Trial Balance » What? Why? When?

 

 

• What is a Trial BalanceThe 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

ParticularsL/F

Debit Amount(in Rs)

Credit Amount(in Rs)

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

–

–

–

–

–

–

–

–

–

–

–

–

–

–

–

–

–

–

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

1,19,000

2,10,000

2,08,000

5,69,000

2,50,000

1,80,000

36,86,000

6,52,950

Total   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 ____

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit Amount

(in Rs)

1st January – Assets a/c

      To Liabilities a/c

      To Capital a/c

Dr –

–

–

–

–

–

[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

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

31st December – Liabilities a/c

Capital a/c

      To Assets a/c

Dr –

–

–

–

–

–

[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 DescriptionAccount

Type

Balance

Nature

WhereWhichSide

Amount

Opening Stock

Textile Purchases

Wages

Octroi

Salaries

Rent

Printing and Stationery

Advertisements

Cash

Direct Expenses

Direct Expenses

Direct Expenses

Direct Expenses

Indirect Expenses

Indirect Expenses

Indirect Expenses

Indirect Expenses

Asset

Nominal

Nominal

Nominal

Nominal

Nominal

Nominal

Nominal

Nominal

Real

Debit

Debit

Debit

Debit

Debit

Debit

Debit

Debit

Debit

Trading a/c

Trading a/c

Trading a/c

Trading a/c

P/L a/c

P/L a/c

P/L a/c

P/L a/c

B/S

Debit

Debit

Debit

Debit

Debit

Debit

Debit

Debit

Assets

63,650

22,56,000

3,25,000

1,78,200

1,04,000

1,26,000

74,650

86,000

26,000

Office Building

Capital

Bank

Motor Vehicles

Sundry Creditors

Sales

P/L Appropriation

Sundry Debtors

Machinery

Asset

Liability

Liability/Asset

Asset

Liability

Direct Incomes

Accumulatd Profit

Asset

Asset

Real

Personal

Personal

Real

Personal

Nominal

Spl. Nominal

Personal

Real

Debit

Credit

Debit

Debit

Credit

Credit

Credit

Debit

Debit

B/S

B/S

B/S

B/S

B/S

Trading a/c

B/S

B/S

B/S

Assets

Liabilitie

s

Assets

Assets

Liabilitie

s

Credit

Liabilitie

s

Assets

Assets

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.

DrTrading and Profit & Loss a/c [For the year ending

31/03/06]Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Textile Purchases

To Wages

To Octroi

To Gross Profit

63,650

22,56,000

3,25,000

1,78,200

8,63,150

By Sales 36,86,000

  36,86,000   36,86,000

To Salaries

To Rent

To Printing and Stationery

To Advertisements

To Net Profit

1,04,000

1,26,000

74,650

86,000

4,72,500

By Gross Profit 8,63,150

  8,63,150   8,63,150

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

Liabilities Amount Assets Amount

Capital

Sundry Creditors

P/L Appropriation

  [6,52,950 + 4,72,500]

2,50,000

1,80,000

11,25,450

Cash

Bank

Office Building

Motor Vehicles

Sundry Debtors

Machinery

26,000

4,23,450

1,19,000

2,10,000

2,08,000

5,69,000

  15,55,450   15,55,450

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

Date ParticularsJ/

F

Amount

(in Rs)Date Particulars

J/

F

Amount

(in Rs)

31/03/06 To Bal c/d – 11,25,450 31/03/06

31/03/06

By Bal b/d

By Net Profit

–

–

6,52,950

4,72,500

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

        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.

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 businessThere 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. Stock taken away by the proprietor for personal use

ii. Abnormal loss of stock

• Transactions which have to be recorded only towards the endThere 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. Depreciation on Assets

ii. Expenses - Outstanding/Prepaid

iii. Incomes - Outstanding/Pre-received

• Transactions relating to Error RectificationsThe 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.

ParticularsL/F

Debit Amount(in Rs)

Credit Amount(in Rs)

Opening Stock

Purchases

Salaries

Wages

Carriage Inwards

Trading Charges

Carriage Outwards

Rent received

Cash

Capital

Bank (Overdraft)

–

–

–

–

–

–

–

–

–

–

–

86,000

11,36,000

1,53,000

18,000

26,900

64,000

52,500

62,500

1,78,300

3,44,700

37,980

Comission

Creditors

Sales

Debtors

Machinery

–

–

–

–

–

42,780

2,56,000

4,80,000

2,68,000

15,48,700

Total   23,77,680 23,77,680

» 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 TransactionsRecording the transactions represented by adjustments normally would result in the existing balance in the

affected ledger accounts to either increase or decrease.

» Transaction

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

This represents an error of principle whereby an expenditure that was to be debited in a particular account has

been debited to another account.

To bring the effect of this transaction into books, the journal entry to rectify this error has to be recorded.

» Journal/Ledger Hide/Show

Journal in the books of M/s Azaya Traders for the year ending 30th

June 2006

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

30/06/06 – Wages a/c

      To Salaries a/c

Dr –

–

2,00,000

2,00,000

[For the transfer of wages erroneously

treated as salaries from the "salaries a/c" to

the "Wages a/c".]

Dr Salaries a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

30/06/06 To Bal b/d –

–

1,53,000 30/06/06

30/06/06

By Wages

Bal c/d

– 43,000

1,10,000

      1,53,000       1,53,000

01/07/06 To Balance b/d – 1,10,000        

Dr Wages a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

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

      43,000       43,000

01/07/06 To Balance b/d – 43,000        

• The Method of AdjustmentThis 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

A. (−) 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".

B. (+) 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.

ParticularsL/F

Debit Amount(in Rs)

Credit Amount(in Rs)

Opening Stock

Purchases

Salaries

Wages

Carriage Inwards

Trading Charges

Carriage Outwards

Rent received

Cash

Capital

Bank (Overdraft)

Comission

Creditors

Sales

Debtors

Machinery

–

–

–

–

–

–

–

–

–

–

–

–

–

–

–

–

86,000

11,36,000

1,53,000

18,000

26,900

64,000

52,500

62,500

42,780

2,56,000

4,80,000

1,78,300

3,44,700

37,980

2,68,000

15,48,700

Total   23,77,680 23,77,680

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 DescriptionAccou

ntType

Balance

Nature

WhereWhatSide

Amount

Opening Stock

Purchases

Salaries

Wages

Carriage Inwards

Trading Charges

Carriage Outwards

Rent received

Cash

Capital

Bank (Overdraft)

Comission

Creditors

Sales

Debtors

Machinery

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

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

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

Debit

Debit

Debit

Debit

Debit

Debit

Debit

Credit

Assets

Liabilitie

s

Liabilitie

s

Debit

Liabilitie

s

Credit

Assets

Assets

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

Dr. Machinery a/c

Cr. Ramsay Machine Tools a/c  

1. (+) To Machinery a/c on the Assets side of the Balance Sheet

2. (+) To Ramsay Machine Tools a/c on the Liabilities side of the Balance

Sheet

2. Detailed Explanation Hide/Show

Journal in the books of M/s Azaya Traders for the year ending 30th June 2006

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

30/06/06 – Machinery a/c

      To M/s Ramsay Machine Tools a/c

Dr –

–

2,00,000

2,00,000

[For the value of machine purchased on

credit.]

Dr Machinery a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

30/06/06 To Bal b/d

To Ramsay

Machine Tools

–

–

4,80,000

2,00,000

30/06/06 By Bal c/d – 6,80,000

      6,80,000       6,80,000

01/07/06 To Balance b/d – 6,80,000        

Dr Ramsay Machine Tools a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

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

      2,00,000       2,00,000

        01/07/06 By Balance b/d – 2,00,000

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

Entry Effect

Dr. Wages a/c

Cr. Salaries a/c    

1. (+) To Wages a/c on the Debit side of the Trading 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.

DrTrading and Profit & Loss a/c of M/s Azaya Traders for the year

ending 30/06/06Cr

ParticularsAmount

(in Rs)

Amount

(in Rs)Particulars

Amount

(in Rs)

Amount

(in Rs)

To Opening Stock

To Purchases

To Wages

    (+) Salary (Tr)

To Carriage Inwards

To Gross Profit

18,000

43,000

86,000

11,36,000

61,000

26,900

2,38,800

By Sales   15,48,700

    15,48,700     15,48,700

To Salaries

    (−) Tr. to Wages

To Trading Charges

Carriage Outwards

To Comission

To Net Profit

1,53,000

43,000 1,10,000

64,000

52,500

42,780

1,47,820

By Gross Profit

By Rent Received

  2,38,800

1,78,300

    4,17,100     4,17,100

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

Liabilities Amount Amount Assets Amount Amount

Capital

    (+) Net Profit

Bank (Overdraft)

Creditors

    (+) Due to M/s

Ramsay

3,44,700

1,47,820

2,68,000

2,00,000

4,92,520

37,980

4,68,000

Cash

Debtors

Machinery

    (+) New Machine

4,80,000

2,00,000

62,500

2,56,000

6,80,000

    9,98,500     9,98,500

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

adjustments wherever needed.

Adjustments to be Dealt with at least Twice

 

 

• Dual Entity ConceptEvery transaction relating to business has its effect on two elements.

Adjustments are transactions relating to the business which are yet to be journalised. We call them adjustments

for the reason that they are dealt with by making mathematical adjustments to the figures of ledger account

balances instead of passing the regular journal entries.

Therefore, in making mathematical adjustments we have to ensure that we are adjusting the two elements that

are affected by the transaction.

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

Where an item appears in the trial balance it is to be dealt with only once and where an adjustment is being

dealt with it is to be dealt with at two or more places depending on the number of elements effected by the

transaction.

» Adjusting more than two accounts

In most of the cases, the journal entry for recording the transaction given as adjustments is a simple entry

involving two accounts (one being debited and the other being credited). However, in some cases, a complex

entry involving more than two elements (accounts) is needed to record the additional transactions. In such

cases more than two accounts may have to be adjusted.

Valuation of Assets » Direct Expenses

 

 

• Asset Valuation PrincipleThe value of an asset includes all the expenses incurred before bringing the asset into usable condition.

• Direct ExpenditureIn financial accounting, we use the term Direct Expense in relation to assets.

Any expenditure that goes into the value of an asset is identified as Direct Expenditure for that asset.

• Assets » Treatment of Direct ExpensesAll the expenses incurred in relation to an asset before bringing the asset into usable condition would form

direct expenses for the asset

All the direct expenses in relation to an asset are to be made part of the value of the asset i.e. are to be

capitalised.

» Example

If a machine is purchased at Delhi and brought to Tenali for use, then all the expenses incurred before bringing

the machine into working mode (usable condition) like transportation charges from Delhi to Tenali, Unloading

Charges at Tenali, Installation Charges etc., should be considered to be part of the value of the machine.

These expenses should not be debited to the respective expenditure accounts, but should be debited to the

Machinery a/c. The Machinery a/c balance which indicates the value of the asset would be the sum of the cost of

the machine, the transportation charges, unloading charges, installations charges, etc..

Is Stock an Asset?

 

 

• Dual nature of Stock

» Purchases : During the Accounting Period

Whenever we purchase stock/goods we debit the Purchases a/c (Nominal account). This implies that we treat

the amount spent on purchasing stock as an expenditure.

Such a treatment is adopted all throughout the year.

» Asset : At the end of the Accounting Period

At the end of the accounting period, while preparing the final accounts we treat stock an asset and show it in

the Balance Sheet on the assets side.

Thus we can say that stock has dual nature. All throughout the year the amount spent on it is expenditure and

only for the moment the balance sheet is prepared it is an asset.

• Valuation of Stock » Based on the Principle for Valuation of AssetsSince Stock is an asset, its valuation should also be made based on the principle for valuation of assets.

The value of stock should include all the expenses incurred before bringing stock into usable condition.

• Usable Condition for Stock » Being ready for SaleConsidering the Stock used in sale, the usable condition for stock would mean getting it ready for sale i.e. it

being finally set up in the show case or sale area.

• Value of StockAll the expenses incurred on the stock till it is placed in the sales area would form direct expenses for the stock

and should be treated as a part of the value of stock.

In situations where it would be difficult/impossible to collect all the expenses in detail, this idea is modified to

mean the expenses incurred before that stage till which point it would be convenient to collect information.

Direct Expenses for Stock used in Trading Business

 

 

In relation to a trading business, the stock used for sale would be an asset.

The usable condition for that stock would be, it being placed ready for sale in the showroom.

Therefore, the direct expenses in relation to this stock would be all the expenses incurred before placing it in the

show room or any other relevant place ready for sale.

Conventionally, expenses like Wages, Carriage Inwards (carriage on purchases), Octroi, Excise, Duties etc.,

Stock purchased, etc. are treated as direct expenses apart from the actual cost of the goods purchased which is

revealed by the "Purchases a/c".

It is not a rule that only these form direct expenses. Any expenditure that would have been incurred in relation

to stock before it is made ready for sale would form direct expenditure for the stock.

Cost of Goods Sold

 

 

• Cost of Goods Sold = Value of the Goods SoldThe cost of goods sold is a term used to indicate the value of the goods sold.

This value is needed to identify the amount of basic/core (gross) profit made by the organisation

» Gross Profit = Sales − Cost of Goods Sold

» Illustrative Explanation

Consider the following data relating to an organisation.

1. Opening Stock at the beginning of the accounting period, Rs. 20,000.

2. Purchases of goods/stock during the accounting period : Rs. 2,48,000.

3. Direct expenses incurred :Rs. 54,000.

4. Unsold stock at the end of the accounting period valued at Rs. 36,000.

5. Value of Stock used for other purposes Rs. 14,000.

Particulars Amount Amount

Opening Stock

(+) a) Purchases (Cost Value)

     b) Direct Expenses

Total Value of Goods

(−) a) Closing Stock (Value)

     b) Stock Unused for Trading

Cost of Goods Sold

2,48,000

  54,000

  36,000

  14,000

20,000

3,02,000

3,22,000

  50,000

2,72,000

The formula for calculating the value of Cost of Goods Sold based on the above calculations can be written as

Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses − Closing Stock − Stock Unused for trading

• Stock Unused for TradingStock with the organisation may have been used for purposes other than trading. The value of such stock

unused for trading purposes has to be deducted from the total value of stock so as to arrive at the value of cost

of goods sold.

Some such instances

Goods being taken away by the proprietor for personal purposes;

Stock used in building up an asset;

Stock used for advertisement purposes;

Normal loss of stock;

Abnormal loss of stock;

Stock used up for other types of businesses (like consignments, branches, joint ventures etc)

Do we need Cost of Goods Sold to find Gross Profit

 

 

• Gross Profit = Sales − Cost of Goods Sold

By definition Gross Profit = Sales − Cost of Goods Sold   ← (1) ⇒ To obtain the value of gross profit we need the figures of cost of goods sold and sales.

• Bypassing finding Cost of Goods SoldCost of Goods Sold = Opening Stock + Purchases + Direct Expenses − Closing Stock − Stock Unused for trading

Substituting this in (1) we get,

• Gross Profit = Sales − (Opening Stock + Purchases + Direct Expenses − Closing Stock − Stock Unused for

trading)

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

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

Expenses)

Thus we do not specifically need to calculate the value of cost of goods sold for finding gross profit, only its

affect is to be brought into account.

Such an ascertainment of Gross Profit is done in the Trading and Profit and Loss account.

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

–

–

–

By Sales

By Stock Unused

By Closing Stock

–

–

–

       

"Purchases a/c" is a nominal account with a debit balance and is a direct expenditure (for stock).

Since Purchases a/c is closed by transfer to the Trading a/c, it appears on the debit side of Trading

a/c.

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

account being debited and the first account being credited.

Thus, all the accounts representing the figures that are added to purchases appear on the debit side

"Sales a/c" is a nominal account with a credit balance and is a direct income.

Since Sales a/c is closed by transfer to the Trading a/c, it appears on the credit side of Trading a/c.

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

account being credited and the first account being debited.

Thus, all the accounts representing the figures that are added to sales appear on the credit side

» Finding Cost of Goods Sold in such cases

Cost of goods sold is a figure that is not straight away available in the books of accounts used in financial

accounting. That figure can be obtained either from the "Trading a/c" or by preparing a separate ledger account

to specific account which gives the information relating to the cost of goods sold.

 

Ascertaining Cost of Goods Sold from Trading a/c

 

Each ledger account serves one or more informational needs of the organisation. The Trading a/c gives the

information relating to the Gross Profit made by the organisation. It can also be used to derive the information

relating to the "Cost of Goods Sold".

» Ascertaining Cost of Goods Sold

Cost of Goods Sold = (Opening Stock + Purchases + Direct Expenses) − (Closing Stock + Stock Unused for

trading)

The "Trading a/c" with this information posted to it would be

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

20,000

2,48,000

54,000

By Closing Stock

By Stock Unused

36,000

14,000

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

       

The trading account before crediting sales would have a greater total on the debit side and thus has a debit

balance. That debit balance represents the cost of goods sold.

Thus, to ascertain the cost of goods sold, we need to balance the "Trading a/c" without crediting sales.

The Sales a/c can be subsequently transferred to the Trading a/c to ascertain the Gross Profit.

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

20,000

2,48,000

54,000

By Closing Stock

By Goods Unused

By Cost of Goods Sold c/d

36,000

14,000

2,72,000

  3,22,000   3,22,000

To Cost of Goods Sold b/d

To Gross Profit

2,72,000

1,08,000

By Sales 3,80,000

  3,80,000   3,80,000

If such a two stage Trading a/c is prepared, we would be able to ascertain the Cost of Goods Sold as well as

Gross Profit from the Trading a/c itself.

» Ascertaining Cost of Goods Sold by Mathematical Calculations

The Trading a/c is generally prepared only as a single stage account as follows

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

To Gross Profit

20,000

2,48,000

54,000

1,08,000

By Sales

By Goods Unused

By Closing Stock

3,80,000

14,000

36,000

  4,30,000   4,30,000

To obtain the value of cost of goods sold from this we use the definition for gross profit.

• Cost of Goods Sold = Sales − Gross Profit [Since Gross Profit = Sales − Cost of Goods Sold]

= Rs. 3,80,000 − Rs. 1,08,000

= Rs. 2,72,000

Finding Cost of Goods Sold using Goods Consumed a/c

 

 

The value of Cost of Goods Sold can also be obtained specifically, by maintaining a separate account for the

purpose. This may be named "Goods Consumed a/c" (any other indicative name may be used).

The basic purpose of accounting is derivation of information and the more

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

maintain.

The Goods Consumed a/c is nothing but the first part of the trading account where it was balanced twice.

Dr Goods Consumed a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

20,000

2,48,000

54,000

By Goods Unused

By Closing Stock

By Trading a/c

14,000

36,000

2,72,000

  3,22,000   3,22,000

The balance in the Goods Consumed a/c represents Cost of Goods sold. This account is closed by transferring

the balance to the Trading a/c.

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Goods Consumed

To Gross Profit

2,72,000

1,08,000

By Sales 3,80,000

  3,80,000   3,80,000

• Cost of Goods ConsumedIf the balances in the ledger accounts representing direct expenses are not transferred to the "Goods Consumed

a/c" but are transferred to the "Trading a/c", then the balance from the "Goods Consumed a/c" cannot be called

cost of goods sold (value of goods sold).

It just represents the cost of goods consumed. To obtain the cost of goods sold from this, the direct expenses

have to be added to this.

 

Goods used within the Organisation have to be valued at Cost

 

The stock that is used within the organisation (stock drawn by the proprietor for own purposes, stock used for

building an asset, stock used for advertisement purposes, etc.,) have to be valued at cost.

This is for the reason that if such usages are recorded at a value which includes an element of profit, the

transaction when recorded would generate a profit, which would amount to making a profit out of a transaction

with oneself.

Principle of Mutuality » One cannot make a profit out of a transaction with

oneself

» Illustrative Explanation

Consider the following data relating to an organisation which started its operations on 28th December 2006:

Opening Stock :: Nil;

Purchases :: Rs. 1,20,000;

Direct Expenses :: Rs. 30,000

Sales :: Nil

Stock used by the organisation internally Rs. 20,000 (Valued at Cost).

Generally Sales are made by adding 25% profit to cost

Closing Stock :: ?

The accounting period ends on 31st December 2006.

Value of Closing Stock with the Organisation = Total Value of Stock − Value of Stock used up internally

= Purchases + Direct Expenses − Rs. 20,000

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

= Rs. 1,30,000

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

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

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

= Rs. 25,000

• Stock used up internally recorded at Sales ValueDr Trading a/c Cr

ParticularsAmount

(in Rs)

Amount

(in Rs)Particulars

Amount

(in Rs)

Amount

(in Rs)

To Purchases

To Direct Exp.

To Gross Profit

1,20,000

30,000

5,000

 

By Sales

By Stock used

By Closing Stock

–

25,000

1,30,000

    1,55,000     1,55,000

There is no commercial activity (no sales), there is no scope for earning profits. But the Trading a/c reveals a

Gross Profit of Rs. 5,000 which is on account of the stock used up internally being recorded at sales value.

Such profit generation is inappropriate for the reason that in using up stock within the organisation, the

organisation is not conducting a transaction with an outside party.

Thus to avoid profit generation in such cases, the stocks so used are to be valued at cost.

• Stock used up internally recorded at CostDr Trading a/c Cr

ParticularsAmount

(in Rs)

Amount

(in Rs)Particulars

Amount

(in Rs)

Amount

(in Rs)

To Purchases

To Direct Exp.

To Gross Profit

1,20,000

30,000

Nil

 

By Sales

By Stock used

By Closing Stock

–

20,000

1,30,000

    1,50,000     1,50,000

The Trading a/c would reveal no profit when the stock used up internally is valued at cost.

Finding Value of Closing Stock from Sales

 

 

We may be able to ascertain what is left out if we know what has been sold. This logic may be applied in finding

the value of closing stock. However, to know this, we need to ascertain the value of cost of goods sold.

i. Gross Profit = Sales − Cost of Goods Sold

ii. Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses − Closing Stock

iii. Gross Profit = Sales − (Opening Stock + Purchases + Direct Expenses − Closing Stock) [From (i) and

(ii)]

= Sales − Opening Stock − Purchases − Direct Expenses + Closing Stock

iv. Closing Stock = Opening Stock + Purchases + Direct Expenses + Gross Profit − Sales [From (iii)]

To use this relation to obtain the value of closing stock, we need the information relating to Gross Profit. All

other information in this relation is readily available from the accounting records.

Gross Profit Ratio

 

 

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

Ratio between two quantities is expressed in the form a : b or a

b, where "a" and "b" do not have a common factor.

Percentage = Ratio × 100

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

» To Sales

Gross Profit Ratio = Gross Profit

Net Sales

Gross Profit as a % of Sales = Gross Profit

Net Sales× 100

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

» To Cost of Goods Sold

Gross Profit Ratio = Gross Profit

Cost of Goods Sold

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

Cost of Goods Sold× 100

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

• Inter-Relationship between the two RatiosThe Gross Profit Ratio (to Sales) and Gross Profit Ratio (to Cost of Goods Sold) are interrelated and one can be

obtained if the other is known.

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

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

= x × y

= xy

Cost of Goods Sold = Sales − Gross Profit

= x − xy

= x (1 − y)

Gross Profit Ratio (to Cost) = Gross Profit

Cost of Goods Sold

= xy

x (1 − y)

= y

(1 − y)

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

Therefore, Gross Profit Ratio (to Cost) = y

(1 − y)

= 0.25

(1 − 0.25)

= 0.25

0.75

= 1

3

= 0.33

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

= 0.33 × 100

= 331

3%

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

100

Gross Profit Ratio (as a % of Cost) = y

(1 − y)× 100

=

m

100

(1 − m

100)

× 100

=

m

100

100 − m

100

× 100

= m

100×

100

100 − m× 100

= m

100 − m× 100

Therefore, Gross Profit as a % of Cost = m

100 − m× 100

= 25

100 − 25× 100

= 25

75× 100

= 100

3

= 331

3

Let the data be represented by1

a⇒ y =

1

a

Gross Profit Ratio (to Cost) = y

(1 − y)

=

1

a

(1 − 1

a)

= 1

a

a − 1

a

= 1

a×

a

a − 1

= 1

a − 1

Given » Gross Profit Ratio (to Sales) = 1

4⇒ a = 4

Gross Profit Ratio (to Cost) = 1

a − 1

= 1

4 − 1

= 1

3

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

= 1

3× 100

= 331

3%

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

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

= p × q

= pq

Sales = Cost of Goods Sold + Gross Profit

= p + pq

= p (1 + q)

Gross Profit Ratio (to Sales) = Gross Profit

Net Sales

= pq

p (1 + q)

= q

(1 + q)

Therefore, Gross Profit Ratio (to Sales) = q

(1 + q)

= 0.2

(1 + 0.2)

= 0.2

1.2

= 1

6

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

= 1

6× 100

= 162

3%

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

100

Gross Profit as a % of Sales = q

(1 + q)× 100

=

n

100

(1 + n

100)

× 100

=

n

100

100 + n

100

× 100

= n

100×

100

100 + n× 100

= n

100 + n× 100

Therefore, Gross Profit as a percentage of Saes = n

100 + n× 100

= 20

100 + 20× 100

= 20

120× 100

= 1

6× 100

= 16 2/3%

Let the data be represented by1

b⇒ q =

1

b

Gross Profit Ratio (to Sales) = q

(1 + q)

=

1

b

(1 + 1

b)

= 1

b

b + 1

b

= 1

b×

b

b + 1

= 1

b + 1

Given » Gross Profit Ratio (to Sales) is 1

5⇒ b = 5

Gross Profit Ratio (to Sales) = 1

b + 1

= 1

5 + 1

= 1

6

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

= 1

6× 100

= 162

3%

» Frequently used conversions

• Hundred Scale

As a % of Cost 20 25 331

350 66

2

3100

As a % of Sales 162

320 25 33

1

340 50

• One Scale

As a % of Cost 0.2 0.25 0.333 0.5 0.666 1

As a % of Sales 0.166 0.20 0.25 0.333 0.4 0.5

• Inverse

As a % of Cost1

5

1

4

1

3

1

2

2

3

1

1

As a % of Sales1

6

1

5

1

4

1

3

2

5

1

2

Gross Profit is generally Non-Uniform

 

 

The gross profit earned by an organsation is in almost all cases not a figure that can be easily derived (without

the availability of the value of closing stock). Deriving the value of closing stock would be far easier than

deriving the value of gross profit made (based on sales).

• Variety of Products being SoldThe organisation may be selling a number of products with different selling prices and different rates of gross

profits.

In such cases, if the gross profit figure is to be ascertained from the sales figure, sales records should be

maintained so as to give the sales details relating to each product with a distinct Gross Profit %. This would

involve a lot of work and would be impractical, more so where there are a large number of products being dealt

with.

• Variations in Sale PricesThe prices charged to customers are dependent on a number of factors like the market conditions, the

immediate competition existing in the market, the loyalty of the customers etc.

Depending on the market conditions, some times the prices may be varied instantaneously.

Depending on the customer to whom the product is being sold, the prices may be varied (a discount may be

given to loyal customers) etc.

In such a situations there would not be uniformity in the Gross profit percentage and it would be near to

impossible to ascertain the gross profit made using the sales figures.

Since using the figure of gross profit to ascertain the value of closing stock available in the organisation is not a

feasible idea, we look at other methods for finding out the value of closing stock.

How is the Value of Closing Stock Ascertained?

 

 

• Physical StockClosing stock is the stock/goods unsold at the end of the accounting period.

The details relating to the physical stock would be readily available with the organisation only if the inventory

records are being maintained by the organisation. In other cases the physical stock would have to be

ascertained by stock taking.

• Stock ValueThere is no specific ledger account in financial accounting that would give us the information relating to the

value of closing stock ready hand.

The value of closing stock is available ready hand only if inventory records are being maintained that too from

the inventory records.

The value of Closing Stock is ascertained by Physical Verification of Stock on the last day of

the accounting period and its valuation at Cost or Market Price (Net Realisable Value)

whichever is lesser

This is the most common method for valuing the closing stock.

The information relating to the value of closing stock is not regularly required by the organisation. It is however

required at the end of the accounting period for the purpose of evaluation of the Cost of Goods Sold.

Convention of Conservatism

 

 

• Net Realisable Value of StockFor the purpose of Valuation of closing Stock, Market Price implies Net Realisable Value/Rate and not the

Selling Price.

Net Realisable Value of stock is the net sale realisation excluding all the expenses directly and exclusively

relatable to the sale (Sale commission, Brokerage etc) from the Sale Realisation.

Therefore, in trying to ascertain the Market Price to be used for valuation, care should be taken to ensure

that such expenses are deducted from the sales price to ascertain the net realisable value of stock.

• Convention of Conservatism

By the Convention of Conservatism we take into consideration all those

expenses and losses of which we are aware, even if they relate to the

subsequent accounting periods.

The act of valuing closing stock at cost or market price is based on the "Convention of Conservatism".

Convention of Conservatism : Valuation of Closing Stock : Illustration

 

 

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

cost.

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

To Gross Profit

20,000

2,48,000

54,000

94,000

By Sales

By Closing Stock

3,80,000

36,000

  4,16,000   4,16,000

» Closing Stock details

The closing stock is made up of

Batch N :: 600 units valued at Rs. 36/unit with a total value of Rs. 21,600

Batch M :: 600 units valued at Rs. 24/unit with a total value of Rs. 14,400

Total 1,200 units with a total value of Rs. 36,000

Value here implies cost + direct expenses

The selling prices and the related expenses are

Batch N :: Rs. 50/unit

Batch M :: Rs. 50/unit [Regular price]

Batch M :: Rs. 25/unit [Current price]

This stock represents an outdated model of the product and the present market conditions would

enable the stock to be sold only at a price of Rs. 25 per unit.

The sales of all stocks are made through a dealer who would charge a commission of 10% of the sale

proceeds.

» Cost and Net Realisable Values of Closing Stock

From the available data, Closing stock can be valued at two different rates. Cost and Market Price (Net

Realisable Rate).

600 units [Batch N]

i. Cost = Rs. 36/unit.

ii. Market Price = Rs. 50/unit.

iii. Expenses directly relatable to sale = Rs. 5/unit

(10% of selling price = Rs. 50/unit × 10%).

iv. Net Realisable Value = Rs. 45/unit

[Market Price (Rs. 50/unit) − Expenses relatable to sale (Rs. 5/unit)]

600 units [Batch M]

i. Cost = Rs. 24/unit.

ii. Market Price = Rs. 25/unit.

iii. Expenses directly relatable to sale = Rs. 2.50/unit

(10% of selling price = Rs. 25/unit × 10%).

iv. Net Realisable Value = Rs. 22.50/unit

[Market Price (Rs. 25/unit) − Expenses relatable to sale (Rs. 2.50/unit)].

» Valuation of Closing Stock based on Convention of Conservatism

600 units [Batch N]

Cost = Rs. 36/unit. Net Realisable Rate = Rs. 45/unit.

Since Cost < Net Realisable Value, the goods are to be valued at cost. ⇒ Value of 600 units is Rs. 21,600 (600 units × Rs. 36/unit)

600 units [Batch M]

Cost = Rs. 24/unit. Net Realisable Rate = Rs. 22.50/unit.

Since Net Realisable Value < Cost, the goods are to be valued at the net realisable value. ⇒ Value of 600 units is Rs. 13,500 (600 units × Rs. 22.50/unit)

Value of Closing stock if valued at cost = Rs. 14,400 (600 units × Rs. 24/unit)

The Closing Stock should be valued therefore at Rs. 35,100 (Rs. 21,600 + 13,500).

» Trading a/c

If value of Closing Stock is taken based on the Convention of Conservatism, the Trading a/c would be

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

To Gross Profit

20,000

2,48,000

54,000

93,100

By Sales

By Closing Stock

3,80,000

35,100

  4,15,100   4,15,100

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

Role of Convention of Conservatism

 

 

The convention of conservatism asks us to take into consideration all those expenses and losses relating to the

subsequent periods of which we are aware.

» Future Losses

Where the Net realisable value of stock is less than its cost, the organisation may incur a loss.

In the above case, the organisation may have to incur a loss of Rs. 900 [Rs. 14,400 (cost) − Rs. 13,500 (net

realisable value)].

• When?

This loss would have to be borne by the organisation if it sells the stock at the net realisable rate.

Since it is the end of the accounting period, such a sale at such a price, if at all it takes place, would be in the

subsequent accounting period.

Thus, the organisation may have to incur this loss in the future.

• Is the loss for sure?

The loss may have to be incurred in the future only if the stock has to be sold at Rs. 25 per unit (which gives a

net realisation of Rs. 22.50).

We may consider such a loss a certainty in cases where the stock is required to be sold at the lower price on

account of it becoming obsolete, losing demand etc.

Bu where the lower market rate is on account of normal market fluctuation and if the rates go up in the

subsequent period and the product can be sold at a higher price, this loss need not be incurred.

How is the loss absorbed?

 

 

Based on the Convention of Conservatism, the loss though it may have to be incurred in the future period, is

absorbed in the current period itself, since its information is known.

This will be the case where the lower valuation is on account of conditions which are certain (obsolete goods,

demand going down etc).

» Crediting a Nominal a/c implies gain

The value of closing stock is credited to the "Trading a/c". By the principle of credit in relation to nominal

accounts (Credit all Incomes and Gains), we can assume the value to indicate a gain.

Reducing the value of closing stock would therefore amount to reducing the credit made to the Trading a/c,

which would be reducing the gain. Debiting an amount is an equivalent of deducting the amount from the

opposite side i.e. the credit side. Therefore, reducing the gain is the same as taking in additional loss.

Therefore, the loss is absorbed by considering the value of closing stock at a lesser value i.e. the net realisable

value. [In the above example, by considering the closing stock at the lower value, the estimated loss of Rs. 900

relating to the subsequent accounting periods has been absorbed in the current period itself.]

Value of Closing Stock = Value of Opening Stock of the Subsequent Period

 

 

The Closing Stock a/c relating to an accounting period and the Opening Stock a/c relating to the subsequent

accounting period represent the same account. Therefore, the value of the closing stock at the end of the

accounting period and the opening stock at the beginning of the subsequent accounting period are the same.

• Closing Stock a/cThe "Closing Stock a/c" is a real account and is created at the last moment of the accounting period.

It represents Stock as an asset. The balance in the "Closing Stock a/c" is carried forward to the next accounting

periods.

• Opening Stock a/cThe account that we name "Closing Stock a/c" is renamed "Opening Stock a/c" at the beginning of the next

accounting period while bringing the values of assets and liabilities into the books of accounts with the help of

an "Opening Entry".

This "Opening Stock a/c" is treated as an equivalent of a Nominal account.

Like other nominal accounts it is closed at the end of the accounting period. It is closed by transfer to the

"Trading a/c" since it goes into the value of cost of goods sold.

» Note

The value of Opening and Closing stocks relating to a particular accounting period do not mean the same. They

are two indicated by distinct ledger accounts - Opening stock by "Opening Stock a/c" which is a nominal account

and Closing stock by "Closing Stock a/c" which is a Real account.

They may or may not have the same values.

Recording the Value of Closing Stock

 

 

The valuation of closing stock and recording of the value of closing stock in the books are two different aspects.

After ascertaining the value of the closing stock, it is to be brought into the books of accounts.

The basic purpose of accounting is derivation of information and the more information we

need the more the accounting heads we need to maintain.

For each additional piece of information that we intend to derive from the books of accounts, we create and use

an additional ledger account.

Thus, to derive the information relating to Closing Stock we maintain a real account by name "Closing Stock

a/c".

The "Closing Stock a/c" gives the information relating to the value of the stock (as an asset) unsold at the end of

the accounting period.

• Recording The value of closing stock is not available ready hand in the books of accounts. It is specifically ascertained at

the end of the accounting period by physical verification of stock and its valuation at cost or market price

whichever is lower.

Thus, by recording the journal entry for Closing Stock, we are in effect bringing the value of Closing Stock into

books.

» Debit : Closing Stock a/c

Accounts representing assets are real accounts and show a debit balance. Since by recording the journal entry

for bringing the value of closing stock into books, we are creating an asset by name "Closing Stock a/c" we debit

that account.

[Closing Stock a/c – Real a/c – Debit what comes in.]

» Credit :

There are three possible variations in the account to be credited for recording the value of closing stock.

i. Trading a/c

ii. Goods Consumed a/c

iii. Purchases a/c

The ledger account to be credited is dependent on which account is used to reflect the value of cost of goods

sold as well as the time of recording the entry.

Recording Closing Stock » Crediting Trading a/c

 

 

Total value of goods = Opening Stock + Purchases + Direct Expenses.

Particulars Amount Amount

Opening Stock

(+) a) Purchases (Cost Value)

     b) Direct Expenses

2,48,000

  54,000

20,000

3,02,000

Total Value of Goods

(−) a) Closing Stock (Value)

     b) Stock Unused for Trading

Cost of Goods Sold

  36,000

  14,000

3,22,000

  50,000

2,72,000

» Direct Incomes/Expenses transferred to Trading a/c

At the end of the accounting period, the balances (amounts) in all the ledger accounts which represent

expenses which go into the value of goods/stock (direct expenses), are closed by transfer to the "Trading a/c".

This would result in the "Trading a/c" being debited with the total value of goods/stock. Show/Hide

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

20,000

2,48,000

54,000

   

  3,22,000   3,22,000

» Revealing/Reflecting Cost of Goods Sold

To reflect/reveal the cost of goods sold, the value of closing stock is to be deducted from the total value of

goods.

Thus the value of closing stock has to be credited to the "Trading a/c" which has the total value of goods/stock

existing in it as a debit balance. Show/Hide

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

20,000

2,48,000

54,000

By Cost of Goods Sold c/d

By Closing Stock

2,86,000

36,000

  3,22,000   3,22,000

To Cost of Goods Sold b/d 2,86,000    

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

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

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

31st Dec – Closing Stock a/c

      To Trading a/c

Dr –

–

36,000

36,000

[For recording the value of Closing Stock in

the books.]

Dr Closing Stock a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

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

  36,000   36,000

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

To Gross Profit

20,000

2,48,000

54,000

94,000

By Sales

By Closing Stock

3,80,000

36,000

  4,16,000   4,16,000

Recording Closing Stock » Crediting Goods Consumed a/c

 

 

Where the organisation intends to specifically identify the cost of goods consumed, a separate ledger account

by name "Goods Consumed a/c" may be created and used for that purpose.

» Direct Expenses transferred to Goods Consumed a/c

At the end of the accounting period, the balances (amounts) in all the ledger accounts which represent

expenses which go into the value of goods/stock (direct expenses), are closed by transfer to the "Goods

Consumed a/c".

This would result in the "Goods Consumed a/c" being debited with the total value of goods/stock. Show/Hide

Dr Goods Consumed a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

20,000

2,48,000

54,000

   

  3,22,000   3,22,000

» Revealing/Reflecting Cost of Goods Sold

To reflect/reveal the cost of goods sold, the value of closing stock is to be deducted from the total value of

goods.

Thus the value of closing stock has to be credited to the "Goods Consumed a/c" which has the total value of

goods/stock existing in it as a debit balance. Show/Hide

Dr Goods Consumed a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

20,000

2,48,000

54,000

By Trading a/c (?)

By Closing Stock

2,86,000

36,000

  3,22,000   3,22,000

• Journal/Ledger

The Journal entry for recording the value of closing stock in the books would be

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

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

31st Dec – Closing Stock a/c

      To Goods Consumed a/c

Dr –

–

36,000

36,000

[For recording the value of Closing Stock in

the books.]

Dr Goods Consumed a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

20,000

2,48,000

54,000

By Trading a/c (?)

By Closing Stock

2,86,000

36,000

  3,22,000   3,22,000

The balance in the "Goods Consumed a/c" represents the cost of goods sold and is transferred to the "Trading

a/c" to ascertain the Gross Profit.

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Goods Consumed

To Gross Profit

2,86,000

94,000

By Sales 3,80,000

  3,80,000   3,80,000

Balance in Goods Consumed a/c not representing Cost of Goods Sold

 

 

The balancing figure in the "Goods Consumed a/c" transferred to the "Trading a/c" does not represent cost of

goods sold, in the following cases

• Direct Expenses Transferred to Trading a/cWhere the direct expenses have been transferred to the Trading a/c instead of the Goods Consumed a/c, the

balancing figure in Goods Consumed a/c does not represent cost of goods sold.

Dr Goods Consumed a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

20,000

2,48,000

By Trading a/c (?)

By Closing Stock

2,32,000

36,000

  2,68,000   2,68,000

Cost of Goods Sold implies the total value of goods sold which includes both cost of the goods (represented by

purchases a/c balance) and direct expenses related to the goods.

Since Direct Expenses have not been debited to Goods Consumed a/c, the balancing figure represents the value

of goods sold excluding direct expenses thereon.

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Direct Expenses

To Goods Consumed

To Gross Profit

54,000

2,32,000

94,000

By Sales 3,80,000

  3,80,000   3,80,000

» Recording Closing Stock

Valuation of closing stock is independent of the accounting treatment. Closing Stock can be credited to either

the Trading a/c or the Goods Consumed a/c.

The only precaution to be taken would be in interpreting the balancing figure value. It should not be considered

as Cost of Goods Sold.

However, in such cases, it would be more appropriate to record the value of closing stock through the Trading

a/c where the value includes both cost and direct expenses.

• Exception

Recording Closing Stock through Goods Consumed a/c would be rational if its value does not include any part of

the direct expenses incurred during the current period which have been debited to the Trading a/c.

• Opening Stock transferred to Trading a/cWhere the balance in "Opening Stock a/c" has been transferred to the Trading a/c instead of the Goods

Consumed a/c, the balancing figure in Goods Consumed a/c may not represent Cost of Goods Sold.

Dr Goods Consumed a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Purchases

To Direct Expenses

2,48,000

54,000

By Trading a/c (?)

By Closing Stock

2,66,000

36,000

  3,12,000   3,12,000

The balance in the Goods Consumed a/c transferred to the Trading a/c represents the value of goods that have

been purchased and sold away during the current period.

This does not include the value of opening stock that might also have been sold away. Thus this balance, cannot

be called "cost of goods sold" though it represents value.

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Goods Consumed

To Gross Profit

20,000

2,66,000

94,000

By Sales 3,80,000

  3,80,000   3,80,000

» Recording Closing Stock

Valuation of closing stock is independent of the accounting treatment. Closing Stock can be credited to either

the Trading a/c or the Goods Consumed a/c.

The only precaution to be taken would be in interpreting the balancing figure value. It should not be considered

as Cost of Goods Sold.

However, in such cases, it would be more appropriate to record the value of closing stock through the Trading

a/c where the total value is debited ultimately.

• Exception

Recording Closing Stock through Goods Consumed a/c would be rational closing stock includes only that stock

which has been purchased during the current accounting period.

This would be the case where the quantity of closing stock is less than the quantity purchased during the

current period and stock is being used up on FIFO basis.

Recording Closing Stock » Crediting Purchases a/c

 

 

Where the following conditions exist, we can credit "Purchases a/c" with the value of closing stock.

Closing stock is physically relatable to the stock that has been purchased during the current period.

[This would be the case where FIFO method is adopted for physical usage of stock]

There are no direct expenses in relation to the stock purchased during the current period

(Or)

The value of closing stock does not include the direct expenses incurred during the current period

• Journal/LedgerThe Journal entry for recording the value of closing stock in the books would be

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

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

31st Dec – Closing Stock a/c

      To Purchases a/c

Dr –

–

36,000

36,000

[For recording the value of Closing Stock in

the books.]

Dr Purchases a/c Cr

Date ParticularsJ/

F

Amount

(in Rs)Date Particulars

J/

F

Amount

(in Rs)

1st-

31st

To Cash/Bank/Crs – 2,48,000 31/12/05

31/12/05

By Closing Stock

By Trading a/c

–

–

36,000

2,12,000

      2,48,000       2,48,000

               

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Direct Expenses

To Gross Profit

20,000

2,12,000

54,000

94,000

By Sales 3,80,000

  3,80,000   3,80,000

• Conventional useTechnically we can credit the value of closing stock to Purchases a/c only when the above conditions are

satisfied.

The use of "Trading a/c" or "Goods Consumed a/c" for crediting the value of closing stock, is possible only if the

journal entry for brining the value of closing stock into books is being recorded at the time of preparation of final

accounts.

Where we are recording the value of closing stock in the accounting books before the preparation of final

accounts, it is a convention that we credit "Purchases a/c" (on account of the absence of "Trading a/c" or "Goods

Consumed a/c" for use).

Closing Stock a/c : Opening Stock a/c

 

 

The "Closing Stock a/c" and the end of an accounting period and the "Opening Stock a/c" at the beginning of the

subsequent accounting period represent the same account.

• At the End of an Accounting PeriodThe closing balances in all the ledger accounts are carried forward to the subsequent accounting periods.

Every ledger posting should have a journal support.

The journal entry that supports the carry forward of balances in ledger accounts is called the "Closing Entry".

» Closing Entry

The journal entry for closing the books of accounts during an accounting period

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

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

31st Dec – Creditors a/c

Bank Loan a/c

Profit & Loss Appropriation a/c

Capital a/c

      To Closing Stock a/c

      To Cash a/c

      To Debtors a/c

      To Furniture a/c

Dr

Dr

Dr

Dr

–

–

–

–

–

–

–

–

48,000

63,000

54,000

1,00,000

36,000

42,000

1,26,000

61,000

[For the balances in the ledger accounts

carried forward to the next accounting

period.]

» Closing Balance Sheet

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

periods.

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

Liabilities Amount Assets Amount

Capital

Profit & Loss Appropriation

Creditors

Bank Loan

1,00,000

54,000

48,000

63,000

Cash

Closing Stock

Debtors

Furniture

42,000

36,000

1,26,000

61,000

  2,65,000   2,65,000

• At the beginning of the Subsequent Accounting PeriodThe opening balances in all the ledger accounts are brought forward from the previous accounting periods.

Every ledger posting should have a journal support and the journal entry that supports the brining forward of

balances in ledger accounts is called the "Opening Entry".

» Opening Balance Sheet

The opening balance sheet of an accounting period and the closing balance sheet of the previous period are the

same. This is something that is not specifically prepared.

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

Liabilities Amount Assets Amount

Capital

Profit & Loss Appropriation

Creditors

Bank Loan

1,00,000

54,000

48,000

63,000

Cash

Closing Stock

Debtors

Furniture

42,000

36,000

1,26,000

61,000

  2,65,000   2,65,000

» Opening Entry

The opening entry is based on the opening balance sheet.

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

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

31st Dec – Cash a/c

Opening Stock a/c

Debtors a/c

Furniture a/c

      To Capital a/c

      To Profit & Loss Appropriation a/c

      To Bank Loan a/c

      To Creditors a/c

Dr

Dr

Dr

Dr

–

–

–

–

–

–

–

–

42,000

36,000

1,26,000

61,000

1,00,000

54,000

63,000

48,000

[For the opening balances in the various

ledger accounts brought forward into the

books of accounts from the previous

accounting period.]

Where the Opening Entry is being recorded, the phrase "Closing Stock" is replaced by the phrase "Opening

Stock".

Closing Stock » Adjustment during Final Accounting

 

 

The value of closing stock is ascertained through physical verification of the stock and its valuation at cost or

market price whichever is lesser.

Thus recording the entries for brining in the value of closing stock into books may not be complete by the time

trial balance is drawn up.

If the value of closing stock is not available (or is not recorded) by the time of making up the trial balance at the

end of the accounting period, it would appear as a part of the transactions appended to the trial balance which

are to be adjusted.

Adjustment is bringing in the effect of the transactions through mathematical operations of addition and

subtraction. The adjustments to be made can be found out by ascertained the net effect of the journal entries to

be recorded.

In adjusting the value of closing stock we consider the entry for recording the same to be the one where the

Trading a/c or Purchases a/c is credited.

Where the closing stock is recorded by crediting its value to the Trading a/c

Entry Effect

Dr. Closing Stock a/c    

Cr. Trading a/c

1. (+) Show the Value of Closing Stock on the Assets side of the Balance Sheet

2. (+) Show the Value of Closing Stock on the Credit side of Trading a/c

Where the closing stock is recorded by crediting its value to Purchases a/c

Entry Effect

Dr. Closing Stock a/c    

Cr. Purchases a/c

1. (+) Show the Value of Closing Stock on the Assets side of the Balance Sheet

2. (−) Deduct the Value of Closing Stock from Purchases on the Debit side of

Trading a/c

Where the closing stock is recorded by crediting Goods Consumed a/c

Entry Effect

Dr. Closing Stock a/c    

Cr. Goods Consumed a/c

1. (+) Show the Value of Closing Stock on the Assets side of the Balance Sheet

2. (+) Show the Value of Closing Stock on the Credit side Goods Consumed a/c

This assumption is generally avoided, where the value of closing stock has to be dealt with as an

adjustment.

Closing Stock in Trial Balance » Interpretation

 

 

Where "Closing Stock a/c" is present in the Trial Balance, it is an indication of the Journal entry for recording the

value of closing stock has already been recorded.

• Dealing with Closing Stock a/cThe "Closing Stock a/c" represents an asset and is thus a Real account.

Since an item appearing in the "Trial Balance" has to be dealt with only once based on its nature, the Closing

Stock a/c appearing in the trial balance is shown on the assets side of the Balance Sheet.

The balance in all the real accounts is carried forward to the subsequent accounting periods. All such accounts

whose balances are carried forward to the subsequent accounting periods are listed in the Balance Sheet as at

the end of the accounting period. Thus all the real account balances are shown on the assets side of the balance

sheet.

• What was the Journal Entry used?The Journal entry used for recording the value can be identified/assumed depending on what ledger accounts

are present in the Trial Balance

» Trading a/c appears in the Trial Balance

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

ParticularsL/F

Debit Amount(in Rs)

Credit Amount(in Rs)

Opening Stock a/c

Purchases a/c

–

Closing Stock a/c

–

Trading a/c

–

–

—

—

—

—

—

—

—

—

20,000

2,48,000

36,000

 

36,000

Total   xxx xxx

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

Dr. Closing Stock a/c    

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

» Trading a/c does not appear, but Purchases a/c appears in the Trial Balance

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

ParticularsL/F

Debit Amount(in Rs)

Credit Amount(in Rs)

Opening Stock a/c

Purchases a/c

–

Closing Stock a/c

–

–

—

—

—

—

—

—

20,000

2,12,000

36,000

 

–

–

—

—

Total   xxx xxx

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

Dr. Closing Stock a/c    

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

» Both Trading a/c and "Purchases a/c" do not appear in the Trial Balance

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

ParticularsL/F

Debit Amount(in Rs)

Credit Amount(in Rs)

Goods Consumed

–

Closing Stock a/c

–

–

–

–

—

—

—

—

—

—

—

—

2,32,000

36,000

 

Total   xxx xxx

Where Purchases a/c and Trading a/c do not appear in the Trial Balance and

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

Dr. Closing Stock a/c    

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

Purchases and Sales » Return a/c's

 

 

Each ledger account provides one or more pieces of information. To enable derivation of additional information

relating to returns of goods/stock, we record the transactions relating to purchase returns as well as sales

returns using Purchase Returns a/c and Sales Returns a/c respectively.

• Purchases Returns a/cPurchase Returns a/c is a nominal account. It provides the information relating to the value of goods/stock

returned to the seller from whom the stock has been purchased.

Being a nominal account, this account is closed at the end of the accounting period.

• Sales Returns a/c

Sales Returns a/c is a nominal account. It provides the information relating to the value of goods/stock returned

by the buyers to whom the stock has been sold.

Being a nominal account, this account is closed at the end of the accounting period.

• Gross Purchases and Gross Sales The Purchase Returns a/c and the Sales Returns a/c provide information relating to returns only.

Since returns are recorded separately using these accounts, the Purchases a/c and Sales a/c give the

information relating to the Gross Purchases and Gross Sales.

• Need for information relating to Net ValuesAlong with the information relating to the returns and the gross values, the organisation needs the information

relating to the net values i.e. the net purchases and net sales made by it.

There are two methods adopted for deriving the information relating to Net Purchases and Net Sales.

By Setting off related Ledger account balances.

By Transferring the balance in the returns accounts to Trading a/c and making adjustments thereon.

This information is generally derived at the end of the accounting period. However, it can be derived as and

when needed, by deducting the balance in the returns account from the balance in the main account.

Finding Net Purchases/Sales by Setting off related Ledger Account Balances

 

 

SET OFF » Setting off of ledger accounts is clubbing two accounts with opposite balances.

In setting off ledger account balances, we close the account with the lower balance by

transferring it to the account with a higher balance.

• Finding Net PurchasesThe Purchases a/c carries a debit balance and the Purchase Returns a/c carries a credit balance. At the end of

the accounting period, the two accounts are set off i.e. the Purchase Returns a/c is closed by transfer to the

Purchases a/c.

Transfer of a credit balance from one account to a second would result in the second account

being credited and the first account being debited.

The balance remaining in the Purchases a/c would thus represent net purchases. While closing the purchases

account at the end of the accounting period, this balance is transferred to the Trading a/c

• Journal/Ledger Show/Hide

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

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

March 31st – Purchase Returns a/c

      To Purchases a/c

Dr –

–

80,000

80,000

[For transferring the balance in the purchase

returns account to the purchases account to

derive the net purchases]

Dr Purchase Returns a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Purchases a/c 80,000

By –

By –

–

–

  80,000   80,000

Dr Purchases a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To –

To –

–

–

By Purchase Returns a/c

By Trading a/c

80,000

5,00,000

  5,80,000   5,80,000

• Finding Net SalesThe Sales a/c carries a credit balance and the Sales Returns a/c carries a debit balance. At the end of the

accounting period, the two accounts are set off i.e. the Sales Returns a/c is closed by transfer to the Sales a/c.

Transfer of a debit balance from one account to a second would result in the second account

being debited and the first account being credited.

The balance remaining in the Sales a/c would thus represent net sales. While closing the Sales account at the

end of the accounting period, this balance is transferred to the Trading a/c

• Journal/Ledger Show/Hide

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

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

March 31st – Sales a/c

      To Sales Returns a/c

Dr –

–

72,500

72,500

[For transferring the balance in the sales

returns account to the sales account to

derive the net sales]

Dr Sales Returns a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To –

To –

–

– By Sales a/c 72,500

  72,500   72,500

Dr Sales a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Sales Returns a/c

To Trading a/c

72,500

7,51,500

By –

By –

–

–

  8,24,000   8,24,000

• Information in Trading a/cIf this method is adopted for deriving the value of net purchases and sales, the Trading a/c would not display

information relating to returns and would contain postings as To Purchases a/c on the debit side and the By

Sales a/c on the credit side.

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Wages

To Octroi

To Carriage Inwards

To Gross Profit

40,000

5,00,000

45,000

32,000

15,000

2,40,500

By Sales

Closing Stock

7,51,500

76,000

  8,27,500   8,27,500

Transferring balances in Purchases/Sales Returns a/c to Trading a/c

 

 

The Purchase Returns a/c and the Sales Returns a/c being nominal accounts are closed at the end of the

accounting period by transfer to the Trading a/c (instead of to the Purchases a/c and Sales a/c respectively).

The Purchase Returns a/c carries a credit balance and the "Sales Returns a/c" carries a credit balance.

• JournalThe journal entries for closing these accounts by transfer to the trading account would be

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

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

March 31st – Purchase Returns a/c

      To Trading a/c

Dr –

–

80,000

80,000

[For transferring the balance in the purchase

returns account at the end of the accounting

period to the trading account]

March 31st – Trading a/c

      To Sales Returns a/c

Dr –

–

72,500

72,500

[For transferring the balance in the sales

returns account at the end of the accounting

period to the trading account]

• Posting in Trading a/cThe "Trading a/c" with these journal entries posted:

Dr Trading a/c Cr

ParticularsAmount

(in Rs)Particulars

Amount

(in Rs)

To Opening Stock

To Purchases

To Sales Returns

To Wages

To Octroi

To Carriage Inwards

To Gross Profit

40,000

5,80,000

72,500

45,000

32,000

15,000

2,40,500

By Sales

By Purchase Returns

Closing Stock

8,24,000

80,000

76,000

  9,80,000   9,80,000

We cannot derive the information relating to Net Purchases and Net Sales by just Posting the entries to the

Trading a/c.

Adjustment in Trading a/c : Information relating to Net Purchases/Sales

 

 

Since the information relating to Net Purchases and Net Sales is not revealed by just transferring the balances in

the returns accounts to the Trading a/c we need to make adjustments to derive that information.

• Net Purchases

Posting (showing) an amount on the credit side of an account is an equivalent of deducting

the amount from an item on the debit side.

Thus the Purchase Returns a/c balance instead of being shown on the credit side is deducted from Purchases a/c

balance on the debit side of the Trading a/c, thereby giving the figure of Net Purchases in the Trading a/c itself.

• Net Sales

Posting (showing) an amount on the debit side of an account is an equivalent of deducting

the amount from an item on the credit side.

Thus, the Sales Returns a/c balance instead of being shown on the debit side would be deducted from Sales a/c

on the credit side of the Trading a/c, thereby giving us the figure of Net Sales in the Trading account itself.

• Deriving from the Trading a/cDr Trading a/c Cr

ParticularsAmount

(in Rs)

Amount

(in Rs)Particulars

Amount

(in Rs)

Amount

(in Rs)

To Opening Stock

To Purchases

    (−) Pur. Returns

To Wages

To Octroi

To Carriage Inwards

To Gross Profit

5,80,000

  80,000

40,000

5,00,000

45,000

32,000

15,000

2,40,500

By Sales

    (−) Sales Returns

Closing Stock

8,24,000

  72,500 7,51,500

76,000

    8,27,500     8,27,500

Such an adjustment would not affect the figure of gross profit.

   

 

Revenue

Income, turnover, revenue are terms used synonymously to mean the amount of money that an organisation

receives from its activities like sale of products, providing services to customers etc. Depending on the nature of

the organisation and the type of activity it is involved in the revenue streams are varied

Sale or Products, Providing Services are the activities most common to business organisations. Taxes, Duties,

Fees etc are the major sources of revenue for Governments. Donations, Grants, Subscriptions, etc are some of

the sources of revenue for non-profit organisations.

The terms Revenue and Sales or Turnover are interchangeably used. This makes sense only when sales

are expressed in terms of value and not in terms of quantity.

Gross Revenue and Net Revenue are terms which are indicative of Gross Sales and Net Sales after

setting off sales returns

Revenue would be meaningful only when it is expressed in relation to a period. Say the revenue is Rs. 5

crores is would not make much sense unless we express the period involved.

Saying the revenue for the last month is Rs. 5 Crores does sound meaningful.

Top Line and Bottom Line

Revenue is often referred to as top line since it is the first item that we consider in preparing the

income statements or accounts. On the Credit Side of the Trading account we find sales generally

towards the top as the first or second item.

Similarly Net Profit (revenue left after deducting all expenses) is termed "Bottom Line". In the Profit

and Loss account, Net Profit/Loss is the last item that appears towards the end.

Even in an income statement (which is nothing but the Trading and Profit & Loss a/c prepared in a

form suitable for financial analysis) we start by considering the gross sales (i.e. gross revenue) and

end with arriving at the net profit.

Revenue Recognition

Revenues are

realized when goods and services are exchanged for cash or receivables (debtors).

realizable when assets received in exchange for goods and services are readily convertible to cash or

receivables (debtors).

earned when the duties to be entitled to compensation are performed.

Recognising revenue implies the act that would make the organisation consider that they have earned the

revenue involved in the transaction. Based on when the revenue is recognised there are two types of accounting

systems (1) Cash Basis of Accounting and (2) Accrual Basis or Mercantile System of Accounting

1. Cash Basis Accounting

Under cash basis accounting revenues are recognized and earned only when cash is received irrespective of

when and how the services were performed or goods delivered.

To put it in different terms, the cash basis of accounting asks you to take into consideration all those

incomes/gains that have been received in cash or other assets and expenses/losses that have been

paid out in cash or other assets during the accounting period in consideration.

2.[1.] Accrual or Mercantile Basis Accounting

Under accrual or mercantile basis accounting, revenues are recognized and earned when they are

realized or realizable irrespective of when the cash is received.

To put it in different terms, the accrual basis of accounting asks you to take into consideration all

those incomes/gains and expenses/losses pertaining to the accounting period for which you are trying

to ascertain the profits and losses irrespective of whether the incomes are received in cash or not and

the expenses are paid out in cash or not.

3.[2.] Hybrid System of Accounting

This is not a system of accounting on its own. It is a combination of the Cash Basis Accounting and

Accrual Basis Accounting. This system is based on the concept of conservatism.

Under the hybrid system of accounting, incomes are recognised as in Cash Basis Accounting i.e. when

they are received in cash and expenses are recognised on accrual basis i.e. during the accounting

period in which they arise irrespective of when they are paid.

What Basis/system to follow?

The basis of accounting to be followed is dependent on the attitude and outlook of the organisation. If

organisations have a conservative attitude, they may adopt the hybrid system of accounting.

The traditional accounting systems used to adopt the cash basis of accounting. Organisations which are to abide

by the various regulations imposed by the various acts under which they are regulated are mostly required to

adopt the Mercantile System of Accounting which is supposed to reveal the information relating to the

organisation in a more appropriate manner than the cash basis of accounting.

   

 

Conversion from One System to Another

In practice we consider only the Cash and Accrual bases as the systems of accounting. As such, conversion

implies converting from cash basis of accounting to the mercantile basis of accounting and vice versa.

For the purpose of deriving each piece of information, a ledger account is created. The more the information we

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

Conversion

From Cash Basis to Accrual/Mercantile Basis would require the following information to be brought into

the books of accounts.

From Mercantile/Accrual Basis to Mercantile Basis would require the following information to be written

off from the books of accounts.

1. Expenses Outstanding [≡ Creditors]

The amount of expenses that have been incurred but have not yet been paid out.

Separate ledger accounts may be used for each distinct expenditure (like outstanding salaries a/c,

Rent payable a/c, Interest unpaid a/c etc.) or a single account may be used in place of all these (like

outstanding expenses a/c or creditors for expenses a/c).

Creditors !!! (for expenses)

When an expenditure is outstanding it amounts to a liability for the organisation. It may have to be

paid to a person or an organisation. Any person or organisation to whom we owe money is called a

creditor. As such, the "outstanding expenditure a/c" is a personal account in the nature of a creditor.

Since it is indicative of a creditor, it carries a credit balance and has to be shown on the liabilities side

of the balance sheet.

The creditors for expenses are cleared in the subsequent periods by paying them out.

2.[1.] Expenses Prepaid [≡ Debtors]

The amount of expenses that have not yet been incurred but have been paid out in advance.

Separate ledger accounts may be used for each distinct expenditure (like Advance salaries a/c, Rent

prepaid a/c, Interest paid in advance a/c etc.) or a single account may be used in place of all these

(like Prepaid expenses a/c or expenses paid in advance a/c).

3.[2.] Incomes Receivable [≡ Debtors]

The amount of incomes (revenue) that have arisen and have not yet been received.

Separate ledger accounts may be used for each such income (like Interest Receivable a/c,

Commission Due a/c, etc.) or a single account may be used in place of all these (like Incomes Still

Receivable a/c).

4.[3.] Incomes Pre-received [≡ Creditors]

Incomes that have not yet arisen but have been received in advance.

Separate ledger accounts may be used for each such income (like Interest received in advance a/c,

Commission Pre received a/c, etc.) or a single account may be used in place of all these (like Pre-

received Incomes a/c or Incomes received in advance a/c).

 

Any Nominal Account Head prefixed or suffixed by the terms outstanding, prepaid, pre-

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

Conversion from Cash Basis to Accrual Basis

To convert the accounting system from cash basis to accrual basis from a particular point of time, one

needs to identify the values attributable to the accounts of the nature as described above and bring

them into the books of accounts, which would take care of the adjustments to be made in the books

for the incomes/expenses relating to the past periods. From thereon, the incomes and expenses have

to be recorded on accrual basis.

The ledger accounts to be brought into the books of accounts are personal accounts and are an

equivalent of either debtors or creditors. Brining the ledger accounts equivalent to debtors would

amount to brining in an undisclosed asset into the books, which would result in a gain. Brining the

ledger accounts equivalent to creditors would amount to brining in an undisclosed liabilities into the

books, which would result in a loss. A ledger account by name "Profit and Loss Adjustment a/c" is

used to record thess gains or losses.

Journal Entries » Hide/Show

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

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

31/12/05 – Profit & Loss Adjustment a/c

      To Expenses Outstanding a/c

Dr –

–

26,000

26,000

[For brining the expenses outstanding to be

paid into the books of accounts.]

31/12/05 – Expenses Prepaid a/c

      To Profit & Loss Adjustment a/c

Dr –

–

16,400

16,400

[For brining the expenses paid in advance

into the books of accounts.]

31/12/05 – Profit & Loss Adjustment a/c

      To Incomes Pre-received a/c

Dr –

–

11,100

11,100

[For brining in the amount of incomes

received in advane into books of accounts.]

31/12/05 – Incomes Receivable a/c

      To Profit & Loss Adjustment a/c

Dr –

–

5,200

5,200

[For brining the incomes receivable into the

books of accounts.]

Ledger Accounts » Hide/Show

Dr Expenses Outstanding a/c Cr

Date ParticularsJ/

F

Amount

(in Rs)Date Particulars

J/

F

Amount

(in Rs)

31/12/0

5

To Bal c/d – 26,000 31/12/05 By P/L

Adjustment.

– 26,000

      26,000       26,000

        31/12/05 By Balance b/d – 26,000

Dr Expenses Prepaid a/c Cr

Date ParticularsJ/

F

Amount

(in Rs)Date Particulars

J/

F

Amount

(in Rs)

31/12/05 To P/L

Adjustment

– 16,400 31/12/0

5

By Bal c/d – 16,400

      16,400       16,400

31/12/05 To Balance b/d – 16,400        

Dr Incomes Pre-received a/c Cr

Date ParticularsJ/

F

Amount

(in Rs)Date Particulars

J/

F

Amount

(in Rs)

31/12/0

5

To Bal c/d – 11,100 31/12/05 By P/L

Adjustment.

– 11,100

      11,100       11,100

        31/12/05 By Balance b/d – 11,100

Dr Incomes Receivable a/c Cr

Date ParticularsJ/

F

Amount

(in Rs)Date Particulars

J/

F

Amount

(in Rs)

31/12/0

5

To P/L

Adjustment

– 5,200 31/12/0

5

By Bal c/d – 5,200

      5,200       5,200

31/12/0

5To Balance b/d – 5,200        

Dr Profit & Loss Adjustment a/c Cr

Date ParticularsJ/

F

Amount

(in Rs)Date Particulars

J/

F

Amount

(in Rs)

31/12/0

5

31/12/0

5

To Out. Exp.

To Pre-rec. Inc.

–

–

26,000

11,100

31/12/0

5

31/12/0

5

By Prepaid Exp.

By Inc.

receivable

By P/L Appropr.

–

–

16,400

5,200

15,500

      37,100       37,100

               

The overall gain or loss revealed by the "P/L Adjustment a/c" is written off to the "P/L Appropriation

a/c" or the "Capital a/c", depending on where the accumulated profits of the previous periods have

been transferred.

These would bring in all the adjustments needed for the various accruals, outstandings and prepaids

that have not been taken into consideration in the previous periods on account of not having received

the cash relating to the same.

Conversion from Accrual Basis to Cash Basis

To convert the accounting system from accrual/mercantile basis to cash basis from a particular point of

time, one needs to identify the accounts of the nature as described above and write them off from the

books of accounts, which would take care of the adjustments to be made in the books for the

incomes/expenses relating to the past periods. From thereon, the incomes and expenses have to be

recorded on cash basis.

The ledger accounts to be written off from the books of accounts are personal accounts and are an

equivalent of either debtors or creditors. Writing off the ledger accounts equivalent to debtors would

amount to writing off an existing asset in the books, which would result in a loss. Writing off the ledger

accounts equivalent to creditors would amount to writing off an existing liability in the books, which would

result in a gain. A ledger account by name "Profit and Loss Adjustment a/c" is used to record these losses or

gains.

Journal Entries » Hide/Show

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

DateV/R

No.Particulars L/F

Debit Amount

(in Rs)

Credit

Amount

(in Rs)

31/12/05 – Expenses Outstanding a/c

      To Profit & Loss Adjustment a/c

Dr –

–

31,650

31,650

[For writing off the expenses outstanding to

be paid, recorded as a liability, from the

books of accounts.]

31/12/05 – Profit & Loss Adjustment a/c

      To Expenses Prepaid a/c

Dr –

–

18,700

18,700

[For writing off the expenses paid in

advance, recorded as an asset, from the

books of accounts.]

31/12/05 – Incomes Pre-received a/c

      To Profit & Loss Adjustment a/c

Dr –

–

13,650

13,650

[For writing off the amount of incomes

received in advance, recorded as a liability,

from books of accounts.]

31/12/05 – Profit & Loss Adjustment a/c

      To Incomes Receivable a/c

Dr –

–

8,750

8,750

[For writing off the incomes receivable,

recorded as an asset, from the books of

accounts.]

Ledger Accounts » Hide/Show

Dr Expenses Outstanding a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

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

      31,650       31,650

               

Dr Expenses Prepaid a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

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

      18,700       18,700

               

Dr Incomes Pre-received a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

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

      13,650       13,650

               

Dr Incomes Receivable a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

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

      8,750       8,750

               

Dr Profit & Loss Adjustment a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

31/12/05

31/12/05

31/12/05

To Prepaid Exp.

To Inc. receivable

To P/L Appropr.

–

–

–

18,700

8,750

17,850

31/12/05

31/12/05

By Out. Exp.

By Pre-rec. Inc.

–

–

31,650

13,650

      45,300       45,300

               

The overall gain or loss revealed by the "P/L Adjustment a/c" is written off to the "P/L Appropriation a/c"

or the "Capital a/c", depending on where the accumulated profits of the previous periods have been

transferred.

These would bring in all the adjustments needed for the various accruals, outstandings and prepaids

that have been taken into consideration in the previous periods on account of not having received the

cash relating to the same.

   

 

Income/Profits

The profits relating to a particular accounting period are revealed by the "Profit & Loss a/c" relating to that

period. The profits are derived by transferring the ledger account balances in the nominal accounts to the

"Trading a/" or "Profit & Loss a/c" as the case may be.

The basis of accounting followed i.e. cash basis or mercantile basis would decide the amount of

incomes/expenses in relation to the accounting period. Since the figure of profit is dependent on the

incomes/expenses, we can say that the figure of profit would vary depending on the method of accounting being

followed by the organisation.

Finding Income under a System given Income under the other

Many a times, in problem solving, we would be required to identify the income under the Mercantile basis

accounting from the income under cash basis account.

We know that the information relating to outstanding expenses, expenses paid in advance, pre-received

incomes, outstanding incomes receivable is to be dealt with in changing the accounting system from Cash to

Mercantile or vice versa from a particular point of time. The same accounts are to be dealt with in finding the

income under one system given the income under the other system of accounting. Moreover, we should

understand that these accounts are to be dealt along with the respective income/expenses accounts and not in

isolation.

Adjusting Expenditure

Consider an expenditure like Salary. Within an accounting period, salary is expended as well as paid.

The amount of salary paid can be identified from the amount of cash paid or cheques issued towards

salaries. The amount of salary expended i.e. the expenditure on account of salary relating to the

current accounting period can be identified by making appropriate adjustments for outstanding and

prepaid salaries both at the beginning and ending of the accounting period.

o Opening Expenses Outstanding

This represents the amount of expenditure that has been outstanding at the beginning of the

accounting period.

This would have to be cleared by paying out the amount in the current period. Therefore, the

cash paid in the current period towards the expenditure is assumed to include this

outstanding amount also (unless there is an indication to the contrary).

Thus to find the expenditure relating to the current period only, this amount has to be

deducted from the Cash Paid for the expense during the current period.

o Opening Expenses Prepaid

This represents the amount of expenditure that has been paid in advance during the

previous period. The prepaid expenses account shows a debit balance at the end of the

previous accounting period. It is an equivalent of a debtor and is treated as an asset. During

the current accounting period, this account is closed by transferring the balance to the

expenditure account.

Thus to find the expenditure relating to the current period only, this amount has to be added

to the Cash Paid for the expense during the current period.

o Closing Expenses Outstanding

This represents the amount of expenditure relating to the current accounting period that has

not yet been paid.

Thus to find the expenditure relating to the current period only, this amount has to be added

to the Cash Paid for the expense during the current period.

o Closing Expenses Prepaid

This represents the amount of expenditure relating to the subsequent accounting periods

that has been paid in advance during the current accounting period.

Thus to find the expenditure relating to the current period only, this amount has to be

deducted from the Cash Paid for the expense during the current period.

Particulars Amount Amount

Expenditure paid in Cash during the Current Period

(+) Opening Expenses Prepaid

       Closing Expenses Outstanding

(−) Opening Expenses Outstanding

       Closing Expenses Prepaid

Expenditure incurred in the current period

  15,425

  45,300

  18,200

  23,750

2,48,000

  60,725

3,08,725

  45,300

2,66,775

The adjustment relating to expenses can be summarised as follows:

Cash Paid + Opening Expenditure Prepaid − Opening Expenditure Outstanding

        + Closing Expenditure Outstanding − Closing Expenditure Prepaid = Expenditure Incurred.

Using the above relation, either the cash paid (which would be the expenditure to be considered in

cash basis accounting) or the expenditure pertaining to the current period (which would be the

expenditure to be considered under the mercantile basis accounting) can be found.

Deriving the Information using the Ledger a/c's » Hide/Show

Dr Expenditure Prepaid a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

01/01/05

31/12/05

To Bal b/d

To Expenditure

a/c

–

–

15,425

23,750

01/01/05

31/12/05

By Expenditure

a/c

By Bal c/d

–

–

15,425

23,750

      39,175       39,175

31/12/05 To Balance b/d – 23,750        

Dr Expenditure Outstanding a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

01/01/05

31/12/05

To Expenditure

a/c

To Bal c/d

–

–

18,200

45,300

01/01/05

31/12/05

By Bal b/d

By Expenditure

a/c

–

–

18,200

45,300

      63,500       63,500

        31/12/05 By Balance b/d – 4,300

Dr Expenditure a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

01/01/05

1st_31st

31/12/05

To Exp. Prepaid

a/c

To Cash/Bank a/c

To Exp. Out a/c

–

–

–

15,425

2,48,000

45,300

01/01/05

1st_31st

31/12/05

By Exp. Out. a/c

By P/L a/c

By Exp. Prepaid

a/c

–

–

–

18,200

2,66,775

23,750

      3,08,725       3,08,725

               

Dr Expenditure a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

01/01/05

1st_31st

31/12/05

To Bal b/d

To Cash/Bank a/c

To Bal c/d

–

–

–

15,425

2,48,000

45,300

01/01/05

1st_31st

31/12/05

By Bal b/d

By P/L a/c

By Bal c/d

–

–

–

18,200

2,66,775

23,750

      3,08,725       3,08,725

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

Dr Expenditure a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

31/12/05 To Bal c/d

–

–

– 45,300

01/01/05 By Bal b/d –

–

–

18,200

      3,08,725       3,08,725

        01/01/06 By Bal b/d – 45,300

Dr Expenditure a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

01/01/05 To Bal b/d – 15,425

31/12/05 By Bal c/d – 23,750

      3,08,725       3,08,725

01/01/06 To Bal b/d – 23,750        

Opening » Outstanding vs Prepaid

The "Expenditure Outstanding a/c" is a personal account with a credit balance and is an equivalent of

a creditor (a liability). Creditors are cleared by paying out the amount due. Thus the oustandings of

the previous periods may be paid out in full or in part during the subsequent periods.

The "Expenditure Prepaid a/c" is a personal account with a debit balance and is an equivalent of a

debtor (an asset). Debtors are normally liquidated by paying realising the amounts due from them.

But, the prepaid expenditure is not an asset that is liquidated by realising it in cash. It is liquidated by

absorbing (writing off) the asset as an expenditure during the subsequent periods.

Adjusting Incomes

Consider an income like Interest. Within an accounting period, interest is earned as well as received

in cash. The amount of interest received can be identified from the amount of cash/cheques received

towards interest. The amount of interest earned i.e. the income on account of salary relating to the

current accounting period can be identified by making appropriate adjustments for outstanding and

pre-received interest both at the beginning and ending of the accounting period.

o Opening Income Receivable

This represents the amount of income that has been outstanding and still receivable at the

beginning of the accounting period.

This would be cleared by realising the amount in the current period. Therefore, the cash

received in the current period towards the income is assumed to include this outstanding

amount also (unless there is an indication to the contrary).

Thus to find the income relating to the current period only, this amount has to be deducted

from the Cash received towards the income during the current period.

o Opening Income Pre-received

This represents the amount of income that has been received in advance during the

previous period. The pre-received income account shows a credit balance at the end of the

previous accounting period. It is an equivalent of a creditor and is treated as a liability.

During the current accounting period, this account is closed by transferring the balance to

the income account.

Thus to find the income relating to the current period only, this amount has to be added to

the Cash received for the income during the current period.

o Closing Income Receivable

This represents the amount of income relating to the current accounting period that has not

yet been received.

Thus to find the income relating to the current period only, this amount has to be added to

the Cash received towards the income during the current period.

o Closing Income Pre-received

This represents the amount of income relating to the subsequent accounting periods that

has been received in advance during the current accounting period.

Thus to find the income relating to the current period only, this amount has to be deducted

from the Cash received towards the income during the current period.

Particulars Amount Amount

Cash Received during the Current Period

(+) Opening Income Pre-received

       Closing Income Receivable

(−) Opening Income Receivable

       Closing Income Pre-received

Income relating to the current period

  8,125

  5,245

  6,850

  3,750

1,32,500

  13,370

1,45,870

  10,600

1,35,270

The adjustment relating to the incomes can be summarised as follows:

Cash Received + Opening Income Pre-received − Opening Income Receivable

      + Closing Income Receivable − Closing Income Pre-received = Income.

Using the above relation, either the cash received (which would be the income to be considered in

cash basis accounting) or the income pertaining to the current period (which would be the income to

be considered under the mercantile basis accounting) can be found.

Deriving the Information using the Ledger a/c's » Hide/Show

Dr Income Pre-received a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

01/01/05

31/12/05

To Income a/c

To Bal c/d

–

–

8,125

3,750

01/01/05

31/12/05

By Bal b/d

By Income a/c

–

–

8,125

3,750

      11,875       11,875

        01/01/06 By Balance b/d – 3,750

Dr Income Receivable a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

01/01/05

31/12/05

To Bal b/d

To Income a/c

–

–

6,850

5,245

01/01/05

31/12/05

By Income a/c

By Bal b/d

–

–

6,850

5,245

      12,095       12,095

01/01/06 To Balance b/d – 5,245        

Dr Income a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

01/01/05

1st_31st

31/12/05

To Inc. Rec a/c

To P/L a/c

To Inc. Pre. a/c

–

–

–

6,850

1,35,270

3,750

01/01/05

1st_31st

31/12/05

By Inc. Pre. a/c

By Cash/Bank a/c

By Inc. Rec. a/c

–

–

–

8,125

1,32,500

5,245

      1,45,870       1,45,870

               

Dr Income a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

01/01/05

1st_31st

31/12/05

To Bal b/d

To P/L a/c

To Bal c/d

–

–

–

6,850

1,35,270

3,750

01/01/05

1st_31st

31/12/05

By Bal b/d

By Cash/Bank a/c

By Bal c/d

–

–

–

8,125

1,32,500

5,245

      1,45,870       1,45,870

               

Dr Income a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

01/01/05 To Bal b/d – 6,850

31/12/05 By Bal c/d – 5,245

               

01/01/06 To Bal b/d – 5,245        

Dr Income a/c Cr

Date Particulars J/FAmount

(in Rs)Date Particulars J/F

Amount

(in Rs)

31/12/05 To Bal c/d – 3,750

01/01/05 By Bal b/d – 8,125

               

        01/01/06 By Bal b/d – 3,750

Opening » Receivable vs Received in Advance

The "Income Receivable a/c" is a personal account with a debit balance and is an equivalent of a

debtor (an asset). Debtors are normally liquidated by realising the amounts due from them. Thus the

Incomes receivable relating to the previous periods may be realised in full or in part during the

subsequent periods.

The "Income Pre-received a/c" is a personal account with a credit balance and is an equivalent of a

creditor (a liability). Creditors are cleared by paying out the amount due to them. But, the pre-

received income is not a liability that is cleared by paying out in cash. It is cleared by absorbing

(writing off) the liability as an income during the subsequent periods.

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

Statement for Finding Income under Mercantile System

Particulars Amount Amount

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

(+) Opening Expenses Outstanding

       Opening Incomes Pre-received

       Closing Expenses Prepaid

       Closing Incomes Receivable

(−) Opening Expenses Prepaid

       Opening Incomes Receivable

       Closing Expenses Outstanding

       Closing Incomes Pre-received

Profit/Income under Mercantile/Accrual Basis Accounting

  18,200

  8,125

  23,750

  5,245

  15,425

  6,850

  45,300

  3,750

  55,320

3,03,320

  49,775

2,53,545

Statement for Finding Income under Cash System

This statement is just the converse of the above statement.

Particulars Amount Amount

Profit/Income under Mercantile/Accrual Basis Accounting

(+) Opening Expenses Prepaid

       Opening Incomes Receivable

       Closing Expenses Outstanding

       Closing Incomes Pre-received

(−) Opening Expenses Outstanding

       Opening Incomes Pre-received

       Closing Expenses Prepaid

       Closing Incomes Receivable

Profit/Income under Cash Basis Accounting

  15,425

  6,850

  45,300

  3,750

  18,200

  8,125

  23,750

  5,245

2,53,545

  49,775

3,03,320

  55,320

2,48,000