In this article we will discuss about the books of accounts and final statements maintained by business entity within the framework of the rules of accountancy: 1. Journal 2. Ledger 3. Cash Book 4. Trial Balance 5. Profit and Loss Account and Balance Sheet.
A journal is a book of original entry in which the transactions are recorded as soon as they occur. Sometimes, journals are also called day books. All business transactions are recorded in the journal in the order in which they take place. This is the primary book of records of all financial transactions in a business.
For each transaction, there will be two entries in the journal or day book – one debit and one credit. Debits and credits are determined by the golden rules explained above. The double-entry system of bookkeeping starts here.
Mr Babu Bhai has commenced business on March 1, 2007 and during the same month the following transactions took place:
March 1 Babu Bhai commenced business with cash Rs 25,000 and buildings worth Rs 50,000
March 3 He purchased goods with list price of Rs 20000 at 20% trade discount from Shiva and paid half the amount at 10% cash discount
March 5 He sold half of the above goods at list price to Govinda at 5% trade discount
March 7 Salary paid to the accountant Rs 2000
March 10 Govinda settles his account at 5% cash discount
March 15 Personal expenses paid Rs 500
March 20 Returned goods worth Rs 200 to Shiva.
March 28 Commission is due from Amin Bhai Rs 400
March 28 Rent paid Rs 500
The above transactions shall be entered in the journal or day book as under:
When a journal is the book of primary entry, the ledger is called the book of final entry. A ledger account may be defined as a summary statement of all the transactions relating to a person, assets, expenses or incomes which take place during a particular period of time and their net effect. For example, in a business, raw materials are purchased from ‘X Co. Ltd.’ and supplies are received from time to time and payments, therefore, are also given by the business on a fortnightly basis. This transaction results into a debit of purchase account and credit of the personal account of X Co. Ltd.
Similarly, when the same business sells the finished goods to a trader ‘Y & Co.’ the transactions by way of debiting Y & Co. and crediting sales take place. From the journal or the day book, all the purchases on different dates from X Co. Ltd. shall be entered in the ledger account of X Co. Ltd. and as and when payments are made to X Co. Ltd. further transactions by way of debiting X Co. Ltd. and crediting cash or bank account take place.
In the same way, when payments are received from Y & Co. the transactions in the form of debiting cash or bank account and crediting Y & Co. happen. During a given period, all the transactions pertaining to a particular account be it personal, real or nominal – are posted in the particular ledger account and at the end of a period the net of the aggregates of the debits and credits in the said account is worked out.
That will show the actual amount owed or owned by the business in the said account. Similarly, the ultimate balances for all the accounts have to be drawn on a particular date.
The journal entries mentioned earlier are now entered in the respective ledger accounts as under:
Similarly, other transactions can be recorded in the respective ledgers showing the net debit or credit balance at the end of the month.
Cash or the balance in the bank account is the most sensitive item for any business and, at any point of time, the number of transactions affecting cash or bank account – either by way of debit or credit – is more than any other type of transactions. Cash or bank account is hit by transactions very frequently.
Due to the very frequent nature of transactions, whenever one of the legs of the transactions is cash or bank account, the entry is directly recorded in the cash book which is considered as both journal as well as ledger. Suppose, in a business, cash paid to an official for travelling purpose and the relative transaction needs to be recorded as ‘debit travelling expenses’ and credit ‘cash account’.
This transaction will not be recorded in the journal separately as it has to be recorded in the cash book because of one leg of the transaction being cash. From the cash book, the debit entry of travelling expenses will be posted in the nominal account ledger for travelling expenses.
It is pertinent to mention here that money may be held in the form of cash or the same or part thereof may be deposited in the bank. Since both are liquid forms of money a combined or double barrel cash book is maintained in most of the business units and the cash book contains two columns one for cask and the other for hank instead of only one cash column shown above. However, the principle of debiting and crediting is same as in cash. It is the combination of two ledgers in one format with separate column for Cash and Bank.
As has been already discussed, at the end of a specified period, the net balance in each of the ledger accounts including the cash book (cash and bank, separately) are to be drawn and all these net balances with their respective names of the accounts are listed in two different columns – one for debit and the other for credit.
Since it is a double entry system, the total of debit and credit columns should tally, which will prove that the entries made were generally correct.
From the net balances of all the ledger accounts, a trial balance can be drawn as under:
Profit and Loss Account and Balance Sheet:
From the balances of various ledger accounts as appearing in the trial balance, we may proceed to prepare the final accounts, viz., Profit and Loss A/ c. for the month ended March 31, 2007 and Balance Sheet as on March 31, 2007.
It is to be noted that the balances of all the nominal accounts in the trial balance are posted in the Profit and Loss Account. This account is prepared to ascertain the net results of the business concern, i.e., the net profit or loss the business has earned or incurred during a particular period.
The balance of this account represents net profit if the total of the debit side is less than that of the credit side or net loss if the total of the debit side is more than that of the credit side. The amount of net profit or loss is transferred to the Balance Sheet.
All real accounts and personal accounts (Debtors and Creditors) balances in the trial balance are the items of Balance Sheet. A Balance Sheet is a statement of assets and liabilities of an organisation as on a particular date. It is the snapshot what the business entity owes and owns on a certain date.
A Balance Sheet is not an account but only a statement of the properties and debts of the business on a particular date. It will not reflect the true position of the assets and liabilities of the business next day, because one single transaction after March 31, 2007 will change the position of the assets and liabilities.
The Balance Sheet can also be called the statement of sources and application of funds. While the liabilities side represents the sources, the asset side shows the various applications of funds. The Balance Sheet may also be drawn in a vertical form presenting the sources of funds (liabilities) at the top and the application of funds (assets) below:
It is to be observed that the initial capital is depleted by the drawings and the net loss incurred during the month. Had there been a profit, the amount of capital would have increased to the extent of the profit.
M/s. Babu Bhai has carried out business activities for the entire year from April 1, 2007 and after completing the journal, ledger, trial balance and Profit and Loss account, finally the following Balance Sheet as at March 31, 2008 was prepared as under:
The final accounts, viz., Profit and Loss Accounts and Balance Sheets are studied and interpreted by different stakeholders for arriving at financial decisions. The interested parties are the owners, creditors, investors, bankers, government departments, etc. Before taking a decision on lending to a business house, banks and financial institutions always scrutinise their financials, especially the Profit and Loss Accounts and Balance Sheets of the previous two/three years.
Apart from the Balance Sheets for the past two/ three years, banks also ask for the Projected Balance Sheet for the ensuing year/s. The various aspects of the financial position of the borrower, including the projected levels for the following year, are scrutinised and examined by the banks for taking a view which ultimately culminates into a decision.
By examining the above balance sheet as on 31.03.2008, the following parameters can be worked out:
1. Working Capital:
The excess of current assets over current liabilities is called working capital. This represents the liquidity position of the business. The working Capital for M/s. Babu Bhai as on 31.03.2008 is (-) Rs 20,275/-. This means M/s. Babu Bhai is not in a position to meet the current obligations by disposal of its current assets. This also signifies that short-term resources have been deployed for long-term purposes.
This is represented by the aggregate of capital, reserves and surplus minus intangible assets. For the above business, the net worth as on 31.03.2008 is Rs 77,725.
3. Debt-Equity Ratio:
This is calculated by dividing the long-term debts by the net worth. In the above Balance Sheet, the long-term debt is Rs. 78000 and the net worth is Rs 77,725 and hence the debt equity ratio is 1:1.
Similarly, different interested people examine and interpret the Profit and Loss Account and Balance Sheet in different ways to suit their individual purpose.
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