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Topic 1
Financial Accounting
Meaning
ScopeImportance
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Accounting-Introduction
American Institute of certified PublicAccountants
(AICPA)
Accounting is the art of recording,classifying & summarizing insignificant manner and in terms of
money, transactions & events whichare, in part at least , of a financialcharacter and interpreting the results
there of2
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Accounting-Introduction
Smith & AshburneAccounting is the science of recordingand classifying business transactions
and events, primarily of a financialcharacter, and the art of makingsignificant summaries, analysis and
interpretations of those transactionsand events and communicating theresults to persons who must makedecisions or form judgment.
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Functions of Accounting
1.Recording
2.Classifying
3.Summarizing
4.Deals with Financial Transactions
5.Analysis and Interprets6.Communicates
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Branches/Scope of Accounting
Financial Accounting
Cost Accounting
Management Accounting
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Financial Accounting
Original form of accounting.
Kohler in Dictionary for accountants, has defined
financial accounting as the accounting for
revenues, expenses, assets and liabilities that iscommonly carried on in the general office of a
business.
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Cost Accounting
It involves classification, accumulation, assignment
and control of costs.
Purpose of cost accounting is to ascertain the cost of
production, to enable the management fix the priceof the product and to ensure cost reduction.
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Management Accounting
Management Accounting is concerned with
accounting information which is useful to the
management in formulating policies and controlling
the business operations.
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Financial vs. Management Accounting
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Financial & Cost Accounting Tracks Historical data
Internal Data
Used for External Reporting
Governed by Law and
Regulations
Used by shareholders,
lenders, suppliers,
government agencies, etc.
Management Accounting Uses Historical & Forecast
Internal & External Data
Used for Internal Reporting
and Decision Making
Free-format and changes
according to users needs
Exclusive use of managers at
different levels
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Importance of Accounting
1.Assistance to Management
i)Planning
ii)Decision Making
iii)Controlling Management2. Replacement of Memory
3. Comparative Study
4. Settlement of Taxation Liability5. Evidence in court
6. Sale of Business
7. Assistance to an Insolvent Person 10
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Topic 2Accounting Principles
Accounting principles may be definedas those rules of action or conduct
which are adopted by the accountantsuniversally while recordingtransactions. These principles can be
classified into two categories:Accounting Concepts
Accounting Conventions11
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Continued---
Accounting Concepts
Basic assumptions or conditions uponwhich the science of accounting isbased.
Accounting ConventionsThose customs or traditions whichguide the accountant while preparing
the accounting statements.12
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Accounting Concepts
1. Separate Entity
2. Going Concern
3. Money Measurement
4. Cost
5. Dual Aspect
6. Accounting period7. Periodic Matching of Cost &
Revenue
8. Realization Concept13
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Accounting Conventions
1. Convention of Conservatism2. Convention of Full Disclosure
3. Convention of Consistency
4. Convention of Materiality
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Assignment No 1Last date of submission Oct 04,2010
For Lateral EntriesQ1. Define Accounting. Explain itsscope and importance.
Q2. state the persons who should beinterested in accounting information.
Q3. what are the accounting conceptsand conventions? Explain them withexamples.
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Accounting Terminology1.Capital
2.Liabilitiesi) Long term Liability
ii) Current Liability
3. Assetsi) Fixed Assets
ii) Current Assets
4. Revenue5. Income
6. Gain
7. Expense16
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Continued---
8. Expenditure
9. Purchases
10. Sales
11. Stock
12. Debtors
13. Receivables
14. Creditors15. Payables
16. Losses
17. Proprietor 17
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Continued---
18.Drawings
19. Discount
i) Trade Discount
ii)Cash Discount
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Topic 3Formation & Imp. of Accounting standards
Accounting standards may be defined as written
statements, issued from time to time by institutions
of accounting professionals, specifying uniform
rules or practices for drawing the financial
statements.
Kohler defines accounting standards as a code
of conduct imposed on accountants by custom, law
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Nature
Lay down the norms of accounting policies
Makes financial statements of different business unit
comparable
Prescribe a preferred accounting treatment
Provide basis of financial statements and information to
the users
Set the limits within which accountant has to function.20
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Importance
It improves the reliability and credibility of financial
statements
It ensures the consistency and comparability of financial
statements
It helps in resolving conflict
It reduce the chances of manipulation and frauds
Helpful to Auditors.21
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Topic 4Accounting Process
1. Identification of Transactions
2. Preparation of Vouchers
3. Recording4. Classifying
5. Summarizing
6. Analysis and Interpretation
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Recording
Journal and Subsidiary Books
Journal is that primary book of accounts in which
transactions are originally recorded in a
chronological (day to day) order.In case number of transactions are large, journal is
categorized into various subsidiary books, namely
Cash Book, Purchases Book, Sales Book, SalesReturn Book, Purchases Returns Book, Bills Payable
Book, Bills Receivable Book, and Journal Proper.
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Double Entry System
In all the business firms, transactions are recorded under theDouble Entry System, which is derived from the basic
concept of Dual Aspect of accounting.
Dual Aspect of Accounting
Assets = Liabilities + Capital
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Account
An account is a summarized record of relevanttransactions at one place relating to a particular head.
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A f 3
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Accounts are of 3 types1. Personal Account
Relates to some personAn individual - Ram
A company - RIL
Debtor, Creditor, Capital Account, Drawing Account.
Rule of Double Entry System
Debit the Receiver and Credit the Giver
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2. Real Account
Relates to tangible or intangible assets of the firm.
Machinery, Plant, Land, Equipment, Building, Stock, Cash,
goodwill, patents etc.
Rule of Double Entry System
Debit what comes in and Credit what goes out
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3. Nominal Account
Relates to expenses, losses, revenues and gains.
Expenses and Losses Salaries Paid, Interest Paid, Loss by
fire, Theft, etc.
Revenues and Gains - Sales proceeds, Income from other
sources, Profit earned.
Rule of Double Entry System
Debit all expenses & losses and credit all revenues & gains
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Guidelines for Debit and Credit Entries
Item Increase in Value Decrease in Value
Asset Debit Credit
Expense Debit Credit
Income Credit Debit
Liability Credit Debit
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Journal Entry
Date Description L.F Debit Credit- Cash a/c Dr. 20,000
To Ram 20,000
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Classifying
Ledger
Entries are made in the journal in serial order as
transactions take place.
Transactions of one nature are posted in an account.
All the accounts put together is known as Ledger
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Working of Ledger
A separate page is allotted to an individual A/c.
Each account has two sides.
Amount and details are brought to the account
from the journal.
This process is called Posting.
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A/c
Dr. Cr.
DATE
-------
PARTICULARS
To ------------
J.F Amt. DATE
-----------
PARTICULARS
By -------------
J.F Amt.
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Preparing a Trial Balance
1. When? At the end of an accounting period.
2. Why? Verification of the sum of debit andcredit balances of the ledger accounts.
3. What? Is a statement of account balances and
their totals.
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Topic 5
Depreciation
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Depreciation is the decrease or depletion in the
value of an asset.
Depreciation is a gradual decrease in the value of
an asset from any cause
Depreciation accounting is a system of
accounting which aims to distribute the cost in a
systematic manner.
It is the process of allocation and not of valuation
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R.N. Carter
Depreciation is the gradual and permanent decreasein the value of an asset from any cause
Spicer & Pegler
Depreciation is the measure of the exhaustion of the
effective life of an asset from any cause during a
given period
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S i
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Special Features
All fixed assets with certain exceptions (Land andAntiques) suffer depreciation
Fall is of permanent nature.
Gradual & continuing process.
It is a process of allocation of the cost of an asset.
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S i l F C i d
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Special Features Continued---
It is a non-cash expense.It represents only book value not mkt. value
Used only in respect of fixed assets
Is a charge against profits
Is different from maintenance
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C
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Causes
By Constant UseBy Expiry of time
By Expiry of legal rights
By Obsolescence
By Accident
By Depletion
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I t
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Importance
For ascertaining the true profit or lossFor showing the true and fair view of the
financial position
To ascertain the accurate cost of production
To provide funds for replacement of assets
To prevent the distribution of profits out of capital
For avoiding over payment of income tax
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F t Aff ti
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Factors Affecting
Total cost of the assetEstimated useful life of Asset
Estimated scrap value
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M th d f D i ti
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Methods of Depreciation
Straight Line Method
Written Down Value Method
Annuity Method
Depreciation Fund Method
Insurance Policy Method
Revaluation Method
Depletion Method
Machine Hour Rate Method 43
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Straight Line Method
Depreciation is charged evenly every year
throughout the effective life of the asset.
This method is also known as:
Equal Installment Method Fixed Installment Method
Original Cost Method
Straight-Line
Depreciation
Expense
=
Asset Cost - Salvage Value
Useful Life
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On January 1, 2009, Monroe Inc. purchased oil
pumping equipment for Rs. 62,000 cash. The
equipment has an estimated useful life of 5 yearsand Monroe expects to sell the equipment at the end
of its life for Rs.2,000 cash.
Lets compute depreciation expense for the yearended December 31, 2006.
2009
Depreciation
Expense
=
Rs.62,000 - Rs.2,000
5
= Rs.12,000
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Merits
Simplicity
Equality of depreciation burden
Assets can be completely written off
Useful for those assets which get depreciated more on
account of expiry of period e.g. lease hold properties,
patents etc.
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Demerits
Total charge for use of the asset goes on increasing
Undue pressure in later years
Unrealistic to written off the value to Zero
Difficulty in determining of scrap value
Does not take into account, the effective utilization of the
assets.
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Written Down Value Method
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Written Down Value Method
Depreciation is charged on the Book Value of the
asset each year.Book Value = Original Acquisition Cost Total
Accumulated Depreciation
This method is also known as
Reducing Installment Method
Diminishing Balance Method
If depreciation rate is not given
Depreciation Rate = 1-n net residual value
acquisition cost48
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Merits
Equal Charge Against Income
No undue pressure in later years
Balance of asset is never written off to zeroApproved method by income tax authorities
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St i ht Li V W itt D
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Straight Line Vs. Written Down
Amount of Depreciation
Basis of calculation of depreciation
Zero Level
Combined effect of depreciation & repairs on P&L A/c
Rate of Depreciation
Approval of Income Tax authorities
Suitability
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A it M th d
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Annuity Method
Annuity method considers both the value of the
asset and amount of interest which might have beenearned, when this amount is used elsewhere. The
interest is debited to asset account and is credited to
profit and loss account.
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D i ti F d M th d
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Depreciation Fund Method
This method provides funds for the replacement of
the asset at the end of its servicing life. The amountof depreciation is credited to an account called
depreciation fund account which is shown on the
liabilities side of the balance sheet.
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I P li M th d
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Insurance Policy Method
In this method an insurance policy is purchased for
the value of the asset. This policy is taken up for thelife of the asset and it matures at a time when the
asset is to be replaced.
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R l ti M th d
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Revaluation Method
In this method the amount of depreciation is
calculated by revaluing the asset at the end of eachyear. The difference between the value of the asset
at the beginning and the end of the period is taken
as depreciation.
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D l ti M th d
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Depletion Method
This method is specially used for those assets
which deplete with use. The cost of the assets isdivided by total workable deposits.
For e.g.:- If a mine has 2 lakh tons of coal and the
value of mine is Rs. 5 lakhs, each ton of coal willcost Rs. 2.5 and the resultant figure will be the
amount of depreciation.
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M hi H R t M th d
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Machine Hour Rate Method
The life of the asset is estimated in hours. The value
of the asset minus scrap value is divided by theestimated number of hours. In this way a machine
hour rate is calculated. Machine hour rate
determines the amount of depreciation per hour.
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i 6 i l A f C
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Topic 6: Final Accounts of Non Corporate
Entities
Capital Expenditure
Acquisition of Fixed
Assets
Expenses incurred onAcquisition
Expansion of Fixed Assets
Revenue Expenditure
Daily routine expenses
Up keep of Fixed Assets
Purchase of stocks ofMaterial
Depreciation
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Expenditure
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Final Accounts
Why ?
To know about two essential facts.
1. Whether he has earned a profit or suffered a lossduring a period
Reply is Income statement (Trading Account andProfit and Loss Account)
2. Where does he stand now/what is the financial
positionReply is Balance sheet
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Income Statement
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Income Statement
Trading Account
Gives the overall result of trading, i.e. purchasing &selling of goods and tells about Gross profit/Loss.
Trading Account
For the period ending XXXXParticulars Amt. Particulars Amt.
To Opening Stock
To Purchases -
Less: Returns -
To Direct Expenses
-
-
-
By Sales -
Less: returns -
By Closing Stock
-
-
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Important Points
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Important Points
Stock
Opening stock
Closing stock
Purchases: Cash + Credit
Sales: Cash + Credit
Direct Expenses: wages, wages and salaries,
customs and import duty, Freight, carriage and
cartage, Royalty, Gas, electricity, water, fuel,
Packing materials
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Profit and Loss Account
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Profit and Loss Account
Gives the net result of the business after considering
all other operating expenses and incomes.
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Important Points
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Important Points
Gross Profit or Gross Loss
Operating Expenses/Incomes: Salaries, Interest,Commission, Trade expenses, Printing and
Stationery, Advertisement, Bad debts,
Depreciation, Discount.
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Balance Sheet
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Balance Sheet
Balance sheet is a statement containing the assets
and liabilities of a business on a particular date. It is a classified summary of the various remaining
accounts.
It has two sides Left hand side represents Liabilities
Right hand side represents Assets
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Balance sheet as on ------
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Balance sheet as on Liabilities Amt. Assets Amt.
Capital A -Add Net Profits -
Less Drawings -
Long term loan
Sundry creditors
Bills payble
Bank overdraft
-
-
-
-
-
GoodwillLand
Building
Plant and Machinery
Furniture
Closing Stock
Debtors
Bills Receivable
Prepaid Expenses
Cash at bank/hand
--
-
-
-
-
-
-
-
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Assets: all rights or properties which a businessowns
Current Assets: acquired with the intention ofconverting into cash during normal businessoperation period
Liquid Assets: immediately convertible
Fixed Assets: acquired for relatively long periodsfor carrying on the business and are not meant forresale
Intangible Assets: which cannot be seen andtouched
Fictitious Assets: not represented by tangible
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i bili i l i i h f fi
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Liabilities: claims against the assets of a firm
whether those of owners or of the creditors
Current Liabilities: payable within a yearFixed Liabilities: other than current liabilities
Owners Liability/Equity: capital+Profits
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Adjustment Entries
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Adjustment Entries
Closing Entries: are required to transfer the
balances of accounts which are supposed to transferin Trading a/c or P&L a/c. Say all income andexpenses a/c
Closing stock:
closing stock a/c Dr.
To Trading a/c
The stock at the end appears in the Balance
Sheet.If the value of the stock is given in the Trial
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O t t di E
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Outstanding Expenses
become due during the accounting period but havenot been paid
Expenses a/c Dr.
To Outstanding Expenses a/c
Liabilities side of balance sheet.
Will be added in the expense in the Debit side of theP&L a/c
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Prepaid Expenses
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Prepaid Expenses
which have been paid in advance
Prepaid Expense a/c Dr.
To Expense a/c
Asset side of Balance SheetWill be deducted from Expense in the debit side
of P&L a/c
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O di I
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Outstanding Incomes
which has become due during the accounting year butwhich has not so far been received.
Outstanding Income a/c Dr.
To Income a/cAsset side of Balance Sheet
Will be added in Income in the credit side of P&L
a/c.
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A d I
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Accrued Income:
earned but which has not yet become due
Accrued Income a/c Dr.
To Income a/c
Asset side of Balance Sheet
Will be added in Income in the credit side of P&La/c.
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Income Received in advance
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Income Received in advance
has been received before it being earnedIncome a/c Dr.
To Income Received in Advance a/c
Deducted from the Income in Credit side ofP&L a/c.
Liabilities side of P&L a/c
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Depreciation
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Depreciation
Decrease in the value of asset due to wear and tear,
lapse of time, and accident.
Depreciation a/c Dr.
To Fixed Asset a/c
Debit side of P&L a/c
Deducted from the asset in the assets side of the
Balance Sheet.
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Bad Debts
Bad debts occur when there are credit sales.
It is a loss to the business and a gain to the debtor.
Bad Debts a/c Dr.To Debtors Personal a/c
Debit side of P&L a/c
Deducted from the asset in the assets side of theBalance Sheet.
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P i i f B d D bt
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Provision for Bad Debts
A firm makes provision at the end of the accoun-ting year for likely bad debts which may happen
during the course of the next year
Profit and Loss a/c Dr.
To Provision for Bad Debts a/c
Deducted from debtors in the Balance Sheet
Charged from the P&L a/c
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I t t C it l
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Interest on Capital
In order to determine the true profit, it isnecessary that the profit should be determined
after deducting interest on such funds, which the
proprietor could have earned otherwise.Interest on Capital a/c Dr.
To Capital a/c
Debit side of P&L a/cWill be added in capital in the liabilities side
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I t t D i
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Interest on Drawings
It is usual practice to charge interest on drawings incase interest is allowed to the proprietor on his
capital.
Capital a/c Dr.To Interest on Drawings a/c
Credit side of P&L a/c
Will be deducted from the capital in the liabilities
side