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 Particulars Opening Stock Textile Purchases Wages Octroi Salaries Rent Printing and Stationery Advertisements Cash Office Building Capital Bank Motor Vehicles Sundry Creditors Sales P/L Appropriation Sundry Debtors Machinery Total L/F Debit Amount Credit Amount (in Rs) (in Rs) 63,650 22,56,000 3,25,000 1,78,200 1,04,000 1,26,000 74,650 86,000 26,000 4,23,450 2,50,000 1,19,000 2,10,000 1,80,000 36,86,000 6,52,950 2,08,000 5,69,000 47,68,950 47,68,950

Why is a Trial Balance prepared?

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 absence of mathematical errors. This is the most important purpose for which the trial balance is prepared.

Isn't Trial Balance made for enabling preparation of Final Accounts?

No, not at all. Preparation of Trial Balance is not an act that forms a part of the activities involved in the regular accounting cycle. Since Final Accounting can be completed without the preparation of the Trial Balance, we can say that enabling the preparation of final accounts is not the purpose of the trial balance.

When is a Trial Balance prepared?

The trial balance is generally prepared at a time when all the ledger accounts are balanced like at the end of the accounting period. Theoretically, the trial balance can be prepared as and when needed. The practical difficulty in preparing the trial balance as and when needed is the requirement of the balances of all the ledger accounts within the organisational accounting system. Different ledger accounts are balanced at different time intervals based on the information needs of the organisation. Say in a typical organisation Cash a/c is balanced daily, Expenses, Creditor and 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 any given instance. Year ending is one such instance when the balances are derived.

Computerised Accounting
In mechanised (computerised) accounting systems, trial balance is a statement that can be automatically derived as and when needed.

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 ____ Date V/R Particulars L/F Debit Credit

No. 1st January

Amount (in Rs)

Amount (in Rs)

Assets a/c Dr To Liabilities a/c 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 1. Making the Trading a/c 2. Closing the Trading a/c by transferring the balance in it to Profit & Loss a/c 3. Making the Profit and Loss a/c 4. 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 Credit V/R Date Particulars L/F Amount Amount No. (in Rs) (in Rs) 31st Liabilities a/c Dr December Capital a/c 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 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 Account Opening Stock Textile Purchases Wages Octroi Description Direct Expenses Direct Expenses Direct Account Balance Where Type Nature Nominal Nominal Nominal Nominal Nominal Debit Debit Debit Debit Debit Trading a/c Trading a/c Trading Which Side Debit Debit Debit Debit Debit Amount 63,650 22,56,000 3,25,000 1,78,200 1,04,000

Salaries Rent Printing and Stationery Advertisements Cash Office Building Capital Bank Motor Vehicles Sundry Creditors Sales P/L Appropriation Sundry Debtors Machinery

Expenses Direct Expenses Indirect Expenses Indirect Expenses Indirect Expenses Indirect Expenses Asset Asset Liability Liability/Asset Asset Liability Direct Incomes Accumulatd Profit Asset Asset

Nominal Nominal Nominal Real Real Personal Personal Real Personal Nominal Spl. Nominal Personal Real

Debit Debit Debit Debit Debit Credit Debit Debit Credit Credit Credit Debit Debit

a/c Debit Trading Debit a/c Debit P/L a/c Assets P/L a/c Assets P/L a/c Liabilities P/L a/c Assets B/S Assets B/S Liabilities B/S Credit B/S Liabilities B/S Assets B/S Assets Trading a/c B/S B/S B/S

1,26,000 74,650 86,000 26,000 4,23,450 2,50,000 1,19,000 2,10,000 1,80,000 36,86,000 6,52,950 2,08,000 5,69,000

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. Dr Trading and Profit & Loss a/c [For the year ending 31/03/06] Cr Amount Amount Particulars Particulars (in Rs) (in Rs) To Opening Stock To Textile Purchases To Wages To Octroi To Gross Profit 63,650 By Sales 22,56,00 0 3,25,000 1,78,200 8,63,150 36,86,00 0 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 Stationery 74,650

To Advertisements To Net Profit

86,000 4,72,500 8,63,150 8,63,150 Assets Cash Bank Office Building Motor Vehicles Sundry Debtors Machinery Amount 26,000 4,23,450 1,19,000 2,10,000 2,08,000 5,69,000 15,55,45 0

Balance Sheet of M/s Wearall Textlies as on 31st March 2006 Liabilities Capital Sundry Creditors P/L Appropriation [6,52,950 + 4,72,500] Amount 2,50,000 1,80,000 11,25,45 0

15,55,45 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 Amount Particulars J/F Date Particulars (in Rs) 11,25,45 31/03/06 By Bal b/d 0 31/03/06 By Net Profit 11,25,45 0 Total

Date

J/F

Amount (in Rs) 6,52,950 4,72,500 11,25,450

31/03/06 To Bal c/d Total

01/04/06 By Balance b/d 11,25,450 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.

How is the Additional Information obtained?

The organisational accounting system provides information in the form of ledger accounts maintained in the books of accounts. The additional information that is needed is obtained by deriving it from the information that is existing in these ledger accounts.

Information relating to Profits

The ledger accounts relating to the organisation are classified into three types. Personal, Real and Nominal.

Nominal Accounts
Nominal accounts are related to expenses, losses, incomes and gains. Since ascertaining profits or losses involves dealing with incomes, gains, expenses and losses we can conclude that all the nominal accounts together would give us the information relating to the profits or losses made by the organisation.

Trading and Profit and Loss Accounts

To derive the information relating to profits from these nominal accounts a ledger account by name "Trading and Profit & Loss a/c" is prepared. Almost in all cases, we use two separate ledger accounts "Trading a/c" and "Profit and Loss a/c" to derive information relating to profits with a greater detail. [The more the information we need, the more the accounting heads we need to maintain]. Preparation of these ledger accounts requires us to think beyond just transferring the information in the nominal accounts into these accounts.

The Position of the organisation

The ledger accounts maintained within an organisational accounting system are classified into three as Personal, Real and Nominal.

 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.

Balance Sheet
To derive the information relating to the position of the organisation from these real and 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 information relating to the personal and real accounts in the statement.

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

Information needs vary from organisation to organisation. Even the information relating to profits and position would also be derived for such periods and on such dates respectively depending on the organisations need or this information.

Period for which profits are ascertained

The information relating to profits is something that is needed by the organisation periodically. For what period do we try to ascertain profits. Do we think of profits made every day or over a week or over a month or over a six month period or over a year? This is dependent on the information needs of the organisation. Though theoretically it is possible to derive this information's for any time period, conventionally it is derived for a year. That is in most cases, information relating to profits is derived over a year. We think of profits made over a year.

Day on which position is ascertained

The information relating to the position may be needed by the organisation at many points of time. Theoretically this is also capable of being derived at any point of time we need it. However, conventionally it is derived at a point which indicates the end of the period for which the profits are ascertained. Say if we think of profits made for the period from 1st April 2005 to 31st March 2006, we think of deriving the position as on 31st March 2006.

Accounting Period
Accounting Period is that period for which the organisation ascertains the profit or loss. If the 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 period is six-months. There are two aspects relating to an accounting period. The length of the period as well as the 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.

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 Ledger Accounts Hide/Show

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 Particulars Cash a/c Capital a/c Bank a/c Furniture a/c Purchases a/c Ram a/c Sales a/c Rahim a/c Salaries and Wages a/c Rent Paid a/c L/F Debit Amount Credit Amount (in Rs) (in Rs) 10,000 77,000 25,000 65,000 50,000 5,000 8,000 1,00,000

15,000 1,25,000

Total

2,40,000

2,40,000

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 Trading and Profit & Loss a/c

The "Trading and Profit & Loss a/c" would be Dr Trading and Profit & Loss a/c Cr Amount Amount Date Particulars J/F Date Particulars J/F (in Rs) (in Rs) 30/06/05 To Purchases a/c " To Salaries & Wages a/c " To Rent Paid a/c sub-total 30/06/05 To Bal (Profit) Total 65,000 30/06/05 By Sales a/c 1,25,000 5,000 8,000 78,000 47,000 1,25,000 Total 1,25,000 sub-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

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] Particulars Cash a/c Capital a/c Bank a/c Furniture a/c Ram a/c Rahim a/c Trading and Profit & Loss a/c Total L/F Debit Amount Credit Amount (in Rs) (in Rs) 10,000 1,00,000 77,000 25,000 15,000 50,000 47,000 1,62,000 1,62,000

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 i. ii. 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. i. ii. iii. 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. Particulars Opening Stock Purchases Salaries Wages Carriage Inwards Trading Charges Carriage Outwards Rent received Cash Capital Bank (Overdraft) Comission Creditors Sales Debtors Machinery Total L/F Debit Amount (in Rs) 86,000 11,36,000 1,53,000 18,000 26,900 64,000 52,500 1,78,300 62,500 3,44,700 37,980 42,780 2,68,000 15,48,700 2,56,000 4,80,000 23,77,680 23,77,680 Credit Amount (in Rs)

Adjustments
The following additional information is available 1. A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet recorded in the books. 2. 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.

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

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. Particulars Opening Stock Purchases Salaries Wages Carriage Inwards Trading Charges Carriage Outwards Rent received Cash Capital Bank (Overdraft) Comission Creditors Sales Debtors Machinery Total L/F Debit Amount (in Rs) 86,000 11,36,000 1,53,000 18,000 26,900 64,000 52,500 1,78,300 62,500 3,44,700 37,980 42,780 2,68,000 15,48,700 2,56,000 4,80,000 23,77,680 23,77,680 Credit Amount (in Rs)

The following additional information is available 1. A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet recorded in the books. 2. 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

Account Opening Stock Purchases Salaries Wages Carriage Inwards Trading Charges Carriage Outwards Rent received Cash Capital Bank (Overdraft) Comission Creditors Sales Debtors Machinery

Description Direct Expenses Direct Expenses Indirect Expenses Direct Expenses Direct Expenses Indirect Expenses Indirect Expenses Indirect Incomes Asset Liability Liability Indirect Expense Liability Direct Incomes Asset Asset

Account Balance Type Nature Nominal Nominal Nominal Nominal Nominal Nominal Nominal Nominal Real Personal Personal Nominal Personal Nominal Personal Real Debit Debit Debit Debit Debit Debit Debit Credit Debit Credit Credit Debit Credit Credit Debit Debit

Where Trading a/c Trading a/c P/L a/c Trading a/c Trading a/c P/L a/c P/L a/c P/L a/c B/S B/S B/S P/L a/c B/S B/S B/SB/S

What Side Debit Debit Debit Debit Debit Debit Debit Credit Assets Liabilities Liabilities Debit Liabilities Credit Assets Assets

Amount 86,000 11,36,000 1,53,000 18,000 26,900 64,000 52,500 1,78,300 62,500 3,44,700 37,980 42,780 2,68,000 15,48,700 2,56,000 4,80,000

An analysis of the additional transactions would enable us to identify what is to be done to incorporate their effect in accounting. 1. 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 1. (+) To Machinery a/c on the Assets side of the Dr. Machinery a/c Balance Sheet Cr. Ramsay Machine 2. (+) To Ramsay Machine Tools a/c on the Liabilities Tools a/c side of the Balance Sheet 2. Detailed Explanation Hide/Show 3. Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries. Entry Dr. Wages a/c Effect 1. (+) To Wages a/c on the Debit side of the Trading a/c

Cr. Salaries a/c

2. () From Salaries a/c on the Debit side of the Profit and Loss a/c

4. Detailed Explanation Above

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. Dr Trading and Profit & Loss a/c of M/s Azaya Traders for the year ending 30/06/06 Cr Amount Amount Amount Amount Particulars Particulars (in Rs) (in Rs) (in Rs) (in Rs) To Opening Stock To Purchases To Wages (+) Salary (Tr) To Carriage Inwards To Gross Profit 86,000 By Sales 11,36,00 18,000 0 43,000 61,000 26,900 2,38,800 15,48,70 0 To Salaries 1,53,000 By Gross Profit () Tr. to Wages 43,000 1,10,000 By Rent Received To Trading Charges 64,000 Carriage Outwards 52,500 To Comission 42,780 To Net Profit 1,47,820 4,17,100 Liabilities Capital (+) Net Profit Bank (Overdraft) Creditors (+) Due to M/s Ramsay Amount Amount Assets Balance Sheet of M/s Azaya Traders as on 30th June 2006 Amount Amount 3,44,700 Cash 62,500 1,47,820 4,92,520 Debtors 2,56,000 37,980 Machinery 4,80,000 2,68,000 (+) New Machine 2,00,000 6,80,000 2,00,000 4,68,000 9,98,500 9,98,500 15,48,700

15,48,700 2,38,800 1,78,300

4,17,100

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. 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 outstanding/prepaid expenses and pre-received/receivable incomes are dealt with here.

Outstanding Expenses
At the end of the accounting period, there may be expenses which have become due but have not yet been paid. If the organisation is following the mercantile system of accounting, these expenses are to be brought into account.

Debit Expenditure a/c

"Expenditure a/c" is a nominal account with a debit balance. The balance in the "Expenditure a/c" generally indicates the total amount paid on account of the expenditure during the current accounting period. To bring the expenditure that has not yet been brought into account into the books, the relevant expenditure account has to be debited. [Expenditure a/c Nominal a/c Debit all Expenses and Losses.]

Credit Expenses Outstanding a/c

"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 expenditure unpaid. The amount of expenditure that has not yet been paid is a liability for the organisation. The persons to whom the organisation owes is its creditor. As such, the amount of expenditure outstanding that 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.] Journal in the books of M/s ____ for the period from 1st July 2005 to 30th June 2006 Debit Credit V/R Date Particulars L/F Amount Amount No. (in Rs) (in Rs) 1st to Expenditure a/c Dr xxx 30th 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 1. Added to the relevant expenditure on the debit side of the "Trading a/" or "Profit & Loss a/c". 2. Shown as a liability on the liabilities side of the balance sheet.

Explanation/Illustration Hide/Show Expenses Prepaid

At the end of the accounting period, there may be expenses which have been paid in advance. These are expenses which are paid in advance and would be adjusted in the relevant expenditure during the subsequent accounting periods. Advances paid are treated in a different manner from expenses prepaid, the difference

being that the advances are recoverable whereas expenditure prepaid are realised by adjusted them in the amounts to be paid in the future towards the expenditure.

Credit Expenditure a/c

"Expenditure a/c" is a nominal account with a debit balance. The balance in the "Expenditure a/c" generally indicates the total amount paid on account of the expenditure during the current accounting period. On the assumption that the payments towards the expenditure include the expenditure prepaid, the expenditure has to be adjusted (reduced) to ascertain the actual expenditure chargeable for the current period. "Expenditure a/c" shows a debit balance and as such to reduce it, the "Expenditure a/c" has to be credited. [Expenditure a/c Nominal a/c Credit all Incomes & Gains.]

Debit Expenses Prepaid a/c

The prepaid expenditure is indicative of an amount that is owed to the organisation by the person or organisation to whom it has been prepaid. The persons who owe to the organisation are its debtors. Thus amount of expenditure prepaid is debited to the "Expenses Prepaid a/c". [Expenditure Prepaid a/c Personal a/c Debit the benefit receiver.] Journal in the books of M/s ____ for the period from 1st July 2005 to 30th June 2006 Debit Credit V/R Date Particulars L/F Amount Amount No. (in Rs) (in Rs) 1st to Expenditure Prepaid a/c Dr xxx 30th To Expenditure a/c xxx [For the amount expenditure relating to the subsequent periods paid in advance being

adjusted from the current period expenditure.]

Adjustment
The amount of expenditure prepaid is to be 1. Deducted from the relevant expenditure on the debit side of the "Trading a/" or "Profit & Loss a/c". 2. Shown as an asset on the assets side of the balance sheet. Trial Balance of M/s ___ as on 1st Jan 2005 Particulars L/F Debit Amount Credit Amount (in Rs) (in Rs)

Expenditure a/c Expenditure Prepaid a/c Total

8,000

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 Particulars L/F Debit Amount Credit Amount (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 Debit Credit V/R Date Particulars L/F Amount Amount No. (in Rs) (in Rs) 1st to Expenditure a/c Dr 86,000 31st 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 Particulars L/F Debit Amount Credit Amount (in Rs) (in Rs) 94,000

Expenditure a/c 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 Debit Credit V/R Date Particulars L/F Amount 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) Expenditur e 88,000

Balance Sheet of M/s ______ as on 31st Dec 2005 Liabilities Amount Amount Assets Expenditure Prepaid Amount Amount 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 Particulars L/F Debit Amount Credit Amount (in Rs) (in Rs) 8,000

Expenditure a/c 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 1) Expenditure Prepaid a/c Dr To Expenditure a/c 2) Expenditure a/c Dr To Trading a/c (Or) Profit & Loss a/c

Net Effect

Expenditure Prepaid a/c Dr To Trading a/c (Or) Profit & Loss 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 1. deducted from the relevant expenditure on the debit side of the "Trading a/" or "Profit & Loss a/c". 2. 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 () Pre paid (cl). Total Exp 94,000 6,000 88,000

Balance Sheet of M/s ______ as on 31st Dec 2005 Liabilities Amount Amount Assets Expenditure Prepaid Amount Amount 6,000