introduction to final accounts

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Preparatory steps for final accounts

Study Note - 3


This Study Note includes

●●●●● Introduction●●●●● Closing Stock●●●●● Depreciation●●●●● Accrued Expenses●●●●● Prepaid Expenses●●●●● Accrued Income●●●●● Income Received in Advance●●●●● Bad and Doubtful Debtors●●●●● Opening Entries●●●●● Closing Entries●●●●● Rectification Entries●●●●● Depreciation Methods●●●●● Bank Reconciliation●●●●● Conclusion

3.0 Introduction

At the end of the last study note, it was said that Trial Balance forms the basis for preparingfinancial statements. However, there are certain other tasks that have to be completed beforethese final accounts are prepared. You know that accounting entries are made on the basis ofactual transactions carried out during an accounting period. These are all included in the trialbalance. However, there could be certain other business realities which are to be recognized aseither asset, liability, income, gain, expense, loss or a combination thereof. As we know thematching concept necessitates the consideration of all aspects which may affect the financialresult of the business. Technically these are called as adjustments for which entries need to bepassed, without which the financial statements will not give a true and fair view of businessactivity. We discuss some of these entries and adjustments in the following sections.Before discussing these, let us understand the meaning of income statement and balance sheet.

Trial Balance based on ledger balances

Income statement shows in-come & gains and expenses &losses for an accounting period.The net result is profit or loss.

Balance Sheet shows assets andLiabilities & owner’s equity.Profit or loss from income state-ment is added or deductedfrom owner’s capital or equity.

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Depending on the nature of business, the income statement is prepared in different forms like:

a) In case of manufacturing concern, a manufacturing, trading and P & L a/c is prepared

b) In case of a trading or service organization, a trading and P & L a/c is prepared

The manufacturing or trading accounts show Gross margins (or gross losses) and the P & L a/c shows Net Profit or net loss. This is explained in depth at a later stage in the next chapter.

The balance sheet exhibits the list of assets (which indicate resources owned) and the liabili-ties & owners’ capital and equity (which shows how the resources are funded).

For company type of organizations, standard formats for P & L and Balance sheet are given inthe Companies Act that is to be adhered to. The accounting should be as per the accountingstandards prescribed by the ICAI.

3.1 Closing Stock

We know when goods are purchased for resale we include them in Purchases a/c, while goodssold are shown in sales a/c. At the end of accounting period, some of these goods may remainunsold. If we show the entire cost of purchases in income statement, it will not be as per thematching concept. We should only show the cost of those goods that are sold during theperiod. The balance cost should be carried forward to the next accounting period through thebalance sheet. How should the closing stock be valued? According to the conservative prin-ciple, the stock is valued at lower of cost or market price. If cost of stock is Rs 125000 and itsrealizable market price is only Rs 115000, then the value considered is Rs 115000 only. What itmeans is the difference of Rs 10000 is charged off to the current periods profits.

Students are advised to refer to Accounting Standard 2 issued by ICAI to get thorough knowledge onvaluation of inventories.

Please remember the closing stock figure does not appear in the trial balance, but is valuedand directly taken to the P & L a/c. The entry passed for this is:

Closing Stock a/c Dr

To Trading and P & L a/c

In solving the examination problem, this entry is not actually passed, but the effect of its outcome isgiven. Here, one effect is “show closing stock as asset in balance sheet” and second effect is “show it onthe credit side of trading a/c”.

3.2 Depreciation

When the business uses its assets to earn income, there is wear and tear of the asset life. Assetswill have limited life and as we go on using it, the value diminishes. Again the question to beasked is – at what value should the asset be shown in the balance sheet? Consider a machinewas bought on 1st April 2005 for Rs 200000. It’s used for production activity throughout theyear. When the final accounts are being prepared, at what value should it be shown in balancesheet as on 31st March 2006?

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A p r 2006M a r 2 00 6

M a rc h sa lar y p a id in A p ril

The entry for this is:

Expense a/c Dr

To outstanding Expense a/c or Expense payable a/c

The two effects when preparing the final accounts are:

One – add in respective expense in P & L a/c and two – show as a liability in the balance sheet.

Well, according to cost principle initial entry for purchase of machine is shown at cost paid for ite.g. Rs 200000 in this case. But the fact that the machine is used must be recognized in financials.Hence the value in the balance sheet must be brought down to the extent of its use. This iscalled as Depreciation. How is it calculated? While there are different methods of calculatingdepreciation (explained in subsequently), the simple idea is to spread it over the useful life ofthe asset, so that at the end of its life the value is zero! In our example, if useful life of themachine is taken as 10 years, the depreciation will be simply Rs 200000 ÷ 10 i.e. Rs 20000 everyyear. So a depreciation of Rs 20000 will be charged to the profit of every year and value of assetwill be brought down by the same value.

Students are advised to refer to Accounting Standard 6 issued by ICAI to get thorough knowledge onDepreciation accounting.

The entry passed for this is:

Depreciation a/c Dr

To Fixed Asset

The effect given is one – include in the P & L a/c as expense for the period and two – reduce from assetvalue in the balance sheet.

Please see section 3.10 describing various methods of depreciation included later in this chapter whichmay please be studied.

3.3 Accrued Expenses or Outstanding Expenses

There may be expenses incurred for the current accounting period, but not actually paid for.The matching concept, however, necessitates that this expense must be recognized as expensefor the current year and should not be deferred till its actual payment. Typically, we knowsalary for the month is normally paid in the 1st week of the next month. Imagine the accountingperiod close is on 31st March. The salary for the month of March is not paid till 31st March. Butis it is related to this month, it must be booked as expense for the current month and also as aliability payable in the next month (which is in next accounting period). This can be shown asfollows:

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As can be seen, out of the total premium period of 12 months, only 3 months are related to thecurrent accounting period and the remaining 9 months’ premium is related to the next ac-counting period. Hence only 3 months’ premium is to be considered as expense for the currentyear i.e. Rs 18750 (75000 ÷ 4).


Prepaid Insurance a/c Dr

To Insurance a/cThe two effects while preparing final accounts are:

One – Reduce from respective expense in P & L a/c and two – show as an asset in the balance sheet

3.5 Accrued Incomes

Just as expenses accrue, there are instances of income getting accrued at the end of accountingperiod. The extent to which it accrues, it must be booked as income for the current accountingperiod. Consider, the business has put a One year fixed deposit of Rs 100000 with Citi Bank ata fixed interest of 9 % p.a. on 1st February 2006 and the interest is credited by the bank on asemi-annual basis. Also, consider that the accounting period ends on 31st March 2006. The Citibank will credit the 1st semi-annual interest on 31st July 2006 and the next on 31st January 2007.Now, consider the following:

3.4 Prepaid ExpensesAt times we may pay for certain expenses which are period related. For example, the businesshas taken an insurance policy against fire on which the annual premium payable is Rs 75000.The policy is taken on 1st January 2006 valid till 31st December 2006. But the company’s ac-counting period ends on 31st March 2006. When considering the insurance expense for theaccounting year, what amount should be considered? See the following.

9 months

1st Jan 2006

31st Mar 2006

31st Dec 2006 12 months

3 months

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It can be noticed that interest for the 2 months will be considered as accrued as on 31st of March2006 and must be taken as income for the current accounting year.


Accrued Interest a/c Dr To Interest a/c

The two effects while preparing final accounts are:One – Show as income in the P & L a/c and two – show as an asset in the balance sheet

3.6 Income received in advance

If an income is received which is not related to the current accounting period, it cannot beincluded in the current year’s P & L a/c. So, if it’s already included as income it must be re-duced. The entry for this is:

Respective Income a/c DrTo Income received in advance a/c

The effects while preparing final account are:One – Reduce from respective income and two – show it as liability in balance sheet

3.7 Bad and doubtful debtors

When goods are sold on credit, the money is generally received after some days. Customersfrom whom money is not received till balance sheet date are called as Debtors or Receivables.The question is what is likelihood of the recoverability of this money? The management has toanalyse all the outstanding cases and form its opinion regarding the recoverability. In case,management feels that some money is not recoverable at all or if it has doubt over some cases,it must factor this while making financial statements.When it is clear that the debtors are not going to pay at all (may be the party has vanished & not

10 months

1st Feb 2006 31st Jan 2007

12 months

2 months

31st Mar 2006

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traceable!), it is considered as ‘Bad Debt’. In case there is only a doubt about likelihood ofgetting payment, it is considered as ‘Doubtful Debt’.In case of Bad Debt, the balance due from customer has to be written off from the books. Theentry for this is:

Bad Debts a/c Dr

To Debtors a/c (in sub-ledger the specific customer a/c is credited)The effects while preparing the final accounts are:One – Show as expense in P & L a/c and two – reduce from debtors in the balance sheetIn case of a Doubtful Debt, no write off is done, but a provision is created to recognise theexpense. The entry for this is:P and L account DrTo Provision for Doubtful debts A/cThe effects while preparing the final accounts are:One – Show as expense in P & L a/c and two – reduce from debtors in the balance sheetIt may happen that the business has made a provision for a doubtful debt last year, and duringthe current year, it becomes certain that the customer is never going to pay. Then during cur-rent year, the entry for complete write off of this debt has to be passed. The entry for this is:Provision for doubtful debts Dr

To BAD debts a/cThe effects while preparing the final accounts are:One –Reduce from the provision amount in the balance sheet and two – reduce from debtors.

Illustration 1

Indicate what effects for the following adjustments when preparing the final accounts for theyear ended 31st March 2006. Show journal entries as well.

1) The value of unsold goods lying as on 31-3-2006 was Rs 35000. The market price ofthese goods was Rs 50000.

2) Depreciation is to be provided as 10 % on Furniture (original cost Rs 50000) and ma-chinery at 33 % (original cost Rs 90000).

3) The expenses for the month of March 2006 not yet paid are – Telephone Rs 1500, andtravel bills Rs 12000.

4) Prepaid Insurance was Rs 12500

5) Included in sales were Rs 25000 received as advance, but the goods are not yet sup-plied. The cost of these goods was included in closing stock.

6) Write off Rs 3000 as bad debts and make a provision of 2% on debtors of Rs 100000.

7) The salesmen were entitled to commission of 2% on total sales. During the year thesales were Rs 525000 before considering the item number (5) above.

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Please note that the students must practice this in order to improve understanding. Actually,there are two ways in which these adjusting entries can be treated:

1) After making trial balance based on transactions captured, these entries are treatedoutside books and adjusted directly in P & L a/c or balance sheet and then passed injournal proper.

2) In practical life however, these entries are passed and then final trial balance is pre-pared based on which final accounts are made.

Answer to Illustration 1The journal entries and the effects in final accounts are shown in the following table:

Sl. Journal Entry Effect in final accountsNo.

1. Closing Stock a/c Dr 35000 Show in trading a/c on credit sideTo trading a/c 35000 and show as asset in balance sheet.

The value should be taken as Rs35000 & not Rs 50000.

2. Depreciation of Furniture a/c Dr 5000 Show both debits as expense in P &Depreciation on Machinery a/c Dr 30000 L a/c and reduce from values ofTo Furniture a/c 5000 respective asset in the balance sheetTo Machinery a/c 30000

3. Telephone expenses a/c Dr 1500 Telephone and travel expenses willTravel a/c Dr 12000 be shown in P & L and outstandingTo outstanding expenses a/c 13500 expenses will be shown as liability

in balance sheet.

4. Prepaid Insurance a/c Dr 12500 Reduce from the Insurance in P & LTo Insurance a/c 12500 a/c and prepaid insurance will be

shown as asset in balance sheet.

5. Sales a/c Dr 25000 Reduce from sales in trading a/cTo sales in advance a/c 25000 and show the sales in advance as a

liability in the balance sheet.

6. Bad Debts a/c Dr 3000 Show both debits as expenses in PDoubtful debts provision a/c Dr 1940 & L a/c and reduce from DebtorsTo Debtors a/c 4940 in the balance sheet.

7. Salesmen commission a/c Dr 10000 Show as expense in the P & L a/cTo commission payable a/c 10000 and as a liability in the balanceCalculation: ( 525000-25000) * 2% sheet.

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In examination problems, trial balance is given and adjustments are given separately. Studentsare expected to pass the adjustments directly in the final accounts. See the illustrations for clearunderstanding.

3.8 Opening Entries

At the end of each accounting period, the books of accounts need to be closed for preparationof final accounts. Also, in the beginning of the new accounting period, new books of accountsare to be opened. For this purpose, opening and closing entries need to be passed. These entriesare passed in journal proper.

The opening entries are passed only for those ledger a/c balances which are carried forwardfrom earlier period to the current accounting period. In other words, the balances of assets,liabilities and owners’ capital and equity accounts are only considered for such opening en-tries. The opening entry is passed with the closing balances of assets and liabilities & capitalaccounts in the last year’s balance sheet.

The entry can be given as:

All Asset a/cs Dr

To all liabilities a/c

To Owners’ capital a/cs

Illustration 2

Consider the following balances in the balance sheet as on 31st March 2006. Pass the openingentry on 1st April 2007.

Subodh’s Capital a/c 275000

Loan from HDFC bank 425000

Plant and machinery 330000

Cash in hand 20000

Balance at Citi bank 175000

Trade Debtors 355000

Closing stock 135000

Trade Payables 295000

Outstanding Expenses 40000

Prepaid Insurance 20000

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Answer

Plant and machinery Dr 330000

Cash in hand Dr 20000

Balance at Citi bank Dr 175000

Trade Debtors Dr 355000

Closing stock Dr 135000

Prepaid Insurance Dr 20000

To Subodh’s Capital a/c 275000

To Loan from HDFC bank 425000

To Trade Payables 295000

To Outstanding Expenses 40000

3.9 Closing Entries

The Closing Entries are passed on the basis of trial balance for transferring the balances toTrading and profit and loss a/c. These entries are mainly for:

a) For transferring purchases and direct expenses (goods related) to trading a/c

Trading a/c Dr

To Opening stock a/c

To Purchases a/c

To factory expenses a/c

To freight & carriage inward a/c

b) For transferring sales and closing stocks

Sales a/c Dr

Closing Stock a/c Dr

To Trading a/c

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c) For transferring gross profit or gross loss to P & L a/c

For gross Profit

Trading a/c Dr

To P & L a/c

For Gross Loss

P & L a/c Dr

To Trading a/c

d) For transferring expenses

P & L a/c Dr

To Respective expense a/cs

e) For transferring IncomesRespective income a/cs DrTo P & L a/c

f) For transferring Net profit or Net lossFor Net ProfitP & L a/c DrTo Capital a/cFor Net LossCapital a/c DrTo P & L a/c

3.10 Rectification Entries

In the section 2.5 of the study note two, you were introduced to the reasons why errors couldoccur and to the fact that while some errors affect trial balance and some errors do not affect it.In this section, we will see in depth how the corrections are made to the wrong entries.When the errors affecting the TB are made, the normal practice is to put the difference to an a/c called as ‘suspense a/c’ till the time errors are located. On identification of errors, the one effectgoes to the correct a/c and the other effect to the suspense a/c. This is done for one sided errorse.g. if sales book total is wrongly taken, but individual customers are correctly debited. Sucherror will cause difference in trial balance as only sales a/c is wrongly credited. In such casesthe rectification entry will be passed through suspense a/c. In all other cases the rectification isdone by debiting or crediting the correct a/c head and by crediting or debiting the wrong a/chead.Let us recapitulate the types of errors and the ways to rectify them in the following table.

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Let us see some illustrations on rectification of entries.

Illustration 3

A merchant, while balancing his books of accounts notices that the TB did not tally. It showedexcess credit of Rs 1700. He placed the difference to Suspense a/c. Subsequently he noticed thefollowing errors:

a) Goods brought from Narayan for Rs 5000 were posted to the credit of Narayan’s a/c asRs 5500

b) An item of Rs 750 entered in Sales returns book was posted to the debit of Pandey whohad returned the goods.

Type of error Rectification a) Error of principle – entering

revenue expense as capital expense or vice versa or entering revenue receipt as capital receipt or vice versa.

b) Error of Omission – transaction forgotten to be entered in books of accounts.

c) Errors of commission –

entering to wrong head of account.

d) Compensating errors – more than one error that could compensate effect of each other.

e) Wrong totaling of subsidiary books

f) Posting on wrong side of an a/c

g) Posting of wrong amount

A journal entry is passed to give correct effect. Simply, the correct entry is passed. Debit or credit wrong a/c head and post it to correct head. Pass correcting entry As it affects TB, pass through suspense a/c

Pass an entry with double effect – one to cancel wrong side and other to give effect on correct side Pass entry with differential amount

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c) Sundry items of furniture sold for Rs 26000 were entered in the sales book.

d) Discount of Rs 300 from creditors had been duly entered in creditor’s a/c but was notposted to discount a/c.

Pass necessary journal entries to rectify these errors. Also show the Suspense a/c.

Answer:

1) Goods bought from Narayan are posted to credit of his a/c as Rs 5500 instead of Rs5000. Here, it is correct to credit Narayan’s a/c. But the mistake is extra credit of Rs 500.This is one sided error, as posting to purchases a/c is correctly made. So the rectifica-tion entry will affect the suspense a/c .This needs to be reversed by the rectificationentry:

Narayan’s a/c DR 500

To Suspense a/c 500

2) Goods supplied by business to Pandey were returned back by him. It should have ap-peared on the credit side of his a/c. For rectifying we will need to credit his a/c withdouble the amount i.e. Rs 1500 (Rs 750 to cancel the wrong debit and another Rs 750 togive effect for correct credit) and the second effect will go to suspense a/c. The correc-tion entry is:

Suspense a/c Dr 1500

To Pandey a/c 1500

3) Sale of furniture was recorded in sales book. What’s wrong here? Remember that salesbook records sale of goods only and nothing else. Sale of furniture will appear in eithercash book (if sold for cash) or journal proper (if sold on credit). Hence, wrong credit tosales a/c must be removed and credit should be given to Furniture a/c. It’s importantto note that this rectification entry will not affect the suspense a/c. The correction entryis:

Sales a/c Dr 26000

To Furniture a/c 26000

4) The discount received from creditor is not entered in discount a/c but was correctlyrecorded in creditors’ a/c. This is one sided error and will therefore be routed throughsuspense for correction. A discount is received; it must be credited being an income.

Suspense a/c Dr 300

To Discount received a/c 300

Let us now see how suspense a/c will look like. Excess credit of Rs 1700 in Trial Balance will beshown on the debit side of suspense a/c. This will bring in total debit equal to total credit.

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Dr Suspense a/c Cr

Date Particulars J. F.

Amount Rs Date Particulars

J. F.

Amount Rs

To balance b/d 1700 By Narayan 500

To discount received 300 By Pandey 1500

2000 2000

Let us see some illustrations on rectification of entries.

Please observe that after correcting passing all rectification entries, the suspense a/c talliesautomatically.

Illustration 4

Pass necessary journal entries to rectify the following errors:

a) An amount of Rs 200 withdrawn by owner for personal use was debited to trade ex-penses.

b) Purchase of goods of Rs 300 from Nathan was wrongly entered in sales book.c) A credit sale of Rs 100 to Santhanam was wrongly passed through purchase book.d) Rs. 150 received from Malhotra was credited to Mehrotra.e) Rs 375 paid as salary to cashier Dhawan was debited to his personal a/c.f) A bill of Rs 2750 for extension of building was debited to building repairs a/cg) Goods of Rs 500 returned by Akashdeep were taken into stock, but returns were not

posted.h) Old furniture sold for Rs 200 to Sethi was recorded in sales book.i) The period end total of sales book was under cast by Rs 100j) Amount of Rs 80 received as interest was credited to commission.

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Srno Particulars

RsDebit

RsCredit

a) Wrong Entry Trade Expenses Dr 200 To Cash 200 Correct entry Drawings Dr 200 To cash 200

Rectificationentry Drawings Dr 200

To Trade expenses 200 b) Wrong Entry Nathan Dr 300 To Sales 300 Correct entry Purchases Dr 300 To Nathan 300

Rectificationentry Purchases Dr 300

Sales Dr 300 To Nathan 600 c) Wrong Entry Purchases Dr 100 To Santhanam 100 Correct entry Santhanam Dr 100 To Sales 100

Rectificationentry Santhanam Dr 200

To Sales 100 To Purchases 100 d) Wrong Entry Cash Dr 150 To Mehrotra 150 Correct entry Cash Dr 150 To Malhotra 150

Rectificationentry Mehrotra Dr 150

To Malhotra 150 e) Wrong Entry Dhawan Dr 375 To cash 375 Correct entry Salary Dr 375 To cash 375

Rectificationentry Salary Dr 375

To Dhawan 375

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f) Wrong Entry Building Repairs Dr 2750 To Cash 2750 Correct entry Buildings Dr 2750 To Cash 2750

Rectificationentry Buildings Dr 2750

ToBuilding Repairs 2750 g) Wrong Entry No entry passed Correct entry Sales Returns Dr 500 To Akashdeep 500

Rectificationentry Sales Returns Dr 500

To Akashdeep 500 h) Wrong Entry Sethi Dr 200 To Sales 200 Correct entry Sethi Dr 200 To Furniture 200

Rectificationentry Sales Dr 200

To Furniture 200 i) Wrong Entry No entry passed Correct entry Suspense Dr 100 To Sales 100

Rectificationentry Suspense Dr 100

To Sales 100 j) Wrong Entry Cash Dr 80 To commission 80 Correct entry Cash Dr 80 To Interest 80

Rectificationentry Commission Dr 80

To Interest 80

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3.10.1 Effect of errors on Profit or loss

Some errors may affect the profit or loss for the period while other won’t. How to find it out?Remember, the P & L a/c reflects items of incomes, gains, expenses and losses. All these ac-counts are nominal accounts. When an error occurs which affects a nominal account, it willaffect profit or loss otherwise not. So, errors that affect real and personal accounts will notaffect profit or loss.

3.10.2 Correction of errors in subsequent accounting period:

At times when the errors are not located, the difference in the TB is transferred to suspense a/c and the books are closed. If errors are located in subsequent accounting period, correctionsshould be done in such way that the subsequent year’s profit is not affected. Therefore a sepa-rate a/c by the name of P & l Adjustment a/c is opened and all errors which affect profit or lossare adjusted through this a/c. The balance in the profit and loss a/c is transferred to the owner’scapital a/c.

Illustration 5

The books of M/s Shakti trading for the year ended 31st march 2006 were closed with adifference that was posted to suspense a/c. The following errors were found subsequently:

a) Goods of Rs 12500 returned to Thick & Fast Corporation were recorded in Return In-ward book as Rs 21500 and from there it was posted to the debit of Thick & fast Corpo-ration.

b) A credit sale of Rs 7600 was wrongly posted as Rs 6700 to customer’s a/c in sales ledger.

c) Closing stock was overstated by Rs 5000 being totaling error in the schedule of inven-tory.

d) Rs 8900 paid to Bala was posted to the debit of Sethu as Rs 9800

e) Goods purchased from Evan traders for Rs 3250 was entered in sales book as Rs 3520

f) Rs 1500, being the total of discount column on the payment side of the cash book wasnot posted.

Rectify the errors and pass necessary entries giving effects to suspense a/c and P & Ladjustment a/c.

Answer

a) There are 2 errors: one – return outward is wrongly recorded as return inward and two– amount is also recorded wrongly. First, we need to remove extra debit to Thick & Fastcorporation i.e. Rs 9000 (21500-12500) by crediting it. Also we need to remove wrongcredit of Rs 21500 in sales return by debiting it and credit Rs 12500 to Purchase returnsa/c.

The rectification entry will be:


To Thick & Fast Corp 9000

To P & L Adjustment a/c 12500

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b) In this case, error has occurred only in customer’s a/c. hence, profit or loss won’t beaffected and the P & L Adjustment a/c will not be in picture. As customer’s a/c isdebited for Rs 6700 instead of Rs 7600, it needs to be corrected.

The rectification entry will be:

Sundry Debtors a/c Dr 900

To Suspense a/c 900

c) Over casting of closing stock had affected profit which must be reduced through P & LAdjustment a/c. The rectification entry is:

P & L adjustment a/c Dr 5000

To Suspense a/c 5000

d) As only personal accounts are affected, there won’t be an effect on Profits. So rectifica-tion will be done through suspense a/c only. The rectification entry is:

Bala a/c Dr 8900

Suspense a/c Dr 900

To Sethu a/c 9800

e) This transaction involves correction of purchase as well as sales, and hence will affectprofit. As the purchases were booked as sales, we will need to cancel sales by debitingand freshly debit purchase. So overall effect on profit will be 3250 + 3520 i.e. 6770. Therectification enry will be:

P & L Adjustment a/c Dr 6770

To Evan Traders 6770

f) If discount is appearing on payment side of cash book, it indicates discount receivedwhile making payment and is an item of income. Hence, it will affect profit. The ac-counting entry will be:


To P & L Adjustment a/c 1500

Illustration 6

The trial balance of M/s G & Co did not match as on 31st March 2006.The balance was trans-ferred to suspense a/c and carried forward the same to the next accounting period. The follow-ing errors were detected in the next year:

Answer:

a) Vehicle purchase should not have gone through purchase book. Purchases were overstatedthereby reducing profit, which needs to be corrected. Vehicle a/c should be debited.

Vehicle a/c Dr 250000To P & L Adjustment a/c 250000

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In suspense a/c, please note the carried forward balance as the balancing figure. This was notgiven in the problem. It is a derived figure.

Dr Suspense a/c Cr



J. F.

Amount Rs

To balance b/d (Balancing figure) 19300 By Customer 17600

To supplier 8800 By P & L Adj 500 By P & L Adj 10000 28100 28100

Dr P & L Adjustment a/c Cr



J. F.

Amount Rs

To suspense 500 By Vehicle 250000 To supplier 10000 To suspense 10000

To Owner's capital 229500

250000 250000

b) The error has occurred in personal a/c only. It will not affect the profit.

Customer’s a/c Dr 17600 To Suspense a/c 17600

c) Discount allowed is expense. Non-recording of the same would affect profit.

P & L Adjustment a/c Dr 500 To Suspense a/c 500

d) As error has occurred in purchase a/c, it will affect profit. The personal a/c of supplier alsoneeds to be corrected.

P & L Adjustment a/c Dr 10000Suspense a/c Dr 8800To Supplier’s a/c 18800

e) As error occurred in sales, it would affect Profit.

P & L adjustment a/c Dr 10000 To Suspense a/c 10000

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In its simplest form depreciation charge will be done on equal basis over the useful life of theasset. In above example, see the charge to P & L and the value of asset as will be shown in thebalance sheet.

Is it always correct to charge depreciation on an equal basis? Is it possible that the asset is usedin the same way and extent every year? In practice, the method of charging depreciation willdepend on the nature of asset, technological obsolescence, nature of business, number of shiftsthe asset is used etc. There are dimensions of time, use, time & use, time & maintenance, time& interest. In India, generally the stipulations of the Companies’ Act are followed for provid-ing depreciation.

Let us discuss some of the methods of depreciation generally followed:

3.11.1 Straight line method

This method goes with the time dimension. It assumes the charge should be related to time. Assuch, the value of asset is reduced by periodic charges over its useful life. The formula appliedis:

Original cost of asset – estimated salvage value Estimated useful life

For example, if value of asset is Rs 100000, estimated salvage value is Rs 10000 and estimateduseful life is 5 years, the depreciation charge for every year will be(100000 – 10000)/5 i.e. Rs 18000.

This would mean that depreciation will be charged @ 18% every year on the original cost.When the asset has an estimated salvage value at the end of its life, the depreciation over its lifewill reduce the value of the asset to the level of its salvage value.

Here the schedule of depreciation and the asset value at the end of each year will be

Year Opening Asset Balance

Depreciation @18%

Closing Asset balance

1 100000 18000 82000 2 82000 18000 64000 3 64000 18000 46000 4 46000 18000 28000 5 28000 18000 10000

3.11 Depreciation MethodsIn section 3.2 we discussed briefly the concept of depreciation and accounting entry thereof.Depreciation is defined as diminution in the value of asset due to use, wear and tear and pas-sage of time. This diminution is the asset value must be charged to the profits earned over theuseful life of the asset. This is a non-cash expense. Consider a machine acquired for Rs 200000on 1st April 2005. The useful life of the machine is taken as 5 years. See the following:

Years 0 1 2 3 4 5

Charge to profit 40000 40000 40000 40000 40000

Value of asset 200000 160000 120000 80000 40000 Nil

�� A 81

Where D is depreciation %, R = Residual value or salvage value, C is cost of asset and n is lifeof asset in years. In above example, D = 100000, R is 10000 and n is 5. Hence,

This % is applied on balance asset value as reduced year by year. The schedule of depreciationis given below:

It can be observed that the depreciation amount is higher in the initial years and goes on reduc-ing as time progresses. We know maintenance costs are lower when the machine is new and itincreases with usage of asset. This is exactly what this method recognises. This method is stipu-lated for taxation purposes.

3.11.3 Production unit method

This method recognises the fact that certain machines have their useful life mentioned in termsof number of units produced by the machine over its useful life. This method cannot be usedfor assets that are non-production assets e.g. building, vehicles, office equipments etc.

The depreciation rate is expressed in terms of ‘Rs per unit produced’ and is computed as:

Year Opening

balance Depreciation

@ 36.9% Closing balance

1

100,000 36,904

63,096

2

63,096 23,285

39,811

3

39,811 14,692

25,119

4

25,119 9,270

15,849

5

15,849 5,849

10,000

R

C

nD = 1-

= 1 – 0.630957 = 0.369043 i.e. 36.90%D = 1- 10000

100000

5

This simple method is used in case of assets that have definite life like patents, leaseholdassets. However, it does not take into account other dimensions discussed above.

3.11.2 Reducing Balance or Written Down value methodIn this method, the periodic charge is calculated on the reduced value of the asset. Here, therate of depreciation is applied to the reduced value of the asset every year. The calculation is:This simple method is used in case of assets that have definite life like patents, leaseholdassets. However, it does not take into account other dimensions discussed above.

��A 82


In above example we have C = 100000, R = 10000. Assume the machine can produce 45000 unitsover its estimated life.

The depreciation will be (100000-10000)/45000 i.e. Rs 2 per unit

This method ignores time factor totally. The amount of depreciation charged will vary with theproduction volumes and will not be spread evenly over its life. Further, if machine is capable ofproducing non-standard units, it’s difficult to adopt this method.

3.11.4 Production hour method

Here all considerations in the production unit method apply except for the fact that the pro-duction hours are taken in place of production units. If in above example, the machine canwork for 30000 hours over its life, the depreciation amount will be (100000-10000)/30000 i.e. Rs3 per hour. The limitations of this method are more or less same as the unit method. However,in this case it can be applied even if machine produces different types of products.

There are other methods as well like annuity method, revaluation method, and sum of digits methods.However, these are very rarely used and hence not discussed at this level.

Students must be aware that the rates of depreciation for company form of organization aregiven in the Companies Act 1956 under schedule XIV. It says that the straight line or writtendown method could be used. Whichever method is selected must be applied consistently. Un-less there is a valid reason, the method should not be changed. If in case of computer systems,the technology changes, the rate of depreciation may be tuned to reflect that fact. The financialstatements should disclose this fact and also disclose the effect of such change on the profitabil-ity of the period.

Illustration 7

A company purchased furniture of Rs 40000 on 1st April 2003. It charges depreciation @ 10% onreducing balance method every year. On 1st July 2005, a part of furniture was sold for Rs 4000,the original cost of which was Rs 8000 purchased on 1st April ‘03. The accounting years of thecompany ends on 31st march every year. Show Furniture a/c from 1st April 2003 to 31st March2006. Also, calculate profit or loss on sale of furniture.

D =C - R

N

�� A 83

Date Particulars Amount

Rs Date Particulars Amount Rs

1-Apr-03 To Bank 40000 31-Mar-04 By Depreciation 4000

31-Mar-04 By Balance c/d 36000

40000 40000

1-Apr-04 To Balance b/d 36000 31-Mar-05

By Depreciation 3600


36000 36000

1-Apr-05 To Balance b/d 32400 1-Jul-05 By bank 4000

1-Jul-05

By Depreciation on sold machine 162

1-Jul-05 P & L (loss on sale) 2318

31-Mar-06 By depreciation 2592


32400 32400 1-Apr-06 23328

Notes :

Calculation of Profit or loss on sale of furniture

Answer:

In books of company

Dr. Furniture a/c Cr.

��A 84


Illustration 8

A fabrication shop has been charging depreciation @ 10% on reducing balance method onopening balance of the asset for the years 1998 to 2001. The balance in the Machinery a/cshowed a balance of Rs 54000. Machines worth 16800 were added in Sept 1998 and worth Rs11400 were added in December 2000. The management decided to charge depreciation @ 20%on the same method but calculated on closing balance of each year with retrospective effectfrom 1998.

Prepare machinery a/c for the years 1998 to 2001. Also show the effect on the profit due tochange in the method of calculation.

Answer:

In this case, the depreciation is calculated on reducing balance. The summary of changes madeby management is:

Rate of Depreciation Calculated on Old method 10% on reducing balance Opening balance of the year New method 20% on reducing balance Closing balance of the year

Please note here, the balance as on 1st Jan 1998 is not given. It will have to be calculated byworking back as shown in following table. The balance on 31-12-01 is given as Rs 54000 whichis closing, but as depreciation is calculated on the opening @ 10%, it will be 1/9th on closingbalance.

Original cost on 1st April 03 8000 Less: depreciation 10% for 2003-04 on 8000 -800 W. D. V. as on 31-3-2004 7200 Less: depreciation 10% for 2004-05 on 7200 -720 W. D. V. as on 31-3-2005 6480

Less: depreciation 10% till 30-06-2005 on 6480 for 3 months

-162 W. D. V. as on 1-7-2005 6318 Sale price 4000 Loss on sale 2318 Depreciation on 31-03-2005 for remaining furniture Original cost of the balance furniture 32000 Less: Depreciation @ 10% for 2003-04 on 32000 -3200 W. D. V. as on 31-3-2004 28800 Less: depreciation 10% for 2004-05 on 28800 -2880 W. D. V. as on 31-3-2005 25920 Less: depreciation 10% for 2005-06 on 25920 -2592

W. D. V. as on 31-3-2006 23328

�� A 85

Now that we have arrived at the balance as on 1st Jan 1998, it will be easy for us to prepare aschedule of depreciation as per the new method. The retrospective effect is shown below.

Depreciation as per current practice of 10% on Opening balance

Date Purchase Clo Balance Dep @ 10%

on op bal Op balance

31-Dec-01

54,000

6,000

60,000

31-Dec-00 Total

60,000

31-Dec-00 New

11,400

31-Dec-00 Old

48,600

5,400

54,000

31-Dec-99

54,000

6,000

60,000

31-Dec-98 Total

60,000

30-Sep-98 New

16,800

31-Dec-98 Old

43,200

4,800

48,000

Total Depreciation till 2001

22,200

Depreciation as per new method of 20% on Closing balance

Date Purchase Op Balance Dep @ 20%

on cl bal Cl balance

31-Dec-98 Old 48,000

30-Sep-98 New 16,800

31-Dec-98 Total 64,800 12,960 51,840

31-Dec-99 51,840 10,368 41,472

31-Dec-00 Old 41,472

31-Dec-00 New 11,400

31-Dec-00 Total 52,872 10,574 42,298

31-Dec-01 42,298 8,460 33,838

Total Depreciation till 2001

42,362

Extra cumulative charge due to change in method

20,162

��A 86


Illustration 9

Suvin runs an engineering machine shop. He procured a second hand lathe machine on 1st

April 2000 for Rs 80000. He spent Rs 10000 for carriage & installation. He further spent Rs 10000on overhauling it to put in proper working condition. On 1st October 2002, the old machinewas sold for Rs 45000 and on the same day he procured another new versatile machine for Rs150000. He used to provide for depreciation @ 10 % on original cost. In 2005, it was decided thatthe method should be changed to 15% on diminishing value. Show Machinery a/c in the booksof Mr. Suvin till 31st March 2005.

Answer:

Here the cost of the first machine that will be capitalized is:

Basic cost of machine 80000

Freight & Installation 10000

Overhauling 10000

Total 100000

The machinery a/c will be prepared as per the old method only till 2001 as this was the actualmethod in vogue. But at the end of 2001, an adjustment will to be passed for the extra deprecia-tion due to change in method. This is shown below.

Date Particulars Amount Rs Date Particulars Amount Rs 1-Jan-98 To balance b/d 48000 31-Dec-98 By depreciation 4800 30-Sep-98 To Bank 16800 31-Dec-98 By balance c/d 60000 64800 64800 1-Jan-99 To balance b/d 60000 31-Dec-99 By depreciation 6000 31-Dec-99 By balance c/d 54000 60000 60000 1-Jan-00 To balance b/d 54000 31-Dec-00 By depreciation 5400 31-Dec-00 To Bank 11400 31-Dec-00 By balance c/d 60000 65400 65400 1-Jan-01 To balance b/d 60000 31-Dec-01 By depreciation (old method) 6000 31-Dec-01 By depreciation (extra as revised) 20162 31-Dec-01 By balance c/d 33838 60000 60000 1-Jan-02 To balance b/d 33838

In books of company

Dr. Machinery a/c Cr

�� A 87

Please note that overhauling charges have been capitalized i.e. considered as cost of machineand not as repairs & maintenance cost. This is because the cost incurred is to put the machine inworking condition initially. Please remember, routine expenses on repairs like servicing andoiling will be considered as revenue expenses for a period and charged to the profit immedi-ately on incurring. But expenses like enhancement to capacity of an asset, initial installationand overhauling will be treated as capital expenditure and will be included in the cost of asset.Depreciation will be calculated thereon. In this case, therefore, the depreciation will be calcu-lated on Rs 100000.

Secondly, the change in method of depreciation is made in 2005. Still, the effect of such changein method has to be calculated with retrospective effect even if it is not stated so in the problem.This is as per Accounting Standard 6 issued by ICAI. The shortfall or excess resulting out ofchange in method will be accounted in P & L a/c of the year of change.

The schedule of depreciation is shown below:

Depreciation as per 10% and 15% on Diminishing balance

Date Cost sale

price Profit /

loss Dep @

10% WDV Dep @

15% WDV 2000-2001 Purchase 100,000

10,000

90,000

2001-2002 Depreciation

9,000

81,000

2002-2003 Sold on 1st Oct 2002

45,000

Depreciation till 30-09-02 (31,950)

4,050

76,950

2002-2003

new purchased 1st Oct 150,000

7,500

142,500

11,250

138,750


14,250

128,250

20813

117937

21,750

32063

Extra depreciation to be charged in 04-05

10313


17691

Total depreciation

28004

100246

��A 88


* Depreciation includes the difference between change in method (10313) and depreciationfor the Year

3.12 Bank Reconciliation

We have studied the cash book which has two columns viz. cash and bank. The majority oftransactions get settled through cash or bank. For cash received or paid, the effect in the cashbox is instant. The transactions settled through the medium of bank (i.e. by way of cheque, payorder, draft etc) take a little longer time. If customer pays by cheque, it is deposited in the bankwho will sent it for clearance and then only it will be credited by the bank into the a/c ofbusiness entity. This may take about a week. Similarly, when a cheque is issued to supplier, hewill deposit in his bank which in turn will clear it. Because of such time lag, there would bedifference in the records.

The records here would mean Cash book (in books of business entity) and Pass book (main-tained by the bank). The contents of bank passbook (or bank statement) are exactly the same asthat of cash book with a mirror image effect. When cheques is received the entry in books ofaccounts of business is

In books of Mr. Suvin Dr. Machinery A/c Cr.


Rs Date Particulars Amount Rs 1-Apr-00 To Bank 100000 31-Mar-01 By depreciation 10000 31-Mar-01 By balance c/d 90000 100000 100000 1-Apr-01 To Balance b/d 90000 31-Mar-02 By depreciation 9000 31-Mar-02 By balance c/d 81000 90000 90000 1-Apr-02 To Balance b/d 81000 30-Sep-02 By depreciation 4050 1-Oct-02 To Bank 150000 1-Oct-02 By Bank 45000 1-Oct-02 By P & L 31950 31-Mar-03 By depreciation 7500 31-Mar-03 By balance c/d 142500 231000 231000 1-Apr-03 To Balance b/d 142500 31-Mar-04 By depreciation 14250 31-Mar-04 By balance c/d 128250 142500 142500 1-Apr-04 To Balance b/d 128250 31-Mar-05 By depreciation* 28004 31-Mar-05 By balance c/d 100246 128250 128250 1-Apr-05 To Balance b/d 100246

�� A 89

Bank a/c Dr

To customer a/c

For the bank, this amount is collected through the clearing system and payable to the businessentity’s a/c. The entry in their books will be

Clearing a/c Dr

To business Entity’s a/c

Hence they will show it as payable i.e. as a credit. Thus all debits in the bank column of the cashbook will correspond to the credit entries in the bank passbook and all credits in the bankcolumn of the cash book will correspond to the debit entries in the bank passbook. Due to thetime differences, these entries may not exactly match at a given point of time. This necessitatesthat these two statements are reconciled regularly:

1) To identify differences

2) To know reasons for differences

3) To ensure the required entries are made in the books of accounts

4) To ensure that entries are made by the bank in time.

It may be noted that before the final accounts are prepared, bank reconciliation is a must. It is avery important preparatory step. If an entity has a/c with more than one bank, all such a/csmust be reconciled regularly i.e. weekly or monthly. In these days of internet banking wherethe bank statements are available online, the reconciliation also can be an online activity. Infact, modern accounting packages are equipped with automatic reconciliations. A bank state-ment is entered in the computer system (or a soft copy is uploaded) and then a programme isrun which will throw up the transactions leading to the differences. It is necessary for a begin-ner to understand the mechanism of how to prepare the bank reconciliation statement. Thefirst milestone on this journey is to understand the various reasons for differences between thetwo records.

3.12.1 Reasons for differences between cash book and pass book

The differences are basically of two types:

a) Items appear in cash book but not appearing in passbook and

b) Items appear in passbook but not appearing the cash book

Let us understand these reasons:

A) Items not appearing in bank passbook

1) Cheques issued by business entity not debited by the bank – This may be becausethey might not have been banked by the payee or it may still be under clearance. Theentry in cash book will be made immediately when the cheque is issued thereby reduc-ing the bank balance in the books of entity’s books of a/cs. Here, bank balance as percash book will be less, but as per bank passbook it will be more. This is also termed asunpresented cheques.

��A 90


2) Cheques deposited but not credited by the bank – The business entity may receivecheques or draft which is deposited into the bank for collecting the payment. Againentry in cash book will be instant thereby increasing the balance. Here, bank balance asper cash book will be more that the balance as per bank passbook. This is also called asoutstanding cheques.

3) Errors – The bank may by mistake miss out entering the debit or credit which results inthe difference.

4) Standing Instructions – The entity may give standing instruction to the bank for cer-tain regular payments like loan repayment installment, transfer of funds etc. This mayget entered in the cash book immediately, but passbook entry may be delayed.

B) Items not appearing in the cash book

1) Bank Interest, bank charges etc. - The bank will charge interest on overdraft or alsocharges for services, issue of demand draft, pay orders etc. Here, being the source oftransaction, the bank will record in the passbook immediately and send the debit ad-vice slips to the business entity. The entry in the cash book may be delayed. Similarlythe bank could credit interest on fixed deposits, which may get entered in businessbooks at a later date.

2) Direct deposits in bank account – Sometimes customers or others may directly depositan amount in the bank for goods or services rendered. The bank will enter it immedi-ately, but entry in cash book will appear later.

3) Bills for collection – The business entity may send bills of exchange for collection. Thebank will collect the payment and credit the same in the passbook. The entry in cashbook will be made only after receipt of information from the bank.

4) Errors – The records may be missed out by the bookkeeper of the business entity.

3.12.2 Steps in preparing Bank Reconciliation statement

One has to have a systematic approach towards preparation of the reconciliation. To avoida lengthy reconciliation, one must ensure that the entries in the cash book are absolutelyonline. One also must obtain the bank statements at regular intervals. Once this checkingis done, bank reconciliation could be done by following these steps:

a) Identify the balances and the character thereof. Remember, a debit balance in cash bookmeans asset where as a credit balance means a bank overdraft. In bank passbook, it’sreverse. A debit balance in passbook means overdraft and a credit balance is a favourablebalance. This must be carefully understood.

b) Based on the above, start with the balance (or overdraft) as per one book and arrive atthe balance (or overdraft) as per the other book. The items of differences will be addedto or deducted from the balance (or overdraft) with which the reconciliation is started.

c) The end result should be the balance (or overdraft) as per the other book e. g. if you startwith balance as per cash book, then after adding or deducting items of differences, youshould arrive at the balance (or overdraft) as per the passbook.

�� A 91

d) One has to make sure that all the items of differences from cash book as well as bankbook are taken into account in the reconciliation statement.

e) Whether the items of differences should be added or deducted will depend on the se-quence you follow. This is shown in following table:

Please note the abbreviations CB – cash book, PB – pass book, OD – overdraft

Illustration 10

The bank column of the cash book showed an overdraft of Rs 5000 on 31-03-2005, whereas asper bank statement the overdraft is Rs 4200. The following differences were noticed betweenthe two records:

1) Cheques of Rs 2400 issued but not encashed by customers

2) Cheques deposited but not cleared Rs 1200

3) Collection charges debited by bank not recorded in CB Rs 100

4) Bank interest charged by the bank not recorded in CB Rs 300

5) Cheques dishonoured debited by bank not in CB Rs 400

6) Interest directly received by bank not entered in CB Rs 400

Prepare bank reconciliation statement after amending the CB.

When reconciliation is started with Bal. as per CB

O/D as per CB

Bal as per PB

OD as per PB

Cheques deposited in bank, but not cleared

Less Add Add Less

Cheques issued, but not presented in bank

Add Less Less Add

Bank charges debited in PB only Less Add Add Less

Interest credited in PB only Add Less Less Add

Interest debited in PB only Less Add Add Less

Payments by bank debited in PB only Less Add Add Less

Direct payment by customer in PB only

Add Less Less Add

Bills discounted & dishonoured in PB only

Less Add Add Less

Cheques deposited, dishonoured in PB only

Less Add Add Less

��A 92


Bank reconciliation statement as on 31-03-2005

Bank OD as per CB 5400

Add: Cheques deposited, but not cleared 1200

Less: cheques issued but not encashed 2400

Bank OD as per PB 4200

Illustration 11

Mr. Narayan has given extract of his HDFC Bank statement for the month of December2006 as follows:

His cash book showed cash balance of Rs 3000 and bank OD of Rs 53450 as on 1st Decem-ber 2005. His transactions during December 2005 were as follows:

a) Cash collected on sales Rs 60000 which was banked on a daily basis. Credit sales wereRs 190000.

Answer:

Here, please note that amended CB is asked. What it actually means is to record all revenue(expense or income) items of differences and those items that are recorded in PB only must firstbe recorded in the CB and then the reconciliation statement should be prepared by taking therevised balance as per CB. Here is the amended CB.

Dr. Cash Book (bank column only) Cr.

Particulars Amount Rs Particulars Amount Rs To Interest received 400 By balance b/d (OD) 5000 By collection charges 100 By bank interest 300 To Balance c/d (OD) 5400

By customer (chq dishonoured) 400

5800 5800

Details Withdrawal Deposit Balance Balance as on 1-12-2005 12500 Cr Deposits realized: Cash Customers’ cheques deposited in Nov 05 deposited in Dec 05

60000 5000

170000

72500 77500

247500

Cr Cr Cr

Bank charges 400 247100 Cr Cash paid 10000 237100 Cr Cheques honoured issued before Dec 05 issued in Dec 05

68100 156000

169000 13000

Cr Cr

�� A 93

b) Cheques received from customers for Rs 150000 in full settlement of the invoices of Rs153000.

c) Credit purchases were Rs 155000

d) Cheques of Rs 132000 were issued against the November purchases of Rs 134000

e) Advances received from customers Rs 30000 & advances paid to suppliers Rs 25000

f) Amount withdrawn from bank Rs 10000 of which Rs 4000 was for personal use of Mr.Narayan and balance was for business expenses.

g) Expenses Rs 9000 of which Rs 5000 was by cheque and the rest by cash

h) Cash paid on behalf of customer Rs 4500

i) Bank charges Rs 150 debited by bank in November were recorded in cash book in De-cember on receipt of bank statement.

It was noticed that cheques Rs 2500 deposited and cheques Rs 5500 issued before 1st Decemberwere not cleared by 31st December. Prepare Cash book for December 2005 with discount, cashand bank columns. Also prepare bank reconciliation statement as on 30th November and as of31st December 2005.

Dr. Cash Book of Mr. Narayan for the month of December 2005 Cr. Particulars Dis HDFC Cash Particulars Dis HDFC Cash Balance b/d 3000 balance b/d (OD) 53450

Cash sales 60000 Cash deposited in bank (contra) 60000

Cash deposited in bank (contra) 60000

Cheques issued to suppliers 2000 132000

Customers cheques deposited 3000 150000

Advances to suppliers by cheque 25000

Advance cheques from Customers 30000

Cash withdrawn (contra) 6000

Cash withdrawn (contra) 6000 Drawings 4000 Expenses paid 5000 4000

Cash paid on behalf of Customer 4500

Bank charges 150 To Balance c/d (OD) Balance c/d 14400 500 3000 240000 69000 2000 240000 69000

��A 94


Please note here, the reconciliation statements are asked for 2 different dates. We must find outitems of differences between cash book and bank statement as on both dates and then shouldprepare the reconciliation statements. Transactions of credit sales and credit purchases for themonth will have no relevance of posting in cash book.

HDFC Bank reconciliation as on 30th November 2005

Particulars Amount Rs.

Amount Rs.

Balance as per bank statement (credit) Add: cheques deposited but not cleared (5000+ 2500) Add: Bank charges not recorded in CB Less: Cheques issued not presented ( 68100 + 5500) Balance as per Cash Book (Overdraft)

7500 150

12500

7650

73600

53450

Particulars Amount Rs

Amount Rs

Balance as per Cash Book Add: Cheques issued but not presented Issued in November Issued in December (162000 – 156000) Less: Cheques deposited but not cleared Deposited in November Deposited in December ( 180000 – 170000) Less: Bank charges for December not entered in CB Balance as per pass Book

5500 6000

2500 10000

14400

11500

12500 400

13000

�� A 95

On investigation it was found that

1) Bank charges of Rs 35 were not entered in the cash book2) A cheques of Rs 47 issued to supplier was entered by mistake as a receipt in the cash

book.3) A cheques of Rs 18 was returned by the bank marked as ‘refer to drawer’ but it’s not

entered in cash book4) The balance brought forward in Sept 2005 should have been 14705) Cheques paid to suppliers Rs 214, Rs 370 and Rs 30 have not been presented for pay-

ment.6) Deposits of Rs 1542 on 30th Sept were cleared by the bank on 2nd October.7) The bank charged a cheque wrongly to Adarsh trading Rs 728) Bank statement shows overdraft as on 30th Sept 2006.

Show what adjustments will you make in the cash book and prepare a bank reconciliationstatement as on 30-09-2006.

Answer:

As we know, the errors in the cash book must first be corrected and entries that have beenmissed out in the CB should be recorded.

Illustration 12

The following is a summary from cash book of M/s Adarsh Trading for the month of Sept 2006

Balance b/d 1407 Payments 15520Receipts 15073 Balance c/d 960

16480 16480

Cash Book for Sept 2006

Original balance b/d 960 Bank charges not recorded earlier 35Error in balance carried 63 Cheques issued recorded as receipt 94

Now corrected (2*47) Cheque returned 18 Revised balance c/d 876

��A 96


Illustration 13

From the following particulars of M/s Suresh enterprises, prepare a bank reconciliationstatement:

1) Bank overdraft as per pass book as on 31st March 2006 was Rs 88002) Cheques deposited in bank for Rs 5800 but only Rs 2000 were cleared till 31st March3) Cheques issued were Rs. 2500, Rs 3800 and Rs 2000 during the month. The cheque of Rs

5800 is still with supplier.4) Dividend collected by bank Rs 1250 was wrongly entered as Rs 1520 in cash book.5) Amount transferred from fixed deposit a/c into the current a/c Rs 2000 appeared only

in pass book6) Interest on overdraft Rs 930 was debited by bank in pass book and the information was

received only on 3rd April 2006.7) Direct deposit by M/s Rajesh Traders Rs 400 not entered in cash book.8) Corporation tax Rs 1200 paid by bank as per standing instruction appears in PB only.

Answer:

Now we can prepare the bank reconciliation statement.

Particulars Amount Rs

Amount Rs

Balance as per Cash Book Less: Deposits not cleared Less: Cheques charged by mistake Add: Cheques issued but not presented (214 + 370 + 30) Overdraft as per pass book

1542 72

876

1614

614

124


Amount Rs.

Overdraft as per Pass Book Add: Cheques issued but not presented till 31st March Add: Transfer from fixed deposit Add: Direct deposit by Rajesh traders Less: Cheques deposited but not cleared Less: Dividend collected excess recorded in CB Less: Interest on overdraft debited in PB only Less: Corporation tax paid appeared in PB only Overdraft as per Cash Book

5800 2000

400

3800 270 930

1200

8800

8200

6200

10800

�� A 97

Answer:

The reconciliation period is 1st Jan to 15th Jan 2006. From comparison of both the extracts it canbe found that:

a) Cheques issued to Bapat, Fakir and Mustafa are not encashed till 15th Jan 06 and willappear in reconciliation.

b) Direct deposit by Jamdar is not appearing in cash book is also a reconciliation item

c) Interest received of Rs 52 is appearing in Cash book only. This has to be dealt withcarefully. Interest is normally credited by bank first and then on the basis of creditadvice an entry is made in cash book. Hence, it’s probable that the interest must have

Dr. Cash Book (bank column only) Cr.


Rs Date Particulars Amount Rs 1-Jan-06 To Balance b/d 1080 2-Jan-06 By wages 850 2-Jan-06 To interest 52 6-Jan-06 By investments 1000 5-Jan-06 To Kamdar 900 8-Jan-06 By purchases 306 8-Jan-06 To sales 609 9-Jan-06 Be self 160 10-Jan-06 To rent 56 10-Jan-06 By Bapat 210 12-Jan-06 To Ganpat 1252 10-Jan-06 By drawings 80 13-Jan-06 To Ram 888 14-Jan-06 By Fakir 1822 15-Jan-06 By Mustafa 810

15-Jan-06 To Balance c/d (OD) 401

5238 5238 Dr. Pass Book Cr.


Rs Date Particulars Amount Rs 2-Jan-06 To wages 850 1-Jan-06 By balance b/d 1132 6-Jan-06 To investments 1000 6-Jan-06 By kamdar 900 7-Jan-06 To purchases 306 8-Jan-06 By sales 609 9-Jan-06 To self 160 10-Jan-06 By rent 56 10-Jan-06 To self 80 10-Jan-06 By Jamdar 200 13-Jan-06 To Bills payable 100 15-Jan-06 To balance c/d 401 2897 2897

Illustration 14Following are the extracts of cash book and pass book of Mr. Sunil. Prepare a bank reconcilia-tion statement.

��A 98


been credited by bank before 1st Jan and it would have appeared in the reconciliationstatement of December. This item is thus not considered.

d) Cheques received from Ganpat and Ram not cleared till 15th Jan and hence will appearin the reconciliation statement.

e) Bills payable cleared by bank not recorded in cash book will appear as item of reconcili-ation.


Amount Rs.

Overdraft as per Cash Book Less: Cheques issued not presented till 15th Jan (210+1822+810) Less: Direct deposit by Jamdar Add: Cheques deposited but not cleared (1252+888) Add: Bills payable not recorded in CB Overdraft as per Pass Book

2842 200

2140

100

401

3042

2240

401

Please note that even if the final balances as per cash book and pass book given in this problemare matching, it’s not necessary that all items of transactions are matching. There could becompensating items due to which reconciliation becomes necessary. It is absolutely essentialthat all items in both books are offset against each other.

�� A 99

Sourcedocum ents

Jou rnal &subsid iary books L e d g e rs

TrialBalance

C losing en tries &A d justm entsFinal

A ccounts - P& L and B.S .

Sourcedocum ents

Jou rnal &subsid iary books L e d g e rs

TrialBalance

C losing en tries &A d justm entsFinal

A ccounts - P& L and B.S .

3.13 Conclusion

Now that you have learnt the entire accounting process, you have reached a stage where youcan prepare the financial statements viz. Profit and Loss a/c and Balance sheet. These financialstatements portray the financial position of the business. It must be ensured that the account-ing principles are strictly adhered to. This will ensure that the financial statements exhibit atrue and fair view of the affairs of the business. Remember, there are quite a few stakeholdershaving different stakes in business. Each stakeholder uses these financial statements and checkwhether their interests are protected. Also, they want to know whether the business is growingand profitable or not.

The process can be summarised in pictorial form as under:

Documents

introduction to final accounts