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What are Fictitious Assets?

Ahuja Sahil
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What are Fictitious Assets?
  1. Meaning
  2. Examples
  3. Inside the Balance Sheet
  4. Is Goodwill a Fictitious Asset?
  5. Difference Between Fictitious Assets and Intangible Assets
  6. Quiz
  7. Revision Video
  8. Journal Entry
  9. Which Accounts are Fictitious Assets Transferred to?
  10. Conclusion

 

Meaning of Fictitious Assets

The best way to understand this is to memorize the meaning of the word “fictitious” which means “not true” or “fake”. Fictitious assets are expenses or losses which are not written off completely during the accounting period of their occurrence.

They are not assets at all, however, they are shown as assets in the financial statements only for the time being.

A straightforward example is that of a significant promotional expense. Suppose a small company decides to spend a large sum of 10 Million on marketing a new product and the benefit of such an expense is to last for 5 years.

In year 1, (1/5th) of the total money spent i.e. 2 Million will be shown in the income statement whereas the remaining (4/5th) 8 Million will be shown in the balance sheet as a fictitious asset (under the head Miscellaneous Expenditure).

 

Important Points

  • They are written off against the firm’s earnings in more than one accounting period. Basically, they are amortized over a period of time.
  • They are recorded as assets in financial statements only to be written off in the future.
  • It is important to note that such assets do not exist physically or have any resale value.
  • The portion of the expense that is kept for the future is a fictitious asset, while that which is written off in the current period is not.

Related Topic – Is Prepaid Expense a fictitious asset? 

 

Reasons why some expenses are not expensed off entirely in the same year

  • Benefit in the future period – If a business determines that the benefit of an expense or loss will be derived in a future accounting period, then splitting the cost accordingly is both logical and advisable.
  • Incorrect financial numbers – A firm may not be able to justify its financial statements if they show the entire expense or loss in a single year. It may end up showing an unreasonably large net loss and this may affect the firm’s valuation of goodwill.

fictitious assets summary

In Simple Terms – Fictitious assets are expenses/losses that are not completely written off during the accounting period in which they occur. There is no value in them, but they are still listed as assets in financial statements (temporarily). Why? – because the related benefits of these assets are expected to be received in the future; therefore, showing them as an expense today would do an injustice to the company’s financials.

Examples

  • Promotional Expenses of a Business

The marketing expenditures of businesses are viewed as investments that are expected to produce long-term returns in future years. The value of these assets is periodically reduced through the process of amortization over a number of years.

  • Preliminary Expenses

The term “preliminary expenses” refers to all costs incurred before the formation of a business. Examples of such expenses incurred before the incorporation of a business are legal costs, professional fees, stamp duty, printing fees,

  • Discount Allowed on the Issue of Shares

An issue of shares at a discount occurs when a company issues its shares for a lower price than its face value. For example, if the face value of a share is 25 and the company issues it at 20, then 5 (25 – 20) is the discount provided by the company on the issue per share.

Now, if the company issues 90,000 such shares at a discount to different investors it would lead to a total loss of 90,000 x 5 = 450,000. Such a loss is treated as a miscellaneous expenditure (fictitious asset).

  • Loss Incurred on Issue of Debentures

The premium payable on redemption of debentures issued at par or at a discount is a capital loss. For example, if a debenture is issued at a par value of 20, however, the redemption is at a premium i.e. 22 then the loss incurred per debenture is 2 (22 – 20).

Now, if the company issues 80,000 such debenture the total loss incurred at the time of redemption shall be 80,000 x 2 = 160,000. This loss should be appropriately reduced over time.

  • Underwriting Commission

The underwriting commission is the compensation an underwriter receives from investors for placing a new issue. It is advisable to write off such a fee over time.

  • Net Loss Incurred by a Company

In some cases, the debit balance of a profit and loss account is also treated as a fictitious asset.

Related Topic – List of Tangible and Intangible Assets

 

Shown in the Balance Sheet

They are shown in the balance sheet on the asset side under the head “Miscellaneous Expenditure”. (To the extent not written off or adjusted)

Fictitious assets example in balance sheet
The amount not written off in the current accounting period is shown on the balance sheet

The above example is provided to demonstrate an expense which may not be treated as an expenditure in the current accounting period, hence it will be recorded as a fictitious asset on the balance sheet.

Why are they shown on the balance sheet?

The organisation will receive returns from these expenses over time, much like it does from other assets. This is the concept behind treating such miscellaneous expenditures as assets.

Depreciation is not possible since they are not tangible, therefore they are amortized as time goes on.

Related Topic – Can Depreciation be Charged on an Asset in the Year of Sale?

 

Is Goodwill a Fictitious Asset

Another way to ask this question is “Are intangible assets such as patents, copyrights, trademarks, etc. also fictitious assets?”.

In short, the answer is No, goodwill is not a fictitious asset and the same is true for other intangible assets.

Acquisitions involve two companies, one purchasing and one being acquired. Goodwill = Purchase price of the targeted/acquired company – (Fair market value of the total assets of the acquired company – Fair market value of the total liabilities of the acquired company)

Reason – An important characteristic of a fictitious asset is that it does not have a realizable value which means it can not be sold in the market to fetch money. However, it is not true for goodwill, patents, and copyrights, since they all have a monetary value and can be sold in the open market.

Related Topic – Can Goodwill be Negative?

 

Fictitious Assets Vs Intangible Assets

Basis Fictitious Assets Intangible Assets
Value They have no realizable value. It means they can not be sold in an open market. They have a realizable value. It means they can be sold in an open market.
Use They are assets only in the name and do not play a role in revenue generation. By actively contributing to revenue generation, they add value to the process.
Extent Such assets are very limited when it comes to their role and usage in a firm. Such assets have a broad spectrum of roles and usage in a business.
Examples Promotional expenses, Preliminary expenses, Loss on the issue of debentures, Loss on the issue of shares, Underwriting commission, etc. Goodwill, Patents, Copyrights, Trademarks, Logos, Licenses, Broadcasting Rights, Customer Data, Franchises, etc.

 

In addition to this, there is another frequently asked question: Are fictitious assets current assets?

The answer is that all intangible assets are not fictitious assets, however, all fictitious assets are definitely intangible in nature. In spite of this, it is important to note that they are not closely related.

Related Topic – Formula to Calculate Net Current Assets

 

Short Quiz for Self-Evaluation

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Related Topic – What is a True-up Entry?

 

Revision & Highlights Short Video

Highly Recommended!!

Do not miss our 1-minute revision video. This will help you quickly revise and memorize the topic forever. Try it :)

 

Related Topic – What is Set off in Accounting?

 

Journal Entry

Depending on the type of expense, the journal entry may differ. Here, we will explain the entry in two steps:

  • Journal entry at the time of payment of expense
Fictitious Asset A/c Debit
 To Bank A/c Credit

At the time when an expense is paid and recognized in the financial statements.

Expense A/c Debit
 To Expense as Fictitious Asset A/c Credit

At the time when the expense is moved back to the income statement from time to time.

Related Topic – Journal Entry for Sale of Services on Credit

 

Fictitious Assets are to be Transferred to Which Account?

This is an accounting FAQ based on the concept of partnership accounting. They are to be transferred to the Partner’s Capital A/c.

As established in the article above that they are considered losses that are not transferred to the realisation account therefore they are transferred to Partner’s Capital account. This is because they are not real assets but are only shown in the financial statements for the time being.

Whenever possible, they are written off against the earnings of the firm. The transfer entry of fictitious assets, if any, is noted as follows:

Partner’s Capital A/c Debit
  To Fictitious Asset A/c Credit

 

Related Topic – Journal Entry for Rent Paid in Advance

 

Conclusion

Fictitious assets is a common term frequently asked in accounting interviews. There is no actual asset associated with it, although it is treated as an asset in the accounting system.

Such treatment is based on the expectation that it will be beneficial to the business in the long run. This expectation may or may not go as planned and as time progresses, further modifications may be needed.

None of the accounting ratios is affected by these assets because of their false nature. They imitate assets except that they have no intrinsic value, they have no scrap value, and the ultimate goal is to write them off completely with the passing of time.

 

>Related Long Quiz for Practice Quiz 30 – Fictitious Assets
>Read Deferred Revenue Expenditure

 

What are Drawings and its Journal Entry (Cash, Goods)?

Ahuja Sahil
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Drawings

In accounting, assets such as Cash or Goods which are withdrawn from a business by the owner(s) for their personal use are termed as drawings. It is also called a withdrawal account. It reduces the total capital invested by the proprietor(s).

In the case of goods withdrawn by owners for personal use, purchases are reduced and ultimately the owner’s capital is adjusted. The adjustment is done at cost price.

For small firms withdrawals are ordinarily seen in the form of cash or business assets, however, if a business is incorporated they are often observed in the form of dividends or scrip dividends. It is a natural personal account out of the three types of personal accounts.

 

Journal Entry for Drawings of Goods or Cash

  • In case of cash withdrawn for personal use from in-hand-cash or the official bank account.
Drawings A/C Debit Debit the increase in drawings
 To Cash (or) Bank A/C Credit Credit the decrease in assets 

 

  • In case of goods withdrawn for personal use from the business.
Drawings A/C Debit Debit the increase in drawings
 To Stock A/C Credit Credit the decrease in assets  

*Purchases account can also be used instead of stock account as the firm’s stock/purchases are being reduced.

It is a temporary account which is cleared during the accounting process at the end of each accounting year & is not shown as a business expense.

A debit balance in drawing account is closed by transferring it to the capital account. It does not directly affect the profit and loss account in any way.

Adjustment entry to show the decrease in capital

Capital A/C Debit
 To Drawings A/C Credit

(Same for both cash & goods)

Related Topic – Journal Entry for Goods Given as Charity/ or Free Samples

 

Example & Placement in Financial Statements

A leather manufacturer withdrew cash worth 5,000 from an official bank account for personal use. Post an appropriate journal entry for this scenario and also show journal entry for adjustment in the capital account.

Journal entry for cash withdrawn for personal use

Drawings A/C 5,000
 To Bank A/C 5,000

(Bank balance reduced by 5,000)

 

Adjustment entry to show the decrease in capital

Capital A/C 5,000
 To Drawings A/C 5,000

(Owner’s capital reduced by 5,000)

 

Type of Account and Where is it Shown in the Financial Statements

It is a Personal A/C and is adjusted from the capital. It is shown in the balance sheet on the liability side as a reduction in capital.

Drawings Shown in Balance Sheet Financial Statements

Related Topic – Compound Journal Entry

 

Change in the Accounting Equation

The accounting equation changes with every transaction that happens in a business. Similarly with withdrawals for personal use the accounting equation changes as follows;

Change in accounting equation from drawings of cash or goods
Change in the Accounting Equation from Withdrawals for Personal Use

 

Short Quiz for Self-Evaluation

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>Related Long Quiz for Practice Quiz 24 – Drawings

>Read Offset Account

 

What are Three Major Financial Statements?

Ahuja Sahil
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Three Major Financial Statements

Financial statements act as a report card for a business. The three major financial statements are prepared as a summary of figures and facts showing the financial condition of a business.

They are not only used to show how a business uses its funds committed by the shareholders and the lenders, but also to see where the business stands in terms of its financial position.

  • Profit & Loss Account or Income Statement
  • Balance Sheet or Statement of Financial Position 
  • Cash Flow Statement or Statement Accounting for Variations in Cash

 

Profit & Loss Account or Income Statement

After the preparation of a trading account, a profit & loss account is prepared to determine the net profit earned or net loss incurred due to the operations of a business. It is an important final account of a business which shows the summarized view of revenues and expenses for a particular accounting period.

In the horizontal form of a P&L account, Gross profit or Gross loss, whatever is determined from the trading account, is transferred accordingly. The debit side will have all expenses and the credit side – all receipts, both arising out of day-to-day activities.

The difference between the two sides of this account is either net profit or net loss, which is then transferred to the capital account.

 

(Sample Format of a P&L Account)

Dr.   Cr.
Particulars Amt Particulars Amt
To Trading A/C (Gross Loss) By Trading A/C (Gross Profit)
To Rent By Commission Earned
To Depreciation  By Bad Debts Recovered 
To Bad Debts  By Interest Earned 
To Printing & Stationery  By Dividends on Share
To Salaries By Example Income 1^
To Legal Cost 
To Example Expense 1^ By Capital A/C (Net Loss)*   
   
To Capital A/C (Net Profit)*    

*Either of the two will appear. ^Any head can be used instead of the example.

 

Balance Sheet or a Statement of Financial Position 

After the preparation of trading and P&L account, a balance sheet is to be prepared. It is a statement that shows a detailed listing of assets, liabilities, and capital demonstrating the financial condition of a company on a given date.

It is not only required to be prepared according to the companies act but also needed to ascertain the financial position of a business.

The liabilities and capital are shown on the left-hand side, whereas the assets are shown on the right-hand side. According to the accounting equation Assets = Capital + Liabilities, the total of the Left-hand side should always be equal to the right-hand side in a balance sheet.

 

(Sample Format of a  Balance Sheet)

Liabilities Amt Assets Amt
Capital Land & Building
Reserves & Surplus Plant & Machinery
Outstanding Expenses Furniture
Loans Stock
Trade Creditors Sundry Debtors
Bills Payable B/R
    Misc. Investments
    Cash
   
Total Total 

 

Cash Flow Statement or Statement Accounting for Variations in Cash

A Cash Flow Statement is a financial statement which is mandatory to be prepared according to the law along with the other two financial statements.

Cash flow statement shows the movement of cash and cash equivalents, it is an in-depth inflow and outflow for a given period of time. The statement shows the net cash flow from operating, investment and financing activities.

A cash flow statement depicts the sources and uses of a company’s cash and equivalents, which is very important information for stakeholders.

 

(Sample Format of a  Cash Flow Statement)

 Cash Flow Statement Indirect Method  Amt
 Cash flows from operating activities  
 Net profit before taxation  
 Adjustments for,  
 Depreciation  
 Investment income  
 Interest expense  
 Foreign Exchange Loss  
 Operating profit before working capital changes  
 Working capital changes:  
 Add Decrease/Less Increase in Sundry Debtors  
 Add Decrease/Less Increase in Inventories  
 Less Decrease/Add Increase in Sundry Creditors  
   
 Cash flow from operations  
 Interest paid  
 Income taxes paid  
 Cash flow from extraordinary items  
 1. Net cash from operating activities  
   
 Cash flows from investing activities  
 Purchase of fixed asset  
 Proceeds from sale of equipment  
 Investment income  
 Dividends Received  
 2. Net cash spent in investing activities  
   
 Cash flows from financing activities  
 Proceeds from issue of share capital  
 Proceeds from long-term borrowings  
 Payment of long-term borrowings  
 Interest & dividends paid  
 3. Net cash used in financing activities  
   
 Net increase in cash and cash equivalents 1+2+3  
   
 Add Cash and cash equivalents at beginning of the period  
   
 Cash and cash equivalents at end of the period  

 

Short Quiz for Self-Evaluation

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>Read What is Bank Reconciliation Statements?

 

What is Working Capital?

Ahuja Sahil
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Working Capital

Also known as working assets, it is part of the total capital which is currently employed in a company’s day-to-day operations. Cash or liquid assets vital to run a company’s daily operations are collectively known as Working Capital. It is computed as the difference between current assets and current liabilities.

Evaluation is done to find out if a business has enough current assets to cover all its short-term liabilities. Monitoring helps with efficient management of a company’s operations and maintenance of its short-term financial health.

Formula to calculate working capital

The volume and composition of working capital vary among different sectors, size, and types of organizations. For example – a manufacturing unit typically sells on credit basis and hence generates plentiful short-term receivables.

On the other hand, a business which runs solely on cash (example – jewellery) may have very few receivables. Another example may be that of a business which only accepts custom orders (example – made to order clothing) may not have a lot of inventory pile-up.

Related Topic – Current Ratio

 

How to Calculate Working Capital

The excess of current assets over current liabilities is known as a company’s working capital, it is calculated as follows:

WC = Current Assets – Current Liabilities

Examples of current assets – Debtors, Cash, Bank, Inventory, Prepaid Expenses, etc.

Examples of current liabilities – Creditors, Overdraft, Outstanding Expenses, etc.

 

Low Working Capital

In the case of inadequacy of working assets, current assets are less than current liabilities, which means the company has to pay more money than it will receive in short-term.

Current Assets < Current Liabilities

A poor working capital condition is the first indication of financial problems for a business and shows that it is struggling to keep up with its daily operations.

 

Excess Working Capital 

In cases where current assets are considerably higher as compared to current liabilities, it is said to be an excess of WC.

Current Assets > Current Liabilities

Surplus WC may indicate inefficiency in the way the business operations as it symbolises that current assets are sitting idle and need to be put to better use.

 

Example

Calculate working assets for the business, with the help of the below extract from a balance sheet.

Liabilities Amt Assets Amt
..
Current Liabilities Current Assets
Sundry creditors 75,000 Bank 1,00,000
Bills payable 25,000 Cash 50,000
Bank overdraft 75,000 Debtors 1,50,000
..

Current Assets = 1,00,000 + 50,000 + 1,50,000

Current Liabilities = 75,000 + 25,000 + 75,000

Applying the formula = Current Assets – Current Liabilities

= 3,00,000 – 1,75,000

= 1,25,000

 

Short Quiz for Self-Evaluation

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>Related Long Quiz for Practice Quiz 33 – Working Capital

>Read Accounting Process

 

What is a Suspense Account?

Ahuja Sahil
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Definition and Use

A suspense account is an account temporarily used in general ledger to carry doubtful amounts which can either be a payment or a receipt. Despite considerable efforts, if the reason(s) causing these questionable amounts are not found, the difference in the trial balance is temporarily transferred to a suspense account till it is properly analyzed and classified.

The difference amount is temporarily recorded in a suspense a/c and should be cleared at some point as it possesses a control risk. It is used to mitigate risk which is addressed and when the errors are rectified.

It is used only because a proper account for a particular transaction couldn’t be determined at the time when the transaction was recorded. When the right account is determined, the amount shall be moved from the suspense account to its proper account.

Related Topic – What is a Rectification Entry?

 

Example Showing the Use of a Suspense Account

Cash received from Unreal Pvt Ltd. for 5,000 is wrongly posted to Unreal Pvt Ltd’s. account as 50,000, It is however correctly recorded in the cash account.

Cash A/C 50,000
To Unreal Pvt Ltd A/C 50,000

 Faulty Journal Entry

Considering the fact that the proper account couldn’t be determined at the time of correction, the journal entry for rectification will be

Unreal Pvt Ltd A/C 45,000
To Suspense A/C 45,000

 Rectification entry 

 

What happens in case a suspense account is not closed?

In case a suspense a/c is not closed at the end of an accounting period, the balance in suspense account is shown on the asset side of a balance sheet if it is a “Debit balance”. In case of a “Credit balance”, it is shown on the liability side of a balance sheet.

 

Short Quiz for Self-Evaluation

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> Read True-up Entry

 

What is a Compound Journal Entry?

Ahuja Sahil
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Compound Journal Entry

Compound means a thing that is composed of two or more separate components. Similarly, when used in accounting, a compound journal entry means a journal entry which includes multiple accounts that are either debited or credited, unlike a simple journal entry which only includes 1 debit and 1 credit.

In other words, an entry which has more than one account in debit, credit, or both is termed as a compound journal entry.

 

Explanation with Example

  • On January 7, YYYY, 9,500 received in cash from Unreal Pvt Ltd. as the full and final settlement of their account worth 10,000. (Allowed a discount of 500)
Date Particulars LF. Debit Credit Type of Account* Rule Applied*
7 Jan YYYY Cash A/C   9500   Real A/C Dr. What comes in 
  Discount Allowed   500   Nominal A/C Dr. All losses 
  To Unreal Pvt Ltd.         10,000 Personal A/C Cr. The giver  

*Used for the explanation purposes.

In the above example of a compound journal entry, there are 2 accounts being debited and 1 account being credited. There are other examples of such entry where you will find more debits than credits or multiple accounts being credited and debited at the same time and so on. It all depends on the complexity of a transaction.

 

>Read How to prepare a journal entry?

 

What is a Trial Balance?

Ahuja Sahil
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Definition of Trial Balance in Accounting

As per the accounting cycle, preparing a trial balance is the next step after posting and balancing ledger accounts. It is a statement of debit and credit balances that are extracted on a specific date.

It is made as an attempt to prove that the total of ledger accounts with a debit balance is equal to the total of ledger accounts with a credit balance. As the name suggests, it is an actual “trial” of the debit and credit balances, they should be equal.

A journal and a ledger are maintained according to the double-entry concept of accounting. In a trial balance, the sum of debits and credits must match.

Related Topic – What is a Debit Balance & Credit Balance?

 

Sample Format of Trial Balance with PDF Download

The format of trial balance mainly consists of 3 columns

format of a trial balance

Open and Download PDF

The suffix “Account” or “A/c” may or may not be written after the account names.

Related Topic – What is an Adjusted Trial Balance?

 

Use of a Trial Balance

  1. It acts as a base to create the final accounts of a business such as an Income statement, a Trading A/C, and a Balance Sheet.
  2. To prepare a trial balance it is important to ensure the arithmetic conceptual accuracy. Due to the dual aspect of accounting, the sum of total credits should be equal to the sum of total debits.
  3. Due to its accuracy, tallied Trial Balances offer significant peace of mind regarding the accuracy of ledger balances.
  4. It acts as a summarized form of all ledger balances, in case the debit and credit balances do not match then it is concluded that there is some error and the difference is temporarily transferred to a “Suspense A/C” and corrected afterwards.
  5. Auditors may decide to use it and transfer the account balances onto their auditing software. They can then perform various different kinds of inspections.

 

Debit and Credit Accounts

In order to provide a summary statement view of the balances of various accounts, the trial balance is prepared. This also indicates the correct nature of the balances of different accounts. A general rule to follow here is;

  • Assets & Expenses shall have a Debit Balance.
  • Liabilities & Incomes shall have a Credit Balance.

The reason or logic behind the above rule is to keep the accounting equation in balance and this is the convention commonly followed. The accounting equation is A = L + E, or assets equal liabilities plus equity. The concept is based on the understanding that all assets of a business are either the financial right of the creditors (liabilities) or the owner (equity) in different proportions.

To balance the equation, a double-entry system with debits and credits is used. A debit increases the asset balance while a credit increases the liability or equity. This is required because they are on different sides of the accounting equation. This results in the majority of asset accounts having debit balances, and the majority of liability and equity accounts having credit balances.

Also, expenses cause the owner’s equity to decrease. Since the owner’s equity’s normal balance is a credit balance, an expense must be recorded as a debit. Similarly, incomes cause the owner’s equity to increase, and hence an income is recorded as a credit.

The following are a few examples of different accounts and their natural balance. Items that appear on the debit side of the trial balance:

  • Land and Buildings
  • Plant and Machinery
  • Furniture and Fixtures
  • Office Tools and Equipment
  • Cash at Bank
  • Cash in Hand
  • Motor Van
  • Loss from the sale of fixed assets
  • Travelling charges
  • Printing and postage expenses

Items that appear on the credit side of the trial balance:

  • Capital Account
  • Sundry Creditors
  • Bank Overdraft/Loan
  • Bills Payables
  • Sales (Revenue)
  • Purchase Returns
  • Common stock
  • Un-earned revenues
  • Retained earnings
  • Interest Received

 

Trial Balance and Balance Sheet

A Trial balance is a summary of balances of all accounts recorded in the ledger. It is prepared at the end of a particular period to indicate the correct nature of the balances of various accounts. A balanced trial balance ascertains the arithmetical accuracy of financial records.

A balance sheet is a statement that represents the financial position of a business on a particular date. All assets and liabilities are presented in the balance sheet in a classified form. Thus, it is a summary of the complete accountancy record. A balance sheet helps the user quickly get a handle on the financial strength and capabilities of the business along with its weaknesses.

Both the trial balance and the balance sheet are very crucial to the financial statements as a whole as they serve different purposes. A Trial balance is used-

  • To check the arithmetical accuracy of the ledger accounts
  • To locate errors in recording
  • To provide a basis for preparing the financial statements

A Balance sheet is used-

  • To know the actual financial standing of a business on a given day
  • To ascertain and identify the trends in a business
  • To project and make provisions for future probable setbacks

A trial balance and a balance sheet may seem similar as they both are the description of accounts and not the accounts themselves. Both are statements and are prepared at a particular point in time. But, they are actually very different as explained in the following table:

Difference between trial balance and balance sheet in table format

 

Short Quiz for Self-Evaluation

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>Read How to prepare a trial balance from ledger balances?

 

What is a Subledger?

Ahuja Sahil
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Subledger

When a business is small there is only one general ledger that is maintained. As the size of the business increases, the number of accounts also grow along with that. New subledgers are created under the general ledger accounts, these subsets of the general ledger are called subledger.

Similar types of accounts are grouped together and their representative account is shown in the general ledger. Few examples include accounts receivable, accounts payable, property, etc.

 

Example

Let’s take an example of the general ledger control account “Accounts Receivable”, which is made up of the following individual debtors of the business:

A’s Receivable A/C = Subledger AR1

B’s Receivable A/C = Subledger AR2

 

A’s Balance + B’s Balance = Accounts Receivables (Control Account)

(AR1) + (AR2) =  Accounts Receivable A/C (To be shown in GL)

 

Example of subledger

 

So, one can imagine a big multinational corporation where hundreds and thousands of debtors, creditors, etc. are not uncommon. It becomes almost impossible to maintain one single ledger.

Hence, creating such subsets is the best possible option to not only maintain the data efficiently but also for calculations and quick access to information on an individual level.

 

>Read What is a Control Account?

 

What is a Ledger?

Ahuja Sahil
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Ledger in Accounting

It is also known as the principal book of accounts as well as the book of final entry. It is a book in which all ledger accounts and related monetary transactions are maintained in a summarized and classified form. All accounts combined together make a ledger and form a permanent record of all transactions.

It is the most important book of accounting as it helps in the creation of trial balance which then acts as a base for the preparation of financial statements.

Example: An account can be either an Asset, Liability, Capital, Revenue or an Expense account. Few examples of each are Furniture, Cash, Creditors, Bank Loan, Capital, Drawings, Sales, Rent, etc.

Related Topic- What is a subledger?

 

Sample Format of a Ledger Account

Sample Format of a Ledger

  • It is shown in “T” format and divided into 2 columns: the left-hand side represents the debit side and the right-hand side represents the credit side.
  • The process of transferring a transaction from a journal to a ledger account is called Posting. It is an essential task as it summarizes all transactions related to that account at one place.
  • Posting is made to accounts from journal entries and various subsidiary books.

 

Account Types and their Balances

 Type of Account  Normal Balance
 Assets  Debit
 Liabilities  Credit
 Capital  Credit
 Revenue  Credit
 Expenses  Debit
 Drawings  Debit

 

 

Short Quiz for Self-Evaluation

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>Read Different Types of Ledgers

 

What are Internal and External Liabilities?

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Internal and External Liabilities

Liabilities are obligations a business owes to external or internal parties. As per the accounting equation liabilities are equal to the difference between assets and capital. For example, if Business A sells goods to Business B on credit, the amount owed by B to A is treated as a liability.

Internal Liability – All obligations which a business has to pay back to internal parties such as promoters (owners), employees etc. are termed as internal liabilities. Examples – Capital, Salaries, Accumulated profits, etc.

External Liability – All obligations which a business has to pay back to external parties i.e. lenders, vendors, etc. are termed as external liabilities. Example – Borrowings, Creditors, Taxes, Overdrafts, etc.

 

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What is a Journal?

Ahuja Sahil
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Journal in Accounting

Journal is the primary book of accounting where daily records of business transactions are first recorded in chronological order, i.e. in the increasing order of dates.

In case of a large business where the number of transactions is substantially more, it is divided into various subsidiary books; such as cashbook, sales book, purchase book, B/R book, B/P book, etc.

It is also called the book of original or first entry. It is a preliminary record where business transactions are first entered into the accounting system. This stage is also known as the original record stage & marks the beginning of a double-entry accounting system.

 

Sample Format & Template

Sample format of a journal

Recording a transaction in a journal using an accounting entry is called Journalizing. It records both the debit and credit side of a business transaction.

The entry of a business transaction recorded in the journal is called a Journal Entry. It shows details of a transaction in a summarized form.

The act of transferring an accounting entry from a journal or a subsidiary book into a ledger account is called Posting.

Nowadays, for businesses and big corporations the entries carry over several pages, hence the totals are mentioned at the end of each page in front of the debit and credit columns.

Totals are carried forward carried down appropriately with the help of abbreviations such as Balance C/F and Balance B/F and Balance B/D and Balance C/D.

 

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What is the Difference Between Bookkeeping and Accounting?

Ahuja Sahil
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Bookkeeping Vs Accounting

Both bookkeeping and accounting are used interchangeably in the financial world, however, there is a notable difference between bookkeeping and accounting. Bookkeeping is a part of accounting whereas accounting itself is a wider concept.

Definition of Bookkeeping – Literally, it means the activity of keeping (or maintaining) financial books, i.e. recording financial transactions & events. The books referred to, in this context, are the books of accounts. This involves extensive data input. Few activities under book-keeping are;

  1. The input of invoice and voucher details into ERP systems.
  2. Receiving and recording payments by customers.
  3. Making and recording payments to vendors.
  4. Efficiently processing payroll information, etc.

Pie chart showing bookkeeping is part of accounting

Definition of Accounting – Accounting, on the other hand, is the process that includes recording, classifying, summarizing, and interpreting the financial information of an economic unit. The economic unit is considered as a separate legal entity. Accounting information is widely used by various types of parties for several different reasons. Few activities under accounting are;

  1. Preparation of a trial balance, ledger accounts, etc.
  2. Preparation of financial statements.
  3. Analysis of financial data.

Related Topic – Difference between Financial and Cost Accounting

 

Difference between Bookkeeping and Accounting (Table)

BookkeepingAccounting
Definition1. Bookkeeping is mainly related to the process of identifying, measuring, recording, and classifying financial transactions.1. Accounting is the process of summarizing, interpreting, and communicating financial transactions that were classified in the ledger account as a part of bookkeeping
Stage2. It is the beginning stage and acts as a base for accounting2. Accounting begins where bookkeeping ends.
Management Decisions3. Management can not make decisions based on bookkeeping.3. Management can make decisions based on accounting.
Objective4. The objective of bookkeeping is to keep proper and systematic records of financial transactions.4. The objective of accounting is to ascertain the financial position and further communicate the information to the relevant parties.
Financial Statements5. Financial statements are not prepared during bookkeeping.5. Financial statements are prepared on the basis of records obtained through bookkeeping.
Skill Level6. Bookkeeping doesn’t require any special skills as it is mechanical in nature.6. Accounting, on the other side, requires special skills due to its analytical and somewhat complex nature.

 

Duties of a Bookkeeper & Accountant

In light of the above discussion, it can be established that there is a usual overlapping between the roles of a bookkeeper and an accountant. It can be hard at times to clearly distinguish the two but the generally accepted convention is that the bookkeeper contributes to the early stages of the common accounting cycle, while an accountant contributes to the latter stages.

Duties of a Bookkeeper

  • To look out for financial data and identify economic transactions for a business.
  • To distinguish between material economic activities and immaterial economic activities.
  • To record events measured in monetary terms, in an orderly manner in a journal or other subsidiary books.
  • To properly maintain the required books of original entry.
  • To produce required bills and invoices with reference to transactions.
  • To post all debits and credits in the general ledger.
  • To classify all transactions in a systematic manner.
  • To balance and reconcile all the accounts in the books of accounts.
  • To summarize the balances in an accurate trial balance.
  • To prepare the bank reconciliation statement.
  • To follow and report on budgetary compliance.
  • To follow due diligence in following the generally accepted conventions of recording and maintaining books of accounts.

 

Duties of an Accountant

  • To examine the recorded transactions in order to check the efficiency of the records.
  • To suggest adjustment entries if any error is present in the bookkeeping process.
  • To analyze the trial balance in order to prepare the financial statements.
  • To prepare the Trading as well as Profit and Loss account to capture the profitability of the business.
  • To prepare the Balance Sheet to reflect the financial position of the business.
  • To estimate the cost of operations and revenue generated for the business.
  • To gauge the income tax and other compliance-related requirements of the company.
  • To interpret the financial statements in a way that can be useful for business decision making by the owners and other stakeholders.
  • To communicate necessary accounting information to the internal as well as the external users.
  • To provide consultation and insights to the owners to help them make an informed decision.

Related Topic – Difference between Journal Entry and Journal Posting

 

Auditing and Accountancy

The most accepted definition of an audit is given as an evaluation of a personal organization, process, system, or business. The term is most ordinarily used with respect to audits in accounting,  and sometimes in project management, legal departments, and financial management also. In other words, an audit is a necessarily unbiased analysis or examination of an organization’s statements. The audit can be both internal as well as external.

Auditing vs Bookkeeping

Auditing starts after the accounting cycle is completed. It is not a part of traditional bookkeeping and/or accountancy. Bookkeeping and auditing are similar in the way that both of them deal with the financial records of the business involved. Also, the utmost care and due diligence is the way to go for both a bookkeeper as well as an auditor. The Bookkeeper works for the organization, while an auditor can be external or internal.

Despite all this, auditing is a completely different process when compared to bookkeeping. The basic difference between the two lies in the tasks involved and the objective of performing the two activities.

  • Bookkeeping is the process of maintaining the records of the business and making sure that all requirements are fulfilled. On the other hand, auditing involves doing analytical and backtesting on the records to establish authenticity.
  • Bookkeeping is done with the simple purpose of recording all material economic activities of a firm in a uniform manner so that it can form the base for decision making. On the other hand, auditing is performed with the objective of evaluating the truthfulness and fairness of the records.

Accountancy vs Accounting vs Auditing

Accountancy and accounting are used interchangeably. In-depth analysis shows that while accounting refers to the steps in the accounting process like recording, classifying, summarizing, etc, accountancy is used to denote the overall duties or functions performed by an accountant.

Accountancy and auditing are also related in the same fashion. Accountancy starts where bookkeeping ends while auditing is performed after accountancy is complete. Both of them are similar in a way that they both have to rely on the records as maintained by the bookkeeping. Both accountancy and auditing are analytical in nature and are performed to make the most of the financial records. The techniques and tools are different in both cases, however.

  • Accountancy involves summarizing and interpreting financial data to facilitate informed decision making. Auditing is the process of checking and ensuring that financial records are reliable.
  • Accountancy is very detailed and generally tries to not miss any detail. If a detailed audit is not being performed, an auditor will usually rely on random samples of financial information.
  • Accountancy is governed by accounting standards while auditing is governed by legal acts that are not very flexible in their approach.
  • An accountant is generally appointed by the management and will be paid a salary. An auditor on the other hand may be appointed by some external authority also and will be paid a specific fee.

Related Topic – Difference between Journal and Ledger

 

Difference Between Bookkeeping and Accounting (PDF)

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What is Petty Cash Book?

Ahuja Sahil
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Meaning and Definition

Petty Cash Book is an accounting book used for recording cash expenses which are small and of little value, for example, stamps, postage and handling, stationery, carriage, daily wages, etc.

Petty Cash Book

These are expenses which are incurred day after day; usually, petty expenses are large in quantity but insignificant in value. To record such expenses, a different book known as a petty cash book is maintained. It may be maintained by ordinary or by the imprest system.

 

Jump to Section

1) Systems of Petty Cash

2) Type 1 – Simple Petty Cash Book (with download and format)

3) Type 2 – Analytical Petty Cash Book (with download and format)

4) Simple Petty Cash Book Vs Analytical Petty Cash Book

5) Advantages of Petty Cash Book

6) Accounting (balancing and posting to the ledger)

7) Quiz

8) Revision Video

 

Systems of Petty Cash

Ordinary system
As part of the normal process of petty cash management, the petty cashier receives an appropriate amount of money.

When the petty cashier spends the amount, he or she submits the account to the head cashier for approval.

Imprest system
The word “imprest” means – A fund that a business uses for small expenditures and usually restores to a fixed amount after a period of time. Imprest system refers to paying an advance at the start and reimbursing the amount spent from time to time.

An Imprest system is where an estimate is made of the amount required to cover small expenses for a given period (for example, a month, quarter, etc.) and the same amount is advanced to the petty cashier as the opening balance.

It is then used by him/her to manage all petty expenses and make the required payments. At the beginning of a new period, the money is replenished when it has been spent. This amount is called imprest money.

Advantages of the Imprest System

Better Accuracy: At regular intervals, the cashier checks the petty cash book to ensure that any mistakes are quickly corrected.

Expense Management: Because petty cash cannot be spent beyond the available petty cash, petty expenses are kept within the limits of imprest.

Fraud Management: As the petty cashier is prohibited from drawing cash as and when we desire, misuse of cash can be minimized.

 

Type 1 – Simple Petty Cash Book

This type of book is maintained just like a cash book. Any cash, which the petty cashier receives, will be recorded on the debit side (left) cash column of the book and any cash which he pays out will be recorded on the credit side (right) cash column of the book.

Format of Simple Petty Cash Book

Simple petty cash book format or template

Download the format in Excel – Download

Download the format in Word – Download

Related Topic – Difference between Cost and Management Accounting

 

Example for the Simple Type Book

From the following information please show a simple petty cash book for the 1st week of Feb YYYY.

Details of petty cash transactions
Date Particulars Amt
YYYY
Feb 1 Received 5,000 for petty cash
Feb 2 Purchased cutlery for office 200
Feb 4 Paid for bank WIRE transfer 500
Feb 5 Bought postage stamps 100
Feb 6 Paid for parking (client visits) 1000
Feb 7 Paid for Stationery 200

 

Solution (Simple Type)Simple Petty Cash Book - Solved Example

Related Topic – Why are Subsidiary Books Maintained in Accounting?

 

Type 2 – Analytical Petty Cash Book

Considered the most beneficial method of recording petty cash payments. In the analytical version, a separate column is used for each commonly occurring item of expenditure such as stamps, postage & handling, stationery, wages etc.

A column for “sundries” is usually added for miscellaneous payments. When a petty expense is recorded on the right-hand side of the book, the same amount is also recorded in the proper expense column.

Sample Format of Analytical Petty Cash BookAnalytical Petty Cash Book Sample

Download the format in Excel – Download

Download the format in Word – Download

Related Topic – Sundry Expenses

 

Example for the Analytical Type Petty Cash Book

From the following information please show an analytical petty cash book (using the Imprest system) for the 1st week of Feb YYYY.

Details of petty cash transactions
Date Particulars Amt
YYYY
Feb 1 Received 5,000 for petty cash
Feb 2 Paid for taxi fare 200
Feb 4 Paid for cartage 500
Feb 5 Bought pens and staplers 100
Feb 6 Paid for postage stamps 1000
Feb 7 Paid for tea and coffee 200

 

Solution (Analytical Type)Analytical Petty Cash Book (Solved Example)Related Topic – Is a Cash Book both Journal and a Ledger?

 

Simple Petty Cash Book Vs Analytical Petty Cash Book

Simple Petty Cash Book Analytical Petty Cash Book
There is no separate record for each type of petty expense. In the analysis column, each item of expense that occurs frequently is listed.
It is difficult to determine the total expenses under different headings at the end of the period. It is easy to determine expenses under different headings at the end of the period.
In a similar way to a cash book, each page is divided down the middle. A large portion of the page is provided for expenses, with separate columns for expenses incurred on a regular basis.

 

Advantages of the Petty Cash Book

Efficiency: This book helps to save the time of the chief cashier.

Control: Managing small payments is easier with the help of this book.

Reduces Effort: As these entries are not recorded in the cash book and posted into the ledger, redundant and extra work is saved.

Ledger Accounts Prepared Easily: Only the totals are taken and posted in the ledger. Information that is unnecessary & trivial is omitted which helps in direct posting to the ledger.

Related Topic – What is Posting?

 

Accounting, Balancing, Journal Entry and Posting

Balancing

Balancing of a petty cash book is done at the end of an accounting period. The columns for “payments” and “expenses” are totalled and it equals the total in the “Total Payment” column.

In the analytical type petty cash book, the closing balance (balance c/d) then becomes the opening balance (balance b/d) of the next period.

 

Petty Cash Journal Entry

(Entry 1) – When the amount is advanced to the petty cashier

Petty Cash A/c Debit Debit the increase in asset
 To Cash A/c Credit Credit the decrease in asset

 

(Entry 2) – When petty cashier submits expense accounts

Expense 1 A/c Debit Debit the increase in expense
Expense 2 A/c Debit Debit the increase in expense
Expense 3 A/c Debit Debit the increase in expense
 To Petty Cash A/c Credit Credit the decrease in asset

(Each expense is debited with its respective amount)

 

Posting

Each item in the book of petty expenses is posted in the ledger accounts at the end of a specific period which is pre-decided (usually – weekly, bi-weekly, monthly, or quarterly)

Ledger entry for each expense is not directly posted instead a petty cash account is maintained in the firm’s ledger.

In the ledger book, each petty expense account is kept separately.

Example to Show Ledger Posting

The petty cashier submitted the below expenses with their respective amounts for the current period amounting to 900. The cashier was advanced 1,000 as petty cash for the period. Post appropriate entries into individual ledger accounts.

Jan 3 – Entry at the start of the period when cash is handed over to the petty cashier,

Petty Cash A/c 1,000
 To Cash A/c 1,000

The chief cashier records petty cash advances to the petty cashier on the credit side of the cash book as “By Petty Cash A/c”. In this case, the entry would for 1,000.

 

Jan 9 – Entry for each expense at the time of submission of accounts by the petty cashier,

Stationery A/c 500
Cartage A/c 300
Postage A/c 100   
   To Petty Cash A/c 900

To pass the journal entry for total expenses paid, individual petty expenses are debited and credited to Petty Cash Account. A separate account is maintained for each petty expense.

 

(Solution)

Stationery A/c

Date Particulars Amount Date Particulars Amount
Jan 9 To Petty Cash A/c 500

Journal entry posted in the Stationery account on the debit side by writing “To Petty Cash A/c”.

 

Cartage A/c

Date Particulars Amount Date Particulars Amount
Jan 9 To Petty Cash A/c 300

Journal entry posted in the Cartage account on the debit side by writing “To Petty Cash A/c”.

 

Postage A/c

Date Particulars Amount Date Particulars Amount
Jan 9 To Petty Cash A/c 100

Journal entry posted in the Postage account on the debit side by writing “To Petty Cash A/c”.

 

Petty Cash A/c

Date Particulars Amount Date Particulars Amount
Jan 3 To Cash A/c 1,000 Jan 9 By Stationery A/c 500
Jan 9 By Cartage A/c 300
Jan 9 By Postage A/c 100
Jan 9 By Balance c/d 100
1,000 1,000
Jan 10 To Balance b/d 100
Jan 10 To Cash A/c 900

Journal entries for each receipt and payment are posted in the Petty Cash Account on the debit & credit sides.

Related Topic – Difference Between Journal Entry and Journal Posting

 

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What is Cash Book?

Ahuja Sahil
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Cash Book

A Cash Book is a type of subsidiary book where cash (or) bank receipts and cash (or) bank payments made during a period are recorded in a chronological order. Receipts are recorded on the debit – the left hand side, and payments are recorded on the credit – right hand side.

Entries are recorded just like a ledger account with the help of “To” and “By“. The number of cash transactions in a business is generally large, hence it is convenient to have a separate cash book to record such transactions.

In case a transaction affects both the cash and the bank account, a contra entry is recorded. There are 3 types of a cash book.

 

Single Column Cash Book

Also known as a simple cash book or a one column cash book, a single column cash book has one relevant column on each side which shows the simple “receipts” and “payments” of cash. Receipts are shown on the left side and the right side is for payments.

 

Sample Format of One Column Cash Book

 Date  Particulars  LF.  Cash  Date  Particulars  LF.  Cash
 Receipt Side  Receipt Side  Receipt Side  Receipt Side  Payment Side  Payment Side  Payment Side  Payment Side
 Receipt Side  Receipt Side  Receipt Side  Receipt Side  Payment Side    Payment Side  Payment Side    Payment Side  

 

Balancing

Just like any other account, it is balanced at the end of a period. The total of receipts should always be greater than the payments. The difference is mentioned on the credit side as “Balance c/d”. The balance on the debit side is then written with “To Balance b/d”, this is the beginning cash balance of a business for the next period.

 

Double Column Cash Book

Also known as a two column cash book, a double column cash book is the one which has a “Bank” column in addition to the regular “Cash” column. Just like the other type of books, it records receipts from cash and bank on the left side and payments – on the right side.

 

Sample Format of Two Column Cash Book

 Date  Particulars  Cash  Bank  Date  Particulars  Cash  Bank

 

 

Triple Column Cash Book

Also called a three column cash book, a triple column cash book has “Cash”, “Bank” and “Discount Allowed” on the receipt on the left side and “Cash”, “Bank” and “Discount Received” on the payments are on the right side of the cash book. Cash discount is recorded, when payments are made in cash or by check.

 

Sample Format of Three Column Cash Book

 Date  Particulars  Discount  Cash  Bank  Date  Particulars  Discount  Cash  Bank

 

 

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What is Bills Payable Book?

Ahuja Sahil
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Bills Payable Book

Also known as a B/P book, bills payable book is a subsidiary or secondary book of accounting where all bills of exchange, which are payable by the business, are recorded. The total value of all the bills payable for an accounting period is transferred to the books of accounts.

In a mid to large sized business where the number of bills exchanging hands is large in number, it is tough to journalize all bills drawn. All such bills are entered in an accounting ERP or a register depending on the business, furthermore, all these entries are transferred to the respective ledger accounts at a regular interval, often monthly.

A bill receivable for a “drawer” is a bill payable for a “drawee”. Bills payable account will usually have a credit balance, as it is supposed to be paid at maturity, it acts as a liability for the business. Generally, every bill has a 3-day grace period.

 

Sample Format of a B/P Book

The person, who draws the bill of exchange, is called a “drawer” and the customer, on whom it is drawn, is called a “drawee” or an “acceptor”.

Sample Format of Bills Payable Book

 

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What is Bills Receivable Book?

Ahuja Sahil
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Bills Receivable Book

Also known as a B/R book, bills receivable book is a subsidiary or secondary book of accounting, where all bills of exchange, which are receivable for the business, are recorded. The total value of all the bills receivable for an accounting period is transferred to the books of accounts.

In a mid to large sized business where the number of bills exchanging hands is large in number, it is tough to journalize all receipt of bills. All the bills are entered in an accounting ERP or a register depending on the business, furthermore, all these entries are transferred to the respective ledger accounts at a regular interval.

Bills receivable account will usually have a debit balance. As a bill receivable is supposed to be received at maturity, it acts as a current asset for the business. Generally, every bill has a 3 day grace period.

 

Sample Format of the B/R Book

A person who draws the bill of exchange is called a “drawer” and a customer on whom it is drawn is called a “drawee” or an “acceptor”. A bill receivable for a “drawer” is a bill payable for a “drawee”.

Format of BR Book

 

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What is Journal Proper?

Ahuja Sahil
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Journal Proper or General Journal

Journal Proper is mainly used for original records of a transaction which due to their importance or rareness of occurrence do not find a place in any of the subsidiary books of accounting. It is also known as a Miscellaneous Journal and it looks much like any other journal.

Sample Format of a Journal Proper

Journal Proper Format

Types of entries that are entered in the journal proper:

  1. Opening Entries
  2. Closing Entries
  3. Rectification Entries
  4. Transfer Entries
  5. Adjustment Entries
  6. Miscellaneous Entries

Related Topic – What is a Journal (With Sample Format)?

 

Opening Entries

As the name suggests, opening entries are recorded at the beginning of a financial period. The balances mentioned in the balance sheet of the previous year are brought forward by recording the liabilities, capital, and assets from the previous year.

Example

The rule to be applied to make an opening entry is

Assets A/C Debit
To Liabilities A/C Credit
To Capital A/C Credit

 

Sample Format of an Opening Entry in a Journal Proper

 Date  Particulars  LF.  Debit  Credit
mm/dd Cash A/C   35,000  
  Furniture A/C   15,000  
  To Sundry Creditors A/C     24,000
  To Capital A/C     26,000

All amounts mentioned in the sample format are the closing balances of the previous year balance sheet.

 

Closing Entries

Almost the opposite of the opening entries, they are recorded at the end of a financial period; closing entries are related to nominal accounts. These accounts are closed by transferring their balances to trading and profit and loss accounts. A record is not included in the ledger without a journal entry, so closing entries are recorded with the help of a journal proper and then recorded in the ledger.

Example

Profit & Loss A/C Debit
To Salaries A/C Credit

At the end of a period Salary account is closed by transferring its balance to profit and loss account.

 

Rectification Entries

In the world of accounting erasing or removing a journal entry once recorded is a strict NO!. Mistakes should only be corrected by passing another entry in the journal.

Example

Purchase for 10,000 was omitted by mistake, it belonged to Unreal Pvt Ltd.

Rectification entry, in this case, will be

Purchase A/C 10,000
To Unreal Pvt Ltd. 10,000

 

Transfer Entries

In simple terms, the transfer entry is used to transfer an item from one account into another. All such transfers are made with the help of journal entries.

Example

Let us take an example where a general reserve is created for a business by transferring 5,00,000 from the profits.

 Date  Particulars  LF.  Debit  Credit
mm/dd Profit & Loss A/C    5,00,000   
  To General Reserve     5,00,000

Adjustment Entries

The amount of expenses or incomes may need to be adjusted for advances paid or received at the end of a financial period, these types of adjustments are made with the help of a journal entry. They are very common at the end of an accounting period. Adjustment entries are mainly used for accrual or depreciation related entries.

Example

There are outstanding wages of 50,000 which need to be accounted for

 Date  Particulars  LF.  Debit  Credit
mm/dd Wages A/C    50,000  
  To Outstanding Wages A/C     50,000

 

Miscellaneous or Other Entries

In addition to the above entries, there are other entries that can be recorded in a journal proper. They are:

  • Discount allowed and received
  • Purchase or sale of items on credit other than goods
  • Effects of accidents such as losses due to fire
  • Consignment and joint venture transactions
  • Endorsement and dishonour of bills of exchange
  • Transaction for goods distributed as samples
  • Sale of obsolete assets

 

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What is Sales Return Book?

Ahuja Sahil
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Sales Return or Returns Inward Book

When a business sends the ordered goods back to a vendor it is recorded in the sales return book. At times the buyer may return goods due to poor quality, inaccurate quantity, untimely delivery or other reasons. It is also called returns inwards and an appropriate sales return or a returns inward book is maintained.

All returns are primarily recorded in the sales return book unless the returns are not that frequent, in which case they are recorded in the journal.

Sample Format of Sales Return Book

 Date  Particulars  Credit Note No.  LF.  Currency  Amount

 

Note: A column for “Remarks” can also be added to the Sales return book which would include a brief description of the reason why the goods were returned.

 When the goods are returned by the customer, a credit note will be prepared and sent out to his name. A duplicate copy is kept for recording and reference purposes. The returns inward book is totalled at the end of each month.

Related Topic – How to Post from Journal to Ledger?

How to Post Entries from Sales Return Book into Ledger?

After the sales return book is properly updated and all transactions are entered into it, the total of the items is transferred to the ledger in an account called the “Sales returns account”

  1. At the end of the day, each entry is posted to the credit side of the appropriate individual’s account in the Debtors’ ledger as this helps the account to remain up to date.
  2. At the end of the month, the total of the “Amount” column is posted to the general ledger with the help of following journal entry.

Journal entry for sales returns

Sales Returns A/C Debit
To Debtors Credit

 

Lite© – Learning Initiative Through Example(s)

 Let’s assume that total sales returns made at the end of a month are 50,000.

  1. Returns made by A are 30,000.
  2. Returns made by B are 20,000.

These 4 different ledger accounts will be updated from the sales returns book.

Sales Return A/C

 Date  Particulars  Amt  Date  Particulars  Amt
 mm/dd  To Sundry Debtors A/C  50,000

 

 Sundry Debtors A/C

 Date  Particulars  Amt  Date  Particulars  Amt
       mm/dd  By Sales Returns A/C   50,000 

 

A’s Account

 Date  Particulars  Amt  Date  Particulars  Amt
 mm/dd  By Sales Returns A/C   30,000

 

B’s Account

 Date  Particulars  Amt  Date  Particulars  Amt
 mm/dd  By Sales Returns A/C  20,000

 

 

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What is Purchase Returns Book?

Ahuja Sahil
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Purchase Returns or Returns Outward Book

At times it may be necessary to return few goods back to a supplier when an order is received, this may be due to poor quality, inaccurate quantity, untimely delivery or other reasons. Purchase returns are also called returns outward and an appropriate purchase returns/returns outward book is maintained.

All returns are primarily recorded in the purchase returns book unless the returns are not that frequent, in which case they are recorded in the journal.

Sample Format of Purchase Returns Book

 Date  Particulars  Debit Note No.  LF.  Details  Amount

 

Note: A column for “Remarks” can also be added to the purchase book which would include a brief description of the reason for why the goods were returned.

When the goods are returned, a debit note will be sent along with them and a debit note number is mentioned in the purchase returns book. In return, the supplier is expected to send a credit note. The returns outward book is totalled at the end of each month.

 Related Topic – What is a Purchase Book?

How to Post Entries from Purchase Returns Book into Ledger?

After the purchase returns book is properly updated and all transactions are entered into it, the total of the items is transferred to the ledger in an account called the “Purchase returns account”.

  1. At the end of the day, each entry is posted to the debit side of the appropriate individual’s account in the creditor’s ledger as this helps the account to stay up to date.
  2. At the end of the month, the total of the “Amount” column is posted to the general ledger with the help of the below-mentioned journal entry.

Journal entry for purchase returns

Creditor A/C Debit
To Purchase Returns A/C Credit

 

Example: Let’s assume that the total purchase returns made at the end of a month are for 50,000.

  1. Returns made to A are 30,000.
  2. Returns made to B are 20,000.

These 4 different ledger accounts will be updated from the purchase returns book.

 Purchase Returns A/C

Date Particulars Amt Date Particulars Amt
mm/dd By Sundry Creditors A/C 50,000

 

Sundry Creditors 

Date Particulars Amt Date Particulars Amt
mm/dd To Purchase Returns 50,000

 

A’s Account

Date Particulars Amt Date Particulars Amt
mm/dd To Purchase Returns 30,000

 

 B’s Account

Date Particulars Amt Date Particulars Amt
mm/dd To Purchase Returns 20,000

 

 

Short Quiz for Self-Evaluation

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What is a Sales Book?

Ahuja Sahil
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Sales Book

Sales book records all credit sales made by a business. It is one of the secondary book of accounts and unlike cash sales which are recorded in cash book, sales book is only to record credit sales. The amount entered in the sales book is on behalf of invoices supplied to purchasers, however, a copy remains with the firm.

Sales book is also called a Sales Journal or Sales Day Book.

Sample Format of Sales Book

Sample format of sales book

 

Lite© – Learning Initiative Through Example(s)

Prepare the sales book of Unreal Pvt Ltd. from the following particulars given below,

Jan 7 – Sold 10 Keyboards to ABC Co. for 300 each.

Jan 24 – Sold 5 headphones to XYZ Co. for 200 each.

Sales book for Unreal Pvt Ltd.

 Date  Particulars   Outward Invoice No.   LF.  Details   Total
 Jan 7  ABC Co. 300×10 Keyboards      3,000  3,000
 Jan 24  XYZ Co.   200×5  Headphones      1,000  1,000
         Total  4,000

Related Topic – What is a Trade Discount?

How to do Ledger Posting of Sales Book?

After all the transactions are posted in sales book the business needs to post them to the related ledger accounts. Following are the steps that need to be followed to post the amounts from sales book to the ledger,

  1. Each entry is posted to the debit side of appropriate individual account in the debtor’s ledger at the end of the day, this keeps the accounts up to date.
  2. The column for “Total” is then summed at the end of each month & posted to the ledger.

Journal Entry for Credit Sale

Debtor’s A/C  Debit
To Sales A/C  Credit

 

Example

Let’s say total sundry debtors at the end of a month are 50,000 where credit sales made from A is 30,000 & B is 20,000 during the period.

 Here are the 4 ledger entries that will be recorded,

Sales Account

 Date  Particulars  Currency  Date  Particulars  Currency
 mm/dd  By Sundry Debtors per Sales Book 50,000

 

Sundry Debtors Account

 Date  Particulars  Currency  Date  Particulars  Currency
 mm/dd  To Sales A/C  50,000

 

A’s Account

 Date  Particulars  Currency  Date  Particulars  Currency
 mm/dd  To Sales A/C  30,000      

 

B’s Account

 Date  Particulars  Currency  Date  Particulars  Currency
 mm/dd  To Sales A/C  20,000   

 

 

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What is a Purchase Book?

Ahuja Sahil
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Purchase Book

It is also known as a Purchase journal, Invoice book or Purchase daybook. A purchase book is a special-purpose subsidiary book prepared by a business to record all credit purchases. Nowadays all these recordings occur in ERPs and only small firms resort solely to notebooks or MS Excel.

A few things to note are,

  • Purchases recorded are only for goods or items related to core business operations of a company i.e. goods procured for resale.
  • Example – If a grocery business purchases office furniture it will not be posted in the purchases book as it is considered as a “purchase of an asset” and not goods.
  • Cash purchases are recorded in the cash book and credit purchases are recorded in the purchase book.

 

Sample Format or Template

Purchase Book Template

Related Topic – What is Cash Discount & its uses?

Example

Prepare the purchase subsidiary book of Unreal Pvt Ltd. from the following details.

Jan 7 – Purchased 10 Keyboards from ABC Co. for 300 each (for resale, invoice # 60)

Jan 24 – Purchased 5 headphones from XYZ Co. for 200 each (for resale, invoice # 75)

 

The Book of Purchases for Unreal Pvt Ltd.

Purchase Book example template

The total purchases at the time of preparing the above records are 4,000 made from 2 companies ABC Co. (3,000) & XYZ Co. (1,000)

 

>Read What is a Purchase Returns Book?

 

What is Trade Discount?

Ahuja Sahil
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Trade Discount

A reduction granted by a supplier of goods/services on list or catalogue price is called a trade discount. This is done due to business consideration such as trade practices, large quantity orders, etc.

It is not separately shown in the books of accounts; entries recorded in purchase book or sales book are recorded as the net amount, i.e. Gross Amount – Trade Discount.

It is mainly provided to increase the volume of sales attained by a supplier. It is also known as a functional discount.

 

Example

Let’s assume that 100 keyboards are sold for the list price of 300 each with a trade discount of 10%.

100 Keyboards X 300 each 30,000
Less 10% of 30,000 30,000 – 3000 = 27,000 (Net Amt)

It is not shown separately instead Net amount is used in the financials.

Related Topic  – Difference Between Bill of Exchange and Promissory Note

 

Journal Entry for Trade Discount

It is generally recorded in the purchases or sales book, but it is not entered into ledger accounts and there is no separate journal entry. However, here is an example demonstrating how a purchase is accounted in case of trade discount.

Let’s assume that 10 tables are purchased from Unreal Pvt Ltd. at the list price of 3000 per item and 10% discount (trade) is allowed. Accounting for the transaction will happen as follows:

Total list price = 10 x 3000 = 30,000

Less (T.D) = 10% of 30,000 = 3000

Amount to be recorded = list price – discount = 30,000 – 3000 = 27,000

Purchase A/C 27,000
 To Unreal Pvt Ltd. 27,000

 

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What is Cash Discount?

Ahuja Sahil
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Cash Discount

A cash discount is a deduction allowed by the supplier of goods or by the provider of services to the buyer from the invoice price. This is done as an incentive in return for paying a bill within a specified time.

Usually, the supplier will reduce the amount owed by a small percentage, e.g. 2%. It can be used by a business to improve the Days Sales Outstanding (DSO). It is not necessary for the supplier to offer a cash discount.

It is shown as an expense in the income statement (profit and loss account)

 

Few Benefits of Cash Discount

  • A cash discount is beneficial to the supplier as it allows him to have access to cash much sooner and therefore ensure liquidity to the business.
  • If used efficiently, a cash discount is beneficial to the buyer as not a mere tool to save some money, but also as a means of maintaining a healthy credit line and a good relationship with the supplier.

 Related Topic – How to show Trade Discount in Purchase Book?

 

Example

Common terms are 2/10, Net 30 (or) 2%/10 days, Net 30. This payment term means that the buyer has an option to avail a 2% cash discount from the invoice price if the payment is made within the first 10 days of receiving the invoice.

If the cash discount is not availed, the net amount due is to be paid within Net 30 days. The payment terms can be modified depending on the supplier’s needs.

Let’s say that 100 keyboards are sold for the invoice price of 300 each and the payment terms are 1/10, Net 30 days.

It means that the buyer will get a 1% cash benefit from the total invoice price if the payment is made within the first 10 days of receipt of the invoice. (Assuming there is no trade discount)

Amount due as per Invoice 30,000
Less Cash Discount 1% 300
Cash to be paid within 10 days 29,700

The buyer has a choice to not avail the discount. In this case, the total amount due will be 30,000 which can be paid within 30 days.

 

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What is a Voucher?

Ahuja Sahil
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Voucher

A document that serves as evidence for a business transaction is called a Voucher. Sometimes, mistakenly seen as just a bill or receipt; it can have many other forms.

It is not the appearance of it that matters it just needs to act as evidence of a transaction. When a transaction is entered, the evidence of that transaction is also confirmed. A voucher helps in recording expenses or liability and further helps in its payment.

They are also called source documents as they help in identifying the source of a transaction. A few examples of vouchers include bill receipts, cash memos, pay-in-slips, checks, an invoice, a debit or credit note.

 

Format and Template of Voucher (Invoice)

 

Accounting Voucher

Open and Download PDF

Related Topic – What is a Promissory Note?

 

Different Types of Vouchers

  1. Source Vouchers
  2. Accounting Vouchers

Source Vouchers

Documents which are created at the time when a business enters into a transaction are called source vouchers, for example, rent receipts, bill receipts at the time of cash sales, etc.

They are expected to contain complete details of a transaction duly signed by the maker and act as evidence of the transaction.

Accounting Vouchers

This type of a voucher basically analyzes a business transaction from the accounting standpoint and is used for recording purposes.

These are commonly prepared by accountants on the basis of supporting vouchers and approved by a different individual.  They are further subdivided into two, cash and non-cash vouchers.

Examples of cash type

  1. Credit vouchers
  2. Debit vouchers

Examples of the non-cash type

  1. Debit note
  2. Credit note
  3. Invoices

 

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What is the Accounting Equation?

Ahuja Sahil
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Accounting Equation

It wouldn’t be wrong to say that this equation is the basis of all accounting. The Accounting Equation is based on the dual aspect concept of accounting, which says that every transaction has two aspects, debit and credit, and for every debit, there is equal and opposite credit.

This equation is also called the Balance Sheet Equation. It helps to prepare a balance sheet, which is the most vital step in creating financial statements.

The Accounting Equation

This relationship between Assets, Capital and Liabilities is called the Accounting Equation or the Balance Sheet Equation. In general, the expression Assets = Capital + Liabilities is termed as the Accounting Equation, but you can use any of the above relationships till the time you understand the fundamentals of the equation.

Therefore, at any point, the total number of assets of a firm is equal to the total number of liabilities. That is because the equation indicates that sources of funds are equal to the uses of funds. In other words, the equation means that capital and liabilities together are equal to assets at all times.

 

Key Highlights

  • The accounting equation acts as a basis for accounting and uses the dual aspect principle of accounting.
  • It is also known as the Balance Sheet Equation.
  • According to the balance sheet equation, total assets are always equal to the sum of capital and external liabilities.

 

Lite© – Learning Initiative Through Examples

A Business has assets worth 2,00,000 and owner’s equity of 69,000. What is the amount of liability that the business has?

Total assets = Total liabilities + Capital (or) Owner’s Equity

2,00,000 = Total liabilities + 69,000

2,00,000 – 69,000 = Total liabilities

1,31,000 = Total liabilities

Related Topic – What is a Journal (with template)?

 

Application and Integrity of the Accounting Equation

In the below-mentioned example, we will deal with 2 different transactions that took place in a newly started business called Unreal Pvt Ltd. This example will help you clearly understand how a transaction affects the variables involved in an accounting equation and still maintains the integrity of the equation.

 

1. Unreal Pvt Ltd. starts a business with 1,000,000 cash (1 Million)

Variables Affected Net Effect of Transaction Accounting Equation
Capital & Assets Assets & Capital Both Increase Assets = Liabilities + Capital
    1,000,000 (cash) = 0 + 1,000,000

Starting a business with 1 million means that the business owner introduced capital or in other words owner’s equity is 1M, which, in this case, was brought inside the business in the form of cash. Therefore, their cash increased by 1M and capital also increased simultaneously by the same amount.

 

2. They purchase raw material for 50,000 cash

Variables Affected    Net Effect of Transaction Accounting Equation
Only Assets Raw material (Asset) increases and Cash (Asset) decreases  by 50k Assets = Liabilities + Capital          
    1M + 50k – 50k (Cash) = 0 + 1M

Unreal Pvt Ltd began operations by purchasing raw material for their business for 50,000 in cash. This transaction ultimately reduced 50k worth of cash and added 50k worth of raw material to the business.

Similarly, when other more complex transactions take place in business, the accounting equation will get affected each time, but it would still maintain its basic fundamental of assets being equal to the sum of capital and liabilities.

 

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