 1st-31st By Cash/Bank a/c – 1,02,000


31/03/06 To Bal c/d – 95,200

1,02,000 1,02,000

31/03/06 By bal b/d – 95,200

Trial Balance of M/s ___ as on 31st March 2006

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Income a/c – 95,200

Income Receivable a/c – – –

Total
The "Income Receivable a/c" does not carry any balance till the receivables is recorded at the end of the
accounting period.

Journal in the books of M/s ____ for the period from 1st April 2005 to 31st
March 2006

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

30/06/06 – Income Receivable a/c Dr – 12,800


To Income a/c – 12,800

[For the total amount of income receivable


at the end of the accounting period
brought into books.]

Note
The total amount of income receivable at the end of the accounting period has to be brought into books
through the above entry and not just the income receivable relating to the current period.

Dr Income a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/03/06 To P/L a/c – 1,08,000 31/03/06 By Bal b/d – 95,200


By Inc. Rec. a/c – 12,800

1,08,000 1,08,000
Dr Income Receivable a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/03/06 To Income a/c – 12,800 31/03/06 By Bal c/d – 12,800

12,800 12,800

31/03/06 To Bal b/d – 12,800

Dr Trading and Profit & Loss a/c Cr

Amount Amount Amount Amount


Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)

Income 1,08,000

Balance Sheet of M/s ______ as on 30th June 2006

Liabilities Amount Amount Assets Amount Amount

Income Receivable 12,800

Method II (alternative): Using Only "Income a/c"


The income receivable is shown as a balance in tte "Income a/c" itself. Thus the "Income a/c" is treated
a personal account for the purpose of making up the balance sheet at the end of the accounting period
and during all other times it is treated as a nominal account.

Trial Balance of M/s ___ as on 1st April 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Income a/c – 6,800

Total
The "Income a/c" is a personal account for the purpose of preparation of the opening balance sheet and
is treated a nominal account.
Thus, the balance shown in the account on the opening day is indicative of an income receivable relating
ot the previous periods.

Dr Income a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/03/06 To Bal b/d – 6,800 1st-31st By Cash/Bank a/c – 1,02,000


To P/L a/c – 1,08,000 31/03/06 By Bal c/d – 12,800

1,14,800 1,14,800

01/04/06 To bal b/d – 12,800

The closing balance in the "Income a/c" indicates the total income receivable at the end of the
accounting period. Even in this case, the total amount received during the current period is to be treated
as being received for the income (without seggregating between receipt for the current period and
receipt for the previous period dues)
The postings in the "Trading a/c" or "Profit and Loss a/c" would be the same as above with the only
difference being in the name of the account head that is shown in the balance sheet. "Income a/c" would
appear in the balance sheet instead of the "Income Receivable a/c".
Adjustment during Final Accounting
Adjustment is bringing in the effect of the transactions through mathematical operations of addition and
subtraction. The adjustments to be made can be found out by ascertained the net effect of the journal
entries to be recorded.
Adjustments are generally required for transactions which are not yet recorded at the time of making up
the final accounts i.e. towards the end of the accounting period.
For the income receivable to be recorded at the end of the accounting period.

Regular Entries Net Effect

1) Income Receivable a/c Dr


To Income a/c Income Receivable a/c Dr
2) Income a/c Dr To Trading a/c (Or) Profit & Loss
To Trading a/c (Or) Profit & Loss a/c a/c
a/c

The net effect would give an understanding on where the amounts are to be adjusted.
The amount of income receivable at the end of the accounting period is to be
Added to the relevant income on the credit side of the "Trading a/" or "Profit & Loss a/c".
Shown as an asset on the assets side of the balance sheet.
Method I
Dr Trading and Profit & Loss a/c Cr

Amount Amount Amount Amount


Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)

Income 96,800
(+) Cur. Per. Out. 11,200
Total Inc 1,08,000
Balance Sheet of M/s ______ as on 30th June 2006

Liabilities Amount Amount Assets Amount Amount

Inc Out. 1,600


(+) Curr. Per. due 11,200
Total Inc. Out. 12,800

Method II
Dr Trading and Profit & Loss a/c Cr

Amount Amount Amount Amount


Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)

Income 95,200
(+) Total Out. 12,800
Total Inc 1,08,000

Balance Sheet of M/s ______ as on 31st March 2006

Liabilities Amount Amount Assets Amount Amount

Inc. Outstanding 12,800


Income Prereceived
At the end of the accounting period, there may be incomes which have been received in advance. These
are incomes which are received in advance and would have to be adjusted in the relevant income
during the subsequent accounting periods.
Advances received are treated in a different manner from incomes prereceived, the difference being
that the advances are repayable whereas incomes prereceived are liquidated by adjusting them in the
amounts to be received in the future towards the income.
Debit » Income a/c
"Income a/c" is a nominal account with a credit balance. The balance in the "Income a/c" generally
indicates the total amount received on account of the income during the current accounting period.
On the assumption that the receipts towards the income include the income prereceived, the income
has to be adjusted (reduced) to ascertain the actual income that can be considered for the current
period.
"Income a/c" shows a credit balance and as such to reduce it, the "Income a/c" has to be debited.
[Income a/c – Nominal a/c – Debit the benefit receiver.]
Credit » Income Prereceived a/c
The income prereceived is indicative of an amount that is owed by the organisation to another person
or organisation. The persons to whom the organisation owes are its creditors.
Thus amount of income prerecieved is credited to the "Income Prereceived a/c".
[Income Prereceived a/c – Personal a/c – Credit the benefit giver.]

Journal in the books of M/s ____ for the period from 1st April 2005 to 31st
March 2006

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

1st to 31st – Income a/c Dr – xxx


To Income Prereceived a/c – xxx

[For the amount income relating to the


subsequent periods received in advance
being adjusted from the current period
income.]

Adjustment
The amount of income prereceived is to be
Deducted from the relevant income on the credit side of the "Trading a/" or "Profit & Loss a/c".
Shown as a liability on the liabilities side of the balance sheet.
Explanation/Illustration » Hide/Show

Trial Balance of M/s ___ as on 1st April 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Income a/c –

Income Prereceived a/c 4,300

Total
The "Income a/c" being a nominal account is created anew in every accounting period. Thus it has no
balance on the opening day of the accounting period.
Cash received towards the income
» Rs. 58,000 (includes Rs. 2,800 pre received)
Method I :: "Income Prereceived a/c" exists all throughout
This method of treating prereceived incomes is not possible since the prereceived income is not paid
out in cash and is adjusted to the relevant income only.
Method II :: "Income Prereceived a/c" is raised and written
off
The "Income Prereceived a/c" is created at the end of the accounting period and is written off by
transfer to the "Income a/c" at the beginning of the accounting period.

Trial Balance of M/s ___ as on 1st April 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Income a/c –

Income Prereceived a/c – 4,300

Total
The balance in the "Income Prereceived a/c" at the beginning of the accounting period represents the
prereceived income at the end of the previous period brought forward. This balance is transfered to the
"Income a/c" at the beginning of the accounting period.

Dr Income Prereceived a/c Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

01/04/0 To Income a/c – 4,300 01/04/0 By Bal b/d – 4,300


5 5

4,300 4,300

The amount that is received during the current period, whether towards the current period dues or for
the subsequent period is recorded through the "Income a/c".

Journal in the books of M/s ____ for the period from 1st April 2005 to 31st
March 2006

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

1st to 31st – Cash'/Bank a/c Dr – 58,000


To Income a/c – 58,000

[For the amount received towards the


income relating to the current period as
well as the income prereceived.]

Dr Income a/c Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

31/03/0 To Bal c/d – 62,300 01/04/0 By Inc. Pre. a/c – 4,300


5 5 By Cash/Bank a/c – 58,000
1st-31st

62,300 62,300

31/03/0
By bal b/d – 62,300
6

Trial Balance of M/s ___ as on 31st March 2006

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)

Income a/c – 62,300

Income Prereceived a/c – –

Total
The "Income Prereceived a/c" does not carry any balance till the entry for recording the total income
prereceived is recorded at the end of the accounting period.

Journal in the books of M/s ____ for the period from 1st April 2005 to 31st
March 2006

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

31/03/06 – Income a/c Dr – 2,800


To Income Prereceived a/c – 2,800

[For the amount expenditure prepaid at the


end of the accounting period.]

Dr Income a/c Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)
31/03/0 To Inc. Pre recd. – 2,800 31/03/0 By Bal b/d – 62,300
6 a/c 59,500 6 –
31/03/0 To P/L a/c
6

62,300 62,300

Dr Income Pre Received a/c Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

31/12/0 To Bal c/d – 2,800 31/12/0 By Income a/c – 2,800


5 5

2,800 2,800

31/03/0
By Bal b/d – 2,800
6

Dr Trading and Profit & Loss a/c Cr

Amount Amount Amount Amount


Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)

Income 59,500

Balance Sheet of M/s ______ as on 31st Dec 2005

Liabilities Amount Amount Assets Amount Amount

Income Pre received 2,800

Method II (alternative): Using Only "Income a/c"


The prereceived income is shown as a balance in the "Income a/c" itself, thereby treating the "Income
a/c" as a personal account for the purpose of making up the balance sheet. The "Income a/c"
appearing in the Balance Sheet is a personal account and for all other purposes it is a nominal account.

Trial Balance of M/s ___ as on 1st April 2005

Particulars L/ Debit Credit


Amount Amount
F
(in Rs) (in Rs)

Income a/c – 4,300

Total
The "Income a/c" is a personal account for the purpose of preparation of the opening balance sheet
and is treated a nominal account all througout the accounting period.
Thus, the credit balance shown in the account on the opening day is indicative of a prereceived income
at the end of the previous period.

Dr Income a/c Cr

J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)

31/03/0 To P/L a/c – 59,500 01/04/0 By Bal b/d – 4,300


6 To Bal c/d – 2,800 5 By Cash/Bank a/c – 58,000
1st-31st

62,300 62,300

01/04/0
By bal b/d – 2,800
6

The closing debit balance in the "Income a/c" indicates the total income prereceived at the end of the
accounting period. Even in this case, the total amount received during the current period is to be
treated as having been received for the income (without seggregating between receipt for the current
period and receipt for the subsequent periods.)
The postings in the "Trading a/c" or "Profit and Loss a/c" would be the same as above with the only
difference being in the name of the account head that is shown in the balance sheet. "Income a/c"
would appear in the balance sheet instead of the "Income Prereceived a/c".
Adjustment during Final Accounting
Adjustment is bringing in the effect of the transactions through mathematical operations of addition
and subtraction. The adjustments to be made can be found out by ascertained the net effect of the
journal entries to be recorded.
Adjustments are generally required for transactions which are not yet recorded at the time of making
up the final accounts i.e. towards the end of the accounting period.
For the prereceived income to be recorded at the end of the accounting period.

Regular Entries Net Effect

1) Income a/c Dr
To Income Prereceived a/c Trading a/c (Or) Profit & Loss a/c
2) Trading a/c (Or) Profit & Loss a/c Dr
Dr To Income Prereceived a/c
To Income a/c

The net effect would give an understanding on where the amounts are to be adjusted.
The amount of income prereceived at the end of the accounting period is to be
deducted from the relevant income on the credit side of the "Trading a/" or "Profit & Loss a/c".
Shown as a liability on the liabilities side of the balance sheet.

Dr Trading and Profit & Loss a/c Cr


Amount Amount Amount Amount
Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)

Income 62,300
(−) Pre Recd (cl). 2,800
Total Income 59,500

Balance Sheet of M/s ______ as on 31st March 2006

Liabilities Amount Amount Assets Amount Amount

Income Prereceived 2,800


Annual Report and Accounts - Introduction
Annual report
• An annual report is a document produced annually by companies designed to
portray a true and fair view of the company’s annual performance, with audited
financial statements prepared in accordance with company law and other
regulatory requirements, and also containing other non-financial information.
• The Companies Act 1985/9 requires companies to publish their annual report
and accounts.
• It should include:
– A balance sheet
– A profit and loss account
– A cash flow statement
– A Directors Report
Stakeholders in the annual report
• Shareholders (the owners of the business).
• Potential shareholders.
• Managers and employees.
• Creditors and potential creditors.
• Suppliers – especially if the supply goods on credit.
• Employees and their trade unions.
• The government – for tax purposes.
Functions of the annual report
• The stewardship and accountability function
– Reporting to shareholders.
• The decision making function
– To provide information about performance and changes in the financial position
of an enterprise that is useful to a wide range of users in making economic
decisions.
– Providing users, especially shareholders with financial information so that they
can make decisions such as buying or selling shares.
• The public relations function
– The annual report is an opportunity to publicise the corporate image
A true and fair view
• Directors are responsible for the preparation of the accounts which must give a
true and fair view.
• A true and fair view is one where accounts reflect what has happened and do
not mislead the readers.
• The accounts must be prepared in accordance with relevant accounting
standards.
Information to be included
• The rules governing the content of the annual report are derived from:
• Statute law - the Companies Act
• Accounting standards
• Stock Exchange rules
• Codes of best practice in corporate governance.
Companies Act 1985/9
• Directors have stewardship of limited companies.
• Directors are required to publish accounts which show a true and fair view of
the company’s financial position.
• Accounts must be sent to:
– All shareholders
– All debenture holders
– The Registrar of Companies at Companies House.
– This must be done within 10 months of the year-end for a private company and
within 7 months of the year end in the case of a public company
Management Accounting

Financial Management

what is financial management?


Introduction
Financial Management can be defined as:
The management of the finances of a business / organisation in order to achieve
financial objectives
Taking a commercial business as the most common organisational structure, the
key objectives of financial management would be to:
• Create wealth for the business
• Generate cash, and
• Provide an adequate return on investment bearing in mind the risks that the
business is taking and the resources invested
There are three key elements to the process of financial management:

(1) Financial Planning


Management need to ensure that enough funding is available at the right time to
meet the needs of the business. In the short term, funding may be needed to
invest in equipment and stocks, pay employees and fund sales made on credit.
In the medium and long term, funding may be required for significant additions to
the productive capacity of the business or to make acquisitions.
(2) Financial Control
Financial control is a critically important activity to help the business ensure that
the business is meeting its objectives. Financial control addresses questions such
as:
• Are assets being used efficiently?
• Are the businesses assets secure?
• Do management act in the best interest of shareholders and in accordance with
business rules?
(3) Financial Decision-making
The key aspects of financial decision-making relate to investment, financing and
dividends:
• Investments must be financed in some way – however there are always
financing alternatives that can be considered. For example it is possible to raise
finance from selling new shares, borrowing from banks or taking credit from
suppliers
• A key financing decision is whether profits earned by the business should be
retained rather than distributed to shareholders via dividends. If dividends are
too high, the business may be starved of funding to reinvest in growing revenues
and profits further.
working capital introduction
The importance of working capital
Definition of working capital
The net working capital of a business is its current assets less its current
liabilities
Current Assets include:
- Stocks of raw materials
- Work-in-progress
- Finished goods
- Trade debtors
- Prepayments
- Cash balances
Current Liabilities include:
- Trade creditors
- Accruals
- Taxation payable
- Dividends payable
- Short term loans
Every business needs adequate liquid resources in order to maintain day-to-day
cash flow. It needs enough cash to pay wages and salaries as they fall due and to
pay creditors if it is to keep its workforce and ensure its supplies.
Maintaining adequate working capital is not just important in the short-term.
Sufficient liquidity must be maintained in order to ensure the survival of the
business in the long-term as well.
Even a profitable business may fail if it does not have adequate cash flow to meet
its liabilities as they fall due.
Therefore, when businesses make investment decisions they must not only
consider the financial outlay involved with acquiring the new machine or the new
building, etc, but must also take account of the additional current assets that are
usually involved with any expansion of activity.
Increased production tends to engender a need to hold additional stocks of raw
materials and work in progress. Increased sales usually means that the level of
debtors will increase. A general increase in the firm’s scale of operations tends to
imply a need for greater levels of cash.

working capital needs of a business


Introduction
Different industries have different optimum working capital profiles, reflecting their
methods of doing business and what they are selling.
• Businesses with a lot of cash sales and few credit sales should have minimal trade debtors.
Supermarkets are good examples of such businesses;
• Businesses that exist to trade in completed products will only have finished goods in stock.
Compare this with manufacturers who will also have to maintain stocks of raw materials
and work-in-progress.
• Some finished goods, notably foodstuffs, have to be sold within a limited period because of
their perishable nature.
• Larger companies may be able to use their bargaining strength as customers to obtain
more favourable, extended credit terms from suppliers. By contrast, smaller companies,
particularly those that have recently started trading (and do not have a track record of
credit worthiness) may be required to pay their suppliers immediately.
• Some businesses will receive their monies at certain times of the year, although they may
incur expenses throughout the year at a fairly consistent level. This is often known as
“seasonality” of cash flow. For example, travel agents have peak sales in the weeks
immediately following Christmas.
Working capital needs also fluctuate during the year
The amount of funds tied up in working capital would not typically be a constant figure
throughout the year.
Only in the most unusual of businesses would there be a constant need for working capital
funding. For most businesses there would be weekly fluctuations.
Many businesses operate in industries that have seasonal changes in demand. This means
that sales, stocks, debtors, etc. would be at higher levels at some predictable times of the
year than at others.
In principle, the working capital need can be separated into two parts:
• A fixed part, and
• A fluctuating part
The fixed part is probably defined in amount as the minimum working capital requirement
for the year. It is widely advocated that the firm should be funded in the way shown in the
diagram below:

The more permanent needs (fixed assets and the fixed element of working capital) should
be financed from fairly permanent sources (e.g. equity and loan stocks); the fluctuating
element should be financed from a short-term source (e.g. a bank overdraft), which can be
drawn on and repaid easily and at short notice.

working capital cycle


Introduction
The working capital cycle can be defined as:
The period of time which elapses between the point at which cash begins to be expended on
the production of a product and the collection of cash from a customer
The diagram below illustrates the working capital cycle for a manufacturing firm

The upper portion of the diagram above shows in a simplified form the chain of
events in a manufacturing firm. Each of the boxes in the upper part of the
diagram can be seen as a tank through which funds flow. These tanks, which are
concerned with day-to-day activities, have funds constantly flowing into and out
of them.
• The chain starts with the firm buying raw materials on credit.
• In due course this stock will be used in production, work will be carried out on
the stock, and it will become part of the firm’s work in progress (WIP)
• Work will continue on the WIP until it eventually emerges as the finished
product
• As production progresses, labour costs and overheads will need to be met
• Of course at some stage trade creditors will need to be paid
• When the finished goods are sold on credit, debtors are increased
• They will eventually pay, so that cash will be injected into the firm
Each of the areas – stocks (raw materials, work in progress and finished goods),
trade debtors, cash (positive or negative) and trade creditors – can be viewed as
tanks into and from which funds flow.
Working capital is clearly not the only aspect of a business that affects the
amount of cash:
• The business will have to make payments to government for taxation
• Fixed assets will be purchased and sold
• Lessors of fixed assets will be paid their rent
• Shareholders (existing or new) may provide new funds in the form of cash
• Some shares may be redeemed for cash
• Dividends may be paid
• Long-term loan creditors (existing or new) may provide loan finance, loans will
need to be repaid from time to time, and
• Interest obligations will have to be met by the business.
Unlike movements in the working capital items, most of these ‘non-working
capital’ cash transactions are not everyday events. Some of them are annual
events (e.g. tax payments, lease payments, dividends, interest and, possibly,
fixed asset purchases and sales). Others (e.g. new equity and loan finance and
redemption of old equity and loan finance) would typically be rarer events.

Planning & Budgeting

introduction to business planning


What is the Business Plan?
The business plan sets out how the owners/managers of a business intend to
realise its objectives. Without such a plan a business is likely to drift.
The business plan serves several purposes:it
(1)enables management to think through the business in a logical and structured
way and to set out the stages in the achievement of the business objectives.
(2)enables management to plot progress against the plan (through the
management accounts)
(3)ensures that both the resources needed to carry out the strategy and the time
when they are required are identified.
(4)is a means for making all employees aware of the business's direction
(assuming the key features of the business plan are communicated to employees)
(5)is an important document for for discussion with prospective investors and
lenders of finance (e.g. banks and venture capitalists).
(6)links into the detailed, short-term, one-year budget.
The Link Between the Business Plan and the Budget
A budget can be defined as "a financial or quantitative statement", prepared for a
specific accounting period (typically a year), containing the plans and policies to
be pursued during that period.
The main purposes of a budget are:
(1)to monitor business unit and managerial performance (the latter possibly
linking into bonus arrangements)
(2)to forecast the out-turn of the period's trading (through the use of flexed
budgets and based on variance analyses)
(3)to assist with cost control.
Generally, a functional budget is prepared for each functional area within a
business (e.g. call-centre, marketing, production, research and development,
finance and administration). In addition, it is also normal to produce a "capital
budget" detailing the capital investment required for the period, a "cash flow
budget", a "stock budget" and a "master budget", which includes the budgeted
profit and loss account and balance sheet.
Preparing a Business Plan
A business plan has to be particular to the organisation in question, its situation
and time. However, a business plan is not just a document, to be produced and
filed. Business planning is a continuous process. The business plan has to be a
living document, constantly in use to monitor, control and guide the progress of a
business. That means it should be under regular review and will need to be
amended in line with changing circumstances.
Before preparing the plan management should:
- review previous business plans (if any) and their outcome. This review will help
highlight which areas of the business have proved difficult to forecast historically.
For example, are sales difficult to estimate? If so why?
- be very clear as to their objectives - a business plan must have a purpose
- set out the key business assumptions on which their plans will be based (e.g.
inflation, exchange rates, market growth, competitive pressures, etc.)
- take a critical look at their business. The classical way is by means of the
strengths-weaknesses-opportunities-threats (SWOT) analysis, which identifies the
business's situation from four key angles. The strategies adopted by a business
will be largely based on the outcome of this analysis.
Preparing the Budget
A typical business plan looks up to three years forward and it is normal for the
first year of the plan to be set out in considerable detail. This one-year plan, or
budget, will be prepared in such a way that progress can be regularly monitored
(usually monthly) by checking the variance between the actual performance and
the budget, which will be phased to take account of seasonal variations.
The budget will show financial figures (cash, profit/loss working capital, etc) and
also non-financial items such as personnel numbers, output, order book, etc.
Budgets can be produced for units, departments and products as well as for the
total organisation. Budgets for the forthcoming period are usually produced
before the end of the current period. While it is not usual for budgets to be
changed during the period to which they relate (apart from the most
extraordinary circumstances) it is common practice for revised forecasts to be
produced during the year as circumstances change.
A further refinement is to flex the budgets, i.e. to show performance at different
levels of business. This makes comparisons with actual outcomes more
meaningful in cases where activity levels differ from those included in the budget.
What Providers of Finance Want from a Business Plan
Almost invariably bank managers and other providers of finance will want to see a
business plan before agreeing to provide finance. Not to have a business plan will
be regarded as a bad sign. They will be looking not only at the plan, but at the
persons behind it. They will want details of the owner/managers of the business,
their background and experience, other activities, etc. They will be looking for
management commitment, with enthusiasm tempered by realism. The plan must
be thought through and not be a skimpy piece of work. A few figures on a
spreadsheet are not enough.
The plan must be used to run the business and there must be a means for
checking progress against the plan. An information system must be in place to
provide regular details of progress against plan. Bank managers are particularly
wary of businesses that are slow in producing internal performance figures.
Lenders will want to guard against risk. In particular they will be looking for two
assurances:
(1)that the business has the means of making regular payment of interest on the
amount loaned, and
(2)that if everything goes wrong the bank can still get its money back (i.e. by
having a debenture over the business's assets). Forward-looking financial
statements, particularly the cash flow forecast, are therefore of critical
importance. The bank wants
openness and no surprises. If
something is going wrong it does
not want this covered up, it wants
to be informed - quickly.
Valuation of Normal/Abnormal Losses f
i
Losses n
a
Losses are classified based on their nature into two types: (a) Normal and (b) Abnormal. l
,
Normal Loss a
Those losses whose occurrence is inevitable i.e. which occur on account of normal reasons are c
normal losses. c
Abnormal Loss o
Those losses whose occurrence can be avoided i.e. which occur on account of abnormal reasons are u
abnormal losses. n
t
Identifying whether a loss is Normal or Abnormal s
A loss being normal or abnormal is dependent on the particular context and the goods in ,
consideration. f
To test whether a loss is Normal or Abnormal, the question we need to consider is "If we take up i
this activity again, will we come across this loss for sure?". If the answer is in the affirmative (i.e. n
yes), then the loss is a normal loss otherwise it is an abnormal loss. a
n
c
A loss that occurs every time an act is i
a
carried on is a normal loss. l
,
a
A loss that does not occur every time c
c
the same act is carried on but only has o
a chance of occurrence is an abnormal u
n
loss. t
i
n
Doesn't Magnitude of Loss indicate whether it is Normal g
,
or Abnormal !!! t
Deciding the nature of the loss based on the magnitude of loss is a wrong practice. However, in r
some situations where the nature of the activity is not known, we may be required to make a a
guess/assumption in which case we use the magnitude of loss as a guide to decide whether the loss d
is normal or abnormal. i
n
Eg Consider a vehicle transporting 10 Metric Tons of oil. There is a loss of 100 kg of Oil. To g
: decide whether this loss is normal or abnormal, we need to consider the question "Will this,
loss occur if we transport the 10 MT of oil again in the same vehicle in the same route?" If p
the answer is yes, then the loss is "Normal". If the answer is no, then the loss is r
"Abnormal". o
In problem solving, where we are not given the relevant information, we consider the f
magnitude of loss to decide whether the loss is normal or abnormal. Here it is 100 kg out of i
10 MT (= 10,000 kg) which would be 100/10,000 i.e. 0.01 or 1%. Since the product is oil t
whose transportation would result in leakage etc., 1% loss is normally possible. Therefore ,
we consider this to be normal loss. One should note that "just because this loss is 1%" we l
cannot conclude it to be normal loss in all situations. o
We resort to such assumptions where it is required of us to consider the loss as either s
normal or abnormal. s
,
a
c
c
o
u
n
t
,
b
a
Valuation of Normal and Abnormal Loss
Let us try to understand the difference between normal and abnormal losses using the following data
(illustration)
1000 units of a product have been purchased at Bombay @ Rs. 100 per unit (including freight and
delivery) at a total value of Rs. 1,00,000. These have been transported to Bangalore, the place where
they have to be used for production purposes. 100 units of these have been damaged in transit. These
100 damaged units would fetch a price of Rs. 1 per unit if sold in the market.
Considering the loss as normal
If the nature of the loss in transportation is such that it would occur every time 1,000 units of this kind
are transported from Bombay to Bangalore, then this loss of 100 units can be considered normal.
If we are to ascertain the cost of the 900 units left (after keeping aside the 100 units lost), we are to
choose between the following propositions.
The cost incurred by the organisation
For 900 units is Rs. 90,000 (900 units × Rs. 100/unit)
For 900 units is Rs. 1,00,000 being the cost of purchasing the total stock.
This would result in the unit cost working out to Rs. 111.11 (1,00,000 ÷ 900)
For 900 units is Rs. 99,900 (Rs. 1,00,000 − Rs. 100), being the cost of purchasing the total stock (Rs.
1,00,000) reduced by the amount realised on selling the loss units (100 units × Rs. 1/unit).
[This would result in the unit cost working out to Rs. 111 (99,900 ÷ 900)]
Normal Cost
Normal cost for stock/goods is the cost that would have to be incurred if we try to acquire the same
quantity and quality of stock/goods in another instance at or about the same time.
The idea relating to cost should also be created based on what happens if we consider a similar
transaction immediately. Suppose we need another lot of 900 units of this product, how many units
have we to buy? Surely, 1,000 units as 100 units will be lost in transit for sure (since the loss is being
termed normal).
The amount that we have to spend would also be for purchasing 1,000 units i.e. Rs. 1,00,000. However,
since the loss units are capable of being sold for Rs. 1 each every time such loss occurs, the cost
incurred can be set off by using this realisation in which case the net cost to be incurred for acquiring
the stock of 900 units would be Rs. 99,900.
Thus, the last idea would be the most appropriate one for deciding the cost per unit of the good stock
(net stock) purchased. This presented in the form of a statement
Particulars Quantity Value Rate

Gross Stock [Cost of Purchase] 1,000 1,00,000 100.00

Less: Normal Loss 100 100 1.00

Net Stock [Net Cost of Purchase] 900 99,900 111.00

Note
The data in the rate column should always be obtained as the quotient of Value ÷ Quantity.
The following conclusions can be derived from the above:
Net Realisable (Market) Value of Normal Loss:
The normal loss units can be sold at Rs. 1 per unit. This rate of Rs. 1 is also called its net realisable
value or net marketable rate or market price.
[Net Realisable Value = Sale Price − Expenses directly relatable to sales like sale commission etc.]
Here we do not have the expenses as such we consider sale price as the net realisable value]
Value of Normal Loss:
We were able to derive the Net cost of purchase i.e. Rs. 99,900 or Rs. 111.00 per unit by deducting Rs.
100 from the cost and 100 units from the units purchased. This implies that we have valued normal
loss at Rs. 1 per unit its market price (net realisable value).

Normal Loss is valued at its market price


(net realisable value)
This is an important valuation principle and is true for valuation of "Normal Loss" anywhere.
f
Cost of Normal Loss Stock i
All the stock was purchased @ Rs. 100 per unit. Therefore all the units that were lost as normal loss n
should also be considered to have been purchased at the same rate of Rs. 100 per unit. Thus the a
cost of the normal loss stock would be Rs. 10,000 (Rs. 100 × 100/unit). l
This cost would never be a part of any calculation (should never be considered) under normal ,
circumstances. We are considering it here only for the purpose of learning. a
c
Net Loss on Normal Loss Stock c
Net loss of Normal Loss Stock = Cost − Net Realisable Value o
Thus, the net loss on account of stock lost in normal loss is Rs. 9,900 (Rs. 10,000 − Rs. 100) u
This would also never be a part of any calculation (should never be considered) under normal n
circumstances. We are considering it here only for the purpose of learning. t
What happens to the Net Loss? s
,
The net loss on account of normal loss stock is absorbed by the good stock. That is the reason the
f
value of good (net) stock has increased from Rs. 100/unit to Rs. 111/unit. The Rs. 11/unit increase
i
being the net loss on account of normal loss (Rs. 9,900) being absorbed by the good stock (900
n
units) which would increase the unit value by Rs. 11/unit (Rs. 9,900 ÷ 900 units).
a
Considering the loss as Abnormal n
c
i
If the nature of the loss in transportation is such that it would not occur every time 1,000 units of
a
this kind are transported from Bombay to Bangalore, then this loss of 100 units can be considered to
l
be abnormal.
,
The cost incurred by the organisation
a
For 900 units is Rs. 90,000 (900 units × Rs. 100/unit)
c
In such a situation, the cost incurred for purchasing the 900 units (1000 − 100) can be calculated
c
based on the cost of purchase. This can be better explained by answering the question, how much
o
are we be required to spend if we are to procure a stock of 900 units again?.
u
Since the loss is abnormal in nature, the loss need not have to be borne every time. Therefore, to
n
acquire 900 units, we need to place an order for 900 units only which would require an expenditure
t
of Rs. 90,000 (900 units × Rs. 100/unit).
i
Particulars Quantity Value Rate n
g
Gross Stock [Cost of Purchase] 1,000 1,00,000 100.00 ,
t
r
Less: abnormal Loss 100 10,000 100.00 a
d
Net Stock [Net Cost of Purchase] 900 90,000 100.00 i
n
g
,
Note p
r
The data in the rate column should always be obtained as the quotient of Value ÷ Quantity.
o
The following conclusions can be derived from the above:
f
Value of Abnormal Loss: i
We were able to derive the Net cost of purchase i.e. Rs. 90,000 or Rs. 100.00 per unit by deducting t
Rs. 10,000 from the cost and 100 units from the units purchased. This implies that we have valued ,
abnormal loss at Rs. 100 per unit, the rate at which they were purchased. This rate of Rs. 100 is its l
purchase price and not selling price or the net marketable rate. o
s
s
Abnormal Loss is valued at cost or its full ,
a
value c
c
o
u
n
t
,
b
a
This is an important valuation principle and is true for valuation of "Abnormal Loss" anywhere.
Net Realisation from Abnormal Loss
Normal Loss is valued at a notional price which is its net realisable price. But abnormal loss is valued at
cost.
The realisation relating to abnormal loss stock would come into picture only when the abnormal loss
stock is sold or realised. The marketable rate of abnormal loss units would be dependent on the
condition of the units lost/destroyed at the time they were treated as having been lost. [The idea
relating to the rate at which the damaged goods can be sold is applicable only to Normal Loss Stock.
The abnormal loss stock cannot be assumed to be capable of being sold at this price except when it is
so specified.]
Assuming that the abnormal loss stock are sold at Rs. 25/unit, the realisation from abnormal loss stock
would be Rs. 2,500 (100 units @ Rs. 25/unit)
Other Realisations from Abnormal Loss Stock
Stock may be insured to cover losses on account of abnormal reasons. Thus where the abnormal loss
stock has been insured, there might be insurance realisation.
Where the stock has been insured, the insurance company might take away the salvaged stock and
consider the total stock as lost for paying the insurance amount. It might also leave the salvaged stock
with the customer, value it at a certain price and consider the rest of the value of the total stock as
having been lost.
Thus there may be only insurance realisation or both sale proceeds and insurance realisation with
regard to the abnormal loss stock.
Say the insurance company has agreed to pay Rs. 1,000.
Cost of Abnormal Loss Stock
All the units in the stock were purchased @ Rs. 100 per unit. Therefore all the units that were lost as
abnormal loss should also have been purchased at the same rate of Rs. 100 per unit. Thus the cost of
abnormal loss stock would be Rs, 10,000 (100 units × Rs. 100/unit).
Net Loss on Abnormal Loss Stock
Net loss of Abnormal Loss Stock = Cost − Net Realisation − Insurance Realisation
Thus, the net loss on abnormal loss stock is Rs. 4,500 (Rs. 10,000 − Rs. 2,500 − Rs. 3,000)
What happens to the Net Loss?
The net loss on account of stock lost on account of abnormal reasons should not be absorbed by the
good stock. It is charged to the "Profit & Loss a/c". This loss being of abnormal nature should not be
charged to any account giving the core profit of a particular type of business activity (like "Trading
a/c" , "Consignment a/c" , "Branch a/c", etc).
That is the reason the value of abnormal loss stock is eliminated from these accounts and dealt with
separately.
The value of net stock would be Rs. 100 per unit and is not influenced by the loss on account of
abnormal loss.
Particulars Quantity Value Rate

Abnormal Loss 100 10,000 100.00

Less: Sale Realisation 100 2,500 25.00

100 7,500 75.00

Less: Insurance Received 1,000 10.00

Net Loss[Transferred to P & L a/c] 100 6,500 65.00


Note f
The data in the rate column should always be obtained as the quotient of Value ÷ Quantity. i
n
Rate of Valuing Abnormal Loss Stock = Rate of Valuing a
Good Stock l
,
Notice that the abnormal loss stock is valued at the same rate as the other stock along with it. From
a
this one has to understand that there are basically two valuation rates only. Normal loss is valued at
c
market price and all other stocks are valued at the same rate which includes purchase price and the
c
relevant direct expenses.
o
Transfer to P & L a/c u
"Trading a/c", "Consignment a/c", "Branch a/c" etc., are accounts which would give us the profit or n
loss made from transactions relating to a certain stream of business. Each of these will generate a t
certain amount of profit/loss which is collected in the profit and loss account and all other s
losses/expenses of indirect nature are set off from this collective profit thereby leaving the "Net ,
Profit" for the organisation. f
In all these businesses, the same principle relating to normal and abnormal losses should be i
adopted. All normal losses should be absorbed by the respective business accounts. The profits that n
are revealed by these accounts should not be influenced by losses of abnormal nature. Therefore, a
they are eliminated from these accounts. Any loss that has to be borne on account of abnormal loss n
stock should be charged to the "Profit & Loss a/c" c
i
Cost to be considered for Valuing Abnormal Loss a
The stock lost on account of abnormal reasons is also an asset and since we find it l
destroyed/damaged we are assuming a loss. Therefore, in valuing abnormal loss stock also, the ,
principles for valuation of assets should be followed. This means that except for the fact that the a
stock is damaged, there is no difference in valuing normal stocks and abnormal loss stocks. c
Value of Stock = Cost + Direct Expenses incurred on the c
o
stock u
n
≡ Value of Abnormal Loss Stock = Cost + Direct Expenses t
incurred on the stock lost i
n
Abnormal Loss :: Accounting Treatment & Adjustments g
Stocks that the organisation deals with may be lost on account of abnormal reasons. Abnormal loss ,
stocks are to be valued at cost. t
The principles that are used in the valuation of assets are used even in the case of valuing abnormal r
loss stocks. a
d
Recording » Journal Entry i
We know that ledgers provide the information we need in accounting and anything that gets into the n
ledger should be through the journal. Even this forms a transaction that should be recorded through g
the journal. ,
Debit » Asset a/c p
r
o
f
i
t
,
l
o
s
s
,
a
c
c
o
u
n
t
,
b
a
The value of abnormal loss stock represents a temporary asset. The organisation would make efforts to
realise this asset in a number of different ways like selling the salvaged stock, insurance realisation
etc.
Thus a temporary asset account by name "Abnormal Loss Stock a/c" is created and used for this
purpose.
[Abnormal Loss Stock a/c – Real a/c – Debit what comes in.]
Many a times we use the words "Abnormal Loss a/c" and consider it a nominal account which is also an
accepted practice. We assume it to be a real account to enable an easier understanding of the
transactions involving abnormal loss stocks.
Some times a name that indicates the reason for the loss (like Stock Lost by Fire Accident) is preferred
in place of a general name like "Abnormal Loss". Whatever may be the name we give it and the nature
we attribute to the account, it is a temporary account.
Credit »
The value of abnormal loss stock represents the value of goods/stock that has not been used for
trading purposes. To reveal the cost of goods sold, the value of stock unused for trading activity is to
be deducted from the total value of goods.
For this the following ledger account would be credited depending on the time of recording the
transaction, what comprises the value of stock drawn and the account in which the related value exists
at the time of recording the entry.
Trading a/c
Generally, at the end of the accounting period, the balances (amounts) in all the ledger accounts which
go into the value of goods/stock, are closed by transfer to the "Trading a/c". This amounts to debiting
the "Trading a/c" with the total value of goods/stock.
Thus the value of abnormal loss stock has to be credited to the "Trading a/c" in which the total value
of goods/stock is existing as a debit balance.
Journal/Ledger » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec – Abnormal Loss Stock a/c Dr – 24,000


31st To Trading a/c – 24,000

[For the value of goods lost on account


of abnormal reasons.]

Dr Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Trading – 24,000 31/12/05 – xxx


a/c

Dr Trading a/c Cr
Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock xx By Sales xxx


To Purchases xx By Abnormal Loss 24,000
To Direct Expenses xx Stock xxx
To Gross Profit xx By Closing Stock

xxxx xxx

Goods Consumed a/c


Where the "Goods Consumed a/c" is used, the balances (amounts) in all the ledger accounts which go
into the value of goods/stock (including opening stock) are transferred to it. Thus the "Goods
Consumed a/c" would hold the total value of stock (as a debit balance).
Thus the value of abnormal loss stock has to be credited to the "Goods Consumed a/c" in which the
total value of goods/stock is existing as a debit balance.
Journal/Ledger » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec – Abnormal Loss Stock a/c Dr – 24,000


31st To Goods Consumed a/c – 24,000

[For the value of goods lost on account


of abnormal reasons.]

Dr Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Goods – 24,000 31/12/05 – xxx


Consumed
a/c

Dr Goods Consumed a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock xx By Abnormal Loss 24,000


To Purchases xx Stock xxx
To Direct Expenses xx By Closing Stock xxx
xx By Trading a/c(?)

xxxx xxx

Purchases a/c
Where the following conditions exist, we can credit "Purchases a/c" with the value of abnormal loss
stock.
The stock lost on account of abnormal reasons is physically relatable to the stock that has been
purchased during the current period.
There are no direct expenses in relation to the stock purchased during the current period
(Or)
The value of abnormal loss stock does not include the direct expenses incurred during the current
period
Journal/Ledger » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Abnormal Loss Stock a/c Dr


To Purchases a/c

[For the value of goods lost on


account of abnormal reasons.]

Dr Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Purchases – 24,000 31/12/05 – xxx


a/c

Dr Purchases a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Cash/Bank/Crs xx By Abnormal Loss 24,000


Stock xxx
By Trading a/c (?)
(Or) Goods Cons
a/c

xxxx xxx
Stock Losses (Abnormal)
Where such transactions occur frequently, the organisation may create a controlling account by name
"Stock Lost a/c". This is a nominal account that gives the information relating to the total value of
stock that has been lost on account of abnormal reasons during the accounting period.
Journal/Ledger » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec – Abnormal Loss Stock a/c Dr – 24,000


31st To Stock Losses (Abnormal) – 24,000
a/c

[For the value of goods used in the


construction of assets.]

Dr Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Stock – 24,000 31/12/05 – xxx


Losses (Ab)
a/c

Dr Stock Losses (Abnormal) a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Trading a/c xx By Abnormal Loss 24,000


(Or) Goods Cons. Stock
a/c

xxxx xxx

The "Stock Losses (Abnormal) a/c" would be closed at the end of the accounting period
by transfer to either the "Trading a/c" or "Goods Consumed a/c" or "Purchases a/c"
depending on where the value related to the stock drawn is included.
Disposing Abnormal Loss Stock
We will come across the following additional transactions relating to disposal of abnormal loss stock
Expenses Incurred » Journal/Ledger :: Hide/Show
The salvaged stock may be in a saleable condition or completely useless. There may be instances when
the salvaged stock can be brought into saleable condition by bearing certain expenditure.

This expenditure may be paid in cash or by cheques or may have been incurred and not yet been
paid.
Debit » Abnormal Loss Stock a/c
Since the amount spent is for the purpose of bringing the abnormal loss stock into saleable
condition would amount to brining the asset by name "Abnormal Loss Stock" into usable
condition, the expenditure should go into the value of the asset.
Thus the "Abnormal Loss Stock a/c" is debited with the amount of expenditure incurred.
Credit »
The expenditure incurred may be credited to
Cash a/c
If the expenses are paid out in cash
[Cash a/c – Real a/c – Credit what goes out.]
Bank a/c
If the expenses are paid by cheques
[Bank a/c – Personal a/c – Credit the benefit giver.]
Expenses Payable a/c (Or) Party/Creditors a/c
If the expenses are still to be paid
[Expenses Payable a/c (Or) Creditor/Party a/c – Personal a/c – Credit the benefit giver.]
Note:
Any nominal account prefixed/suffixed by the terms outstanding, prepaid, still receivable, still
payable etc., is a personal account and not a nominal account

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Abnormal Loss Stock a/c Dr – 1,000


To Cash a/c – 1,000

[For the amount spent on the abnormal


loss stock to bring it into saleable condition
paid in cash.]

Dec 31st – Abnormal Loss Stock a/c Dr – 2,800


To Bank a/c – 2,800

[For the amount spent on the abnormal


loss stock to bring it into saleable condition
paid by cheques.]

Dec 31st – Abnormal Loss Stock a/c Dr – 1,200


To Exp. Payable (Or) – 1,200
Party/Creditors a/c

[For the expenditure incurred on the


abnormal loss stock to bring it into
saleable condition which is still payable.]
Dr Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 24,000 31/12/05 – xxx


a/c – 1,000
To Cash a/c – 2,800
To Bank a/c – 1,200
To Exp. Payable.

Sale Realisation » Journal/Ledger :: Hide/Show


The salvaged stock may be directly sold (if in a saleable condition) or after getting them repaired or
refurbished.

The sale proceeds may be received in cash or by a cheques or may be still receivable
Credit » Abnormal Loss Stock a/c
Since the asset represented by the "Abnormal Loss Stock a/c" is being disposed off, it amounts
to the asset moving out of the organisation.
Thus the "Abnormal Loss Stock a/c" is credited with the amount of sale realisation
Debit »
The sale proceeds may be debited to
Cash a/c
If the proceeds are received in cash
[Cash a/c – Real a/c – Debit what comes in.]
Bank a/c
If the proceeds are received by cheques
[Bank a/c – Personal a/c – Debit the benefit receiver.]
Proceeds Receivable a/c (Or) Party/Debtors a/c
If the proceeds are still to be received
[Proceeds Receivable a/c (Or) Debtor/Party a/c – Personal a/c – Debit the benefit receiver.]
Note:
Any nominal account prefixed/suffixed by the terms outstanding, prepaid, still receivable, still
payable etc., is a personal account and not a nominal account

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Cash a/c Dr – 4,000


To Abnormal Loss Stock a/c – 4,000

[For the amount realised on the sale of


abnormal loss stock in cash.]
Dec 31st – Bank a/c Dr – 2,400
To Abnormal Loss Stock a/c – 2,400

[For the sale proceeds of abnormal loss


stock received through a cheques.]

Dec 31st – Proc. Receivable (Or) Party/Debtors Dr – 2,900


a/c – 2,900
To Abnormal Loss Stock a/c

[For the sale of salvaged stock and the sale


proceeds still receivable.]

Dr Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 24,000 31/12/05 By Cash – 4,000


a/c – 1,000 By Bank – 2,400
To Cash a/c – 2,800 By Pro. Rec – 2,900
To Bank a/c – 1,200
To Exp. Payable

Insurance Realisation » Journal/Ledger :: Hide/Show


Where the stock has been insured with one or more insurance companies, the insurance company
would pay the amount of compensation based on the contract of insurance.
The contract of insurance being a contract of indemnity, the total amount of compensation received
from all the insurance companies together would be not more than the total loss incurred.

The insurance amount may be recorded directly after it has been received or immediately on the
insurance company accepting the claim.
Credit » Abnormal Loss Stock a/c
Since the asset represented by the "Abnormal Loss Stock a/c" is being realised (though not
physically given away) or disposed off, it amounts to the asset moving out of the organisation.
Thus the "Abnormal Loss Stock a/c" is credited with the amount of sale realisation
Debit »
The insurance amount may be debited to
Bank a/c
Where the insurance amount has been received from the insurance company and where no entry
has been recorded for the amount the insurance company has accepted to pay.
[Bank a/c – Personal a/c – Debit the benefit receiver.]
Insurance Receivable (or Insurance Company) a/c
Where the insurance company has accepted to pay and the amount has not yet been received,
the amount may be shown as an asset (as a debtor).
This may be shown in the name of "Insurance Receivable a/c" or the "Insurance Company a/c"
[Insurance Receivable (or Insurance Company) a/c – Personal a/c – Debit the benefit receiver.]
Note:
Any nominal account prefixed/suffixed by the terms outstanding, prepaid, still receivable, still
payable etc., is a personal account and not a nominal account
Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Bank a/c Dr – 5,000


To Abnormal Loss Stock a/c – 5,000

[For the insurance amount relating to the


abnormal loss stock realised from the
insurance company.]

Dec 31st – Insurance Receivable (Company) a/c Dr – 2,500


To Abnormal Loss Stock a/c – 2,500

[For the insurance amount accepted to be


paid by the insurance company which is
still receivable.]

Dr Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 24,000 31/12/05 By Cash – 4,000


a/c – 1,000 By Bank – 2,400
To Cash a/c – 2,800 By Pro. Rec – 2,900
To Bank a/c – 1,200 By Bank – 5,000
To Exp. Payable By Ins. Rec – 2,500
Commission on Sale
Where there is a commission being paid or payable on the sale of abnormal loss stock it may be
Deducted from the sale proceeds received/receivable and only the net proceeds may be brought into
account
Recorded just like any other expenditure that goes into the value of the Abnormal Loss Stock
Profit/Loss on Disposal » Journal/Ledger :: Hide/Show
The "Abnormal Loss Stock a/c" may carry a balance after having sold the salvaged stock and realising
the insurance amount.
If there is a debit balance it represents the amount of asset value that is unrealisable and as such a
loss.
Though, it is a very rare occurrence, the "Abnormal Loss Stock a/c" may carry a credit balance which
indicates that the asset has realised at a value greater than the actual asset value, thereby resulting in
a profit.
Whether there is a profit or a loss, it is of abnormal nature since it is related to "Abnormal Loss Stock
a/c". The profit or loss is transferred to the "Profit & Loss a/c" thereby closing the "Abnormal Loss
Stock a/c".

When there is a loss


Debit » Profit & Loss a/c
"Profit & Loss a/c" being a nominal account, any loss should be debited to it.
[Profit & Loss a/c – Nominal a/c – Debit all expenses and losses.]
Credit » Abnormal Loss Stock a/c
The "Abnormal Loss Stock a/c" has a debit balance and has to be closed by transferring the
balance to the "Profit & Loss a/c".
Thus the "Abnormal Loss Stock a/c" has to be credited.
["Abnormal Loss Stock a/c" – Real a/c – Credit what goes out.]
The "Abnormal Loss Stock a/c" carries a debit balance when there is a loss. Transfer of a debit
balance from one account to a second results in the second account being debited and the first
account being credited.

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Profit & Loss a/c Dr – 12,200


To Abnormal Loss Stock a/c – 12,200

[For the net loss in abnormal loss stock


being transferred to the profit and loss
account.]

Dr Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 24,000 31/12/05 By Cash – 4,000


a/c – 1,000 By Bank – 2,400
To Cash a/c – 2,800 By Pro. Rec – 2,900
To Bank a/c – 1,200 By Bank – 5,000
To Exp. Payable By Ins. Rec – 2,500
By P/L a/c – 12,200

29,000 29,000
When there is a gain
Credit » Profit & Loss a/c
"Profit & Loss a/c" being a nominal account, any profit should be credited to it.
[Profit & Loss a/c – Nominal a/c – Credit all incomes and gains.]
Debit » Abnormal Loss Stock a/c
The "Abnormal Loss Stock a/c" has a credit balance and has to be closed by transferring the
balance to the "Profit & Loss a/c".
Thus the "Abnormal Loss Stock a/c" has to be debited.
The "Abnormal Loss Stock a/c" carries a credit balance when there is a profit. Transfer of a
credit balance from one account to a second results in the second account being credited and the
first account being debited.

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Abnormal Loss Stock a/c Dr – 2,800


To Profit & Loss a/c – 2,800

[For the gain in the abnormal loss stock


account transferred to the profit and loss
account.]

Dr Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 24,000 31/12/05 By Cash – 4,000


a/c – 1,000 By Bank – 2,400
To Cash a/c – 2,800 By Pro. Rec – 2,900
To Bank a/c – 1,200 By Bank – 20,000
To Exp. Payable – 2,800 By Ins. Rec – 2,500
To P/L a/c

31,800 31,800

Assume that the insurance realisation is Rs. 20,000 in place of Rs. 5,000 for understanding this.

Adjustment during Final Accounting


Adjustment is bringing in the effect of the transactions through mathematical operations of addition
and subtraction. The adjustments to be made can be found out by ascertained the net effect of the
journal entries to be recorded.
Adjustments are generally required for transactions which are not yet recorded at the time of making
up the final accounts i.e. towards the end of the accounting period.

Regular Entries Net Effect


1) Abnormal Loss Stock a/c Dr
To Trading a/c
2) Abnormal Loss Stock a/c Dr
To Expenses Outstanding Insurance Company a/c Dr
a/c Proceeds Receivable a/c Dr
3) Insurance Company a/c Dr Profit and Loss a/c Dr
To Abnormal Loss Stock a/c To Trading a/c
4) Proceeds Receivable a/c Dr To Expenses Outstanding a/c
To Abnormal Loss Stock a/c
5) Profit and Loss a/c Dr
To Abnormal Loss Stock a/c

Note
Since adjustment is needed at the end of the accounting period, we assume that the proceeds are
receivable, expenses are payable and insurance amount is receivable where the information relating to
them is to be incorporated into the accounts.
The net effect would give an understanding on where the amounts are to be adjusted. Since the journal
entry representing the net effect is a compound entry, the number of accounts affected, thereby the
number of adjustments to be made , can be identified by the number of accounts involved in the
compound entry.
The value of stock used in the building up of the asset is to be
The value of stock lost should be credited to the "Trading a/c"
The net profit or loss on disposing the abnormal loss stock should be transferred to the "Profit & Loss
a/c"
Where there is no realisation either in the form of sale proceeds of salvaged stock or insurance
realisation, the total value of stock lost (value of stock + expenses incurred) would be a loss.
Where there is sale or insurance realisation or both the total value realised is reduced by the total
amount of realisation giving us the net amount of loss.
Where there is sale or insurance realisation or both, if the total value realised is more than the total
value of the stock there would be a gain. [This is a very rare occurrence.]
Abnormal Loss Stock » Statement to ascertain Loss/Gain
Hide/Show

Amou
Particulars Amount
nt

Incomes/Realisations:
Sale Realisation
Cash 4,000
Bank 2,400
Receivable 2,900 9,300
Insurance
Received 5,000
Receivable 2,500 7,500

Total Realisation 16,800

Expenses/Costs:
Value of Stock 24,000
Expenses Incurred
Paid in Cash 1,000
Paid by Cheque 2,800
Outstanding 1,200 5,000
Commission on Sale – –

Total Cost/Value of the Abnormal Loss Stock 29,000

Profit(+)/Loss(−) [Sale Realisation − Total −


f
Cost/Value] 12,200 i
n
The amount of expense payable outstanding if any relating to the abnormal loss stock has to be a
shown as a liability on the liabilities side of the balance sheet. l
The amount of sale proceeds receivable if any relating to the abnormal loss stock has to be shown as ,
an asset on the assets side of the balance sheet. a
The insurance amount receivable if any relating to the abnormal loss stock has to be shown as an c
asset on the assets side of the balance sheet. c
o
Dr Trading and Profit & Loss a/c Cr u
n
t
Amount Amount Amount Amount s
Particulars Particulars ,
(in Rs) (in Rs) (in Rs) (in Rs)
f
i
n
By Abnormal Loss 24,000 a
n
c
i
a
l
,
a
c
To Abnormal Loss 12,200 c
Stock o
u
n
t
i
n
Balance Sheet of M/s ______ as on 30th June 2006 g
,
t
Liabilities Amount Amount Assets Amount Amount r
a
d
i
Realisation Receivable 2,900 n
Expenditure Outstanding 1,200 g
Insurance Company 2,500 ,
p
r
o
f
Using Temporary Accounts i
t
,
l
o
s
s
,
a
c
c
o
u
n
t
,
b
a
Recording the value of stock lost on account of abnormal reasons would result in the "Abnormal Loss
Stock a/c" or an account by any relevant name being created. The "Abnormal Loss Stock a/c" would be
used in recording the transactions relating to expenses on the stock, sale realisations, insurance
realisation etc., if the entries are being recorded subsequent to recording this transaction.
However, where the journal entry for recording the value of abnormal loss stock has not yet been
recorded, the "Abnormal Loss Stock a/c" would not be found in the books of accounts. In such cases,
where the accountant is confused about which account to use some temporary account by relevant
name would be used to complete recording the transaction.
In such cases, care should be taken to ensure that these temporary accounts are cleared by using them
in recording the entries relating to abnormal loss stock. These can be identified by their presence in the
"Trial Balance".
For Expenses Paid
When expenses are paid, a temporary account, say by name "Expenses on Abnormal Loss Stock a/c"
may be used to record the expenditure incurred. If such an account is used, it would appear in the
"Trial Balance".
This has to be closed by absorbing the expenditure to the "Abnormal Loss Stock a/c".
Journal » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Expenses on Abnormal Loss Stock a/c Dr – 2,500


– 2,500
To Cash/Bank/Outst Exp a/c

[For the expenses on abnormal loss stock.]

Trial Balance of _____ as on 31st December 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)



Expenses on Abnormal Loss Stock – 2,500

Total

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Abnormal Loss Stock a/c Dr – 2,500


To Exp. on Abnormal Loss Stock
a/c – 2,500

[For the expenses on abnormal loss stock


absorbed.]

Dr Expenses on Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st To Cash/Bank/Drs – 2,500 31/12/05 By Ab. Loss – 2,500


-31st Stock a/c

2,500 2,500

Dr Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Trading a/c – 24,000 –


31/12/05 To Exp. Ab. Ls. – 2,500
Stc

The temporary account is assumed to have got exhausted and the expenditure is added to the
value of stock for the purpose of incorporating the same information as adjustment.

For Sale Realisation


When sale proceeds are received, a temporary account, say by name "Sale of Abnormal Loss Stock a/c"
may be used to record the proceeds received/receivable. If such an account is used, it would appear in
the "Trial Balance".
This has to be closed by absorbing the proceeds to the "Abnormal Loss Stock a/c".
Journal » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Cash/Bank/Proc. Rec a/c Dr – 8,000


To Sale of Abnormal Loss Stock – 8,000
a/c
[For the amount received on the sale of
abnormal loss stock.]

Trial Balance of _____ as on 31st December 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)



Sale of Abnormal Loss Stock – 8,000

Total

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Sale of Abnormal Loss Stock a/c Dr – 8,000


To Abnormal Loss Stock a/c – 8,000

[For the sale realisation of abnormal loss


stock absorbed.]

Dr Sale of Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Abnormal – 8,000 1st By Cash/Bank/Drs – 8,000


Loss Stock a/c -31st

8,000 8,000

Dr Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)
31/12/05 To Trading a/c – 24,000
31/12/05 By Sale of Ab. – 8,000
ls. St

For the purpose of incorporating the same information as adjustment, the temporary account is
assumed to have got exhausted and the proceeds are considered for ascertaining the profit or
loss on abnormal loss stock.

For Insurance Realisation


When insurance realisation is received, a temporary account, say by name "Insurance received a/c"
may be used to record the amount received/receivable. If such an account is used, it would appear in
the "Trial Balance".
This has to be closed by absorbing the proceeds to the "Abnormal Loss Stock a/c".
Journal » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Cash/Bank a/c Dr – 5,000


To Insurance Received a/c – 5,000

[For the amount received towards


compensation for loss of stock from the
insurance company.]

Trial Balance of _____ as on 31st December 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)



Insurance Received – 5,000

Total

Journal in the books of M/s __ for the period from ____ to _____

Date V/R Particulars L/F Debit Amount Credit


No. (in Rs) Amount
(in Rs)

Dec 31st – Insurance Received a/c Dr – 8,000


To Abnormal Loss Stock a/c – 8,000

[For the insurance realisation of abnormal


loss stock absorbed.]

Dr Insurance Received a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Abnormal Loss – 5,000 1st By Cash/Bank – 5,000


Stock a/c -31st

5,000 5,000

Dr Abnormal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Trading a/c – 24,000 –


31/12/05 By Ins. – 5,000
Received

For the purpose of incorporating the same information as adjustment, the temporary account is
assumed to have got exhausted and the proceeds are considered for ascertaining the profit or
loss on abnormal loss stock.

Normal Loss :: Accounting Treatment & Adjustments


Stocks that the organisation deals with may be lost on account of normal reasons. Normal loss stocks
are to be valued at their net realisable price and not at cost.
Recording » Journal Entry
We know that ledgers provide the information we need in accounting and anything that gets into the
ledger should be through the journal. Even this forms a transaction that should be recorded through
the journal.
Debit » Asset a/c
The value of normal loss stock represents a temporary asset. The organisation would make efforts to
f
realise this asset by selling it, if at all it has a realisable value.
i
Thus a temporary asset account by name "Normal Loss a/c" is created and used for this purpose.
n
[Normal Loss a/c – Real a/c – Debit what comes in.]
a
Many a times we consider the "Normal Loss a/c" to be a nominal account which is also an accepted
l
practice. We assume it to be a real account to enable an easier understanding of the transactions
,
involving normal loss.
a
Where there are two or more types of normal losses, to differentiate the accounts the reason for the
c
loss may be included with the account name. "Normal Loss (Wastage) a/c" , "Normal Loss (Weight
c
Loss) a/c". Whatever may be the name we give it and the nature we attribute to the account, it is a
o
temporary account.
u
Credit » n
The value of normal loss stock represents the value of goods/stock that has not been used for t
trading purposes. To reveal the cost of goods sold, the value of stock unused for trading activity is to s
be deducted from the total value of goods. ,
For this the following ledger account would be credited depending on the time of recording the f
transaction, what comprises the value of stock drawn and the account in which the related value i
exists at the time of recording the entry. n
a
Trading a/c n
Generally, at the end of the accounting period, the balances (amounts) in all the ledger accounts c
which go into the value of goods/stock, are closed by transfer to the "Trading a/c". This amounts to i
debiting the "Trading a/c" with the total value of goods/stock. a
Thus the value of normal loss stock has to be credited to the "Trading a/c" in which the total value l
of goods/stock is existing as a debit balance. ,
Journal/Ledger » Hide/Show a
c
c
Journal in the books of M/s __ for the period from ____ to _____ o
u
n
Credit t
V/R Debit Amount
Date Particulars L/F Amount i
No. (in Rs)
(in Rs) n
g
Dec – Normal Loss a/c Dr – 1,200 ,
31st To Trading a/c – 1,200 t
r
a
[For the value of normal loss.] d
i
n
g
Dr Normal Loss a/c Cr ,
p
r
Amount Amount o
Date Particulars J/F Date Particulars J/F f
(in Rs) (in Rs)
i
t
31/12/05 To Trading – 1,200 31/12/05 – xxx ,
a/c l
o
s
s
,
a
c
c
Dr Trading a/c Cr o
u
n
t
Amount Amount ,
Particulars Particulars
(in Rs) (in Rs) b
a
To Opening Stock xx By Sales xxx
To Purchases xx By Normal Loss 1,200
To Direct Expenses xx By Closing Stock xxx
To Gross Profit xx

xxxx xxx

Goods Consumed a/c


Where the "Goods Consumed a/c" is used, the balances (amounts) in all the ledger accounts which go
into the value of goods/stock (including opening stock) are transferred to it. Thus the "Goods
Consumed a/c" would hold the total value of stock (as a debit balance).
Thus the value of normal loss stock has to be credited to the "Goods Consumed a/c" in which the total
value of goods/stock is existing as a debit balance.
Journal/Ledger » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Debit Credit
V/R
Date Particulars L/F Amount Amount
No.
(in Rs) (in Rs)

Dec – Normal Loss Stock a/c Dr – 1,200


31st To Goods Consumed a/c – 1,200

[For the value of normal loss.]

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Goods – 1,200 31/12/05 – xxx


Consumed a/c

Dr Goods Consumed a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock xx By Normal Loss 24,000


To Purchases xx By Closing Stock xxx
To Direct Expenses xx By Trading a/c(?) xxx
xx

xxxx xxx
Purchases a/c
Where the following conditions exist, we can credit "Purchases a/c" with the value of normal loss
stock.
The normal loss stock is physically relatable to the stock that has been purchased during the current
period.
There are no direct expenses in relation to the stock purchased during the current period
(Or)
The value of normal loss stock does not include the direct expenses incurred during the current period
Journal/Ledger » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Debit Credit
V/R
Date Particulars L/F Amount Amount
No.
(in Rs) (in Rs)

1st - – Normal Loss a/c Dr – 1,200


31st To Purchases a/c – 1,200

[For the value of normal loss.]

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Purchases – 1,200 31/12/05 – xxx


a/c

Dr Purchases a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Cash/Bank/Crs xx By Normal Loss 1,200


By Trading a/c (?) xxx
(Or) Goods Cons
a/c

xxxx xxx
Stock Adjustment (Normal Loss)
Where such transactions occur frequently, the organisation may create a controlling account by name
"Stock Adjustment (Normal) a/c". This is a nominal account that gives the information relating to the
total value of stock that has been lost on account of normal reasons during the accounting period.
Journal/Ledger » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Debit Credit
V/R
Date Particulars L/F Amount Amount
No.
(in Rs) (in Rs)

Dec – Normal Loss a/c Dr – 1,200


31st To Stock Adjustment (Normal) – 1,200
a/c

[For the value of normal loss.]

Dr Normal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Stock Adj. – 24,000 31/12/05 – xxx


(Nor) a/c

Dr Stock Adjustment (Normal) a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Trading a/c xx By Normal Loss 1,200


(Or) Goods Cons.
a/c

xxxx xxx

The "Stock Adjustment (Normal) a/c" would be closed at the end of the accounting
period by transfer to either the "Trading a/c" or "Goods Consumed a/c" or "Purchases
a/c" depending on where the value related to the normal loss stock is included.
Disposing Normal Loss Stock
We will come across the following additional transactions relating to disposal of normal loss stock
Expenses Incurred » Journal/Ledger :: Hide/Show
The normal loss stock may be in a realisable state or a completely useless. There may be instances
when some expenditure may have to be incurred on the normal loss stock to be able to bring it into
realisable state.

This expenditure may be paid in cash or by cheques or may have been incurred and not yet been
paid.
Debit » Normal Loss a/c
Since the amount spent is for the purpose of bringing the normal loss stock into saleable
condition would amount to brining the asset by name "Normal Loss" into usable condition, the
expenditure should go into the value of the asset.
Thus the "Normal Loss a/c" is debited with the amount of expenditure incurred.
Credit »
The expenditure incurred may be credited to
Cash a/c
If the expenses are paid out in cash
[Cash a/c – Real a/c – Credit what goes out.]
Bank a/c
If the expenses are paid by cheques
[Bank a/c – Personal a/c – Credit the benefit giver.]
Expenses Payable a/c (Or) Party/Creditors a/c
If the expenses are still to be paid
[Expenses Payable a/c (Or) Creditor/Party a/c – Personal a/c – Credit the benefit giver.]
Note:
Any nominal account prefixed/suffixed by the terms outstanding, prepaid, still receivable, still
payable etc., is a personal account and not a nominal account

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Normal Loss a/c Dr – 100


To Cash a/c – 100

[For the amount spent on the normal loss


stock to bring it into saleable condition
paid in cash.]

Dec 31st – Normal Loss a/c Dr – 200


To Bank a/c – 200

[For the amount spent on the normal loss


stock to bring it into saleable condition
paid by cheques.]

Dec 31st – Normal Loss a/c Dr – 150


To Exp. Payable (Or) – 150
Party/Creditors a/c

[For the expenditure incurred on the


normal loss stock to bring it into saleable
condition which is still payable.]

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 1,200 31/12/05 – xxx


a/c – 100
To Cash a/c – 200
To Bank a/c – 150
To Exp. Payable.

Sale Realisation » Journal/Ledger :: Hide/Show


The normal loss stock may be sold as they are (if in a saleable condition) or after getting them repaired
or refurbished.

The sale proceeds may be received in cash or by a cheques or may be still receivable
Credit » Normal Loss a/c
Since the asset represented by the "Normal Loss a/c" is being disposed off, it amounts to the
asset moving out of the organisation.
Thus the "Normal Loss a/c" is credited with the amount of sale realisation
Debit »
The sale proceeds may be debited to
Cash a/c
If the proceeds are received in cash
[Cash a/c – Real a/c – Debit what comes in.]
Bank a/c
If the proceeds are received by cheque
[Bank a/c – Personal a/c – Debit the benefit receiver.]
Proceeds Receivable a/c (Or) Party/Debtors a/c
If the proceeds are still to be received
[Proceeds Receivable a/c (Or) Debtor/Party a/c – Personal a/c – Debit the benefit receiver.]
Note:
Any nominal account prefixed/suffixed by the terms outstanding, prepaid, still receivable, still
payable etc., is a personal account and not a nominal account

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Cash a/c Dr – 400


To Normal Loss a/c – 400

[For the amount realised on the sale of


normal loss stock in cash.]
Dec 31st – Bank a/c Dr – 600
To Normal Loss a/c – 600

[For the sale proceeds of normal loss stock


received through a cheque.]

Dec 31st – Proc. Receivable (Or) Party/Debtors Dr – 900


a/c – 900
To Normal Loss a/c

[For the sale of normal loss stock and the


sale proceeds still receivable.]

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 1,200 31/12/05 By Cash – 400


a/c – 100 By Bank – 600
To Cash a/c – 200 By Pro. Rec – 900
To Bank a/c – 150
To Exp. Payable

Insurance Realisation
Insurance companies do no provide insurance against normal loss.
Commission on Sale
Where there is a commission being paid or payable on the sale of normal loss stock it may be
Deducted from the sale proceeds received/receivable and only the net proceeds may be brought into
account
Recorded just like any other expenditure that goes into the value of the Normal Loss Stock
Profit/Loss on Disposal » Journal/Ledger :: Hide/Show
Normal Loss is initially valued at a certain price which is indicative of its net realisable value. Where
there is a surplus or shortage on account of the actual realisation being greater or lesser than the
estimate, it is treated as abnormal and is transferred to the "Profit & Loss a/c" thereby closing the
"Normal Loss Stock a/c".
The "Normal Loss a/c" may carry a balance after recording all the realisations and expenses.
If there is a debit balance it represents the amount of asset value that is unrealisable and as such a
loss.
If there is a credit balance it indicates that the asset has realised at a value greater than the actual
asset value, thereby resulting in a profit. This is a very rare occurrence though.

When there is a loss


Debit » Profit & Loss a/c
"Profit & Loss a/c" being a nominal account, any loss should be debited to it.
[Profit & Loss a/c – Nominal a/c – Debit all expenses and losses.]
Credit » Normal Loss a/c
The "Normal Loss a/c" has a debit balance and has to be closed by transferring the balance to
the "Profit & Loss a/c".
Thus the "Normal Loss a/c" has to be credited.
["Normal Loss a/c" – Real a/c – Credit what goes out.]
The "Normal Loss a/c" carries a debit balance when there is a loss. Transfer of a debit balance
from one account to a second results in the second account being debited and the first account
being credited.

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Profit & Loss a/c Dr – 100


To Normal Loss a/c – 100

[For the net loss in normal loss stock being


transferred to the profit and loss account.]

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 1,200 31/12/05 By Cash – 400


a/c – 100 By Bank – 250
To Cash a/c – 200 By Pro. Rec – 900
To Bank a/c – 150 By P/L a/c – 100
To Exp. Payable –

1,650 1,650

Assume that the amount of sale proceeds received by cheques is Rs. 250 instead of Rs. 600
When there is a gain
Credit » Profit & Loss a/c
"Profit & Loss a/c" being a nominal account, any profit should be credited to it.
[Profit & Loss a/c – Nominal a/c – Credit all incomes and gains.]
Debit » Abnormal Loss Stock a/c
The "Normal Loss a/c" has a credit balance and has to be closed by transferring the balance to
the "Profit & Loss a/c".
Thus the "Normal Loss a/c" has to be debited.
The "Normal Loss a/c" carries a credit balance when there is a profit. Transfer of a credit
balance from one account to a second results in the second account being credited and the first
account being debited.

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Normal Loss a/c Dr – 2,800


To Profit & Loss a/c – 2,800
[For the gain in the normal loss account
transferred to the profit and loss account.]

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 1,200 31/12/05 By Cash – 400


a/c – 100 By Bank – 600
To Cash a/c – 200 By Pro. Rec – 900
To Bank a/c – 150 –
To Exp. Payable – 250 –
To P/L a/c

1,900 1,900

Adjustment during Final Accounting


Adjustment is bringing in the effect of the transactions through mathematical operations of addition
and subtraction. The adjustments to be made can be found out by ascertained the net effect of the
journal entries to be recorded.
Adjustments are generally required for transactions which are not yet recorded at the time of making
up the final accounts i.e. towards the end of the accounting period.

Regular Entries Net Effect

1) Normal Loss a/c Dr


To Trading a/c
2) Normal Loss a/c Dr
Proceeds Receivable a/c Dr
To Expenses Outstanding
Profit and Loss a/c Dr
a/c
To Trading a/c
3) Proceeds Receivable a/c Dr
To Expenses Outstanding a/c
To Normal Loss Stock a/c
4) Profit and Loss a/c Dr
To Normal Loss Stock a/c
Note
Since adjustment is needed at the end of the accounting period, we assume that the proceeds are
receivable and the expenses are payable where the information relating to them is to be incorporated
into the accounts. This is based on the assumption that all the transactions involving cash and bank are
recorded without fail.
The net effect would give an understanding on where the amounts are to be adjusted. Since the journal
entry representing the net effect is a compound entry, the number of accounts affected, thereby the
number of adjustments to be made , can be identified by the number of accounts involved in the
compound entry.
The value of normal loss stock should be credited to the "Trading a/c"
The net profit or loss on disposing the normal loss stock should be transferred to the "Profit & Loss
a/c"
Where there is no realisation in the form of sale proceeds, the total value of stock lost (value of stock +
expenses incurred) would be a loss.
Where there is sale realisation, the stock total is reduced by the total amount of realisation giving us
the net amount of loss.
Where there is sale realisation, if the total value realised is more than the total value of the stock there
would be a gain. [This is a very rare occurrence.]
Normal Loss Stock » Statement to ascertain Loss/Gain
Hide/Show

Amou Amou
Particulars
nt nt

Incomes/Realisations:
Sale Realisation
Cash 400
Bank 600
Receivable 900 1,900

Total Realisation 1,900

Expenses/Costs:
Value of Stock 1,200
Expenses Incurred
Paid in Cash 100
Paid by Cheques 200
Outstanding 150 450
Commission on Sale – –

Total Cost/Value of the Normal Loss Stock 1,650

Profit(+)/Loss(−) [Sale Realisation − Total


+ 250
Cost/Value]

The amount of expense payable outstanding if any relating to the normal loss stock has to be shown as
a liability on the liabilities side of the balance sheet.
The amount of sale proceeds receivable if any relating to the normal loss stock has to be shown as an
asset on the assets side of the balance sheet.

Dr Trading and Profit & Loss a/c Cr

Amount Amount Amount Amount


Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)
f
By Normal Loss 1,200 i
n
a
l
,
a
c
c
By Normal Loss 150 o
u
n
t
s
,
f
i
Balance Sheet of M/s ______ as on 30th June 2006 n
a
n
c
Liabilities Amount Amount Assets Amount Amount
i
a
l
Realisation Receivable 900 ,
Expenditure Outstanding 150 a
c
c
o
u
Using Temporary Accounts n
t
i
Recording the value of normal loss would result in the "Normal Loss a/c" or an account by any n
relevant name being created. The "Normal Loss a/c" would be used in recording the transactions g
relating to expenses on the stock, sale realisations, if the entries are being recorded subsequent to ,
recording this transaction. t
However, where the journal entry for recording the value of Normal Loss has not yet been recorded, r
the "Normal Loss a/c" would not be found in the books of accounts. In such cases, where the a
accountant is confused about which account to use, some temporary account by relevant name d
would be used to complete recording the transaction. i
In such cases, care should be taken to ensure that these temporary accounts are cleared by using n
them in recording the entries relating to Normal Loss. These can be identified by their presence in g
the "Trial Balance". ,
p
For Expenses Paid r
o
When expenses are paid, a temporary account, say by name "Expenses on Normal Loss a/c" may be
f
used to record the expenditure incurred. If such an account is used, it would appear in the "Trial
i
Balance".
t
This has to be closed by absorbing the expenditure to the "Normal Loss a/c".
,
Journal » Hide/Show l
o
s
Journal in the books of M/s __ for the period from ____ to _____ s
,
Credit a
V/R Debit Amount c
Date Particulars L/F Amount
No. (in Rs) c
(in Rs)
o
u
Dec 31st – Expenses on Normal Loss a/c Dr – 125 n
To Cash/Bank/Outst Exp a/c – 125 t
,
b
a
[For the expenses on Normal loss stock.]

Trial Balance of _____ as on 31st December 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)



Expenses on Normal Loss – 125

Total

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Normal Loss a/c Dr – 125


To Exp. on Normal Loss a/c – 125

[For the expenses on normal loss stock


absorbed.]

Dr Expenses on Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st To Cash/Bank/Drs – 125 31/12/05 By Normal Loss – 125


-31st a/c

125 125

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)
31/12/05 To Trading a/c – 1,200 –
31/12/05 To Exp. Nor. Loss – 125

The temporary account is assumed to have got exhausted and the expenditure is added to the
value of stock for the purpose of incorporating the same information as adjustment.

For Sale Realisation


When sale proceeds are received, a temporary account, say by name "Sale of Normal Loss Stock a/c"
may be used to record the proceeds received/receivable. If such an account is used, it would appear in
the "Trial Balance".
This has to be closed by absorbing the proceeds to the "Normal Loss a/c".
Journal » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Cash/Bank/Proc. Rec a/c Dr – 150


To Sale of Normal Loss Stock a/c – 150

[For the amount received on the sale of


normal loss stock.]

Trial Balance of _____ as on 31st December 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)



Sale of Normal Loss Stock – 150

Total

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Sale of Normal Loss Stock a/c Dr – 150


To Normal Loss a/c – 150

[For the sale realisation of normal loss


stock absorbed.]

Dr Sale of Normal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Normal Loss – 150 1st By Cash/Bank/Drs – 150


a/c -31st

150 150

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Trading a/c – 1,200


31/12/05 By Sale of Nor. – 150
ls. St

For the purpose of incorporating the same information as adjustment, the temporary account is
assumed to have got exhausted and the proceeds are considered for ascertaining the profit or
loss on abnormal loss stock.

Simplest Treatment
Going by the basic understanding that the more the information that is needed, the more the
accounting heads that have to be maintained, the simplest form of accounting for normal loss stocks
would need none of the above procedure to be adopted.
To understand this, let us consider the net effect of recording the transactions at the end of the
accounting period.

Net Effect Net Effect Net Effect


[Loss] Profit No Profit/Loss

Proceeds Receivable a/c Proceeds Receivable a/c


Proceeds Receivable a/c
Dr Dr
Dr
Profit and Loss a/c Dr To Trading a/c
To Trading a/c
To Trading a/c To Expenses Payable a/c
To Expenses Payable a/c
To Expenses Payable a/c To Profit and Loss a/c
Proceeds = Exp + Value
Proceeds < Exp + Value Proceeds > Exp + Value
Net Realisable Value = Zero
Where the normal loss stock is of very low value, they may be considered to be having a nil value for
accounting purposes. Their net realisable price would be taken to be zero in such cases.
Where the value of normal loss stock is zero, there is nothing to be credited to the "Trading a/c". The
net effect after eliminating the "Trading a/c" would therefore be

Net Effect Net Effect Net Effect


[Loss] Profit No Profit/Loss

Proceeds Receivable a/c Proceeds Receivable a/c


Proceeds Receivable a/c
Dr Dr
Dr
Profit and Loss a/c Dr To Expenses Payable a/c
To Expenses Payable a/c
To Expenses Payable a/c To Profit and Loss a/c
Proceeds = Exp + 0
Proceeds < Exp + 0 Proceeds > Exp + 0

The "Trading a/c" is left unaffected by the transactions relating to normal loss and only the "Profit &
Loss a/c" is affected that too when the expenses incurred on and the sale proceeds from the normal
loss stock are not equal.
To give effect to this condition, we just ignore the presence of normal loss and credit the profit and loss
account with the sale realisation (as if it is miscellaneous income) and debit the profit and loss account
with the expenses (as it it is miscellaneous expenses).
Net Realisable Value = Net Proceeds Receivable
Net Proceeds Receivable = Proceeds Receivable − Expenses Payable
Where the net proceeds receivable is equal to the value of normal loss stock, there would be neither
profit nor loss.
[Proceeds = Exp + Value ⇒ Proceeds − Exp = Value ⇒ Net Proceeds = Value]
In such a case there is nothing to be credited/debited to the "Profit & Loss a/c". The net effect after
eliminating the "Profit & Loss a/c" would therefore be

Net Effect
No Profit/Loss

Proceeds Receivable a/c


Dr
To Expenses Payable a/c
To Trading a/c
Proceeds = Exp + Value

To give effect to this condition, we assume that the normal loss stock is being valued at a value equal
to the Net Proceeds receivable. Thus the amount of net proceeds is credited to the "Trading a/c" to
complete recording the transactions relating to normal loss.
Though theoretically, the expenses can be debited and gross proceeds can be credited to the "Trading
a/c", it is seldom resorted to avoid unnecessary complication.
Stocks that the organisation deals with may be lost on account of normal reasons. Normal loss stocks
are to be valued at their net realisable price and not at cost.
Recording » Journal Entry
We know that ledgers provide the information we need in accounting and anything that gets into the
ledger should be through the journal. Even this forms a transaction that should be recorded through
the journal.
Debit » Asset a/c
The value of normal loss stock represents a temporary asset. The organisation would make efforts to
f
realise this asset by selling it, if at all it has a realisable value.
i
Thus a temporary asset account by name "Normal Loss a/c" is created and used for this purpose.
n
[Normal Loss a/c – Real a/c – Debit what comes in.]
a
Many a times we consider the "Normal Loss a/c" to be a nominal account which is also an accepted
l
practice. We assume it to be a real account to enable an easier understanding of the transactions
,
involving normal loss.
a
Where there are two or more types of normal losses, to differentiate the accounts the reason for the
c
loss may be included with the account name. "Normal Loss (Wastage) a/c" , "Normal Loss (Weight
c
Loss) a/c". Whatever may be the name we give it and the nature we attribute to the account, it is a
o
temporary account.
u
Credit » n
The value of normal loss stock represents the value of goods/stock that has not been used for t
trading purposes. To reveal the cost of goods sold, the value of stock unused for trading activity is to s
be deducted from the total value of goods. ,
For this the following ledger account would be credited depending on the time of recording the f
transaction, what comprises the value of stock drawn and the account in which the related value i
exists at the time of recording the entry. n
a
Trading a/c n
Generally, at the end of the accounting period, the balances (amounts) in all the ledger accounts c
which go into the value of goods/stock, are closed by transfer to the "Trading a/c". This amounts to i
debiting the "Trading a/c" with the total value of goods/stock. a
Thus the value of normal loss stock has to be credited to the "Trading a/c" in which the total value l
of goods/stock is existing as a debit balance. ,
Journal/Ledger » Hide/Show a
c
c
Journal in the books of M/s __ for the period from ____ to _____ o
u
n
Credit t
V/R Debit Amount
Date Particulars L/F Amount i
No. (in Rs)
(in Rs) n
g
Dec – Normal Loss a/c Dr – 1,200 ,
31st To Trading a/c – 1,200 t
r
a
[For the value of normal loss.] d
i
n
g
Dr Normal Loss a/c Cr ,
p
r
Amount Amount o
Date Particulars J/F Date Particulars J/F f
(in Rs) (in Rs)
i
t
31/12/05 To Trading – 1,200 31/12/05 – xxx ,
a/c l
o
s
s
,
a
c
c
Dr Trading a/c Cr o
u
n
t
Amount Amount ,
Particulars Particulars
(in Rs) (in Rs) b
a
To Opening Stock xx By Sales xxx
To Purchases xx By Normal Loss 1,200
To Direct Expenses xx By Closing Stock xxx
To Gross Profit xx

xxxx xxx

Goods Consumed a/c


Where the "Goods Consumed a/c" is used, the balances (amounts) in all the ledger accounts which go
into the value of goods/stock (including opening stock) are transferred to it. Thus the "Goods
Consumed a/c" would hold the total value of stock (as a debit balance).
Thus the value of normal loss stock has to be credited to the "Goods Consumed a/c" in which the total
value of goods/stock is existing as a debit balance.
Journal/Ledger » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Debit Credit
V/R
Date Particulars L/F Amount Amount
No.
(in Rs) (in Rs)

Dec – Normal Loss Stock a/c Dr – 1,200


31st To Goods Consumed a/c – 1,200

[For the value of normal loss.]

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Goods – 1,200 31/12/05 – xxx


Consumed a/c

Dr Goods Consumed a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Opening Stock xx By Normal Loss 24,000


To Purchases xx By Closing Stock xxx
To Direct Expenses xx By Trading a/c(?) xxx
xx

xxxx xxx
Purchases a/c
Where the following conditions exist, we can credit "Purchases a/c" with the value of normal loss
stock.
The normal loss stock is physically relatable to the stock that has been purchased during the current
period.
There are no direct expenses in relation to the stock purchased during the current period
(Or)
The value of normal loss stock does not include the direct expenses incurred during the current period
Journal/Ledger » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Debit Credit
V/R
Date Particulars L/F Amount Amount
No.
(in Rs) (in Rs)

1st - – Normal Loss a/c Dr – 1,200


31st To Purchases a/c – 1,200

[For the value of normal loss.]

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Purchases – 1,200 31/12/05 – xxx


a/c

Dr Purchases a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Cash/Bank/Crs xx By Normal Loss 1,200


By Trading a/c (?) xxx
(Or) Goods Cons
a/c

xxxx xxx
Stock Adjustment (Normal Loss)
Where such transactions occur frequently, the organisation may create a controlling account by name
"Stock Adjustment (Normal) a/c". This is a nominal account that gives the information relating to the
total value of stock that has been lost on account of normal reasons during the accounting period.
Journal/Ledger » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Debit Credit
V/R
Date Particulars L/F Amount Amount
No.
(in Rs) (in Rs)

Dec – Normal Loss a/c Dr – 1,200


31st To Stock Adjustment (Normal) – 1,200
a/c

[For the value of normal loss.]

Dr Normal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Stock Adj. – 24,000 31/12/05 – xxx


(Nor) a/c

Dr Stock Adjustment (Normal) a/c Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)

To Trading a/c xx By Normal Loss 1,200


(Or) Goods Cons.
a/c

xxxx xxx

The "Stock Adjustment (Normal) a/c" would be closed at the end of the accounting
period by transfer to either the "Trading a/c" or "Goods Consumed a/c" or "Purchases
a/c" depending on where the value related to the normal loss stock is included.
Disposing Normal Loss Stock
We will come across the following additional transactions relating to disposal of normal loss stock
Expenses Incurred » Journal/Ledger :: Hide/Show
The normal loss stock may be in a realisable state or a completely useless. There may be instances
when some expenditure may have to be incurred on the normal loss stock to be able to bring it into
realisable state.

This expenditure may be paid in cash or by cheques or may have been incurred and not yet been
paid.
Debit » Normal Loss a/c
Since the amount spent is for the purpose of bringing the normal loss stock into saleable
condition would amount to brining the asset by name "Normal Loss" into usable condition, the
expenditure should go into the value of the asset.
Thus the "Normal Loss a/c" is debited with the amount of expenditure incurred.
Credit »
The expenditure incurred may be credited to
Cash a/c
If the expenses are paid out in cash
[Cash a/c – Real a/c – Credit what goes out.]
Bank a/c
If the expenses are paid by cheques
[Bank a/c – Personal a/c – Credit the benefit giver.]
Expenses Payable a/c (Or) Party/Creditors a/c
If the expenses are still to be paid
[Expenses Payable a/c (Or) Creditor/Party a/c – Personal a/c – Credit the benefit giver.]
Note:
Any nominal account prefixed/suffixed by the terms outstanding, prepaid, still receivable, still
payable etc., is a personal account and not a nominal account

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Normal Loss a/c Dr – 100


To Cash a/c – 100

[For the amount spent on the normal loss


stock to bring it into saleable condition
paid in cash.]

Dec 31st – Normal Loss a/c Dr – 200


To Bank a/c – 200

[For the amount spent on the normal loss


stock to bring it into saleable condition
paid by cheques.]

Dec 31st – Normal Loss a/c Dr – 150


To Exp. Payable (Or) – 150
Party/Creditors a/c

[For the expenditure incurred on the


normal loss stock to bring it into saleable
condition which is still payable.]

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 1,200 31/12/05 – xxx


a/c – 100
To Cash a/c – 200
To Bank a/c – 150
To Exp. Payable.

Sale Realisation » Journal/Ledger :: Hide/Show


The normal loss stock may be sold as they are (if in a saleable condition) or after getting them repaired
or refurbished.

The sale proceeds may be received in cash or by a cheques or may be still receivable
Credit » Normal Loss a/c
Since the asset represented by the "Normal Loss a/c" is being disposed off, it amounts to the
asset moving out of the organisation.
Thus the "Normal Loss a/c" is credited with the amount of sale realisation
Debit »
The sale proceeds may be debited to
Cash a/c
If the proceeds are received in cash
[Cash a/c – Real a/c – Debit what comes in.]
Bank a/c
If the proceeds are received by cheque
[Bank a/c – Personal a/c – Debit the benefit receiver.]
Proceeds Receivable a/c (Or) Party/Debtors a/c
If the proceeds are still to be received
[Proceeds Receivable a/c (Or) Debtor/Party a/c – Personal a/c – Debit the benefit receiver.]
Note:
Any nominal account prefixed/suffixed by the terms outstanding, prepaid, still receivable, still
payable etc., is a personal account and not a nominal account

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Cash a/c Dr – 400


To Normal Loss a/c – 400

[For the amount realised on the sale of


normal loss stock in cash.]
Dec 31st – Bank a/c Dr – 600
To Normal Loss a/c – 600

[For the sale proceeds of normal loss stock


received through a cheque.]

Dec 31st – Proc. Receivable (Or) Party/Debtors Dr – 900


a/c – 900
To Normal Loss a/c

[For the sale of normal loss stock and the


sale proceeds still receivable.]

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 1,200 31/12/05 By Cash – 400


a/c – 100 By Bank – 600
To Cash a/c – 200 By Pro. Rec – 900
To Bank a/c – 150
To Exp. Payable

Insurance Realisation
Insurance companies do no provide insurance against normal loss.
Commission on Sale
Where there is a commission being paid or payable on the sale of normal loss stock it may be
Deducted from the sale proceeds received/receivable and only the net proceeds may be brought into
account
Recorded just like any other expenditure that goes into the value of the Normal Loss Stock
Profit/Loss on Disposal » Journal/Ledger :: Hide/Show
Normal Loss is initially valued at a certain price which is indicative of its net realisable value. Where
there is a surplus or shortage on account of the actual realisation being greater or lesser than the
estimate, it is treated as abnormal and is transferred to the "Profit & Loss a/c" thereby closing the
"Normal Loss Stock a/c".
The "Normal Loss a/c" may carry a balance after recording all the realisations and expenses.
If there is a debit balance it represents the amount of asset value that is unrealisable and as such a
loss.
If there is a credit balance it indicates that the asset has realised at a value greater than the actual
asset value, thereby resulting in a profit. This is a very rare occurrence though.

When there is a loss


Debit » Profit & Loss a/c
"Profit & Loss a/c" being a nominal account, any loss should be debited to it.
[Profit & Loss a/c – Nominal a/c – Debit all expenses and losses.]
Credit » Normal Loss a/c
The "Normal Loss a/c" has a debit balance and has to be closed by transferring the balance to
the "Profit & Loss a/c".
Thus the "Normal Loss a/c" has to be credited.
["Normal Loss a/c" – Real a/c – Credit what goes out.]
The "Normal Loss a/c" carries a debit balance when there is a loss. Transfer of a debit balance
from one account to a second results in the second account being debited and the first account
being credited.

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Profit & Loss a/c Dr – 100


To Normal Loss a/c – 100

[For the net loss in normal loss stock being


transferred to the profit and loss account.]

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 1,200 31/12/05 By Cash – 400


a/c – 100 By Bank – 250
To Cash a/c – 200 By Pro. Rec – 900
To Bank a/c – 150 By P/L a/c – 100
To Exp. Payable –

1,650 1,650

Assume that the amount of sale proceeds received by cheques is Rs. 250 instead of Rs. 600
When there is a gain
Credit » Profit & Loss a/c
"Profit & Loss a/c" being a nominal account, any profit should be credited to it.
[Profit & Loss a/c – Nominal a/c – Credit all incomes and gains.]
Debit » Abnormal Loss Stock a/c
The "Normal Loss a/c" has a credit balance and has to be closed by transferring the balance to
the "Profit & Loss a/c".
Thus the "Normal Loss a/c" has to be debited.
The "Normal Loss a/c" carries a credit balance when there is a profit. Transfer of a credit
balance from one account to a second results in the second account being credited and the first
account being debited.

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Normal Loss a/c Dr – 2,800


To Profit & Loss a/c – 2,800
[For the gain in the normal loss account
transferred to the profit and loss account.]

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

16/08/05 To Purchases – 1,200 31/12/05 By Cash – 400


a/c – 100 By Bank – 600
To Cash a/c – 200 By Pro. Rec – 900
To Bank a/c – 150 –
To Exp. Payable – 250 –
To P/L a/c

1,900 1,900

Adjustment during Final Accounting


Adjustment is bringing in the effect of the transactions through mathematical operations of addition
and subtraction. The adjustments to be made can be found out by ascertained the net effect of the
journal entries to be recorded.
Adjustments are generally required for transactions which are not yet recorded at the time of making
up the final accounts i.e. towards the end of the accounting period.

Regular Entries Net Effect

1) Normal Loss a/c Dr


To Trading a/c
2) Normal Loss a/c Dr
Proceeds Receivable a/c Dr
To Expenses Outstanding
Profit and Loss a/c Dr
a/c
To Trading a/c
3) Proceeds Receivable a/c Dr
To Expenses Outstanding a/c
To Normal Loss Stock a/c
4) Profit and Loss a/c Dr
To Normal Loss Stock a/c
Note
Since adjustment is needed at the end of the accounting period, we assume that the proceeds are
receivable and the expenses are payable where the information relating to them is to be incorporated
into the accounts. This is based on the assumption that all the transactions involving cash and bank are
recorded without fail.
The net effect would give an understanding on where the amounts are to be adjusted. Since the journal
entry representing the net effect is a compound entry, the number of accounts affected, thereby the
number of adjustments to be made , can be identified by the number of accounts involved in the
compound entry.
The value of normal loss stock should be credited to the "Trading a/c"
The net profit or loss on disposing the normal loss stock should be transferred to the "Profit & Loss
a/c"
Where there is no realisation in the form of sale proceeds, the total value of stock lost (value of stock +
expenses incurred) would be a loss.
Where there is sale realisation, the stock total is reduced by the total amount of realisation giving us
the net amount of loss.
Where there is sale realisation, if the total value realised is more than the total value of the stock there
would be a gain. [This is a very rare occurrence.]
Normal Loss Stock » Statement to ascertain Loss/Gain
Hide/Show

Amou Amou
Particulars
nt nt

Incomes/Realisations:
Sale Realisation
Cash 400
Bank 600
Receivable 900 1,900

Total Realisation 1,900

Expenses/Costs:
Value of Stock 1,200
Expenses Incurred
Paid in Cash 100
Paid by Cheques 200
Outstanding 150 450
Commission on Sale – –

Total Cost/Value of the Normal Loss Stock 1,650

Profit(+)/Loss(−) [Sale Realisation − Total


+ 250
Cost/Value]

The amount of expense payable outstanding if any relating to the normal loss stock has to be shown as
a liability on the liabilities side of the balance sheet.
The amount of sale proceeds receivable if any relating to the normal loss stock has to be shown as an
asset on the assets side of the balance sheet.

Dr Trading and Profit & Loss a/c Cr

Amount Amount Amount Amount


Particulars Particulars
(in Rs) (in Rs) (in Rs) (in Rs)
f
By Normal Loss 1,200 i
n
a
l
,
a
c
c
By Normal Loss 150 o
u
n
t
s
,
f
i
Balance Sheet of M/s ______ as on 30th June 2006 n
a
n
c
Liabilities Amount Amount Assets Amount Amount
i
a
l
Realisation Receivable 900 ,
Expenditure Outstanding 150 a
c
c
o
u
Using Temporary Accounts n
t
i
Recording the value of normal loss would result in the "Normal Loss a/c" or an account by any n
relevant name being created. The "Normal Loss a/c" would be used in recording the transactions g
relating to expenses on the stock, sale realisations, if the entries are being recorded subsequent to ,
recording this transaction. t
However, where the journal entry for recording the value of Normal Loss has not yet been recorded, r
the "Normal Loss a/c" would not be found in the books of accounts. In such cases, where the a
accountant is confused about which account to use, some temporary account by relevant name d
would be used to complete recording the transaction. i
In such cases, care should be taken to ensure that these temporary accounts are cleared by using n
them in recording the entries relating to Normal Loss. These can be identified by their presence in g
the "Trial Balance". ,
p
For Expenses Paid r
o
When expenses are paid, a temporary account, say by name "Expenses on Normal Loss a/c" may be
f
used to record the expenditure incurred. If such an account is used, it would appear in the "Trial
i
Balance".
t
This has to be closed by absorbing the expenditure to the "Normal Loss a/c".
,
Journal » Hide/Show l
o
s
Journal in the books of M/s __ for the period from ____ to _____ s
,
Credit a
V/R Debit Amount c
Date Particulars L/F Amount
No. (in Rs) c
(in Rs)
o
u
Dec 31st – Expenses on Normal Loss a/c Dr – 125 n
To Cash/Bank/Outst Exp a/c – 125 t
,
b
a
[For the expenses on Normal loss stock.]

Trial Balance of _____ as on 31st December 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)



Expenses on Normal Loss – 125

Total

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Normal Loss a/c Dr – 125


To Exp. on Normal Loss a/c – 125

[For the expenses on normal loss stock


absorbed.]

Dr Expenses on Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

1st To Cash/Bank/Drs – 125 31/12/05 By Normal Loss – 125


-31st a/c

125 125

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)
31/12/05 To Trading a/c – 1,200 –
31/12/05 To Exp. Nor. Loss – 125

The temporary account is assumed to have got exhausted and the expenditure is added to the
value of stock for the purpose of incorporating the same information as adjustment.

For Sale Realisation


When sale proceeds are received, a temporary account, say by name "Sale of Normal Loss Stock a/c"
may be used to record the proceeds received/receivable. If such an account is used, it would appear in
the "Trial Balance".
This has to be closed by absorbing the proceeds to the "Normal Loss a/c".
Journal » Hide/Show

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Cash/Bank/Proc. Rec a/c Dr – 150


To Sale of Normal Loss Stock a/c – 150

[For the amount received on the sale of


normal loss stock.]

Trial Balance of _____ as on 31st December 2005

Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)



Sale of Normal Loss Stock – 150

Total

Journal in the books of M/s __ for the period from ____ to _____

Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)

Dec 31st – Sale of Normal Loss Stock a/c Dr – 150


To Normal Loss a/c – 150

[For the sale realisation of normal loss


stock absorbed.]

Dr Sale of Normal Loss Stock a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Normal Loss – 150 1st By Cash/Bank/Drs – 150


a/c -31st

150 150

Dr Normal Loss a/c Cr

Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)

31/12/05 To Trading a/c – 1,200


31/12/05 By Sale of Nor. – 150
ls. St

For the purpose of incorporating the same information as adjustment, the temporary account is
assumed to have got exhausted and the proceeds are considered for ascertaining the profit or
loss on abnormal loss stock.

Simplest Treatment
Going by the basic understanding that the more the information that is needed, the more the
accounting heads that have to be maintained, the simplest form of accounting for normal loss stocks
would need none of the above procedure to be adopted.
To understand this, let us consider the net effect of recording the transactions at the end of the
accounting period.

Net Effect Net Effect Net Effect


[Loss] Profit No Profit/Loss

Proceeds Receivable a/c Proceeds Receivable a/c


Proceeds Receivable a/c
Dr Dr
Dr
Profit and Loss a/c Dr To Trading a/c
To Trading a/c
To Trading a/c To Expenses Payable a/c
To Expenses Payable a/c
To Expenses Payable a/c To Profit and Loss a/c
Proceeds = Exp + Value
Proceeds < Exp + Value Proceeds > Exp + Value
Net Realisable Value = Zero
Where the normal loss stock is of very low value, they may be considered to be having a nil value for
accounting purposes. Their net realisable price would be taken to be zero in such cases.
Where the value of normal loss stock is zero, there is nothing to be credited to the "Trading a/c". The
net effect after eliminating the "Trading a/c" would therefore be

Net Effect Net Effect Net Effect


[Loss] Profit No Profit/Loss

Proceeds Receivable a/c Proceeds Receivable a/c


Proceeds Receivable a/c
Dr Dr
Dr
Profit and Loss a/c Dr To Expenses Payable a/c
To Expenses Payable a/c
To Expenses Payable a/c To Profit and Loss a/c
Proceeds = Exp + 0
Proceeds < Exp + 0 Proceeds > Exp + 0

The "Trading a/c" is left unaffected by the transactions relating to normal loss and only the "Profit &
Loss a/c" is affected that too when the expenses incurred on and the sale proceeds from the normal
loss stock are not equal.
To give effect to this condition, we just ignore the presence of normal loss and credit the profit and loss
account with the sale realisation (as if it is miscellaneous income) and debit the profit and loss account
with the expenses (as it it is miscellaneous expenses).
Net Realisable Value = Net Proceeds Receivable
Net Proceeds Receivable = Proceeds Receivable − Expenses Payable
Where the net proceeds receivable is equal to the value of normal loss stock, there would be neither
profit nor loss.
[Proceeds = Exp + Value ⇒ Proceeds − Exp = Value ⇒ Net Proceeds = Value]
In such a case there is nothing to be credited/debited to the "Profit & Loss a/c". The net effect after
eliminating the "Profit & Loss a/c" would therefore be

Net Effect
No Profit/Loss

Proceeds Receivable a/c


Dr
To Expenses Payable a/c
To Trading a/c
Proceeds = Exp + Value

To give effect to this condition, we assume that the normal loss stock is being valued at a value equal
to the Net Proceeds receivable. Thus the amount of net proceeds is credited to the "Trading a/c" to
complete recording the transactions relating to normal loss.
Though theoretically, the expenses can be debited and gross proceeds can be credited to the "Trading
a/c", it is seldom resorted to avoid unnecessary complication.

What you need to know?


The procedure explained above is to enable you to decide whether to add or deduct the amount
involved in the reason for the difference.
What you really need to understand is the influence of the various bank transactions on the bank
account balance and how and when they are recorded in the cash book and the pass book. In all the
above situations the journal entry that you would have to recollect is the same.
If you apply the logical steps above and are thorough with the knowledge of recording the bank
transactions in both the books, then preparing BRS is very simple

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Strategy
balance sheet - straight line depreciation: worked example
Introduction
In our introduction to the methods available to calculate depreciation, we
suggested that there are two main methods that can be used:
- Straight- line depreciation
- Reducing balance method
We emphasised the point that these two methods simply provide an alternative
way of allocating the total depreciation charge over several accounting periods.
The total depreciation charge using either method will be the same over the total
useful economic life of the asset.
To illustrate the reducing balance depreciation method, we have calculated the
depreciation charge for the following asset:
Data
A business purchases a new machine for £75,000 on 1 January 2003. It is
estimated that the machine will have a residual value of £10,000 and a useful
economic life of five years. The business decides to calculate annual depreciation
at the rate of 40% of the written-down value. The business has an accounting
year end of 31 December.
Reducing balance depreciation method
Using the straight line depreciation method, the calculation of the annual
depreciation charge is as follows:
31 December £
Original machine cost 75,000

2003 Depreciation in 2003 (40% cost) 30,000

Written down value at 31 December 2003 45,000

Depreciation in 2004 (40% of WDV @ 31 December


2004 18,000
2003)

Written down value at 31 December 2004 27,000

Depreciation in 2005 (40% of WDV @ 31 December


2005 10,800
2004)

Written down value at 31 December 2005 16,200

Depreciation in 2006 (40% of WDV @ 31 December


2006 6,480
2005)

Written down value at 31 December 2006 9,720

Depreciation in 2007 (40% of WDV @ 31 December


2007 3,888
2006)

Written down value at 31 December 2007 5,832


The reducing balance method can result in significant differences in the annual
depreciation charge, depending on the "percentage" of written-down value that is
used to calculate the charge.
In the example above, the total amount charged to depreciation in the first three
years of owning the machine (2003-2005) was £58,800 (compared with £39,000 if
a straight line depreciation method has been used).
balance sheet - straight line depreciation: worked example
Introduction
In our introduction to the methods available to calculate depreciation, we
suggested that there are two main methods that can be used:
- Straight- line depreciation
- Reducing balance method
We emphasised the point that these two methods simply provide an alternative
way of allocating the total depreciation charge over several accounting periods.
The total depreciation charge using either method will be the same over the total
useful economic life of the asset.
To illustrate the reducing balance depreciation method, we have calculated the
depreciation charge for the following asset:
Data
A business purchases a new machine for £75,000 on 1 January 2003. It is
estimated that the machine will have a residual value of £10,000 and a useful
economic life of five years. The business decides to calculate annual depreciation
at the rate of 40% of the written-down value. The business has an accounting
year end of 31 December.
Reducing balance depreciation method
Using the straight line depreciation method, the calculation of the annual
depreciation charge is as follows:
31 December £

Original machine cost 75,000

2003 Depreciation in 2003 (40% cost) 30,000

Written down value at 31 December 2003 45,000

Depreciation in 2004 (40% of WDV @ 31 December


2004 18,000
2003)

Written down value at 31 December 2004 27,000

Depreciation in 2005 (40% of WDV @ 31 December


2005 10,800
2004)

Written down value at 31 December 2005 16,200

Depreciation in 2006 (40% of WDV @ 31 December


2006 6,480
2005)

Written down value at 31 December 2006 9,720


Depreciation in 2007 (40% of WDV @ 31 December
2007 3,888
2006)

Written down value at 31 December 2007 5,832


The reducing balance method can result in significant differences in the annual
depreciation charge, depending on the "percentage" of written-down value that is
used to calculate the charge.
In the example above, the total amount charged to depreciation in the first three
years of owning the machine (2003-2005) was £58,800 (compared with £39,000 if
a straight line depreciation method has been used).
INTEXT QUESTIONS 27.3
Write in one sentence how in the following cases it is a limitation of cost
accounting :
1. It is expensive.
...............................................................................................................
...............................................................................................................
2. It increases the workload
...............................................................................................................
...............................................................................................................
3. It is unnecessary for cost control.
...............................................................................................................
...............................................................................................................
WHAT YOU HAVE LEARNT
_ Cost accounting is the process of determining and accumulating the cost
of product or activity.
_ There is a relationship among information needs of management, cost
accounting objectives, and techniques and tools used for analysis in cost
accounting. Cost accounting has the following main objectives:
Determining selling price,
Controlling cost
Providing information for decision-making
Ascertaining costing profit
Facilitating preparation of financial and other statements.
_ Difference between Financial accounting and Cost accounting:
After studying financial accounting and cost accounting, you can
understand the difference between these two accounting systems.
Objective Nature
Recording of data Accounting system
Users of information Analysis of costs and profits
Presentation of information
_ Importance of Cost accounting
Importance to Management:
Importance to Employees
Cost accounting and creditors
Importance to National Economy
_ Limitations of cost accounting
It is expensive
The results shown by cost accountant differ from those shown by
financial accountant.
It is unnecessary because it involves duplication of work.
TERMINAL QUESTIONS
l. State the meaning and scope of cost accounting.
2. Explain the objectives of cost accounting.
3. Differentiate between cost accounting and financial accounting
4. What is the importance of cost accounting in a production unit?
5. State the limitation of cost accounting.

ANSWER TO INTEXT QUESTIONS


Intext Question 27.1
(i) Cost accounting (ii) cost (iii) sell
(iv) managerial (v) cost accounting
Intext Question 27.2
1. Management 2. Employees 3. Creditors
4. Management
Intext Question 27.3
1. Analysis, allocation etc. of cost requires additional work
2. Preparation of reconciliation statements
3. Management can control cost without the help of cost accounting

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