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ACCOUNTING DEMISTIFIED FOREVERYONE
by :
DR. T.K. JAIN
AFTERSCHOOL
centre for social entrepreneurship
sivakamu veterinary hospital road
bikaner 334001 rajasthan, [email protected]
mobile : 91+9414430763
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What is accounting, accountancy
and bookkeeping?Accountancy is science which gives principlesof accounting. Accounting means recording,
analysing and presenting information abouttransactions involving money. Book keeping is
a part of accounting, where you undertakerecording of the day to day transactions.
Accounting has further many parts : financialaccounting, management accounting and cost
accounting etc.
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What is posting ?
When you record a transaction, it is called
posting. Traditionally we first record it in daybook or in journal and then post it in ledger.
Now a days all these processes dont take place
as you directly enter in computer software andthere is nothing like day book or journal orposting you straight make the entries.
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What is a day book and ledger?
We keep day book for recording day to daytransactions. Generally we have 4 types of
transactions : purchase, sale, other
expenditure, other income. These can beagainst cash or credit.
Thus we keep purchase book and sale book as
our day books for recording credit purchase /sale. All the cash transactions are recorded incash book. For other income and and other
expenditure, we make record in journal proper
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How to prepare journal entry?
Whenever you are trying to prepare an entry,
just try to visualise its impact on assets orliabilities. Each transaction has two aspects.
Bot these aspects must be analysed in terms of
impact on assets or liabilities. Remember thebasic accounting equation :
Assets = liabilities + capital
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Principles of posting.....
When assets increase, debit that transactions
and when liabilities increase, credit thattransaction. Thus any transaction that
increases assets must be debited. Remember,
your loss is treated as an asset and profit istreated as liability (because profit belongs toowner who is external to the organisation)
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posting....
When you increase income, it is credited andwhen you increase expenditure, it is debited.
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Types of accounts...
Nominal : income or expenditure nothing
real must be closed down at the end of theyear, unless it is related to next year (like
prepaid expenditure)
real : assetspersonal: debtors, creditors, owner (capital)
etc.
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Fundamental rules to remember
Every transaction increasing assets should be debited.
Every transaction decreasing assets should be credited.Every transaction increasing liabilities should be credited
Every transaction reducing liabilities should be debited.
All losses (expenses) are assets and all incomes / profits
are liabilities.
Capital is a liability (owner is different from firm).
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Fundamental rules traditional
principlesIncome nominal account Credit it
Expenditure nominal account debit it
Assets real account debit it when itincreases (debit what comes in, credit what
goes out)
liability :- personal account credit it when itincrease (Debit the receiver, credit the giver).
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Q: X started his business with cash 100, loan from bank 100,purchase goods 50, credit purchase from Y 50, Cash sales 100,
Credit sales to Z 50, Paid interest on loan 10, paid cash to Y10, received cash from Z 10, Loan paid to bank 20, Drawings
10, Drawings of goods 10, Sales return by Z 10, Issue of shares: 30, Purchased plant 100, Depreciation 10. closing stock 10
Show entries.
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Solution - 1st entry
Business start : it will affect two accounts cash iscoming in and capital is created. Thus there are two
accounts cash and capital account. Cash account is a real
account, when cash increases, we debit it and capitalaccount is a personal account and when personal accountis a liability, it is credited (credit the creditor and debit the
debitor). It is basic principle that Credit the giver and if
you give something to some person, debit his account.When assets increase, debit for that, when liability
increases, credit for that here cash is debited and capitalis credited.
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Solution 2
Loan from bank : it increases cash andliabiities also. Cash increase should be debited.
Loan taken creates loan account, which is apersonal account and when liability increases,
credit it (credit the giver). Thus Cash Debit andLoan a/c credit.
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Solution : 3rd entry :
Cash purchase : both accounts are real account.
Cash is going out (debit what comes in creditwhat goes out), so credit cash account. With
purchase, goods are coming in theorganisation, so debit the purchase account.
With first aspect asset is decreasing (cashgoing out) so credit cash, with purchase,assets are increasing, so purchase debit.
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Solutionn 4th entry
Credit purchase : There is one real account
(purchase account is a real account) and onepersonal account (Y- the creditor is a personal
account), when we purchase, assets increase,
so debit purchase (debit what comes in). WhenY gives credit, credit his account (debit thereceiver and credit the giver).
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Solution : 5th entry
Cash sales : with this 2 accounts are affected :cash and sales. Cash is a real account, when
sales happen, cash increase and so debit cash.(when assets increase, debit them, debit what
comes in real account). Sales is nominalaccount, (Credit all income, debit all
expenses), so sales being income, should becredited. Sales reduces assets (so if assets
reduce, credit it ).
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Solution : 6th entry
Credit sales to Z : it affects account of sales
and Z. Sales is nominal account it is income(credit all income) so credit sales account. Z is
a debtor (debit receiver, credit giver) so we
have to debit Z. Sales reduced assets (so creditit ) and debtors increased our assets (so debitit).
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Solution : 7th entry
Paid interest on loan : here we have two accounts : interestaccount it is expenditure so it is nominal account (debit
all expenses) so we have debit it. Cash is going out soit is real account (credit what goes out) so we have to
credit it. Cash is reducing, so it is reducing our assets soit should be credited (when assets reduce, credit them)
interest payment is increasing our losses (expenditure) all losses are assets, when assets increase, debit them - so
interest account should be debited.
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Solution - 8th entry
Paid to Y : here we have two accounts cash(which goes out real account ) and Y
(receiver personal account)
Credit what goes out and Debit the receiverso Credit cash account and debit Y's accoumt
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Solution 9th entry
Cash received from Z : cash comes -it willincrease assets so debit cash account Debitwhat comes in
Personal account of Z (debtor) will also reduce,
thus assets will reduce so credit it. Credit thegiver.
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Solution : 10th entry
Loan paid : it affects loan account and cash account. Loanaccount is personal account Debit the receiver so we
have to debit it
Cash goes out it is real account Credit what goes out,so credit it
Loan is liability, so increase in liability is always creditedand reduction in liabiity is debited, so debit this accountand cash is asset, decrease in asset is always credited.
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Solution - 11th entry
Drawings : here cash is withdrawn so thereare two accounts cash account and capital
account when cash reduces credit it (creditwhat goes out) when assets decrease, we
have to credit them.
Capital account (drawings account) is aliability- drawing reduces liability sodecrease in liability should be debited.
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Solution - 13th entry
Sales return by Z : sales return affects twoaccounts sales return (which is reverse of
sales), and Z's personal account (which ispersonal account).
Assets will increase as sales return increaseinventory- so sales return should be debited.
Z's personal account will reduce (Z is adebtor), so it will reduce our assets - so it
should be credited.
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Solution : 14th entry
Issue of share capital : here we have twoaccounts cash and capital. Cash will increase
assets - so debit cash.
Equity capital is a liability so increase inliability should be credited.
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Solution : 15th entry
Purchase of plant : it will increase assets increase in assets should be debited. It will
reduce cash which is assets - so decrease inassets should be credited : entry :
Plant a/ c Debitcash a.c credit
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Solution : 16th entry
Depreciation means reduction in value of plant. It is justan entry - there is no physical change in assets with thisentry. When the value of plants reduce it reduces assets so it should be credited. Depreciation is an expense- allexpenses are debited (all expenses / losses are assets) so
we have to debit.
Entry : depreciation a/c debit
plant account credit
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CASH BOOK
ITEMS INCREASING CASH
Capital : 100, loan from bank 100, cash sales :100 , , receivedcash from Z 10, Issue of shares 10 TOTAL : 320
ITEMS DECREASING CASH : purchase goods 50 ,Purchased plant 100,paid cash to Y 10 Paid interest on loan
10, Loan paid to bank 20, Drawings 10 TOTAL : 200
THUS CASH BALANCE = 120
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TRIAL BALANCE
Debit Sides : Purchase : (50+50) = 100 Depreciation : 10 ,Interest 10, Cash balance 120, Drawings : 20, Sales return 10,
Plant ( 100-10) =90 Z (debtor) : 30 TOTAL : 400
Credit sides : sales : (100+50) = 150, Loan (100-20) 80,
Capital (100 + 30) = 130 Y : 40 TOTAL 400
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PROFIT AND LOSS ACCOUNT
CREDIT SIDE (all incomes + closing stock) :SALES : CREDIT (100-10) = 90, CASH : 50
stock : 10 TOTAL : 150DEBIT SIDE (all expenses + opening stock) :
purchase credit 50, cash 50, depreciation 10,
interest : 10 TOTAL : 130profit : 150 130 = 20
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BALANCE SHEET
LIABILITIES : Capital (100-10-10)=80, +Equity issued 30, + loan (100-20) = 80, +
Y(creditor) (50-10) = 40 profit (it is a liability,as it belongs to owner) : 20 , TOTAL : 250
ASSETS : Plant : (100-10) =90, Z (debtor)
(50-10-10) = 30, Cash = 120 Stock =10TOTAL =250
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Rectify the previous question
The previous question + solution containssome mistakes try to identify them
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Which of these accounts willshow the same balance in the next
financial year ?
Patents, Goodwill, Salary, Salary outstanding,repairs, Outstanding rent, Prepaid expenditure,Commission received, Purchase, Sales, capital
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solution...
Patents real account so it will be shown, Goodwill -yes, Salary - no closed at the end of the year as it is
nominal account, Salary outstanding - yes, repairs no it is nominal account so closed at the end of year,Outstanding rent yes , Prepaid expenditure - yes,Commission received no -it is nominal account,
Purchase it is real account, but it will be shown asopening stock, Sales no , capital yes, but it maychange due to profit / loss
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What will be journal entry for the
following :Purchase furniture by cash 100
(furniture debit, cash credit 100)
paid outstanding loan 100
loan ac debit and cash / bank credit 100
paid repairs charges Rs. 200
Repairs debit cash credit 200
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Using accounting equationapproach, try to find impact of
following :
Purchased building on credit :assets increased and liabilities also increased.
When building is purchased, assets increase so
debit building account and liabilities is alsoincreased so credit the party (creditor)
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Can you identify balances ofthese accounts, if they are to be
put in a trial balance, where willthey come ?
Preliminary Expenditure, Bank overdraft, loans fromrelatives, patents, goodwill, Salary outstanding (to be
paid), Income acrued but not received, outstanding rent (tobe paid), Closing stock, Carriage ourward, Purchase,
Sales return
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Solution
Preliminary Expenditure- Debit, Bank overdraft - credit,
loans from relatives - credit, patents -debit, goodwill-debit, Salary outstanding (to be paid) will not come in
TB, Income acrued but not received- will not come in TB,outstanding rent (to be paid)-will not come in TB, Closing
stock-will not come in TB, Carriage ourward-Debit,Purchase-debit, Sales return-debit
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Discussion
Outstanding expenditure or acrued income
these are adjustments that we do at the end ofthe year and after preparing trial balance. Atthat time our entry is to debit P&L account andcredit outstanding expenditure and Credit P&L
account and debit acrued income. Thus theywil not appear in Trial balance (TB). Similarlyclosing stock will not appear in Trial balance.
Prepare accounts from the followng
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Prepare accounts from the followngsummary of totals of various accounts
in all the ledgers that the companyhas ?
Capital 10, building 4, wages 2, sales 100, interest paid 2,purchase 30, salary 10, repairs 1, postage 1, commissionreceived 1, interest received 1, bad debt 1, debtors 10,
creditors 3, cash 10, investments 4, depreciation 1, plant20, provision for bad debt 1, furniture 10, loan 20.
Provision for bad debt must be 20% of debtors. Openingstock 10, closing stock 10
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Step 1 trial balanceWhich accounts will have debit balance ?
building 4, interest paid 2, purchase 30, salary 10, repairs 1, postage1 , wages 2, bad debt 1, debtors 10,furniture 10 cash 10, investments
4, depreciation 1, plant 20
total : 106
Which accounts will have credit balance ?
Capital 10, sales 100, , commission received 1, interest received 1,creditors 3, provision for bad debt 1, loan 20.
total 136trial balance dont tally, so put 30 more in debit side till you find the
reason for diference.
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What should be the next step?
guess.....
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steps....
1. prepare a trial balance
2. prepare p& l account
3. prepare balance sheet
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Trading accout (first part of P & L
account)Trading account shows purchase, sale, manufacturing and
other direct expendtireu and gross profit.
Credit side : (sales + closing stock)sales 100, closing stock 10 total 110
Debit : (purchase+ opening stock+direct exp.)
opening stock 10, purchase 30, wages 2, total : 42
gross profit : 68 total :110
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Profit and loss account ...
Credit side : (income other than sales)
gross profit : 68, interest received 1
commission received 1total 70debit side : (all expenditure)
interest paid 2, salary 10, repairs 1, postage 1 , bad debt 1,depreciation 1, provision for bad debt 1
total : 17
net profit : (70 17= 53) total 70
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Working notes....
In the previous example, we have created
suspense account of 30, which must be tracedout. Accouting is like mathematics, it will notmatch, if trial balance totals dont match. We
have created additional provision for bad debitof 1, because it has to be 20% of debtors (wealready had provision of 1).
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BALANCE SHEET
LIABILITIES:
Capital 10, Profit : 53, creditors 3 loan 20. Provision for
bad debt 2 total : 98
ASSETS :
building 4, debtors 10, cash 10, investments 4, plant 20,furniture 10, closing stock 10 suspense 30 total : 98
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What will be the journal entries ?
You have to provide for 10% provision forbad debt Debtors are 9000. :
solution :
P & L account Debitto provision for bad debt account
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What will be journal entry?
By mistake, you had mentioned personal
widhdrawals of Rs. 5000 as sales.
Solution :
Sales a/c debit 5000
Drawings a/c Dr. 5000
to Cash a/c 10000
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How to judge the health of a
company ???
Look at its balance sheet and try to find out the
following aspects :1. can it meet its liabilities
2. can it meet urgent requirements and have
cash whenever required.3. is it able to earn sufficient profit and is it
able to use its assets properly.
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Find the health of the following
company:LIABILITIES : equity 500, preference 150, reserves 70,
Profit :;; 125, debenture 150, bank loan 100, overdraft 45,
creditors 55, tax payable 100, dividend payable 60,security premium 30 total : 1385
ASSETS : land 530, plant 110, furniture 20, investment90, stock 95, debtors 175, BR 25, cash 80, prepaid exp.
15, securities 20, preliminary exp. 40, goodwill 110,patents 75 total 1385
sales was 1300
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solution....
In the example the total of liabilities andassets are equal, that has to be there otherwise,
we have to create a suspense account to matchthem and find the reasons for difference(remember, the totals of assets and liabilites isequal, and totals of debit and credit side of trial
balance is also equal). Arrange these inliquidity order or permance order. Now look at
their financial health.
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liquidity???
Do the company has ability to meet short term liabilitiesand to encash opportunities that come to the company. For
this let us judge liquidity. Compare current assets andcurrent liabilities.
Current assets: (175+25+80+15+20+95)=410
current liability : (45+55+100+60) =260
current assets are 1.6 times current liabilities it musthave been at least 2 times current liabilitie.s
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Liquidity acit test ratioLook at those current assets which are quickassets, - they may be used any time to encash
and pay the liabilities : (remove inventory and
prepaid exp. From current assets)Quick assets: (175+25+80+20)=300
current liability : (45+55+100+60) =260
Quick assets are more than current liabilities this is
good, the quick assets should always be more than curentliabilties. Do find the quality of the quick assets- are the
debtors good enough etc.
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Find solvency of the company...
Can the company remain solvent in the long term. For findingsolvency, we have to look at the overall ability of the company
to meet its liabilities in the long term.
Total long term debt / fixed interest bearing capital :(150+150+100) = 400
equity + reserves+profit = (500+70+125) = 695
we have treated preference shares also as debt. The company iscomfortable as Debt can be upto two times equity + reserves.
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Find profitability of the
company...Find fixed assets turnover ratio :
total fixed assets : (110+75+530+110+90)
= 915sales was 1300, so
fixed turnover ratio is : 1300/915 = 1.4, which is not avery good one. But we have to compare these ratio to
other companies in the same industry. It is possible that itis a capital intensive industry so require huge investment
in fixed assets.
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ROI / ROCE
Ultimate measure of returns is ROI and ROCE.
ROI means return on investment how much
returns are the shareholders getting for theirmoney. ROCE means return on capital
employed, how much return are you able to
generate on total investment.Divide profit by money invested and find
overall profitability...
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Remember the basics....
DO Anticipate all losses if there can be a loss make a provision for that, if there can be
some expenditure, make a provision for that
DONT anticipate your income let the incomeactually come
adopt the principles of conservatism, prudence.
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What are provisions & reserves ?
We prepare provisions for some uncertainsituation and for a particular situation.Reserves are general and can be used for anypurpose. We make provisions for things like
bad debts etc. Thus provisions are for thosesituations which may take place in future.
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What are nominal / real / personal
accounts?Expenditures and incomes are nominal accounts and
must be closed at the end of the year by transferring to
P&L accountassets and provisions are real accounts and will
continue for ever, so they will appear in balance sheetevery year
personal accounts include debtors, creditors, capitalaccount, loan account etc. And will appear in balance
sheet every year.
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What is provision for bad debt?
On the basis of your past experience, if you
know that 5% debtors dont make payments,then you can make a provision for bad /
doubtful debt @5% of outstanding debtors.Thus at the end of the year you have to pass ajournal entry for this purpose. Later you have
to maintain it at 5% level of debtors.
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Example : your debtors are 1 lakh
and bad debts are 5000 and makea provision for 5% for future.
Your trial balance shows a baddebt of 15000. what entry willyou make and for how much ?
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solution...
There are two journal entries for bad debt :
1. bad debt a/c debit and debtors a/c credit
2. p&l account debit and bad debt a/c credit
when trial balance shows bad debt of 15000, it means you
have already passed the first entry. So now pass the 2nd entry at the time of closing the account (it is a nominal
account and has to be closed) thus the second entry will beP& L account debit and bad debt a/c credit 15000.
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Solution ...continued...
When you find that you have 5000 more of bad
debt, just pass an entry for this :bad debt debit and debtors credit : 5000
to make a provision for bad debt, pass another
entry :P & L account debit and provision for bad debt
a/c credit (5% of 95000)
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Impact on balance sheet
Bad debt account is a nominal account, so it willdisappear at the end of the accounting year and
will be closed by transferring to P & L account.Provision of bad debt will not close and will appearin balance sheet. We have made only one entry ofthis account, thus it will show credit balance and
will appear in both P & L account and balancesheet and will continue in the next year also.
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Balances for year 2009
Capital : 25, Plant19, Depreciation 1, repairs 1,wages 1, salares 2, income tax 1, Cash 1,
building 38, depreciation on building 1,purchase 61, sales 125, bank overdraft 2,acrued income 1, salaries outstanding 1, BR 5,
BP 1, Provision for bad debt 3, bad debts 1,
Discount on purchase 2, debtors 17, creditors11, opening stock 18, closing stock 15.
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continued...
write off bad debts 2, maintain provisions of5% on debtors, goods costing 2 sent to
customer on sale or returned basis on 1/3/9
recorded as actual sales. Rate of gross profitwas 16.67% of sales. Rent of office 1 debited
to landlord's account and were included indebtors, manager gets 10% commission on net
profit after charging commission of workmanager and his own. Work manager gets 5%
on gross profit
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Steps
Prepare trial balance, find out adjustments tobe made, make necessary adjustment for
account finalisation and then prepare P & L
accounts, balance sheet
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Important rules.
Income will have credit balance, expenditure willhave debit balances. Assets will have debit
balances and liabilities will have credit balances,
based on these try to prepare trial balance.Remember, all the income and expenditure
accounts are closed at the end of the year, for thistransfer their balance to trading account or P & L
account, assets and liabilities acccounts andpersonal account are not closed therefore their
balances are shown in balance sheet.
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Trial balance
CREDIT SIDE : Capital : 25,bank overdraft 2, BP 1,Provision for bad debt 3 creditors 11 Discount on
purchase 2, sales 125, salaries outstanding 1, TOTAL =169
DEBIT SIDE : Plant 19, repairs 1, Depreciation 1,depreciation on building 1, wages 1, salares 2, income tax
1, Cash 1, building 38, purchase 61, acrued income 1,BR 5, , bad debts 1, debtors 19, opening stock 18,TOTAL=169
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TRADING ACCOUNT
CREDIT SIDE :
sales : (125-2)=123, closing stock : (15 +1.67)total :139.67
DEBIT SIDE :
Purchase (61-2)=59, wages 14, total : 73
gross profit : 66.67
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Profit and Loss account
Credit side :
gross profit 66.67, income acrued 1, Prov. For bad debt (excess) 1.25 total : 67.92
Debit side :
salaries (2+1), Depreciation 1, Depreciation on building 1, Repairs 1, rent 1, baddebts 1, income tax 1
total : 9
outstanding commission
works manager : 3.5 Manager 5
net profit : 49.16
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Balance sheet
Liabilities :
capital 25, profit 49.16 creditors 11, bank
overdraft 2 , BP 1 outstanding salary 1,outstanding commission 8.38 total :97.5
Assets :
building (38-1) 37, plant (18-1) 17, Debtors 15,BR 5, Cash 1, Stock 16.67 , Acrued income 1
suspense account 5 total : 97.5
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Debtors account
Balance 19
less sale not taking place 2less landlord's rent 1 = 16
less bad debt written off = 1
debtors 15
make a provision on 15 @ 5% = .75
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Provision for bad debt
Opening balance : 3
less bad debt 1
closing balance 2
but we have to keep it only .75, so remaining
amount will be transferred back to P & Laccount = 1.25
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