FINANCIAL ACCOUNTING

NOTES 1

Prepared by
Prof. Srinivas Mantripragada
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A. FORMS OF BUSINESSES & ORGANISATIONS

1. Types of businesses
 Merchandising
o Buy and sell
o Also called trading organisations
 Manufacturing
o Convert inputs (materials) into finished products
o Can they take up merchandising?
 Service
 An organisation can perform all three types of activities. However, based on the predominant activity,
an organisation would be referred to by one of the types
 Business organizations are cash generating-cum-dispensing machines

2. Forms of business organisations

Business
Organisation

Individual Ownership- Collective

Proprietorship Ownership

Sole
Partnership Company
Proprietor

One Person
HUF LLP
Company

Co-operative
Trust
Society

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3. Brief explanation
 In the eyes of law, sole proprietorship and partnership have no separate legal identity. All other forms
have a separate legal identity
 As a result, both the above forms of business have unlimited liability on the owner/ partners
 A Company is formed under the Companies Act, 2013 (earlier Companies Act, 1956)
 An LLP or ‘Limited Liability Partnership’ is a go between a partnership and a company especially
beneficial or professional services organisations like Chartered Accountants, Lawyers etc., but other
businesses can also be formed as this type
 An Company and LLP have limited liability – on the owners (shareholders, partners respectively)
 A company, partnership, and LLP are the most popular forms of business organisation (in that order)
world over (see below in this section for more details about company)
 An HUF (Hindu Undivided Family) is under the Hindu Law and can also undertake business
 A Trust generally does not undertake business, but can if the trust deed permits it to
 A co-operative society undertakes business strictly for the benefit of its members
 One person company is a concept under companies act.

4. Throughout the course, we will refer to company to mean business. These two terms will be used
interchangeably for ease. But students should be aware of the distinction between each. We shall not be
covering any specific form of business. However, financial statements would be with reference to a
Company under Companies Act.

5. Differences between Company, LLP, and Partnership

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6. Company as business organisation

 Registered Under the Companies Act, 2013

 Also called corporate entity
 Limited liability in most cases, except when it a company with unlimited
 Private limited company; XYZ Private Limited (XYZ Pvt. Ltd.)
 Public limited company (XYZ Ltd.)
o May chose to list its shares on a recognised stock exchange – Listed Company
o May chose not to list – Unlisted Company
 To be listed, a company must necessarily be a ‘Public Company’
 All private limited companies are privately held. Unlisted public limited companies are also privately
held. In the second case, it simply means that large number in public do not hold ownership and the
company’s shares are not listed on any stock exchange.

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B. INTRODUCTION TO ACCOUNTING
1. Introduction
 What is Accounting
 Need for Accounting
 Definition of Accounting
 Different forms of Accounting
 Uses and Limitations of Accounting
 Users of Accounting, Information and Financial Reports
 Principles, GAAP
 Concepts
 Conventions
 Accounting Equation

2. Economic Activities result in Accounting

 Accounting captures the impact of economic activities

 Does that mean profit generation is essential in an economic activity? NO
 Even those activities which do not result in profit, are performing economic activities, like a
cultural organisation, a co-operative society or an NGO. Because, all these also generate/ add
value
 Hence, all types of organisations, for profit and not for profit need accounting
 What about loss?
 In accounting, a general reference to profit means loss as well
 But why need accounting?
 All organisations need to keep track of resources they are using to generate value and deliver
such value to customers/ users/ receivers.
 Since all business organisations exist to make profit, they need to track the incomes and expenses
to calculate profit
 Accounting helps them achieve this objective
 There are other objectives also that accounting help meet

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3. Businesses ask?
1. Is it sufficient to only ascertain profit or loss from a business activity?
2. Are the profits adequate? Comparable?
3. Is the profit real?
4. Are the operations being performed efficiently?
5. Is the business under utilising or over utilising assets?
6. Is the investment generating reasonable return? For what?
7. Does it have enough resources or access to them to continue operations?
8. What resources are required?
9. How is the performance compared to competitors?
10. Is the financial position healthy? Or are there risks?

Besides tracking use of resources and output, accounting answers several questions.

4. About Accounting
 Accounting is the language of business and records various financial activities
 Answers what happened to our money – who has spent on what, when and how
 Are we making profit or not? How much? In what period?
 How old are our assets? Tracking this helps in timely replacement of assets
 What and how much do we own and owe? To whom do we owe and who owes us? Answers to these
questions ensures that the company discharges its liabilities on time and has a good name, and
collects on time what is due to it from others
 How does Accounting answer the above questions that business and others ask?
o Through Financial Statements – the ultimate reporting for all stakeholders
o Financial Statements are Balance Sheet, Income Statement and Cash Flow Statement
o We will learn more about these statements as we progress
 Who are stakeholders? Those who have some interest in the business or are impacted directly by it.
 Who does Accounting serve (Users)?
o Owners/ Shareholders (investment)
o Analysts, Prospective investors (investment)
o Management (agency responsibility-planning, operations, growth, return)
o Employees, Customers, Suppliers (stability, profitability)
o Lenders, banks, financial institutions (investment)
o Auditors (statutory duty)
o Government, Regulators (oversight)
o Public/ Society (local resources vs. benefits, CSR)

ACCOUNTING PROVIDES INSIGHTS INTO THE BUSINESS & HELPS USERS MAKE
ECONOMIC DECISIONS

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5. Definition of Accounting
 Most acceptable one by AICPA Committee on Technology:
o “Accounting is the Art of Recording, Classifying, and Summarising in a significant manner and
in terms of Money, transactions and events which are in part at least, of a financial character
and interpreting the results thereof.”

o Key Points:
 Art and/ or Science?
 Recording by nature
 Classification or grouping
 In terms of Money, owned & owed converted into money viz. value of assets, sales,
costs etc.
 Transaction having no financial character cannot be recorded
 Interprets the classified data i.e. analysis

 Another Definition by American Accounting Association (AAA):

o “Accounting is the process of identifying, measuring, and communicating economic
information to permit informed judgments and decisions by the users of information.”

o Key Points:
 A Process
 Identifying Economic activity
 Measuring Economic activity
 Communicating the Economic information …. In terms of Money
 To Users who need it
 Who can form an opinion or judgment
 To make decisions

6. Branches of Accounting
 Financial: Concerned with preparation of general purpose FS following GAAP and for external
reporting; assists in compliances; based on historical events only; objective data
 Cost: Develops detailed cost information relating to products, services, departments; assists in
financial accounting; considers market information for cost analysis; objective data
 Management: Develops detailed analytical reporting for management decision; provides special
purpose FS/ financial reports for internal use; includes past data, projections; objective & subjective
 Cost & Management accounting function together. Generally, large manufacturing, infrastructure,
real estate organisations have a separate function of cost accounting. Others generally do not have a
dedicated cost accountant and the cost accounting activities are performed by a financial analyst
under the overall finance function

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7. Functions of Accounting
 Keeping systematic records – Accuracy, Timeliness, Reliability
 Protecting properties of the business
 Communicating the results to owners, investors, lenders, creditors, employees etc.
 Different type of users have different uses of Financial Statements
 Since it is not possible to prepare separate set meant for each, One Common set of Financial
Statements are prepared – these are known as General Purpose Financial Statements
 Meeting legal requirements
 Periodic reporting to Government; Calculation and payment of taxes
 Keeping accounting records as mandated by different laws – company law, employment, tax, GST

8. Limitations of Accounting
 Only monetary transactions or transactions which can be measured in monetary terms can be
recorded
 Events, howsoever important and impacting the business – positively or negatively – cannot be
recorded if they are not capable of being measured in monetary terms. For example, if the highly
successful CEO/ SMO etc. leave the company, it is highly likely that future performance of the
company is affected. But this cannot be recorded in accounting
 All transactions are recorded at historical cost (with some exceptions as you will learn later) –
therefore change in value of money and/ or market factors are ignored (there are exceptions)
 Subjectivity arising from judgement – different accounting policy and treatment between managers
or companies or between years affects the financial statements
 Accounting is prone to manipulations to achieve pecuniary benefits at management level –
WorldCom, Satyam. These get discovered after a couple of years (in rare cases, never)

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C. FINANCIAL STATEMENTS, GAAP

1. Financial Statements

There are 3 main Financial Statements that users look to for financial information about an
organisation:

1) Balance Sheet or Statement of Affairs (B/S) reflects the financial position as at a particular date. It is
always prepared as on a date, for example as at 31st March, 2019, and shows
◦ What the entity owns and their values (Assets)
◦ How much the entity owes (Liabilities or External claims on Assets)
◦ How much belongs to owners (Residual claims on Assets)
2) Profit & Loss Account (P&L) or Income Statement (I/S) is the financial result of operations for a
period, for example for the period 1st April, 2018 to 31st March, 2019 (or simply for the year 2018-19),
and shows
◦ How much the company earned from its core business activities and other activities
◦ What amounts were spent on major expenditure items
◦ What profit was earned or loss incurred, tax expenditure
3) Statement of Cash Flow (CF) is a summary of cash inflows and outflows to reflect availability of liquid
(cash) resources to run operations smoothly

 In addition to the above, incorporated entities (Companies) have to prepare a fourth financial
statement called Statement of Changes in Equity
 Note that only B/S and P&L are a direct result of financial accounting
 CF is the summary of cash generated and spent
 Financial Statements are summarised accounting information. Not all transactions recorded in
accounting can be included in financial statements
 Therefore, to give details of important economic activities measured in monetary terms, financial
statements are accompanied by Notes to Accounts
 Notes to Accounts are not Financial Statements. They provide additional details in respect of items in
Financial Statements which the user should know and aid in making economic decisions

2. Reporting Elements
 The result of the Accounting needs to be reported to owners and other users
 Such reporting is done through financial statements
 All the accounting transactions cannot be reported as that would make the financial statements
clumsy and unintelligible
 To make the financial statements more easily understandable, there is a classification under which
the accounting is presented
 Such classification also helps in accounting appropriately as will see shortly
 The highest level of classification of all accounts is an Element
 An Element is the broadest classification referred to as such in the Financial Statements

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 The Elements in Financial Statements are

Balance Sheet Profit & Loss Account

• Asset • Income
• Liability • Expense
• Equity

 Since management, users, regulators all need further details of these elements for various purposes,
the elements are further sub-classified or divided
Element Classification Sub-classification
Asset Building Factory Building
Office Building
Warehouse
Asset Machinery Main line
Assembly line
Packing line
Expense Salaries Salaries
Directors’ Salaries
Expense Travel Domestic travel
Foreign travel
Expense Materials consumed Raw materials
Packing materials
Other supplies
Income Sales Domestic sales
Export sales

 Generally, the sub-classification is an account itself unless there is a need for further sub-division
 Thus Element  Classification  Sub-Division 1  Sub-division 2 etc.
 Each of the lowest level of classification is called an account
 Thus each account is known as
o Asset account
o Liability account
o Expense account (salaries, cost of goods sold, material consumed, rent, electricity etc…)
o Income account (sales, interest on deposit, dividend received etc.)
 How do we decide to what level to divide and how to name the account?
 To what level we should the division be and what name to give the account depends on the following:
o Nature of business
o Management’s requirements w.r,t,
 Periodic reporting, controls
 Planning and budgeting
o Legal and regulatory requirements
o IT Systems requirements
o Cost-benefit analysis of having accounting which is complex or elaborate or simple or moderate

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3. Financial statements are prepared following certain principles called GAAP or Generally Accepted
Accounting Principles. GAAP can be considered to contain the following two broad sets:
a. Those which are not codified, by a regulatory authority or the appropriate professional
accounting body on that country. These are the principles and concepts and are followed in
preparation of the financial statements
b. Those that are codified by a regulator (like the SEC in US), and/ or the appropriate professional
accounting body (like ICAI in India, IFRS worldwide, FASB in US)

4. GAAP
a. Need, benefits:
i. Uniformity in adoption of accounting principles between orgnaisations
ii. GAAP compliant Financial Statements improve qualitative characteristics
b. Widely accepted:
i. IFRS/ IAS
ii. IND-AS
iii. US GAAP

5. Accounting Standards
 These are written documents issued by an authorised accounting body in a country
 In India, the ICAI or The Institute of Chartered Accountants of India is the authorised body
 Standards are mandatory, except initial period after a standard is issued. During such period, the
standards is only recommendatory
 IFRS: International Financial Reporting Standards are the global standards issued by an Internal
body (IASB) in London. The objective is to enable acceptance of financial statements of multi
nationals in more than one country and raise capital cross border, besides standardisation,
comparability and many more benefits
 Prior to IFRS, the standards were called International Accounting Standards (IAS)
 IAS were also issued by IASB and hence IFRS are a continuity of IAS
 Both IFRS and IAS together are now called IFRS
 Indian Accounting Standards (IND-AS) are converged with IFRS (i.e. adapted) and therefore, there
are some differences between IFRS and Ind-As
 Many countries have adopted IFRS without changes
 IFRS and Ind-AS are largely principles based
 US GAAP is largely rules based

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D. PROCESS, PRINCIPLES, METHODS

1. The process…a simple model

2. Accounting Principles
 Necessary
o Like all other disciplines viz. mathematics, physics, chemistry or grammar
o Because everyone then understands and interprets the same way
o Without these, everyone prepares the way they think appropriate causing confusion and
inconsistency in interpretation by stakeholders and issues in taxation
 Consist of 2 sets
o 1st Set: Basic conditions necessary for preparing accounts. They are fundamental and not
frequently changed like a constitution cannot be changed frequently or easily. These are also
known as postulates, axioms. These are Concepts and Conventions
o 2nd Set: Those that govern detailed practices in preparation of FS. They provide specific
guidance on how certain elements of FS must be treated or valued – for example valuing
inventory, depreciation etc.

3. Accounting Concepts
 Concept is ‘an idea of what something is or how it works’. In accounting parlance, concepts are used
to denote basic accounting postulates, the necessary assumptions/ ideas fundamental to accounting.
1. Entity Concept or Business Entity Concept
2. Dual Aspect Concept
3. Going Concern Concept
4. Accounting Period Concept
5. Money Measurement Concept
6. Cost Concept or Historical Cost Concept
7. Revenue Recognition Concept
8. Matching Concept
9. Accrual Concept
10. Objectivity Concept

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4. Few accounting concepts

a. Business entity (or Entity) concept: Law does not consider an owner and partners distinct from
business, like in sole proprietor and partnership. Bit for accounting, business is a separate entity
and owner is a separate entity. This means that the money given by ‘owner/s’ is to be returned
back to them by ‘business’
b. Money measurement concept: If a business transactions cannot be measured in terms of money
and no resources have flowed (or will flow) into the business or flowed (or will flow) out of the
business, that transaction cannot be recorded in accounting. As a result, events and transactions
howsoever important cannot be brought into books of account if this principle is not met
c. Historical cost concept: Accounting records only facts. A cost is a fact and only that will be
recorded in accounting.
d. Accounting period concept: It is one year. For management control and track business
performance and position on regular basis, companies follow monthly accounting.
e. Accrual concept and Matching principle are explained below

5. Accounting Conventions
 Dictionary meaning of Convention is ‘a custom or tradition’. In accounting parlance, convention is
used to denote guide to the preparation of accounting statements.
1. Disclosure: All financial information that enables a user to make economic decisions must be
disclosed, besides what is mandated by applicable laws to be disclosed
2. Materiality: Trivial or minor matters need not be disclosed unless a law requires. What is material
depends on many factors including type of business, economic conditions, size of business, the
context in which an assessment of materiality is being made, an assessment of possible impact on
users’ decision if disclosed/ not disclosed
3. Consistency: Accounting policies must be applied consistently from year to year without changes.
A change should be made when business/ economic situations demand and not making a change
would mean the financial information presented does not represent the economic reality
4. Conservatism: Recognise all losses but not all gains

6. Concepts and Conventions are not codified anywhere. But the law, taxation, and accounting standards,
all recognise their existence. Besides some of them are required to be mandatorily mentioned by the
managements when financial information is disclosed. Auditors are required to ensure that these
principles are followed.

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7. Accrual concept
 This and Matching Principle are very important, are logical and an economic reality
 Let us take the below example where a company make identical sale amount in 2 years, but has
expenses.

Year 1 Year 2 2 Months total

Sales 50,00,000 50,00,000 1,00,00,000
Paid for 2 years @
None paid in
Total expenses Rs. 35 lac per month= 70,00,000
the year
70,00,000
Profit or (Loss) 50,00,000 (20,00,000) 30,00,000

 The company used some resources in Year 1, but did not pay for those resources. This resulted in
payment in 2nd year for both years. You can see how profit is distorted in each of the year. Profit total
for 2 years together is correct, but not for individual year
 Same is true if there were no sales in both the years. Since resources were used cost must be
recognised.
 What about income? The same principle applies. Let us say, you gave up some benefit is provided by
the company in a year, to a customer, the payment for which has not been received yet. The benefit
belongs to this year and must be recognised in this year.
 If a resource is used/ given up in a period, the cost/ benefit thereof must be recognised in the same
period irrespective of when it is paid/ received

8. Matching principle
 If a benefit has been provided by a company, it must have used some resource to provide that benefit
 Say a technician services an engine (no parts or supplies used) in a period. Company has provided a
benefit to customer, for which it has used the technical resource.
 The benefit provide by the company has value and paid by the customer (hence ‘sale’). To provide the
benefit, company used a resource (technician) and such resource has cost. Both have occurred in the
same period viz. sale and cost
 Both must be matched in the same period
 The costs incurred for generating income in a period, must be recognised in the same period i.e. the
costs corresponding to income must be matched in the same period
 Ex:
o X buys goods costing Rs. 50,000 in a period. He normally sells them at 25% profit
o In the period, he sells goods costing Rs. 20,000. What is the sale value = Rs. 25,000; Profit made
on this sale Rs. 5,000 i.e. 25%
o If sale of Rs. 25,000 is recorded in the period, cost of Rs. 20,000 must also be recorded in the
same period. Otherwise, sale will be in one period with profit of Rs. 25,000 and in another
period, you have only cost and hence loss of Rs. 20,000

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9. Accounting equation, double entry

 Consider any balance sheet, say ITC or Infosys or SBI
 You will notice that there are 2 sections in the balance sheet – ‘Assets’ and ‘Equity & Liabilities’
 The total of each section is the same i.e. ‘Total of Assets’ = ‘Total of Equity + Liabilities’
 At a broad level this is the Accounting Equation

10. Asset
 A resource is an asset if:
o The enterprise controls it, and therefore owns it; and
o It is expected to give benefits in future
 How does the enterprise get control of the resource and come to own it? If it can prevent others from
using it, and therefore has power over its use
 Benefits can be…..? In the form of income, cost savings, productivity improvements
 Types of assets:
o Benefits derived in the short term – one year or operating cycle of the company: Current
Assets
o Benefits derived over periods longer than one year/ operating cycle of the company: Long
Lived Assets/ Non-Current Assets
o Assets with physical form: Tangible Assets; Others are Intangible Assets
o Those represented in terms of money : Financial Assets
 How does an enterprise control an Intangible Asset?

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11. Liability
 It is money owed, i.e. an obligation to pay/ re-pay; it is the opposite of Asset
 How does a liability arise?
 Contractual liabilities vs. Estimates
 How do you discharge liabilities? By paying cash or giving away some asset. Liabilities are, therefore
claims on assets
 Some Liabilities:
o Debt in the form of Bonds, Debentures, Term Loans and Working Capital Loans
o Liabilities for purchase of goods, materials and services
o Taxes, duties payable to Government
o Amounts payable to employees
 Liabilities too are classified as Current and Non-Current
 Differentiate between Debt and Non-debt liability

12. Equity (or Capital)

 Capital is the amount contributed by owner/s into the business – this is increase in Capital/ Equity. If
an owner withdraws money, it reduces Capital/ Equity
 Types of capital by organisation
o Sole proprietor: Capital
o Partnership: Partner’s Capital (for share of each partner)
o Company: Share Capital/ Equity Capital
 The capital in Companies can be of 2 types:
o Equity Share Capital (these are the real owners of the company)
o Preference Share Capital (quasi debt/ capital)
 After an entity has settled all its liabilities, whatever is left from the Assets belongs to the owners.
Therefore, Equity is a Residual Claim on Assets
 Equity also includes the profits generated in the business since profits belong to the owners. Profits/
Reserves are called ‘Other Equity’

13. Accounting Equation: Double Entry (Dual Aspect concept)

Dual Aspect concept says that every transaction has two sides which net off. If a transaction does not net off,
then the transaction has not been entered correctly.

Assets = Capital + Liabilities

Profit = Income – Expenses: (Profit belongs to Owners)
 Hence Capital includes Original Capital and Accumulated Undistributed Profits. Undistributed
Profits are also called Residual Earnings i.e. from the profit in a year, if some amounts have
been paid to owners, the balance is residual.
 Such residual amount is carried forward year to year since the owners can take it anytime
they wish. Residual earnings accumulated over time is called Reserves
Assets = (Capital + Profit) + Liabilities
Profit = Residual Earnings (Reserves) if nothing paid to Owners; or
Residual Earnings = Profits – Payments to Owners (Distributions)
Assets = (Capital + Residual Earnings) + Liabilities
Possible withdrawals of capital (Drawings, Buyback) are a reduction of capital, not of profits
Assets = (Capital – Withdrawals + Residual Earnings) + Liabilities

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E. JOURNALISING & POSTING

1. Accounting process (refer to the Accounting Definition by AICPA)

2. Journal (see the format sent separately)

 When a transaction occurs and is measurable in term of money, it is first recorded in a book
called Journal
 Depending on business requirements, convenience, controls, timely & accurate recording, a
company may sub-divide the journal based on transactions of similar nature.
 When a Journal is sub-divided, the transactions pertaining to that nature are entered into that
sub-journal. All sub-journals are given a name indicating the nature of transaction. For example,
Sales, Purchases, Cash, Bank etc.
 Journal helps answer, when did the transaction take place (date),how was it done, and what was
the amount involved
 Whichever transaction cannot be entered in the sub-divided journal, is then entered into a
common book which is simply called the Journal. Hence ‘Journal’ is for all purposes, ‘Sales
Journal‘ is only for sales transactions and so on

3. Ledger is a collection of Accounts (see the format of an Account sent separately)

 This is a book which classifies the transactions into those of same type/ nature. If a company
wants to know how much cash was spent in a week or a month, it is possible from the journal.
But one has to total all transactions and this is tedious and time consuming. Businesses don’t
have time. Ledger provides this answer immediately. Same is the case with ‘how much sales did
we make in this month’, or ‘what is the value of buildings that we currently have’, etc.
 Just like Journal, depending on business requirements, controls, information, legal and regulatory
reporting, convenience, a company may sub-divide the Ledger based on transactions of similar
nature. For example, Sales Ledger, Purchase Ledger, Customer Ledger, Supplier Ledger etc. These
are called Sub-Ledgers
 Whichever transaction cannot be entered in sub-ledger, is entered in the General Ledger

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4. Differences

5. Account vs. Transaction

 An Account is a record of moneys paid or received, due from or due to, owed or owned, with all
such moneys being of same nature
 Thus an accounting transaction will include 2 sides of different nature, and every transaction is
different. But an Account records transactions of same nature
 Every transaction will have minimum 2 accounts – this will balance the Accounting equation
 You can never have only one side in a transaction.
 Can you have only one account mentioned on both sides? Yes, it is possible theoretically. But why
would you Debit and Credit the same account at the same time?

6. Account and terminology (refer to the format of Account)

 Account (written as A/c)
 Posting to A
 Balancing an A/c
 Debit or Credit balance (at period end)
 Carry forward/ down (C/f or C/d)
 Brought forward/ down (B/f or B/d)

7. Debit and Credit rules

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Points to remember:
 Debit and Credit are the Accounting terms for increase/ decrease
 Increase in Asset is Debit. Asset is on LHS of the Accounting equation
 Equity (or Capital) and Liability is on the RHS of the Accounting equation
 If Asset increases (LHS) , something on RHS must also increase for Accounting equation to tally
 If increase on LHS is called Debit, any increase on RHS cannot be called Debit. It must be named
differently. It is Credit.
 Profit belongs to owner. They increase the capital or amounts owed by the business to the owners
(LHS). Hence Profit is Credit
 Profit = Income – Expenses. Logically income is an increase in Profit; so that too must be Credit. By
deduction, Expenses must be

8. Steps to Account in books and terminology

 First Journalise the transaction i.e. prepare Journal Entry
 Journalising is the process of recording a financial transaction
 Journal Entry is a financial transaction which is entered in an accounting book called Journal
following the rules and principles of accounting
 Second also record the journal entry in the book of second entry viz. Ledger. This is called Posting
 Posting is the process of entering a Journal Entry in a classified manner with all transactions of
same nature entered at one place.
 Therefore, even though all sales can be called same nature, domestic sales and export sales differ.

9. Steps to Journalise
i) Ascertain whether the transaction meets the definition of Accounting
ii) Follow Accrual concept/ Matching principle
iii) Identify minimum 2 Accounts; there can be more in most transactions
iv) Identify the Element of each Account (Asset, Liability, Income, Expense, Equity)
v) Journalise the transaction following the Debit and Credit rules
vi) Ensure that total of Debits = total of Credit for every transaction

10. Posting to an Account

 After journalising, the transaction details are entered in the Ledger
 Remember, Ledger is a collection of Accounts
 The process of
 If an Account is Debited (or Credited) in a Journal Entry, the amount thereof will be entered in the
same Account on the same side (Debit or Credit)

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 Financial Accounting Notes -1

11. Balancing an Account

 Almost on every Account, after posting, the total of debits will not be equal to total of credits
 But at every month end, the account must be balanced i.e. the difference found out.
 Steps for Balancing an Account:
o At end of month, draw a line below the columns of Debit and Credit and write the total of the
respective columns.
o If Debit total > Credit total, mention the difference on the Credit side and re-total. Now the
totals on both sides match.
o Against the difference mentioned on the Credit side, under Particulars column, write Balance
c/f.
o Such Balance c/f is the amount carried forward to the next month.
o Hence, at start of next month, this amount will be mentioned on Debit side as Balance b/f
o If Credit total > Debit side, same process is repeated, but on the side opposite to that
mentioned above
 Notice that
o Debit total > Credit total, balance is called Debit balance and is mentioned on the Credit side
(because there is a debit balance in the account)
o Credit total > Debit total, balance is called Credit balance and is mentioned on the Debit side
o A Debit balance is brought forward (b/f) at start of the next month on the Debit side only
o A Credit balance is brought forward (b/f) at start of the next month on the Credit side only
 Monthly balancing helps ensure that Accounting team can provide the necessary management
reports, ensure that statutory obligations are completed as due, and perform certain reconciliations
to ensure accounting has been done correctly and old items are tracked
 Balancing is done every month, till end of the year
 At end of the year, all incomes and expenses are closed by calculating the profit
 Such profit is transferred to a separate account called Residual Earnings (explained earlier)
 All other accounts and residual earnings are carried forward to the next year

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