ACCOUNTING DEMISTIFIED FOR

EVERYONE

by :
DR. T.K. JAIN
AFTERSCHO☺OL
centre for social entrepreneurship
sivakamu veterinary hospital road
bikaner 334001 rajasthan, india
afterschoool@in.com
mobile : 91+9414430763

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What is accounting, accountancy
and bookkeeping?
Accountancy is science which gives principles
of accounting. Accounting means recording,
analysing and presenting information about
transactions involving money. Book keeping is
a part of accounting, where you undertake
recording of the day to day transactions.
Accounting has further many parts : financial
accounting, 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 day
book 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 and
there is nothing like day book or journal or
posting – you straight make the entries.
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 What is a day book and ledger?
We keep day book for recording day to day
transactions. Generally we have 4 types of
transactions : purchase, sale, other
expenditure, other income. These can be
against 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 in
cash book. For other income and and other
expenditure,
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we make record in
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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 or
liabilities. Each transaction has two aspects.
Bot these aspects must be analysed in terms of
impact on assets or liabilities. Remember the
basic accounting equation :
Assets = liabilities + capital
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 transaction????

Transaction means any dealing which has a

bearing on either assets or on liabilities or on
both.
Thus when you purchase raw material, your
inventory (assets) will go up and your cash
(assets) will reduce.

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 Principles of posting.....

When assets increase, debit that transactions

and when liabilities increase, credit that
transaction. Thus any transaction that
increases assets must be debited. Remember,
your loss is treated as an asset and profit is
treated as liability (because profit belongs to
owner – who is external to the organisation)
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 posting....

When you increase income, it is credited and

when 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 the
year, unless it is related to next year (like
prepaid expenditure)
real : assets
personal: debtors, creditors, owner (capital)
etc.
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 Prepare accounts from the followng
summary of totals of various accounts
in all the ledgers that the company
has ?

Capital 10, building 4, wages 2, sales 100, interest paid 2,

purchase 30, salary 10, repairs 1, postage 1, commission
received 1, interest received 1, bad debt 1, debtors 10,
creditors 3, cash 10, investments 4, depreciation 1, plant
20, provision for bad debt 1, furniture 10, loan 20.
Provision for bad debt must be 20% of debtors. Opening
stock 10, closing stock 10

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 Step 1 – trial balance
Which accounts will have debit balance ?
building 4, interest paid 2, purchase 30, salary 10, repairs 1, postage
1 , 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 136
trial 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 70
debit 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 traced
out. Accouting is like mathematics, it will not
match, if trial balance totals dont match. We
have created additional provision for bad debit
of 1, because it has to be 20% of debtors (we
already 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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 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, investment
90, 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 and
assets are equal, that has to be there otherwise,
we have to create a suspense account to match
them and find the reasons for difference
(remember, the totals of assets and liabilites is
equal, and totals of debit and credit side of trial
balance is also equal). Arrange these in
liquidity order or permance order. Now look at
their financial health.
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 liquidity???

Do the company has ability to meet short term liabilities

and to encash opportunities that come to the company. For
this let us judge liquidity. Compare current assets and
current 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 must
have been at least 2 times current liabilitie.s

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 Liquidity – acit test ratio
Look at those current assets which are quick
assets, - 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 curent
liabilties. 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 finding
solvency, 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 is
comfortable 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)
= 915
sales was 1300, so
fixed turnover ratio is : 1300/915 = 1.4, which is not a
very good one. But we have to compare these ratio to
other companies in the same industry. It is possible that it
is 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 their
money. 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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 ROI

Profit = 125
equity : 500 (you can take reserves also with equity, if
you wish).
so ROI = 125/500*100 = 25% which is good. If we look
at total capital employed, we can take preference shares,
and debt also to find our ROCE, then we have to take
profit before interest and taxes, but that data is not
available to us.

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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 income
actually come
adopt the principles of conservatism, prudence.

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What are provisions & reserves ?

We prepare provisions for some uncertain

situation – and for a particular situation.
Reserves are general and can be used for any
purpose. We make provisions for things like
bad debts etc. Thus provisions are for those
situations 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 account
assets and provisions are real accounts and will
continue for ever, so they will appear in balance sheet
every year
personal accounts include debtors, creditors, capital
account, 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 a
journal 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 make
a provision for 5% for future.
Your trial balance shows a bad
debt of 15000. what entry will
you 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 be
P& 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 will

disappear 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 appear
in balance sheet. We have made only one entry of
this account, thus it will show credit balance and
will appear in both P & L account and balance
sheet 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, creditors
11, opening stock 18, closing stock 15.

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 continued...
write off bad debts 2, maintain provisions of
5% on debtors, goods costing 2 sent to
customer on sale or returned basis on 1/3/9
recorded as actual sales. Rate of gross profit
was 16.67% of sales. Rent of office 1 debited
to landlord's account and were included in
debtors, manager gets 10% commission on net
profit after charging commission of work
manager and his own. Work manager gets 5%
on gross profit
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 Steps

Prepare trial balance, find out adjustments to

be 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 will
have 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 this
transfer their balance to trading account or P & L
account, assets and liabilities acccounts and
personal 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, bad
debts 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 2
less – 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 & L
account = 1.25
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