Depreciation, Provisions and Reserves Notes Class 11 Accountancy Chapter 7

SECTION-1 (Depreciation)
The term ‘Depreciation’ means a decline in the value of fixed assets due to use, the passage of time, or obsolescence. an accounting item, depreciation is that part of the cost of a fixed asset that has expired on account of its usage and/or lapse of time. The amount of depreciation, being a charge against profit, is debited to the profit and loss account.

Meaning of Depreciation
Depreciation may be described as a permanent, continuing, and gradual shrinkage in the book value of fixed assets. It is based on the cost of assets consumed in a business and not on its market value,

“The depreciation is the diminution in the intrinsic value of the assets due to use and/or lapse of time.”

– Institute of Cost and Management Accounting, London (ICMA)
Accounting Standard-6 issued by The Institute of Chartered Accountants of India (ICAI) defines depreciation as “a measure of the wearing out, consumption or other loss of value of depreciable assets arising from use, effluxion of time or obsolescence through technology and market change.

Depreciation is allocated so as to change the fair proportion of depreciable amount in each accounting period during the expected useful life of the assets. Depreciation includes amortization of assets whose useful life is predetermined.”

Features of Depreciation:

1. It is a decline in the book value of fixed assets.
2. It includes loss of value due to effluxion of time, usage, or obsolescence.
3. It is a continuing process.
4. It is an expired cost and hence must be deducted before calculating taxable profits.
5. It is a non-cash expense.

Depreciation and, Other Similar Terms:

1. Depletion: It is used in the context of extraction of natural resources like mines, quarries, etc. that reduces the availability of the quantity of the material or assets.
2. Amortization: It refers to writing off the cost of intangible assets like patents, copyright, trademarks, franchises, leasehold mines which have entitlements to use for a specified period of time.

Causes of Depreciation:

• Wear and tear due to use or passage of time.
• Expiration of legal rights.
• Obsolescence due to technological changes etc.
• Abnormal factors such as accidents due to fire, earthquake, floods, etc.

Need for Depreciation:

• Matching of Costs and Revenue.
• Consideration of Tax.
• True and Fair Financial Position.
• Compliance with Law.

Factors affecting the Amount of Depreciation

1. Cost of Assets.
2. Estimated Net Residual Value.
3. Depreciable Cost.
4. Estimated Useful Life.

Methods of Calculating Depreciation Amount
The selection of an appropriate method depends upon the following:

1. Type of the asset.
2. Nature of the use of such assets.
3. Circumstances prevailing in the business.

1. Straight Line Method:
This method is based on the assumption of equal usage of the assets over its entire useful life. It is also called the fixed installment method because the amount of depreciation remains constant from year to year over the useful life of the assets. Accordingly to this method, a fixed and equal amount is charged on depreciation in every accounting period during the lifetime of an asset. This method is also known as a fixed percentage on the original cost method.

Formula:
Depreciation = \frac{\text { Cost of assets-Estimated residual value }}{\text { Estimated usefullife of the asset }}
Rate of Depreciation = \frac{\text { Annualdepreciation amount }}{\text { Acquisition cost }} × 100

2. Written Down Value Method:
Under this method, depreciation is charged on the book value of the asset. It is also known as the reducing balance method. The amount of depreciation reduces year after year.

Under this method, the rate of depreciation is computed by using following formula:
R = \left[1-\sqrt[n]{\frac{s}{c}}\right] × 100

Where . R = rate of deprecition
n = expected useful life
s = scrap value
c = cost of an asset

Straight Line Method and Written Down Method: A Comparative Analysis


Methods of Recording Depreciation:
In the books of account, there are two types of arrangements for recording depreciation of fixed assets.

1. Charging depreciation to assets account.
2. Creating provision for depreciation/accumulated depreciation account.

1. Charging depreciation to assets account: Under this, depreciation is deducted from the depreciable cost of the asset (credited to the asset account) and charged (or debited) to the profit and loss account.

Journal Entries:
1. For recording purchase of asset: (Only in the year of purchase)
Asset A/c Dr. [With the cost of assets including installation etc.]
To Bank/Vendor A/c

2. Following two entries are recorded at the end of every year
(a) For deducting depreciation amount from the cost of the asset.
Depreciation A/c Dr. [[With the amount of depreciation]
To Asset A/c

(b) For charging depreciation to profit and loss account.
Profit & Loss A/c Dr. [With the amount of depreication]
To Depreciation A/c

The fixed asset appears at its net book value i.e. cost less depreciation charged till date on the asset side of the balance sheet,

2. Creating Provision for Depreciation Account/ Accumulated Depreciation Account: Under this method of recording depreciation, the asset account continues to appear at its original cost year after year over its entire life, and depreciation is accumulated on a separate account instead of being adjusted into the assets account at the end of each accounting period.

Journal Entries:
l. For recording purchase of asset: (Only in the year of purchase)
Asset A/c Dr. [With the cost of assets including installation etc.]
To Bank/Vendor A/c [Cash/Credit purchase]

2. Following two journal entries are recorded at the end of each year
(a) For crediting depreciation amount to provide for depreciation account
Depreciation A/c Dr. [[With the amount 0f depreication]
To Provision for depreciation A/c.

(b) For charging depreciation to profit and loss account.
Profit & Loss A/c Dr. [With the amount of depreication]
To Depreciation A/c

Balance Sheet Method: In the balance sheet, the fixed assets continue to appear at their original cost on the assets side. The depreciation charged till that date appears, in the provision for depreciation account which is shown either on the liabilities side of the balance sheet or by way of deduction from the original cost of the assets concerned on the asset side of the balance sheet.

Disposal of Asset:
Disposal of an asset can take place either at the end of its useful life or during its useful life due to obsolescence or any other abnormal factor.

Journal Entries:
1. For the sale of asset as scrap
Bank A/c Dr.
To Assets A/c

2, For transfer of balance in assets account
(a) In case of profit
Asset A/c Dr.
To Profit & Loss A/c

(b) In case of loss
Profit & Loss A/c Dr.
To Assets A/c

In case, however, the provision for depreciation account has been in use for recording the depreciation, then before passing the above entries transfer the balance of the provision for depreciation account to the asset account by recording the following journal entry:
Provision for Depreciation A/c Dr.
To Asset A/c

Asset Disposal Account:
This method is generally used when a part of the asset is sold and a provision for a depreciation account exists.

Journal Entries:
1. Assets Disposal A/c Dr. [With the original cost of the asset, being sold]
To Assets A/c

2. Provision for Depreciation A/c Dr. [With the accumulated balance in provision for depreciation account]
To Assets Disposal A/c

3. BankA/c Dr. [With the net sale proceeds]
To Assets Disposal A/c

4. In case of loss
Profit & Loss A/c Dr. [With the amount of loss on sale]
To Assets Disposal A/c

5. In case of profit
Assets Disposal A/c Dr. [With the amount of profit on sale]
‘ To Profit & Loss A/c

SECTION-II (Provisions and Reserves)
Provisions:
Provisions mean, “any amount written off or retained by way of providing for depreciation, renewals or diminution in the value of assets, or retained by way of providing for any known liability .of which the amount cannot be determined with substantial accuracy’’. Provision is a charge Against profit.

Reasons/Purposes of creating Provisions

1. To provide for doubtful debts.
2. To provide for taxation.
3. To provide for depreciation, etc.

Reserves:
Reserve means the profit retained in the th&business not having any attributes of a provision. A provision in excess of the amount considered necessary for the purpose for which it was created is to be treated as a reserve. Thus it is an appropriation of profit.

Difference between Reserve and Provision:
1. Basic nature: A provision is a charge against profit whereas a reserve is an appropriation of profit.

2. Purpose: A provision is made to meet a specific liability or contingency whereas reserves are created to strengthen the financial position of the business.

3. Presentation in Balance Sheet: Provision is shown either

1. by way of deduction from the item on the asset side for which it is created or
2. on the liabilities side along with the current liabilities. On the other hand, the reserve is shown on the liabilities sides of the capital.

4. Effect on taxable profits: Provision reduces taxable profits whereas reserve has no effect on the taxable profits.

5. Element of compulsion: Creation of provision is necessary to ascertain true and fair profit or loss whereas the creation of a Reserve is at the discretion of the management however in certain cases law has stipulated for creation of specific reserves such as Debenture Redemption Reserve. ,

6. Use for the payment of dividend: Provision cannot be used for dividend distribution whereas Reserves can be used for dividend distribution.

Types of Reserves:

1. General Reserves: When the purpose for which reserve is created is not specified, it is called General Reserve.
2. Specific Reserves: Specific reserve is a reserve, which is created for some specific purpose and can be utilized only for that purpose.

Examples are:

• Dividend Equalisation Reserve
• Workmen Compensation Fund
• Investment Fluctuation Fund
• Debenture Redemption Reserve

Reserve is also classified as revenue and capital reserve according to the nature of profit out of which they are created.

Revenue Reserves:
They are created from revenue profits which arise out of the normal operating activities of the business and are otherwise freely available for distribution as dividend Examples are:

1. General Reserve
2. Workmen Compensation Fund
3. Investment Fluctuation Fund
4. Dividend Equalisation Reserve
5. Debenture Redemption Reserve etc.

Capital Reserves:
They are created out of capital profits that do not arise from the normal operating activities. Such reserves are not available for distribution as dividends. These reserves can be used for writing off capital losses or issue of bonus shares in the case of a company.

Examples are:

1. Premium on issue of shares or debentures
2. Profit on sale of fixed assets
3. Profit on redemption of debentures
4. Profit on revaluation of fixed assets and liabilities.
5. Profit prior to incorporation
6. Profit on the reissue of forfeited shares.

Importance of Reserves:
A business firm may consider it proper to set up some mechanism to protect itself from the consequences of unknown expenses and losses.

The amount so set aside may be meant for the purpose of:

1. To meet the unforeseen liability or loss
2. To strengthen the financial position of the business
3. To provide funds for meeting a specific liability
4. To provide funds for the payment of dividends at the time of inadequacy of profits.

Secret Reserves:
It is a reserve that does not appear in the balance sheet. It may also help to reduce the disclosed profits and also tax liability. When total depreciation charged is higher than the total depreciable cost, a secret reserve is created.

Trial Balance and Rectification of Errors Notes Class 11 Accountancy Chapter 6

Meaning of Trial Balance
A trial balance is a statement showing the balances, or total of debits and credits, of all the accounts in the ledger with a view to verify the arithmetical accuracy of posting into the ledger accounts.

“The statement prepared with the help of ledger balances, at the end of the financial year (or at any other date) to find out whether debt total agrees with credit total is called Trial Balance.” – William Pickles

Objectives of Preparing the Trial Balance
The trial balance is prepared to fulfil the following objectives:

1. To ascertain the arithmetical accuracy of the ledger accounts.
2. To help in locating errors.
3. To help in the preparation of the financial statements.

Preparation of Trial Balance:
1. Totals Method: Under this method, the total amount of debit side of each ledger account is put on the debit side of the trial balance and the total amount of credit side of each ledger account is put on the credit side of a trial balance.

2. Balances Method: Under this method, the trial balance is prepared by showing the balances of all ledger accounts and then totalling up the debit and credit columns of the trial balances to assure their correctness.

3. Totals-cum-balance Method: This method is a combination of the totals method and the balances method. Under this method, four columns for amount are prepared. Two columns for writing the debit and credit totals of various ‘ accounts and two columns for writing the debit and credit balances of these accounts.

Significance of Agreement of Trial Balance
Normally, a tallied ‘Trial Balance’ stands that debit and credit entries have been made correctly for each transaction. However, the agreement of ‘Trial Balance’ only proves, to a certain extent, that the posting is arithmetically correct, but it does not guarantee that there is no error compelled in the accounting records.

Classification of Errors:
1. Errors of Commission: Errors caused due to wrong recording of a transaction, wrong totalling, wrong casting, wrong balancing etc.

2. Errors of Omission: The errors of omission may be committed at the time of recording the transactions in the books of original entry or while posting to the ledger. It is caused due to omission of recording a transaction entirely or partly in the books of accounts.

3. Errors of Principle: Errors arising due to the wrong classification of receipts and payments between revenue and capital receipts and revenue and capital expenditure.

4. Compensating Errors: Two or more errors committed in such a way that nullifies the effect of each other on the debits and credits.

Searching of Errors:
If the trial balance does not tally, it is a clear indication that at least one error has occurred. The error or errors needs to be located and corrected before preparing the financial statements.

Rectification of Errors:
From the point of view of rectification, the errors may be classified into the following two categories:
(a) Errors that do not affect the trial balance.
(b) Errors that affect the trial balance.

This distinction is relevant because the errors which do not affect the trial balance usually take place in two accounts in such a manner that it can be easily rectified through a journal entry whereas the errors which affect the trial balance usually affect one account and a journal entry is not possible for rectification unless a suspense account has been opened.

Suspense Account:
Sometimes, in spite of best efforts, all the errors are not located and the trial balance does not tally. In such a situation, to avoid the delay in the preparation of final accounts, the difference in the Trial Balance is placed to a newly opened account known as ‘Suspense Account’ and the trial balance tallies.

When all the errors are located and rectified the suspense account stands disposed of.

Bank Reconciliation Statement Notes Class 11 Accountancy Chapter 5

We know that Banks provide very important financial services in modern society. These days a large number of cash transactions are in fact passed through banks. Usually, all the business firms open a current account with a bank, and in order to record the transactions entered into with the bank, maintain a Bank Column in the Cash Book. Bank also maintains an account for each customer in its books.

All deposits by the customer are recorded on the credit side of his/her account and all withdrawals are recorded on the debit side of his/her account. A copy of this account is regularly sent to the customer by the bank. This is called ‘Pass Book’ or ‘Bank Statement’. The amount of balance shown in the passbook or the bank statement must tally with the balance as shown in the cash book. The businessman has to ascertain the cause for such a difference.

Meaning of Bank Reconciliation Statement:
According to Patil, “Bank reconciliation statement is a statement prepared mainly to reconcile the difference between the ‘Bank Balance’ shown by the Cash Book and Bank Pass Book.”

In other words, Bank Reconciliation Statement is a statement of account that explains the reasons for any difference between the bank balance as per cash book and bank balance as per bank statement/passbook and reconciles the two.

In simple words, it is generally experienced that where a comparison is made between the bank balance as shown in the firm’s cash book and the bank balance as shown in the bank passbook, the two balances do not tally/Hence, we have to first ascertain the causes of difference thereof and then reflect them in a statement called Bank Reconciliation Statement to reconcile (tally) the two balances.

Need for Reconciliation:
It is neither compulsory to prepare Bank Reconciliation Statement nor the date is fixed on which it is to be prepared. It is prepared from time to time to check that all transactions relating to the bank are properly recorded by the businessman in the bank column of the cash book and by the bank in its ledger account. Thus, it is prepared to reconcile the bank balances shown by the cash book and by the bank statement. It helps in detecting if there is an error in recording the transactions and ascertaining the correct bank balances as a particular date.

Reasons or Causes of Difference in the balance of the Cash Book and Pass Book
Reconciliation of the cash book and the bank passbook balances amounts to an explanation of differences between them. The differences between the cash book and the bank passbook is caused by:

1. Timing differences on a recording of the transactions
2. Errors made by the business or by the bank.

1. Timing Difference:
(a) Cheques issued by the firm but not yet presented for payment in the bank.
(b) Cheques paid or deposited into the bank but not yet collected.
(c) Bank charges or other charged, charges by the bank on behalf of the customer.

(d) Amount collected or credited by bank on standing instructions given by the customers.
(e) Amount paid or debited by the bank on standing instructions given by the customer.
(f) Interest credited by the bank.
(g) Interest debited by bank or overdraft.
(h) Direct payment by the customer into the bank account.
(i) Dishonour of cheques or bills.

2. Differences caused by errors
(a) Errors committed in recording transactions by the firm.
(b) Errors committed in recording transactions by the bank.

Preparation of Bank Reconciliation Statement
After identifying the causes of difference, the reconciliation may be done in the following two ways:
(a) Preparation of bank reconciliation statement without adjusting cash book balances.
(b) Preparation of bank reconciliation statement after adjusting cash book balance.

Preparation of Bank Reconciliation Statement without adjusting cash book balances
We may have two types of balances while preparing the Bank Reconciliation Statement which is following:
(a) Favourable balances

1. Credit balance as per passbook or bank statement is given and the balance as per cash book is to be ascertained.
2. Debit balance as per cash book is given and the balance as per pass book is to be ascertained.

(b) Unfavourable balances

1. Debit balance as per pass book (i.e. overdraft) is given and the balance as per cash book is to be ascertained.
2. Credit balance as per cash book (i.e. overdraft) is given and the balance as per pass book is to be ascertained.

Steps are to be taken for preparation of the Bank Reconciliation Statement
1. When debit balance as per Cash Book (Favourable balance) is given:

1. Take balance as a starting point say Balance as per Cash Book.
2. Add all transactions that have resulted in increasing the balance of the passbook.
3. Deduct all transactions that have resulted in decreasing the balance of the passbook.
4. Extract the net balance shown by the statement which should be the same as shown in the passbook.

Proforma:
Bank Reconciliation Statement as on…………..


2. When the credit balance as per Pass Book (Favourable balance) is given:

1. Take balance as a starting point say Balance as per Pass Book.
2. Add all transactions that have resulted in increasing the balance of the cash book.
3. Deduct all transactions that have resulted in decreasing the balance of the cash book.
4. Extract the net balance shown by the statement which should be the same as shown in the cash book.

Proforma:
Bank Reconciliation Statement as on…………..


3. When the credit balance as per Cash Book (Uufavoarable balance) is given:

1. Take balance as a starting point say Overdraft as per Cash Book.
2. Add all the transactions that have resulted in decreasing the balance of the passbook.
3. Deduct all the transactions that have resulted in increasing the balance of the passbook.
4. Extract the net balance shown by the statement which should be the same as shown in the passbook.

Proforma:
Bank Reconciliation Statement as on……………..


4. When the debit balance as per Pass Book (Unfavourable balance) is given:

1. Take balance as a starting point say overdraft as per Pass Book.
2. Add all the transactions that have resulted in decreasing the balance of the cash book.
3. Deduct all the transactions that have resulted in increasing the balance of the cash book.
4. Extract the net balance shown by the statement which should be the same as shown in the cash book.

Proforma:
Bank Reconciliation Statement as on…………….

Preparation of Bank Reconciliation Statement with Adjusted Cash Book
Bank Reconciliation Statement is prepared usually without adjusting the Cash Book during the different months of the financial year. However, at the. end of the financial year, the Cash Book must be adjusted before preparing the Bank Reconciliation Statement as the adjusted balance of the Cash Book is to be shown in the Balance Sheet.

The procedure for finding out adjusted cash balance is as follows:
1. Firstly a Cash Book with Bank Columns only will be prepared with the balance of the existing Cash Book.

2. All errors that have been committed in the Cash Book will have to be rectified by passing adjusting entries in the Cash Book.

For example:
(a) Any amount recorded twice in the Cash Book.
(b) Recording of issued cheques omitted in Cash Book.
(c-) Cheques deposited into the bank but omitted to be recorded in • Cash Book.
(d) Overcosting or undercoating of debit or credit column of Cash Book.
(e) Entries on the wrong side of columns etc.

3. Amounts for which bank has given credit in Pass Book but not recorded in the debit side of Cash Book. They will be recorded.
(a) Interest allowed by the bank.
(b) Interest Or dividend collected by the bank.
(c) Amount directly deposited by customers into bank etc.

4. Amounts for which bank has given debit in Pass Book but not recorded in the credit side of Cash Book. They will be recorded, such as
(a) Interest charged by the bank on overdraft.
(b) Bank charges, commission charges, etc.
(c) Insurance premium paid by the bank.
(d) cheque sent for collection and dishonored.

5. Following items must not be recorded in the Amended/Adjusted Cash Book:
(a) Cheques deposited into the bank but not collected.
(b) Cheques issued but not presented for payment.
(c) Any wrong entry in Pass Book.

6. Adjusted Cash Book is then balanced and this new balance is taken as a starting point for preparing the Bank Reconciliation Statement.

Recording of Transactions 2 Notes Class 11 Accountancy Chapter 4

A small business may be able to record all its transactions in one book only, i.e., the journal. But as the business expands and the number of transactions becomes large, it may become cumbersome to journalize each transaction. For the quick, efficient, and accurate recording of business transactions, Journal is sub-divided into special journals. These special journals are also called day books or subsidiary books. A transaction that cannot be recorded in any special journal is recorded in a journal called the Journal Proper.

Following are the subsidiary books for special purposes:

1. Cash Book
2. Purchase Book
3. Purchases Return Book,
4. Sales Book
5. Sales Return Book
6. Journal Proper, etc.

1. Cash Book: Cash Book is a special Journal that is used for recording all cash receipts and cash payments. It starts with the cash or bank balances at the beginning of the period. The Cash Book is both a journal and a ledger. It is also called the book of original entry.

Types of Cash Book

1. Single Column Cash Book: Single Column Cash Book records all cash transactions of the business in chronological order. It has one amount column on each side. All cash receipts are recorded on the debit side and all cash payments are recorded on the credit side.

Format of Single Column Cash Book:

2. Double Column Cash Book: Double Column Cash Book has two amount columns (One for Cash and one for Bank) on each side when the number of bank transactions is large, it is convenient to have a separate amount column for bank transactions in the cash book itself instead of recording them in the journal. This helps in getting information about the position of the bank account from time to time. All cash receipts, deposits into the bank are recorded on the debit side and all cash payments and withdrawals from the bank are recorded on the credit side.

Contra Entry: When cash is deposited into the bank, and when cash is withdrawn from the bank for use1 in the office, each such transaction affects both ‘Cash column’ as well as ‘Bank column’, and the transaction is, therefore, recorded on both sides of the cash book. Such entries, the double-entry of which is complete in the cash book itself, are called contra entries’.

Format of Double Column Cash Book:

3. Petty Cash Book: In every organization, a large number of small payments such as conveyance, cartage, postage, telegrams, and other expenses are made. These are generally repetitive in nature. If all these payments are handled by the cashier and are recorded in the main cash book, the procedure is found to be very cumbersome. To avoid this large organizations normally appoint one more cashier (petty cashier) and maintain a separate cash book to record these transactions such a cash book maintained by the petty cashier is called a petty cash book. The petty cashier works on the imprest system.

Format of Petty Cash Book:

2. Purchases (Journal) Book: All credit purchases of goods are recorded in the Purchases (Journal) Book. It records neither the cash purchase of the goods nor the purchase of any assets other than the good. The source documents for recording entries in the books are invoices or bills received by the firm from the supplies of the goods. Entries are made with the net amount of the invoice. The monthly total of the purchases book is posted to the debit of purchases account in the ledger.

Format of Purchases (Journal) Book:
Purchase (Journal) Book

3. Purchases Return (Journal) Book: Purchases Returns Book (Return Outward Book) is used for the purposes of recording the returns of goods purchased on credit. It records neither the returns of goods purchased on a cash basis nor the returns of any assets other than the goods. The entries in the purchases return book are usually made on the basis of debit notes issued to the suppliers or credit notes received from the suppliers.

A debit note is a document prepared by the purchaser to inform the supplier that his account has been debited with the amount mentioned and for the reasons stated therein. The debit note contains the date of return, name of the supplier to whom the goods have been returned, details of the goods returned, reasons for returning the goods. Each debit note is serially numbered.

Format of Purchases Return (Journal) Book:
Purchases Return (Journal) Book

Format of Debit Note:

4. Sales (Journal) Book: All credit sales of goods are recorded in the sales journal. It records neither the cash sale of the goods nor the sale of any assets other than goods. The source document for recording entries in the sales journal is a sales invoice or bill issued by the firm to the customer.

Format of Sales (Journal) Book:
Sales (Journal) Book

The sales journal is totaled periodically (generally monthly), and this total is credited to the sales account in the ledger.

5. Sales Return (Journal) Book: This journal is used to record the return of goods by customers to them on credit. On receipt of goods from the customer, a credit note is prepared. The source document for recording entries in the sales return book is generally the credit note.

A credit note is a document prepared by the seller to inform the buyer that his account has been credited with the amount mentioned and for the reasons stated therein. Credit does not contain the date of return of goods, the name of the customer who has returned the goods, detail Is of goods received back, and the number of such goods. Each credit r/ote is serially numbered.

Format of Sales Return (Journal) Book:
Sales Return (Journal) Book

6. Journal Proper: Journal proper is a residuary book in which those transactions are recorded which cannot be recorded in any other subsidiary book. The various examples of transactions entered in a journal proper are opening entry, Adjustment Entries, Rectification Entries, Transfer Entries, Closing Entries, etc.

Recording of Transactions 1 Notes Class 11 Accountancy Chapter 3

As we know that, accounting involves a process of identifying and. analyzing the business transactions, recording them, classifying and summarising their effects, and finally communicating it to the interested users of accounting information. Now, we will discuss the details of each step involved in the accounting process. The first step involves identifying the transactions to be recorded and preparing the source documents which are in turn recorded in the basic book of original entry called journal and are then posted to individual accounts in the principal book called ledger.

Business Transactions and Source Document
Business Transactions: Business transactions are exchanges of economic consideration between parties and have the two-fold effect that one recorded in at least two accounts. For example, purchase of furniture for cash.

It involves the reciprocal exchange of two things:

1. payment of cash,
2. delivery of furniture.

Source Document: Each business transaction should be supported by documentary evidence such as cash memos, cash receipts, invoices or bills, debit and credit notes, pay-in-slip, cheque,s, etc. These business documents are called source documents.

Vouchers: On the basis of source document entries are, first of all, recorded on vouchers, and then on the basis of vouchers recording is made in the Journal or books of original entry. A separate voucher is prepared for each transaction and it specifies the accounts to be debited and credited. Vouchers are prepared by an accountant and each voucher is countersigned by an authorized person of the firm.

Types of Accounting Vouchers

Note: Transfer Voucher is also called Transaction Voucher. Specimen of Transaction Voucher

Specimen of Debit Voucher

Specimen of Credit Voucher

The transaction with multiple debits and multiple credits are called complex transactions and the accounting voucher prepared for such transactions is called a Complex Voucher/Journal Voucher.

Specimen of Complex Transaction Voucher:

Features of Accounting Voucher:
An accounting Voucher must contain the following essential features:

1. It is written on a good quality paper;
2. The name of the firm must be printed on the top;
3. The date of the transaction is filled up against the date;
4. The number of the voucher is to be in serial order;
5. The name of the account to be debited or credited is mentioned;
6. Debit and the credit amount is to be written in figure against the amount;
7. Description of the transaction is to be given account-wise;
8. The person who prepares the voucher must mention his name along with his signature;
9. The name and signature of the authorized person are mentioned on the voucher.

Accounting Equation:
An accounting equation is a statement of equality between the resources (Assets) and the sources (Capital and Liabilities) which finance the resources. In simple words, an accounting equation signifies that the assets of a business are always equal to the total of its liabilities and capital (owner’s equity) in mathematical form:
Assets = Liabilities + capital

The accounting equation is also called the Balance Sheet Equation, as it depicts fundamental relationship among the components of the balance sheet.

Using Debit and Credit
Every transaction involves a give and takes aspect, in double-entry accounting both the aspect of the transaction is recorded. If the business acquires something, it must have been acquired by giving something. While recording each transaction, the total amount debited must be equal to the total amount credited.

The term ‘Debit’ and ‘Credit’ indicate whether the transaction is to be recorded on the left-hand side or right-hand side of the account. In its simplest form, an account looks like the English language letter “T”. This helps in ascertaining the ultimate position of each item at the end of an accounting period. In a “T” account, the left side is called debit (Dr.) and the right side is called credit (Cr.).

Specimen of T Account:

Rules of Debit and Credit:

Two fundamental rules are followed to record the changes in these accounts:
1. For recording changes in Assets/Expenses/Losses

1. “Increase in assets is debited and decrease in assets is Credited.”
2. “Increase in expenses/losses is debited and decrease in expenses/losses is credited.”

2. For recording changes in Liabilities and Capital/Revenue/Gains.

1. “Increase in liabilities is credited and decrease in liabilities is debited.”
2. “Increase in the capital is credited and decrease in the capital is debited.”
3. “Increase in revenue/gain is credited and decrease in revenue/gain is debited.

The rules applicable to the different kinds of accounts have been summarised in the following chart:


Books of Original Entry:
The book in which the transaction is recorded for the first time is called a journal or book of original entry. The source document is required to record the transactions in the journal. This practice provides a complete record of each transaction in one place and links the debit and credits for each transaction. The process of recording transactions in the journal is called journalizing. The process of transferring journal entry to individual accounts is called posting. This sequence causes the journal to be called the Book of Original Entry and the ledger account on the Principal Book of entry.

Journal is sub-divided into a number of books of original entry as follows:

1. Journal proper
2. Cash Book
3. Other day Books
   (a) Purchase Book
   (b) Sales Book
   (c) Purchase Returns Book
   (d) Sales Returns Book
   (e) Bills Receivable Book
   (f) Bills Payable Book

Journal:
A Journal is a book in which transactions are recorded in the order in which they occur i.e., in chronological order. A Journal is called a book of prime entry (also called of original entry) because all business transactions are entered first in this book.

Format of Journal:

1. Date Column: In this column, the date on which the transaction is entered is recorded. The year and month are written once till they change.

2. Particulars Column: In this column, first the name of accounts to be debited then the names of the account to be credited, and lastly the narration is entered.

3. L.F. (Ledger Folio) Column: In this column, the ledger page number containing the relevant account is entered at the time of posting.

4. Debit amount column: In this column, the amount to be debited is entered.

5. Credit amount column: In this column, the amount to be credited is entered.

The Ledger:
A ledger is a principal book that contains all the accounts (Assets Accounts, Liabilities Accounts, Capital Accounts, Revenue Accounts, Expenses Accounts) to which the transactions recorded in the books of original entry are transferred. As the ledger is the ultimate destination of all transactions, the ledger is called the “Book of Final Entry”.

Format of Ledger

1. Name of the Account: The name of the item is written at the top of the format as the title of the account. The title of the account ends with the suffix ‘Account’.
2. Dr./Cr.: Dr. means Debit side of the account that is left side and Cr. means Credit side of the account i.e. right side.
3. Date: Year, Month, and Date of transactions are posted in chronological order in this column.
4. Particulars: The name of the item with reference to the original book of entry is written on the debit/credit side of the account.
5. Journal Folio: It records the page number of the original book of entry on which relevant transaction is recorded.
6. Amount: This column records the amount in numerical figure, corresponding to what has been entered in the amount column of the original book of entry.

The distinction between Journal and Ledger:

Classification of Ledger Accounts:

All permanent accounts are balanced and carried forward to the next accounting period. The temporary accounts are closed at the end of the accounting period by transferring them to the trading and profit and loss accounts. This classification is also relevant for preparing financial statements.

Theory Base of Accounting Notes Class 11 Accountancy Chapter 2

Accounting aims at providing information about the financial performance of a firm to its various users. Accounting information must be reliable and comparable based on some consistent accounting policies, principles, and practices. This calls for developing a proper theory base of accounting.

The importance of accounting theory need not.be over-emphasized as no discipline can develop without a sound theoretical base. The theory base of accounting consists of principles, concepts, rules, and guidelines developed over a period of time to bring uniformity and consistency to the process of accounting and enhance its utility to different users of accounting information.

Apart from these, the Institute of Chartered Accountants of India which is the regulatory body for the standardization of accounting policies in the country has issued Accounting Standards which are expected to be uniformly adhered to, in order to bring consistency in the accounting practices.

Generally Accepted Accounting Principles (GAAP)
Generally Accepted Accounting Principles refers to the rules or guidelines adopted for recording and reporting business transactions in order to bring uniformity in the preparation and presentation of financial statements. These principles are also referred to as concepts and conventions.

From the practical viewpoint, various terms such as principles, postulates, conventions, modifying principles, assumptions, basic accounting concepts, etc. have been used interchangeably. However, the principles of accounting are not static in nature. These are constantly influenced by changes in the legal, social and economic environment as well as the needs of the users.

Basic Accounting Concepts
The basic accounting concepts are referred to as the fundamental, ideas or basic assumptions underlying the theory and practice of financial accounting and are broad working rules for all accounting activities and developed by the accounting professions.

The important basic accounting concepts are following:
1. Business Entity Concept: This concept assumes that a business, has a distinct and separate entity from its owners. Thus, for the purpose of accounting, a business and its owners are to be treated as two separate entities.

2. Money Measurement Concept: The concept of money measurement states that only those transactions and happenings in an organization, which can be expressed in terms of money are to be recorded in the books of accounts. Also, the records of the transactions are to be kept not in the physical units but in the monetary units.

3. Going Concern Concept: This concept assumes that a business firm would continue to carry out its operations indefinitely (for a fairly long period of time) and- would not be liquidated in the near future.

4. Accounting Period Concept: The accounting period refers to the span of time at the end of which the financial statements of an enterprise are prepared to know whether it has earned profit or incurred losses during that period and what exactly is the position of its assets and liabilities, at the end of that period.

5. Cost Concept: The cost concept requires that all assets are recorded in the book of accounts at their cost price, which includes the cost of acquisition, transportation, installation, and making the assets ready for use.

6. Dual Aspect Concept: This concept states that every transaction has a dual or two-fold effect on various accounts and should therefore be recorded in two places. The duality principle is commonly expressed in terms of fundamental accounting equations, which is
Assets = Liabilities + Capital

7. Revenue Recognition (Realisation) Concept: Revenue is the gross inflow of cash arising from the sale of goods and services by an enterprise and use by others of the enterprise’s resources yielding interest royalties and dividends. The concept of revenue recognition requires that the revenue for business transactions should be considered realized when a legal right to receive it arises.

8. Matching Concept: The concept of matching emphasizes that expenses incurred in an accounting period should be matched with revenues during that period. It follows from this that the revenue and expenses incurred to earn this revenue must belong to the same accounting period.

9. Full Disclosure Concept: This concept requires that all material and relevant facts concerning the financial performance of an enterprise must be fully and completely disclosed in the financial statements and their accompanying footnotes.

10. Consistency Concept: This concept states that accounting policies and practices followed by enterprises should be uniform and consistent over a period of time so that results are composable. Comparabilities results when the same accounting principles are consistently being applied by different enterprises for the period under comparison, or the same firm for a number of periods.

11. Conservatism Concept: This concept requires that business transactions should be recorded in such a manner that profits are not overstated. All anticipated losses should be accounted for but all unrealized gains should be ignored.

12. Materiality Concept: This concept states that accounting should focus on material facts. If the item is likely to influence the decision of a reasonably prudent investor or creditors, it should be regarded as material, and shown in the financial statements. 13. Objectivity Concept: According to this concept, accounting transactions should be recorded in the manner so that it is free from the bias of accountants and others.

Systems of Accounting:
There are two systems of recording business transactions which are following:
1. Double Entry System: This system is based on the principle of “Dual Aspect” which states that every transaction has two effects, viz. receiving of a benefit and giving of a benefit. Each transaction, therefore, involves two or more accounts and is recorded at different places in the ledger. The basic principle followed is that every debit must have a corresponding credit. A double-entry system is a complete system as both the aspects of a transaction are recorded in the books of accounts.

2. Single Entry System: This system is not a complete system of maintaining records of financial transactions. It does not record the two-fold effect of each and every transaction. Instead of maintaining all the accounts, only personal accounts and cash books are maintained under this system. The accounts maintained under this system are incomplete and unsystematic and, therefore, not reliable.

Basis of Accounting
From the point of view of the timing of recognition of revenue and costs, there can be two broad approaches to accounting. These are:

1. Cash basis
2. Accrual basis

1. Cash Basis of Accounting: Under the cash basis, entries in the book of accounts are made when cash is received or paid and not when the receipt or payment becomes due. This system is incompatible with the matching principle, which states that the revenue of a period is matched with the cost of the same period.

2. Accrual Basis of Accounting: Under the accrual basis, revenue and costs are recognized in the period in which they occur rather than when they are paid. A distinction is made between the receipt of cash and the right to receive cash and payment of cash and the legal obligation to pay cash. Thus, under this system, the monitory effect of a transaction is taken into account in the period in which they are earned rather than in the period in which cash is actually received or paid by the enterprise.

Accounting Standards:
Accounting standards are written statements of uniform accounting rules and guidelines or practices for preparing the uniform and consistent financial statements and for other disclosures affecting the user of accounting information. However, the accounting standards cannot override the provision of applicable laws, customs, usages, and business environments in the country.

Kohler defines accounting standards as “a mode of conduct imposed on accountants by custom, law or professional body”.

In order to bring uniformity and consistency in the reporting of accounting information, the Institute of Chartered Accountants of India (ICAI) constituted an Accounting Standard Board in April 1977 for developing Accounting Standards. Accounting Standard Board submits the draft of the standards to the council of ICAI, which finalizes the accounting standards.

Accounting-Standards (AS):
The ICAI has issued the following standards:

• AS 1 Disclosure of Accounting Policies
• AS 2 Valuation of Inventories
• AS 3 Cash Flow Statements
• AS 4 Contingencies and Events Occurring after the Balance Sheet Date
• AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies
• AS 6 Depreciation Accounting AS 7 Construction Contracts
• AS 8 Accounting for Research and Development
• AS 9 Revenue Recognition
• AS 10 Accounting for Fixed Assets
• AS 11 The Effects of Changes in Foreign Exchange Rates
• AS 12 Accounting for Government Grants
• AS 13 Accounting for Investments
• AS 14 Accounting for Amalgamations
• AS 15 Accounting for Retirement Benefits in the Financial Statements of Employers (recently revised and titled as Employee Benefits’)
• AS 16 Borrowing Costs
• AS 17 Segment Reporting
• AS 18 Related Party Disclosures
• AS 19 Leases
• AS 20 Earnings Per Share
• AS 21 Consolidated Financial Statements
• AS 22 Accounting for Taxes on Income
• AS 23 Accounting for Investments in Associates in Consolidated Financial Statements
• AS 24 Discontinuing Operations
• AS 25 Interim Financial Reporting AS 26 Intangible Assets
• AS 27 Financial Reporting of Interests in Joint Ventures AS 28 Impairment of Assets
• AS 29 Provisions. Contingent Liabilities and Contingent Assets

International Financial Reporting Standards (IFRS):
“International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB), the international accounting standard-setting body, which came into existence in the year 2001.

The use of a single set of high-quality accounting standards would facilitate investment and other economic decisions across borders, increase market efficiency and reduce the cost of capital. IASB places emphasis on developing standards based on sound and clearly stated principles, from which interpretation is necessary. Therefore, IFRS are referred to as principles-based accounting standards.

IFRS issued by the IASB:

IASB has adopted all outstanding IAS and SIC issued by the IASC as its own standards. Those IAS and SIC continue to be in force to the extent they are not amended or withdrawn by the IASB. Out of 41 IAS, 12 IAS standards withdrawn and in effect 29 IAS are still applicable.

IFRS compliant financial statements are:

1. Statement of Financial Position,
2. Comprehensive Income Statement,
3. Statement of Changes in Equity,
4. Statement of Cash Flow, and
5. Notes and Summary of Accounting Policies.

Difference between IFRS and Indian Accounting Standards:
The principal difference between the two is that while IFRS is based on principle and fair value. Indian Accounting Standards are based on rules and historical value.