Half Yearly Notes For Accounting

UNIT 1-

Q1.What Is Accounting?
Accounting is the process of recording financial transactions pertaining to
a business. The accounting process includes summarizing, analysing, and
reporting these transactions to oversight agencies, regulators, and tax col-
lection entities.

Q2. Nature of Accounting

The nature of financial accounting is outlined as follows:

Identifying monetary transactions – First, the transaction has to take place and be identified so
that it can be accounted for.

Measuring and recording transactions – The value of transactions has to be meas-

ured in terms of money and those concerned with revenues and expenditures need
to be recorded
Classifying payments – The huge data needs to be classified in a record known as a
ledger. For example, all salary-related expenses can be classified under one column.
Summarisation – Hence, the record needs to be summarised in a form where it can
be easily comprehended.
Analysing, interpretation, and communication--The summarised data needs to be analysed
well and interpreted so that it can be communicated to the concerned stakeholders so that
they have the full knowledge of the company’s financial position.

Q3. Scope of Accounting

Reporting the account statement to various stakeholders highlights the scope of accounting.
Various parties in various forms use this information for their benefit and the benefit of the
company.

a) Reporting to shareholders.

b) Reporting to the Public.

c) Reporting to Government.

d) Reporting to employees.

Q4. Difference between Fixed Assets and Current Assets.

Fixed assets, also known as property, plant, and equipment (PP&E) and as capital
assets, are tangible things that a company expects to use for more than one ac-
counting period. Current assets, such as cash and inventory, are items that the com-
pany expects to use up or sell within a year.

Q5. Define the 3 terms.

a) Revenue---In accounting, revenue is the total amount of income generated by the sale
of goods and services related to the primary operations of the business . Example: Rent
received. Amount received from one time sale of an asset. Interest received
from bank accounts.

b) Assets---An asset is a resource with economic value that an individual,

corporation, or country owns or controls with the expectation that it will
provide a future benefit. Assets are reported on a company's balance
sheet. They're classified as current, fixed, tangible, and intangible. They
are bought or created to increase a firm's value or benefit the firm's
operations. Example: Fixed Assets= Machinery, Property .Current
Assets=Raw materials and inventory. Intangible items = Patents,
Royalties.

c) Liability ---is a term in accounting at is used to describe any kind of financial obligation
that a business has to pay at the end of an accounting period to a person or a business.
Liabilities are recorded on the right hand side of the balance sheet.
Liabilities can be of short term and long term. Short term liabilities are due within an
accounting period (12 months) and long term liabilities become due within a duration of
more than 12 months.

Types of Liabilities
Liabilities can be classified into three main categories, which are:
1. Current Liabilities: ex. creditors
2. Non-current Liabilities: ex. Bank loans
3. Contingent Liabilities: ex. Case filed against our company.

Q6. What does term Expense differ from cost?

A cost typically refers to the price paid to acquire an asset, while an expense is
an ongoing expense, such as an employee's salary or rent on a retail space.

Q7.What are intangible fixed assets? Explain with Example

Intangible Assets: An intangible asset is an asset which doesn't possess a physi-
cal existence. Brand recognition, intellectual property, goodwill and such as copy-
rights, trademarks, and patents are all examples of intangible assets.

Q8.What are the 2 basis of Accounting?

Every business records revenues and expenses into its financial statements at a specific
time. This timing of documentation is known as the basis of accounting.
There are two main types of accounting methods: cash basis accounting and Accrual
basis accounting.

Cash basis accounting documents revenues only when the money is received, and ex-
penses only when they get paid. This means, there are no recordings of receivables and
payables.

Accrual basis accounting measures a business’ financial performance by recognizing

financial transactions when they occur, regardless of when the cash exchange takes place.
In simpler terms, expenses are recorded when they get billed, and revenues when earned.
For example, a finished project will be recorded as income for the business, even if the
customer hasn’t paid yet.

Q9. What Are the Golden Rules of Accounting?

• Rule 1 - Debit the receiver, credit the giver.
• Rule 2 - Debit what comes in, credit what goes out.
• Rule 3 - Debit all expenses and losses and credit all incomes and gains.

Q10. An accountant should be skilled, Analytical and number minded. Do

you agree?
YES I agree.
Analytical skills are important for anyone in the accounting field. Being able
to analyse data and financial statements is essential for making sound de-
cisions and providing accurate information. Yes he should be skilled to use
latest technology and number minded as numbers are the core of account-
ancy.

Q11. What Is Meant by Fictitious Assets?

Fictitious assets are those assets which do not have a physical existence and any
realisable value, but are represented as actual cash expenditure in the financial
statements.
Fictitious means not real or imaginary.
• Example: Discount on issue of shares.
• Discount/Loss on issue of debentures.

Q12. What is Management Accounting.

Managerial accounting, also called management accounting, is a method of accounting that
creates statements, reports, and documents that help management in making better decisions
related to their business' performance.

Q13. What is the difference between debtor and creditor.

The difference between a debtor and a creditor is that the creditor is the one who
lends money in a credit relationship, and the debtor is the one who borrows it.
Example from the person whom we purchase goods, becomes our Creditor be-
cause we have to pay him in the near future.
Example the person whom we sell goods, becomes our Debtor.

Q14. State the difference between expense and expenditure.

An expense is an amount spent by a business in the process of earning revenue. Expenditure
is the amount spent on acquiring an asset, goods or services etc.

Q 15. Accounting as a source of information.

Accounting is a definite process of interlinked activities that begins with the identification of
the transactions and ends with the preparation of the financial statements.
--Every step in the process of Accounting generates information.
-- It is a means to facilitate information to different user groups.
-- Such information helps the users to take economic information.

Q 16. What are the Objectives of Accounting?

a)Recording business transactions systematically
b) Determining profit earned or loss incurred
c) Ascertaining financial position of the firm
d) Assisting management
e) Assessing the progress of the business
f) Detecting and preventing frauds and errors
g)Communicating accounting information to various users

Q 17. What is the role of Accountant in todays Business world, and how do they
help Management ?
A Management accountant works within a business to prepare and present finan-
cial reports to senior management teams in order to give an insight into busi-
ness performance. The reports are used to aid with business strategy and also in
decision making within the business, to ensure growth and profitability.

Question 18. What is capital expenditure, explain with example.

Capital expenditures are long-term investments, meaning the assets purchased
have a useful life of one year or more. Types of capital expenditures can include
purchases of property, equipment, land, computers, furniture, and software.

Question 19.What are capital receipts? Explain with Example

Cash or cash equivalents from the sale of assets, either tangible or intangi-
ble. Loan amount disbursed from a bank or other financial institution. Cash re-
ceived from an insurance claim. Capital gains from the sale of shares.

Question 20. State difference between capital receipts and revenue

receipts
Capital receipts are money brought into business from non-operating
sources. In contrast, revenue receipts are the result of a company's routine
activities during the financial year, including commissions, sales, invest-
ments, or interest.

Question 21. What are capital expenditure and revenue expenditure ?

Capital expenditures are typically one-time large purchases of fixed assets that will
be used for revenue generation over a longer period. Revenue expenditures are the
ongoing operating expenses, which are short-term expenses used to run the daily
business operations.
Difference between Capital and Revenue Expenditure
Parameters Capital Expenditure Revenue Expenditure

Purchase of Machinery or patent, Wages, salary, utility bills printing and sta-
Examples copyright, installation of equip- tionery, inventory, postage, insurance, taxes
ment and fixture, etc. and maintenance cost, among others.

Question Defining the accounting cycle with steps:

What Is the Accounting Cycle?

The accounting cycle is a collective process of identifying, analysing, and
recording the accounting events of a company. It is a standard 8-step
process that begins when a transaction occurs and ends with its inclusion
in the financial statements.
The key steps in the eight-step accounting cycle include recording journal
entries, posting to the general ledger, calculating trial balances, making
adjusting entries, and creating financial statements.
Question

What are Journal Entries?

https://youtu.be/NP99QtgkiOQ

Please watch the above video for revision

A journal entry is the act of keeping or making records of any transactions ei-
ther economic or non-economic. Transactions are listed in an accounting journal
that shows a company's debit and credit balances. The journal entry can consist of
several recordings, each of which is either a debit or a credit.

3 Golden Rules very important

Debit what comes in Credit what goes out.

Debit the receiver and Credit the giver.
Debit the expenses and losses, Credit all the incomes and gains.
The format of the Journal given below
Question: What are Ledgers.

The ledger is a permanent summary of all amounts entered in supporting journals which list
individual transactions by date. Every transaction flows from a journal, to one or more ledgers. A
company's financial statements are generated from summary totals in the ledgers.[2]
Ledgers include:
• Sales ledger, records accounts receivable. This ledger consists of the financial trans-
actions made by customers to the company.
• Purchase ledger records money spent for purchasing by the company.
• General ledger representing the five main[3][citation needed] account types: assets, liabili-
ties, income, expenses, and capital.
For every debit recorded in a ledger, there must be a corresponding credit, so that the debits
equal the credits in the grand totals.

Preparation of Ledgers
https://youtu.be/bcNh3L786Ek

Watch the above video for understanding.

The format of ledger given below

Question What is a trial Balance.

A trial balance is a bookkeeping worksheet in which the balances of all ledgers are compiled
into debit and credit account column totals that are equal. A company prepares a trial balance
periodically, usually at the end of every reporting period. The general purpose of producing a
trial balance is to ensure that the entries in a company’s bookkeeping system are
mathematically correct.
A trial balance is so called because it provides a test of a fundamental aspect of a set of
books, but is not a full audit of them. A trial balance is often the first step in an audit
procedure, because it allows auditors to make sure there are no mathematical errors in the
bookkeeping system before moving on to more complex and detailed analyses.
KEY TAKEAWAYS
• A trial balance is a worksheet with two columns, one for debits and one for credits,
that ensures a company’s bookkeeping is mathematically correct.
• The debits and credits include all business transactions for a company over a certain
period, including the sum of such accounts as assets, expenses, liabilities, and reve-
nues.
• Debits and credits of a trial balance must tally to ensure that there are no mathemati-
cal errors, but there could still be mistakes or errors in the accounting systems.
0 seconds of 1 minute, 24 secondsVolume 75%

Types of Trial Balance

There are three main types of trial balance:
• The unadjusted trial balance
• The adjusted trial balance
• The post-closing trial balance.
https://youtu.be/w3hhhQxHiwo
Please view the Video above to understand Trial Bal-
ance.
Format of the trial balance given below
Question
What is a cash book.
A cash book is a financial journal that contains all cash receipts and disburse-
ments, including bank deposits and withdrawals. Entries in the cash book are
then posted into the general ledger.

Cash Book - Definition, Features, Types and Ad-

vantages
Cash is an essential medium of conducting transactions taking place in a business and needs
to be recorded for maintaining proper bookkeeping of the transactions. Cash is a current
asset, and examples of cash transactions can be bank overdraft, money orders, demand
deposits.
This leads to the need for maintaining all cash transactions in one place for the business and
necessitates the use of a cash book.

Cash Book definition

Cash book is a special type of book that is only concerned with the recording of cash
transactions of an organisation. It performs the dual role of both journal and a ledger for all
the cash transactions taking place in a business organisation.
A cash book records all the cash receipts on the debit side and all the cash payments of the
organisation on the credit side.

Features of Cash Book

Cash book has the following features:
1. Acts as both a journal and a ledger.
2. Can be used as an alternative to a cash account for recording transactions.
3. It follows the dual entry system of accounting (i,e. Debit and credit side in cash book).
4. The debit side should be identical to the credit side.
5. Cash book should always have a debit balance.

Types of Cash Book

There are four types of cash books used for accounting purposes. Let us have a look at the
types of cash books.
1.Single column cash book
2.Double column cash book
3.Triple column cash book
4. Petty cash book
Single column cash book: Single column cash book is also called a simple cash book. It
presents entries for cash received (receipts) on the left side or debit side and cash payments
on the right hand side or credit side.
The bank transactions and the discounts that are given for transactions will be featured in
separate ledger accounts in case of single-column cash books.
Cash books are updated on a daily basis in some business firms. The most striking feature of
a cash book is that it can never have a credit balance. It should always show a debit balance.
Double Column cash book: In a double column cash book, there is an additional column
that is reserved for the discounts. Therefore, in a double-column cash book, also known as
two-column cash book, the cash receipts and transactions are recorded in one column while
the second column records discounts received and discounts provided.
Discount being a nominal account the discount provided is placed on the debit side of the
cash book while discount received is placed on the credit side of the cash book.
At the end of the accounting period, both the columns are balanced, and the closing balances
are transferred appropriately.
Triple column cash book: In a triple column cash book, the two columns are similar to the
double column cash book. While the additional column is for bank transactions.
Due to the advances in the banking industry, most firms deal in cheques and therefore, the
presence of a bank column in a cash book is helpful in understanding the transactions
properly.
Petty cash book: Petty cash book, as the name suggests, is for very small transactions that
take place in an organisation. Such transactions can occur in a day and are repetitive in
nature, which can put undue load on the general cash book. For this reason, it is maintained
separately.
Examples of such transactions are: stationery, postage, food bills, etc.

Advantages of Cash Book

Cash book offers the following advantages:
1.It offers easy verification of cash by matching the balance in the cash book with actual cash
in hand and is therefore helpful in identifying mistakes in the entry.
2.It helps in creating a regular record of transactions date wise for the convenience of
accounting personnel.
3. As it is maintained date wise, any cash payments or the transaction can be correctly traced
back in the cash book.
4. It is helpful in detecting any cash frauds in the organisation.
5.It helps in saving time and labour by reducing the workload

What Is a Single Column Cash Book?

The single column cash book resembles a T-shaped cash account in
almost all respects. The pages of this book are vertically divided into two
equal parts. The receipts are entered on the left (debit) side. Payments are
entered on the right (credit) side.

A single column cash book has only one money column on the debit and
credit sides to record cash transactions. This is the reason why it is called a
single column cash book (or a simple cash book).

Explanation
A single column cash book records only cash receipts and payments.

This form of a cash book has only one amount column on each of the debit
and credit sides of the cash book. All the cash receipts are entered on the
debit side, and cash payments are entered on the credit side.
In essence, a single column cash book is nothing but a cash account. A cash
account cannot show a credit balance on the principle that you cannot pay
what you do not have. This means that a cash account always shows a debit
balance or nil balance.

Format of a Single-Column Cash Book

The standard format of a single column cash book is shown below.

Example
Record the transactions shown below in a single column cash book and
post to the ledger.

For the year 2016, the transactions are as follows:

• Sep. 01: Cash in hand (balance b/d) $2,327

• Sep. 02: Paid salaries for August $1,500
• Sep. 05: Cash received from S & Co. $1,360
• Sep. 06: Purchased merchandise for cash $ 700
• Sep. 07: Cash sales for the first week $2,350
• Sep. 10: Paid cash for office furniture $1,540
• Sep. 12: Purchased stationery for cash $85
• Sep. 15: Cash sales for the second week $4,500
• Sep. 17: Cash paid to A & Co. $890
• Sep. 20: Purchased merchandise for cash $1,230
• Sep. 21: Cash sales for the third week $1,200
• Sep. 24: Cash received from S & Co. $1,200
• Sep. 28: Paid office rent $800
 • Sep. 30: Cash sales for the last week $3,600
Solution
Cash Book
Cash Book

General Ledger
Ledger For Accounts Receivable

Ledger For Accounts Payable

Cash Book Exercises

• Multiple choice questions (MCQs)
• Fill in the blanks quiz with answers

Frequently Asked Questions

What is a cash book?
A cash book is a financial record of all cash transactions that occur within a business. This
includes receipts, payments, and withdrawals.

What information is included in a cash book?

The cash book can be used to calculate the business’s Cash Flow, track inventory levels and
monitor financial performance. It can also be used to help make informed business decisions.

How is the cash book updated?

The cash book is updated each time a transaction occurs. This information is then used to
produce Financial Statements and other reports.

What are the benefits of using a cash book?

The main benefits of using a cash book are that it helps businesses track their financial
position, make informed business decisions, and improve their overall financial performance.

What is a Three Column Cash Book?

A cash book with three columns for discounts received and
paid, cash transactions, and bank transactions is known as a
three column cash book.
Explanation
A three column cash book, also known as a triple column cash book,
contains three money columns on both the debit and credit sides: one on
each side for recording discount, cash, and bank amounts.

If a business holds a bank account frequently makes receipts and payments

through that bank account, then it is useful to maintain a three column cash
book rather than a single or double column cash book.

It is customary for businesses to allow discounts for early payments. For

example, if cash is paid early, creditors may receive a discount. On the
other hand, if debtors pay early, a discount may be allowed to them.

You may remember that cash and discounts are closely related. This is the
reason why discount columns are also provided in the cash book.
In a three column cash book, three columns are provided for the amounts
on each side. One column records cash receipts and payments, the second
records banking transactions, and the third records discounts received and
allowed.

Although single and double column cash books are alternatives to a cash
account, the three column cash book serves the purpose of cash as well as
a bank account.

Discount Columns: Key Points

Consider the following critical aspects of discount columns in a triple
column cash book:

1. The discount allowed column is located on the debit side and the dis-
count received column is located on the credit side.

2. The discount allowed and discount received columns represent two

different accounts. They are not related.

3. The discount columns are memorandum columns in nature. There-

fore, two separate accounts, "Discount Allowed" and "Discount Re-
ceived", are opened in the ledger.

4. Since discount allowed and discount received are unrelated, they are
not balanced. Both columns are summed separately and the aggre-
gate is transferred to the ledger accounts.

Format of a Three Column Cash Book

The common format used in a three column cash book is shown below.

It is worth mentioning that the format of a three column cash book is

similar to that of a two column cash book. The only exception is that a
column is added in a three column cash book to account for bank-related
transactions.

Hints for Record Keeping in a Three Column Cash Book

If you are ever recording entries in a three column cash book, this section
presents a few key points you should bear in mind.

Opening Balance
The opening balance of cash in hand and cash at the bank are recorded on
the debit side in the cash and bank columns, respectively. If the bank
balance is a credit balance (overdraft), then it is entered on the credit side
in the bank column.

Receipt of Cheque or Cash

If a cheque is received and deposited into a bank account on the same
date, it will appear on the debit side on the cash book in the bank column.

If the cheque is not deposited into a bank account on the same date, it is
treated as cash and, therefore, the amount will appear in cash column.

Finally, in the usual manner, the receipt of cash is recorded in the cash
column.

Payment by Cheque or Cash

If a payment is made by cheque, it will be recorded on the credit side in the
bank column. This is because the cash at bank has decreased.

If the payment is made in cash, it will be recorded in the cash column in the
usual manner.

Bank Charges
Bank charges are recorded on the credit side of the cash book in the bank
column. This is because cash at bank decreases as a result of such charges.

Contra Entries: Definition

If an entry is made on the debit side and the same entry is recorded on the
credit side of the cash book, it is called a contra entry.

To differentiate contra entries from other entries, letter “C” is printed in

the posting reference column (on both the debit and credit sides of the
cash book). The letter “C” indicates that the contra effect of this transaction
is recorded on the opposite side.
Contra entries may be one of the following types:

Type 1
When cash is deposited into a bank, two entries are required: one on the
credit (payment) side in the cash column, which records the reduction in
cash in hand; and the other on the debit (receipt) side in the bank column,
which records the increase in cash at bank.

Type 2
When cash is withdrawn from a bank for office use, two entries are needed:
one on the credit side in the bank column, which records the reduction of
cash at bank; and the other on the debit side in the cash column, which
records the increase in cash in hand.

Type 3
It has already been explained that when a cheque is received and not
deposited into a bank on the same date, the amount will be recorded on
the debit side of the cash book in the cash column.

When the same cheque is deposited into a bank account on another date,
two entries are required: one on the debit side in the bank column, which
records the increase in the amount at bank; and the other on the credit side
in the cash column, which records the cash (cheque) paid into the bank.

Balancing the Three Column Cash Book

Whenever it is necessary to determine the bank balance, the bank columns
are summed on both sides.

If the debit column is larger than the credit column, the difference
represents cash at bank. If, on the other hand, the credit column exceeds
the debit column, the difference represents “overdrawn balance”.

A bank account may have an overdrawn balance because by arranging an

overdraft with the bank, it is possible that more money may be withdrawn
from the bank than what was deposited.

The cash columns are balanced as usual. The discount columns are simply
summed and not balanced. An overview of this procedure is given on
the double column cash book page.
Posting Three Column Cash Book to Ledger Accounts
The method of posting a three column cash book into ledger is as follows:

1. The opening balances of the cash book are not posted.

2. Contra entries are not posted because the double entry account-
ing for these transactions is completed within the cash book.

3. All items on the debit side of the cash book are posted to the credit
of respective accounts in the ledger.

4. All items on the credit side of the cash book are posted to the debit
of respective accounts in the ledger.

5. The total of the discount column on the debit side is posted to the
debit of discount allowed account, and the total of the discount col-
umn on the credit side is posted to the credit of discount received ac-
count in the ledger.

Example
During May 2016, the John Trading Company made the following
transactions:

May 01: Cash balance $2,200, bank overdraft $365. May 03: Paid J & Co.
by cheque $1,200, discount received amounting to $15. May 05: Received
from A & Co. a cheque for $980, discount allowed to them $20. May
07: Deposited into bank the check received from A & Co. on May 05. May
10: Purchased stationery for cash, $150. May
15: Purchased merchandise for cash, $1,300. May 15: Cash sales for the
first half of the month, $2,350. May 16: Deposited into bank $1,600. May
18: Cash withdrawn from bank for personal expenses $150. May 19: Issued
a cheque for merchandise purchased, $1,650. May 21: Drew cash from
bank for office use, $650. May 24: Received a cheque from S & Sons and
deposited it into bank, $1,560. May 25: Paid a cheque to Ali Inc. for $400
and received a discount of $15. May 27: Purchased furniture in cash for
office use, $390. May 29: Paid office rent by cheque, $450. May 30: Cash
sales for the second half of the month, $4,300. May 31: Paid salaries by
check, $1,760. May 31: Withdrew cash from bank for office use, $1,470.

Required: Record the above transactions in a three column cash book.

Solution

Cash Book Exercises

• Multiple choice questions MCQs
• Fill in the blanks quiz with answers
• Short questions with answers
Question : What is rectification of errors and what are type of errors?

Rectification of Errors: Definition

In accounting, errors are the mistakes that the bookkeeper or accountant
makes. These mistakes may occur in any of the following situations, among
others:

• Classifying accounts
• Writing subsidiary books
 • Posting entries to ledger accounts
• Casting totals
• Balancing accounts
• Carrying balances forward
The process of finding and correcting mistakes of this kind is
called rectification of errors. Rectification of errors can be addressed by
answering the questions of what, why, and how.

Accounting errors occur when, in the accounting period, the basic principle
is violated that every debit should have an equal credit.
A core principle of accounting is that every debit should have an equal
credit. If this basic principle is violated in any manner, at any time, or at any
stage during the accounting period, errors (i.e., mistakes) occur.
To prove the arithmetical accuracy of accounting, the trial balance is
prepared (either under the total method or under the balance method) to
confirm that the debits are equal to the credits.

Despite the best efforts of the bookkeeper or accountant and the

agreement of the trial balance, errors may still continue to prevail. If such
errors are left uncorrected, they affect the final accounts of the concern.

Therefore, there is a need for rectification.

Classification of Errors
Errors can be classified broadly into two types: intentional errors and
unintentional errors.

Intentional Errors
Intentional errors are generally strategic in nature. Such errors are
committed at the management level and not at the clerical level.

For example, stock may be recorded at market price, which is higher than
the cost price, to increase the current ratio and to create confidence
among creditors. This is done knowing that stock should be recorded in
the books at cost or market price, whichever is less.

Sometimes, the balance sheet of the company is window-dressed to paint

a picture that is rosier than reality to the shareholders and the public.
Such intentional errors attract legal remedies rather than rectification.
Therefore, intentional errors are excluded from this article’s discussion of
how errors should be rectified.

Unintentional Errors
Our prime focus is on unintentional errors, which occur at the clerical level
during the normal course of recording, classifying, posting, casting, and so
on.

Unintentional errors are a category of mistakes that need to be rectified to

maintain accounts correctly (i.e., to ensure they are true and fair). Therefore,
in this article, whenever we refer to rectification of errors, we mean
unintentional errors.

Classification of Unintentional Errors

Unintentional errors are classified based on the following:

• Disclosed errors and undisclosed errors

• How errors affect the accounts
• The nature of the errors
Hence, unintentional errors are classified on many bases. One of the
classifications is on the basis of disclosed errors and undisclosed errors.

This classification is intended to demonstrate that the trial balance is not

the absolute proof of the accuracy of ledger accounts, although it proves
arithmetical accuracy. A trial balance can disclose the following errors:

• Wrong totaling of subsidiary books

• Posting the wrong amount
• Posting on the wrong side of the account
• Posting twice to a ledger
• Omission of an account from the trial balance
• Wrong additions or balancing of ledger accounts
• Balance of account written to the wrong side of the trial balance
• Errors made in preparing the list of debtors and creditors
• Errors made in carrying forward the total from one page to another
page
 • Where double entry is incomplete
• Omission of an account in the opening entry
• The wrong amount of capital in the opening entry
• The wrong casting of trial balance totals
However, a trial balance cannot disclose errors of principle, errors of
omission, posting to the wrong account, the wrong entry of the amount in
the original books, and compensating errors.

Another classification of errors is based on how errors affect accounts. This

classification system is as follows:

• Errors affecting one account only: Examples include errors of posting,

casting, or carry forward and the omission of the balance of any sin-
gle account in the trial balance
• Errors affecting two or more accounts: Examples include posting to
the wrong account, errors of omission, errors of principle, and com-
pensating errors.
A final popular classification system for errors is based on their nature. The
types of errors identified under this system are the following:

1. Errors of omission

Errors of Omission: Definition

When some transactions are completely omitted from the books of
accounts or entered but not posted, they are treated as errors of omission.

If a transaction is omitted altogether from the books of accounts, there

would be neither a debit nor a credit entry in the ledger. Hence, the trial
balance will not be affected.

Types of Errors of Omission

There are two types of errors of omission:

Partial Omission
The transaction is recorded in the books but not posted to the ledger. This
type of error can happen in any subsidiary book.
For example, goods purchased and returned to the supplier may be
entered in the purchase returns book but not posted in the debit of
supplier account.

Complete Omission
The transaction is completely omitted from being recorded in the books.
For example, a transaction relating to the receipt of cash may not be
recorded in the cash book.

Partial omissions are easy to locate, but this is not the case with complete
omissions. One can only learn about such errors when the statement of
accounts is received from or sent to creditors or debtors, as the case may
be.

Effect on Accounts
The ledger will have no record of the transaction because there will be no
debit or credit entry in the ledger.

Rectification of Entry
The transaction is recorded in the general journal in the same way that it
would have been recorded when it originally took place. The reason for the
delay is given in the narration.

Example
A credit note for $2,750, received from Hattar Wholesalers, was misplaced
and not recorded in the books. It was discovered two months later on 21
July 2017. For this reason, the following rectification entry was made in
the journal.
 2. Errors of commission

Errors of Commission: Definition

Errors of commission occur due to the negligence of the accountant or clerk. For this
reason, they are often referred to as clerical errors or errors of inadvertence.

Let’s consider a few examples to show how errors of commission are caused:

• Entering the wrong amount in the correct subsidiary book

• Posting the correct amount in the wrong subsidiary book
• Posting the wrong amount to the correct side of the account
• Posting the correct amount to the wrong side of the account
• Double-posting (i.e., posting is done twice)
• Posting to the wrong account of the same class (i.e., cash paid to B is debited to B &
Bros.)
Other types of errors of commission may arise out of casting, posting, carryforward, and
balancing.

Effects on Accounts
One of two effects is possible. Either the correct account will not be debited and an irrelevant
account will be debited, or the correct account will not be credited and an irrelevant account
will be credited.

Rectification of Entry
If an irrelevant account is debited instead of the correct account, follow these steps:

1. Debit the account that should have been debited

2. Credit the account that has been erroneously debited

If an irrelevant account is credited instead of the correct account, take these measures:

1. Debit the account that has been erroneously credited

2. Credit the account that should have been credited

Example
A credit sale of goods for $7,200 to Mr. David was erroneously debited to Mr. John’s
account.
Example
A cheque for $3,480 was received from Royal Motors but was erroneously credited to TAU
Motors’ account.

3. Error of principle

Errors of principle arise due to a bookkeeper’s or an accountant’s improper understanding

of accounting and its core principles.

These errors resemble errors of commission except in one respect: errors of commission
usually lead to oversight whereas errors of principle are caused by a lack of knowledge of
accounting principles.

The common error is the treatment of capital expenditure as revenue expenditure (or vice
versa). Capital expenditure is expenditure on purchasing fixed assets, whereas revenue
expenditure is incurred in the day-to-day running of the business.

For example, the purchase of a motor car is a capital expenditure while the purchase of fuel
for the car is a revenue expenditure.

Effect on Accounts
As with errors of commission, errors of principle have the following effects on accounts:

• Either the correct account will not be debited and an irrelevant account will be deb-
ited, or
• The correct account will not be credited and an irrelevant account will be credited.
Errors of Principle: Rectification Entry
Rectification entries for errors of principle are the same as rectification entries for errors of
commission. That is to say, if an irrelevant account has been debited instead of the correct
account:

• Debit the account that should have been debited

• Credit the account that has been incorrectly debited
If an irrelevant account has been credited instead of the correct account:

• Debit the account that has been incorrectly credited.

• Credit the account that should have been credited.

Example
Some furniture was bought on credit for $2,500 for office use. It was debited to
the purchases account. (This means that a capital expenditure is being treated as revenue
expenditure.)

Rent received from a tenant, $4,500, was credited to a premises account. (This means that
a revenue receipt is being treated as a capital receipt.)

4. Compensating errors

Compensating Errors: Definition

When an already-committed error is offset by another error (or set of
errors), the latter error is known as a compensating error. Compensating
errors occur when errors in equal amount but opposite in sense cancel each
other.
Explanation
When errors have been compensated, the trial balance is in agreement.
The result is that locating such errors becomes difficult.

Compensating errors pose greater problems to a business compared to

other types of errors. This is because they are not single errors but are
combinations of more than one error.

For this reason, to correct compensating errors, it is necessary to identify

not one error but more than one error (or a number of errors).

For example, consider that advertising charges of $1,000 are debited in the
advertising account as $1,500. Also, the interest received of $2,000 is
credited in the interest account as $2,500.

Then the excess debit of $500 in the advertising account is set off against
the excess credit in the interest account. As the excess debit is
compensated with the excess credit, the trial balance does not reveal the
errors.

It is also possible for two or more errors of this kind to be made in the
books, which cancel out each other's effects.

For example, if both the sales book and purchases book are overcast by
$1,000, the net effect in the ledger will be nil. This is because the over-debit
in the purchases account is nullified by the over-credit in the sales account.

To correct compensating errors, each error must be corrected individually.

Example
The trial balance extracted on 31 December 2017 from the books of a
wholesaler does not agree, and so the difference was allocated to a
suspense account.

The trial balance totals were Dr. $213,820 and Cr. $212,230. Later, the
following errors were discovered:

• An invoice for $620 issued to Levis was recorded in the sales book as
$1,620 and posted to the ledger accordingly.
• Returns inward book was overcast by $100.
 • A credit note for $550, received from Sydney Traders, was recorded
correctly in the appropriate subsidiary book but posted to the credit
of Sydney Traders account.
• A cheque for $1,780, received from Harry, was entered in the cash
book but not posted to his personal account in the ledger.
• A credit purchase of an office machine for $1,250 was journalized
through the purchases book. This means that it was treated as a pur-
chase of goods instead of an asset.
• A purchase of goods for $5,340 from Melbourne Wholesalers was
recorded correctly in the purchases book but posted to their account
in the ledger as $5,430.
• Goods costing $950 were taken by the owner for their personal use
but no corresponding entry was made in the books.
• There was a mistake in balancing the salaries account. Its balance was
shown as Dr. $16,230 instead of the correct balance of Dr. $15,330.
Required: Rectify the entries in the journal and suspense account, ensuring
that they are duly balanced.
Note: The total for the Dr. side ($213,820) of the trial balance exceeded the
Cr. side total ($212,230) by $1,590. Therefore, the opening entry in the
suspense account was made at $1,590 on the Cr. side, bringing the
total credit equal to the total debit.

How to Locate Errors

Locating errors is like searching for a black cat in a dark room, all the while
wearing sunglasses. However, there are some methods that can make it
easier to locate errors.

A trial balance is prepared to check arithmetical accuracy. Hence, the task of

locating errors should start from the trial balance.

Earlier, it was mentioned that some errors are disclosed by the trial balance,
while others are not. If the trial balance is in disagreement, then it is an
indication that errors exist in the books of accounts.

Steps to Locate Errors

The steps mentioned here, if meticulously followed, will help to locate
unintentional errors:

Step 1
Begin by checking the totals of the trial balance once again.

For example, if the debit total is not equal to the credit total (or vice versa),
find out the difference between the debit and credit totals, divide that
difference by 2, and see whether such an amount appears in the trial
balance.

If a similar figure exists, check whether it is entered in the correct column.

Also, if a figure is entered in the wrong column, then there will be a
difference to the extent of double the amount.

Steps 6-8
As the second step, check whether the cash and bank balances are correctly
listed and properly entered in the trial balance.

For step 3, check whether the opening balances are correctly brought
forward.
For step 4, check whether all the closing ledger balances are correctly
recorded in the trial balance.

As the fifth step, recheck the totals in the list of sundry debtors and sundry
creditors.

In turn, for step 6, recompute the account balances if necessary.

For step 7, once again check the castings and carryforwards of

the subsidiary books.

For step 8, check whether the postings of the individual items from the
books of the original entry are made properly.

Step 9
We cannot rule out the possibility of errors still existing due to the
transposition or transplacement of figures.

To locate these errors, divide the difference by 9. If the difference divides

evenly into 9, there is a chance that errors exist due to transposition or
transplacement.

Transposition indicates that the individual figures in an item are

interchanged, whereas in transplacement, the digit is either moved forward
or backward to cause the error. For example, see the following tabular
representation.

Step 10
If there are still errors after checking the journal, ledger, subsidiary books,
and trial balance totals, then transfer the difference to
a temporary account (called a suspense account), enter that amount in
the trial balance, tally the trial balance, and prepare the final accounts.
When the error is located, corrections can be applied by giving the
necessary debit or credit to the erroneous account and making the
opposite entry in the suspense account. Thus, the suspense account is
closed after being temporarily created.

The Need for Rectification of Errors

Errors should be rectified; otherwise, a business enterprise will not be
transparent. It will fail to be creditworthy and not show the correct profit or
loss. In other words, it will not show the true picture.

So, errors should be rectified; but are there other reasons for doing so?

Every business is interested in finding out its true results in terms

of profit or loss from the operational activities, as well as its true financial
position at the end of the financial year.

Personnel in the accounts department will try to maintain the firm’s

accounts accurately, ensuring that the true profits or losses are determined
and, furthermore, that the statement of affairs paints a correct picture.

On the basis of the principle that prevention is better than the cure, the
early detection of errors is needed to help businesses be transparent,
creditworthy, and show the correct profit or loss, thereby painting an
accurate picture of their financial position.

In other words, the rectification of errors is essential to ensure:

1. Accountability

2. Reliability

3. Profitability

4. Manageability

Suppose that errors are left uncorrected. These errors will influence
the profit and loss account and balance sheet.
Although the trial balance is prepared to evaluate accuracy, it does not
disclose every type of error. Furthermore, it is possible that the trial balance
was made to agree by entering the suspense account balance.

In any case, if the errors are not rectified, they will have an adverse effect on
the firm’s position in terms of profits or losses and assets or liabilities.
Therefore, they must be rectified. Such rectification may be carried out with
the help of the following steps:

1. Before the trial balance is prepared (pre-trial balance stage)

2. After the trial balance is prepared with or without the suspense ac-
count (pre-final accounts stage)

3. After the final accounts are prepared (post-final accounts stage)

Across the pre-trial balance, post-trial balance, and pre-final accounts

stages, rectification is carried out by modifying entries either directly or
through a suspense account. For the post-final accounts stage, rectification
is carried out through profit and loss account adjustments.

How Are Errors Rectified?

To ensure confidence in the entries made in the books of account,
corrections are not undertaken by striking off figures, erasing figures, or
rewriting them. Even overwriting is not allowed.

Instead, corrections are applied by following a standard methodology. The

permitted methodology involves correcting any errors through rectifying
entries.

Rectification of Errors Through Journal Proper

In the books of account, the following are not allowed:

1. Striking off figures

2. Erasing the figures

3. Rewriting or overwriting figures

Generally, rectification is carried out through the journal proper.

1. If the errors are located before the preparation of the trial balance,
corrections can be carried out directly by means of a rectifying entry, which
may be a single corrective entry or a rectifying journal entry.

Whether a rectifying journal entry should be passed or not depends on the

nature of the mistake.

For example, a company’s sales book is undercast by $1,000. This can be

corrected by crediting the sales account directly with $1,000. No rectifying
journal entry is required.

Suppose the sale of old furniture for $5,000 is credited to the sales account.
This error cannot be corrected directly by crediting the furniture account
with $5,000.

Instead, a rectifying journal entry is required to apply the correction to both

the sales account and the furniture account. Thus, the rectifying journal
entry will be as follows:

2. If the errors are located after the preparation of the trial balance (post-
trial balance stage) with the suspense account, then all the corrections are
carried out through rectifying journal entries only.

As it is necessary to close the suspense account, the other aspect

of debit or credit of the rectification will affect the suspense account.

In the previous example, where the sales book is undercast by $1,000, the
correction is carried out by passing a rectifying journal entry as follows:

Here, after the sales account has been given a proper credit entry, the
suspense account receives a debit as rectification.

3. If the errors are located after the preparation of the final accounts, they
will already have impacted the profit or loss of the business. Hence, the
rectification should be carried out using a profit and loss adjustment
account.
The above example of a sales book being undercast is corrected with a
rectifying entry as follows:

Given that the sales figure increases the profit, it is necessary to credit the
profit and loss adjustment account to rectify this mistake. By debiting the
same amount to a suspense account, the balance of the suspense account
is reduced to that extent.

Error Rectification Methodology

For the purpose of establishing a clear understanding of the methodology
used to rectify errors, the following format may be followed:

1. See what is actually done in the books (i.e., determine the error
committed)

2. Correctly analyze what should have been done (i.e., find the correct entry
that should have been passed)

3. See what correction is needed (i.e., the rectified entry that is recorded by
comparing the entries in (1) and (2)). See the following tabular
representation.

Question What is a Bank Reconciliation Statement.

Bank Reconciliation Statement: Definition

A bank reconciliation statement is prepared by a depositor
(account holder) to overcome differences in the balances of the cash book
and bank statement.

Another definition is that a bank reconciliation statement is a process

of accounting for differences between the balance as stated on the bank
statement and the balance of cash according to the depositor’s records.
Bank Reconciliation Statement: Explanation
One of the procedures for establishing the correct cash balance (and for
controlling cash) is the reconciliation of the bank and book cash balances.

The bank reconciliation statement explains the difference between the

balance in the company’s records and the balance in the bank’s records.
When completed, the reconciliation should show the correct cash balance.

Differences may be attributed to three sources:

• Items in transit
• Errors
• Service charges
In the case of items in transit, these arise from several circumstances. The
firm’s account may contain a debit entry for a deposit that was not
received by the bank prior to the statement date.

Similarly, some checks credited to the ledger account will probably not
have been processed by the bank prior to the bank statement date. Banks
often record other decreases or increases to accounts and notify the
depositor by mailed notices.

Examples include deposited checks returned for non-sufficient funds (NSF)

or notes collected on the depositor’s behalf. Since these items are generally
reported to the company before the bank statement date, they seldom
appear on a reconciliation.

Needs and Importance of Bank Reconciliation

Statement
The need and importance of a bank reconciliation statement are due to
several factors. First, bank reconcilation statements provide a mechanism
of internal control over cash.

Additionally, bank reconciliation statements brings into focus errors and

irregularities while dealing with the cash. Furthermore, they reflect the
actual position in terms of bank balance.
Bank reconciliation statements safeguard against fraud in recording
banking transactions. They also help to detect any mistakes in cash
book and bank statement.

They also explain any delay in the collection of cheques, and they identify
valid transactions recorded by one party but not the other.

Format of Bank Reconciliation Statements

Bank reconciliation statements usually have the following format:

If, however, the cash book shows an overdraft (Cr. Balance per cash book
but Dr. balance per bank statement), the bank reconciliation takes the
following format:

Effect of Time Intervals On Bank Reconciliation

Statements
A bank reconciliation statement is prepared at the end of the month. The
entries in the statement stop being the cause of discrepancies after a few
days.

For example, if a businessman issues a check for $2,500 to a supplier on 28

May, it is quite possible that the check may not be presented by the
supplier to his bank until, say, 5 June.

The bank statement submitted by the businessman at the end of May will
not contain an entry for the check, whereas the cash book will have the
entry. As a result, a difference of $2,500 is caused between the two
balances.

Nevertheless, on 5 June, when the bank pays the check, the difference will
cease to exist.

Similarly, if a businessman deposits any checks on the last day of the

month, these cheques may be collected by his bank and shown on his bank
statement three or four days later.
While this will cause a discrepancy in balances at the end of the month, the
difference will automatically correct itself once the bank collects the checks.

Hence, at the end of each month, the first thing to do is to consult the bank
reconciliation statement prepared at the end of the previous month. The
items therein should be compared to the new bank statement to check if
these have since been cleared.

If so, these entries will not appear in the bank reconciliation statement
prepared at the end of the current month.

This is an important fact because it brings out the status of the bank
reconciliation statement. A bank reconciliation statement is only a
statement prepared to stay abreast with the bank statement; it is not in
itself an accounting record, nor is it part of the double entry system.

Example
The following is the bank column of a cash book prepared by Sara Loren for
May 2017:

She received the following bank statement for May 2017:

A careful comparison of the above two documents indicates the following:

(a) Deposits made by Sara Loren on 30 May, $1,810, and on 31 May,

$2,220, have not been credited to the bank statement.

(b) Checks Nos. 789 and 791 for $5,890 and $920, respectively, do not
appear on the bank statement, meaning these had not been presented for
payment to the bank by 31 May.

(c) A deposit of $5,000 received by the bank (and entered in the bank
statement) on 28 May does not appear in the cash book. This must be a
direct deposit received by the bank.

(d) Check deposited on 14 May ($2,540) was returned unpaid on 17 May.

The cash book does not contain a record of dishonor.

(e) Standing order payment of $1,500 (for rent) also fails to appear in the
cash book.

(f) The cash book does not contain a record of bank charges, $70, raised on
31 May.
Evidently, the cash book should be updated by recording items (c) to (f)
listed above. The completed cash book should then be balanced. After
doing this, it would appear as follows:

The Dr. balance shown in the completed cash book is $7,090, while the
bank statement shows a Cr. balance of $9,870. A bank reconciliation
statement must, therefore, be prepared as follows:

Do you want to test your knowledge about bank reconciliation statement?

Take the Multiple Choice Questions we have prepared for you here
What is Inventory Management: Definition
Inventory management is the process of fixing the minimum and
maximum limits of an inventory and determining the size of inventory to
be maintained.

Inventory management encompasses considerations relating to issue

prices, norms of receipts and inspections, determining the economic order
quantity (EOQ), providing proper store facilities, and keeping an effective
check on obsolescence.

Inventories are the goods that will be sold in the future in the normal
course of business operations.

Coverage of Inventories
Inventories consist of:

• Raw Materials: These are the basic materials used for production
• Work-in-Progress: These are raw materials that have been applied in
the production process but that have not been finished
• Finished Stock: These are the final products available for sales made
out of raw materials

FIFO,” or First In, First Out, is a method of inventory accounting which

expenses the first inventory received prior to later inventory when
calculating the cost of goods sold.

This inventory accounting method stands in contrast with “LIFO“ or “Last In,
First Out” and “WAC” or “Weighted Average Cost” methods.

Example of First In, First Out

FIFO Justice buys 3 sets of 1,000 wristbands fighting for justice for $1.70
each, then $1.30 each, then $2.00 each. FIFO Justice determines it has sold
2,000 units for the period.

When calculating their cost of goods sold under FIFO, the 2,000 wristbands
bought for $1.70 each and $1.30 each will be included, but not the 1,000
wristbands for $2.00 each.
Their cost of goods sold for the period is therefore $3,000.

Last In, First Out (LIFO) Definition

The term “LIFO,” or Last In, First Out, is a method of inventory account-
ing which expenses inventory in the order of most recently acquired
to least recently acquired when calculating the cost of goods sold. It
stands in contrast with FIFO, or first in, first out, which expenses older in-
ventory first. A company may opt for LIFO if their inventory often under-
goes sudden price changes and recent inventory better represents their
cost of goods
LIFO Cycle, a bicycle manufacturer, buys 100 widgets for $17 each, then 50
for $13 each, then another 50 for $20 each. LIFO Cycle determines it has
sold 100 units for the period. When calculating their cost of goods sold for
the period under LIFO, only the 50 widgets purchased for $20 each and 50
widgets purchased for $13 each will be included, totaling $1,650.
Question : What is Depreciation
(With Definitions And Formulas)
The depreciation of a fixed asset is the systematic reduction in
its cost over time until its value becomes zero or negligible. An
asset's depreciation period depends on its estimated useful life
or how long you can use it.
1. Straight-line basis
Also known as the fixed instalment method, this is the most widely used tech-
nique to calculate depreciation. This applies to assets, such as vehicles, comput-
ers, office furniture and office buildings. Under this method, the depreciation
amount is the same for every fixed asset for each accounting period. Below is
the formula to calculate annual depreciation expense using the straight-line
bias technique.
Annual depreciation expense = (Cost of an asset – Salvage value)/Useful
life of an asset
Example
https://youtu.be/MwbMQgzEbpA
Suppose a business has bought a machine for $ 10,000. They have
estimated the machine’s useful life to be eight years, with a salvage
value of $ 2,000.

Now, as per the straight-line method of depreciation:

• Cost of the asset = $ 10,000

• Salvage Value = $ 2000
• Total Depreciation Cost = Cost of asset – Salvage Value =
10000 – 2000 = $ 8000
• The useful life of the asset = 8 years
Thus, annual depreciation cost = (Cost of asset – Salvage
Cost)/Useful Life = 8000/8 = $ 1000

Hence, the Company will depreciate the machine by $1000 annually

for eight years.

• We can also calculate the depreciation rate, given the annual

depreciation amount and the total depreciation amount, which
is the annual depreciation amount/total depreciation amount.
• Hence, depreciation rate = (annual depreciation amount/total
depreciation amount)*100 = (1000/8000)*100 = 12.5%
The depreciation account of the balance sheet will look like the
below over the eight years of the machine’s life:
Differences between straight line method and written down value method

Following are the differences between straight line method and written down
value method

Basis of Compari- Straight Line Method Written Down Value Method

son

How it is calculated Original asset cost is taken as the basis Reducing balance is the basis of
for calculating Depreciation calculating depreciation. Reducing
balance is also known as book
value

How depreciation is A fixed amount is deducted every year Depreciation is deducted based on
charged till the useful life of the asset the written down value of an asset
every year till the effective life of
an asset.

Value of Asset It reaches zero at the effective life of the It never becomes zero and hence
asset and is written off not completely written off.

Asset Suitability Assets such as buildings and lands Assets requiring more repair, like
which require less repair and have less machinery, plant, and cars are
chance of becoming obsolete are suita- more suitable
ble for this method

Impact of Deprecia- Increases every year Remains constant every year

tion and repairs on
P & L account

Diminishing Value Method: Definition and Formulae

https://youtu.be/pn70KmmYU_0
Example

On 1.1.2012, a firm purchased a machine at a cost of Rs. 1,00,000. Depreciation

charged at 10% p.a. on Diminishing value method for the five years is as follows:

Question : What is Bills of Exchange?

What is Bill Of Exchange? Features, Examples

Meaning of Bill of Exchange
According to the Negotiable Instruments Act 1881, a bill of exchange is defined as “an
instrument in writing containing an unconditional order, signed by the maker, directing a
certain person to pay a certain sum of money only to, or to the order of a certain person or to
the bearer of the instrument”.

Features of Bill of Exchange

• It is important to have a bill of exchange in writing
• It must contain a confirm order to make a payment and not just the request
• The order should not have any condition
• The bill of exchange amount should be definite
• Fixed date for the amount to be paid
 • The bill must be signed by both the drawee and the drawer
• The amount stated on the bill should be paid on-demand or on the expiry of a fixed
time
• The amount is paid to the beneficiary of the bill, specific person, or against a definite
order
Also Read: Important Questions for Bills of Exchange

Advantages of Bill of Exchange

• Legal Document- It is a legal document, and if the drawee fails to make the payment,
it will be easier for the drawer to recover the amount legally.
• Discounting Facility- In cases where the drawer is in immediate need of money, the
bill can be converted into cash by discounting it from a bank by paying some nominal
charges.
• Endorsement Possible- This bill of exchange can be exchanged from one individual
to another for the adjustment of the debt.

Bill of Exchange Format

In the above-mentioned bill of exchange format, Kunal Singh is the drawer as well as the
payee of the bill.

Related Read: DK Goel Solutions for Bills of Exchange

Parties of Bill of Exchange

A bill of exchange has three parties:
(1) Drawer:
 • The drawer is the maker of a bill of exchange.
• The bill is signed by Drawer.
• A creditor who is entitled to receive payment from the debtor can draw a bill of ex-
change.
(2) Drawee:
• Drawee is the person upon whom the bill of exchange is drawn.
• Drawee is the debtor who has to pay the money to the drawer.
• He is also known as ‘Acceptor’.
(3) Payee:
• The payee is the person to whom payment has to be made.
• The payee may be the drawer himself or a third party.
Also Check: Difference between Bill of Exchange and Promissory Note

What is Promissory Note

The promissory note is defined as an instrument in writing (not being a banknote or a
currency note), containing an unconditional undertaking signed by the maker, to pay a certain
sum of money only to or to the order of a certain person, or to the bearer of the instrument.

Importance of Promissory note in Bill of Exchange

According to the Negotiable Instruments Act 1881, the meaning of promissory note is ‘an
instrument in writing (not being a banknote or a currency note), containing an unconditional
undertaking signed by the maker, to pay a certain sum of money only to or to the order of a
certain person, or to the bearer of the instrument. However, according to the Reserve Bank of
India Act, a promissory note payable to bearer is illegal. Therefore, a promissory note cannot
be made payable to the bearer.’

Parties to a Promissory Note

There Are Two Parties to a Promissory Note:
(1) Maker: Maker or drawer is an individual or entity who makes or draws the promissory
note with a promise to pay a certain sum as is specified in the promissory note. Maker is also
known as promsior.
(2) Payee: The payee is the person in whose favour the promissory note is drawn.
The above mentioned is the concept, that is elucidated in detail about ‘Bill of Exchange’ for
the Commerce students.
Important Terms:

Q.1 Define the Terms:

(a) Term of Bill or Period of Bill
(B) Due Date
(C) Days of Grace
(D) Date of Maturity

Answer:

(a) Term of Bill or Pe- It is the time period between the date on which a bill is drawn and the date on
riod of Bill which it is payable.

(B) Due Date It is the date on which the payment of the bill is due.

(C) Days of Grace These are the three extra days added to the period of bill.

(D) Date of Maturity The date which comes after adding three days of grace to the period of bill.

Q.2 Briefly Explain the Terms :

(a) Discounting of Bill
(B) Endorsement of Bill; and
(C) Bill Sent for Collection.

Answer:

(a) Discounting of Bill • It means encashment of bill before the date of its maturity.
• The bank deducts its charges from the bill.

(B) Endorsement of Bill • Endorsement means the transfer of bill or promissory note to another per-
son.
• It is transferred on account of the settlement of debts and dues.

(C) Bill Sent for Collec- • When a bill is sent to the bank for collection with instruction, that it will be
tion retained till the maturity date.
• Bill will be realised on its due date. It is known as ‘Bill sent for collection’.

Q.3 Briefly Explain the Terms

(a) Dishonour of Bill;
(B) Noting of a Bill; and
(C) Nothing Charges.

Answer:

(a) Dishonour of Bill • When payment is not made by the acceptor of the bill on its due
date. It is known as ‘Dishonor of Bill’.
• Non-payment may be due to insufficient balance or insolvency.
(B) Noting of a Bill • On dishonour of a bill, when this fact is brought to the notice of a
Notary Public, it is termed as ‘Noting of a bill’.
• Notary public charges to record or take a noting of dishonour.

(C) Noting Charges • It is the fee paid to the Notary Public for noting of dishonour of a
bill.

Q.4 What Do You Mean by Retiring of a Bill and Renewal of a Bill?

Answer:

(a) Retiring of a Bill • When the Drawee pays the bill before its due date, It is termed as
the retirement of a bill.
• It happens with the mutual understanding between the Drawer and
the Drawee.
• To encourage Retiring of the bill, the holder allows some discount
called Rebate on the bill amount from the date of retiring the bill to
the maturity.

(B) Renewal of a Bill • When the holder of a bill is not in a position to meet the bill on its
due date, Drawee approaches the Drawer with a request of exten-
sion of time for payment.
• If Drawer agrees, the old bill is cancelled, and a fresh bill with the
new terms of payment is drawn and duly accepted and delivered.
This is called Renewal of the Bill.

(C) When Maturity Date Falls • If the due date of the bill is on the national holiday
on a National Holiday
• Then the maturity day of the bill shall be the preceding business
day.
• Example:-If due date of the bill falls on 26th January (Republic
Day), then its due date will be 25th January.
• If the due date is 15th August (Independence Day), then the due date
will be 14th August.

(D) When the Maturity Date • If the due date of the bill is declared as an emergency holiday,
Has Been Declared as Emer-
gency Holiday • Then the due date of the bill shall be after 1 day from the date of
maturity.
• Example:- if the due date of a bill is 25th July and it is declared as
an emergency holiday, then the due date will be 26th July.
 Q.2 What Do You Mean by Bills Receivable and Bills Payable?

Answer:

(a) Bills Receivable or B/R • For the person who draws the bill of exchange and is entitled to re-
ceive its payment is known as Bill Receivable.
• The drawer of the bill will show B/R on the assets side of the Bal-
ance Sheet.

(B) Bills Payable or B/P • For the person who accepts the bill, and is liable to make its pay-
ment, is known as Bills Payable.
• The Drawee of the bill will show B/P on the liabilities side of the
Balance Sheet.

When Bill Is Discounted With the Bank

Q.1 When Bill is Discounted With the Bank.

Answer:
• Discounting of the bill means encashing the bill before the date of its maturity.
• Bank charges an amount (Discounting charges) from the bill amount.

Renewal of Bill

Q.1 What Do You Mean by Renewal of a Bill?

Answer:

Renewal of • When the acceptor is not in his capacity to pay his bill on the due date.
Bill
• He may request the drawer of the bill to cancel the original bill and draw a new Bill
in place of the old Bill.
• If drawer agrees and a new bill is drawn, it is known as Renewal of a Bill.

Dishonour of a Bill

Q.1 What Do You Mean by Dishonour of Bill?

Answer:

Dishonour of a • A bill is said to be dishonoured when the drawee fails to make the payment on the
Bill date of maturity.
• The bill may get dishonoured when the drawee does not have sufficient funds to pay
the bill or he becomes insolvent.
• In this situation, the liability of the acceptor is restored.

Accommodation Bill
 Q.1 Explain the Concept of Accommodation Bill.

Answer:

Accommodation • Accommodation bill is drawn and accepted for the purpose of mutual help.
Bill
• It is accepted by the drawee to accommodate the drawer.
• Hence, the drawee is called the ‘Accommodating Party’ and the drawer is called
the ‘Accommodation Party’.
• Accounting entries are made for accommodation bills in the same manner as for
other bills.

Frequently Asked Questions on Bills of Exchange

What is the importance of bills of exchange?

Bills of exchange are important in the following ways:
1. Provide adequate time to the creditor to pay for the purchases made.
2. It serves as a basis on which the seller can take legal action against the buyer in case
payments are not made in time.

What is the difference between Bill of Exchange and Cheque?

The difference between a bill of exchange and cheque is that
1. Bill of exchange can be drawn on anyone which includes a banker, while a cheque
can only be drawn on the banker.
2. Bill of exchange needs to be accepted before any demand for payment can be made,
while in case of cheque, there is no requirement of acceptance, it requires immediate
payment.

Why is a bill of exchange unconditional?

Bill of exchange is unconditional as it contains a written order by the drawer to the drawee,
signed by drawer, and requires the drawee to pay on demand, or at a fixed or determinable
future time, a sum certain in money to, or to the order of, a specified person (the payee) or to
the bearer.

What are the 2 characteristics of a bill of exchange?

Two characteristics of the bill of exchange are:
1. Bill of exchange should be in writing.
2. The order should be unconditional.
Question: Explain 11 important Accounting Concepts
11 important concepts in accounting
Accounting bodies classify concepts as based on assumptions or based on prin-
ciples. Every type of business—including a sole proprietorship, partnership or a
public or private company—records its financial transactions based on these as-
sumptions and principles. These are some of the important concepts in ac-
counting:
1. Business entity concept
The business entity, economic entity or separate entity concept assumes that a
business is independent of its owner. A business may not record its owner's
personal expenses, income, liabilities and assets. It aids in tracking a business's
expenses, incomes and tax deductions without any ambiguity. In addition, it
safeguards a business owner's personal finances and helps build their credit-
worthiness. It reflects cash flow and financial position more accurately. This
clear distinction helps stakeholders and creditors take appropriate business de-
cisions based on a company's performance rather than the owner's financial
position.
2. Going concern concept
Going concern concept prescribes that accountants prepare financial state-
ments on the assumption that a business may continue its operations for the
foreseeable future. Under this concept, the definition of a foreseeable future is
a period of 12 months from the end date of the reporting period. If a business
owner or the management is invested in scaling down business operations to
zero, they cannot apply the going concern concept for accounting. Accountants
may no longer apply the going concern concept if a company is:

• unable to pay dividends

• unable to raise credit from banks and financial services
• facing losses and negative operating cash flow
• facing an adverse financial position
• unable to pay back crucial debts
• facing an unfavourable legal or regulatory action against it

3. Money measurement concept

This is an accounting concept based on assumption, and it stipulates that com-
panies record only those transactions that they can quantify and measure in
terms of money. If they cannot assign a monetary value to a transaction, they
do not record it in their annual financial statement. Though these transactions
affect a company's financial performance, they may not find a place in financial
statements, as monetising them can be challenging. Some examples of non-
monetary value include employee competence, product quality, employee effi-
ciency, market sentiment, business productivity and stakeholder satisfaction.
4. Accounting period concept
The accounting period concept prescribes a timeframe within which a business
records and reports its financial performance for the purview of internal and ex-
ternal stakeholders. An accounting period of a company may coincide with the
fiscal year. A company can determine a timeframe for internal reporting, like
three or six months, or prepare monthly financial reports to analyse their cash
flow positions. The management can determine a convenient accounting period
for internal reporting, but the reporting for investor, government and tax pur-
poses is typically for the period of one year.
5. Accrual concept
Accrual is a fundamental concept that guides how a business can record cash or
credit transactions. Under this concept, a business records a financial transac-
tion in the period it occurs. It does not consider whether the business pays or
receives cash at the time of the transaction, or if it pays cash after a certain pe-
riod. For example, a company records a credit purchase at the time of purchase
rather than when it pays back the seller. This helps record and report income,
expenses, liabilities and receivables accurately. All modern accounting systems
follow the accrual concept in recording financial transactions.
6. Revenue realisation concept
Under the revenue realisation or revenue recognition concept, a seller records
potential revenue from a transaction, regardless of whether they have or have
not received proceeds. The ownership of a product transfers from a buyer to a
seller during a sale. A seller recognises the transaction by creating a receivable
against the buyer's name in their ledger. An accountant creates another entry
when they receive the due amount in the future.
7. Full disclosure concept
The full disclosure concept requires a business entity to furnish necessary infor-
mation for the benefit of those who read financial statements and reports for
investment, taxation or audit purposes. This concept aims to provide important
financial information to investors, creditors, shareholders, clients, and other
stakeholders. Disclosure policies cover revenue recognition, depreciation, in-
ventory, taxes, earnings, stock value, leases and liabilities.
8. Dual aspect concept
Dual aspect concept states that every transaction affects two accounts of a busi-
ness. A business then records both aspects to enable accurate accounting.
Every financial transaction has a credit or debit or a giver or receiver aspect. If
an accounting process does not represent both, it may lead to faults in the final
accounting record. The dual aspect concept is the foundation of the double-en-
try system of bookkeeping, which is now a standard method for auditing and
taxation.
9. Materiality concept
The materiality concept prescribes guidelines to identify if a piece of financial in-
formation is material and whether it can influence the person reading a compa-
ny's financial statements. Based on this concept, an accountant or a business
may remove negligible transactions that may not have a bearing on final ac-
counts. This concept is open to subjective interpretation and the basis for using
the materiality concept varies with the size of a company. While a large com-
pany may round off figures in the final accounts to crores, a small firm may
round off their figures to lakhs.
10. Verifiable objective evidence concept
Under this concept, a business can record only those transactions that they can
furnish documentary proof for. Without proper and valid documentary evi-
dence, a transaction can be biased or undependable, and it can increase the
scope of financial irregularities. For example, a retail employee may present a
bill for purchases and sales, and corroborate it with sale and purchase invoices.
11. Historical cost concept
The historical cost concept states that a business may record assets and liabili-
ties at their historical cost rather than their current market or sale value. It
helps to maintain consistent, reliable and verifiable financial information. In-
cluding the current value of an entity can result in financial irregularities