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Lesson#9
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BOOKS OF ACCOUNT and FINANCIAL STATEMENTS
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BOOKS OF ACCOUNT & FINANCIAL STATEMENTS
Books of Account to be Kept by Company [SECTION-230]
A company should keep proper books of account in respect of:
a) Cash received and expended by the company;
b) Sales and purchases of goods by the company
c) All Assets and liabilities of the company; and
d) In case of a company engaged in production, processing,
manufacturing, or mining
activities, a production record as may be required by the
Commission through a general or
special order;
Books of account should be preserved for ten years;
Books of account are to be kept at the registered office of the
company. If kept at any other place, the
registrar should be informed;
Books of account should give a true and fair view of the state
of affairs of the company and should contain
explanation of transactions.
Directors can inspect the books of account during the business
hours.
If company fails to comply with the above provisions a director,
including chief executive and chief
accountant:
(a) of listed company is liable to imprisonment for one year and
a fine of not less than Rs.
20,000 not more than Rs. 50,000, and a further fine of Rs. 5000
per day during which the
default continues; or
(b) of other companies is liable to imprisonment for six months
and with a fine, which may
extend to Rs. 10,000
Accounting Cycle
• Transaction
• Document
• Voucher
• Books of original
entry/journal/day book
• Books of secondary
entry/ledger
• Financial statement
Transaction Source Document
Sale Invoice Issue
Purchase Invoice Receive
Sales return Credit Note Issued
Purchases return Credit Note Received
Cash received Receipt/Cash Memo Issue
Cash paid Receipt/Cash Memo Received
Lease/Hire Purchase Agreement
Voucher
• Receipt voucher
• Payment voucher
• Journal voucher
• Petty cash voucher
Books of Original Entry
• Purchase journal
• Sale journal
• Purchase return journal
• Sales return journal
• Cash book (two/three
column)
• Petty cash book
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• General journal/
transfer journal
Books of Secondary Entry
• Main ledger
• Subsidiary ledger
Financial Statement
• Balance sheet
• Income statement
• Statement of changes in
equity
• Cash flow statement
• Notes to the accounts
Recording of Transactions from Source Documents
To enter into a transaction we need
approval
from our responsible managers. When, after having
approval of
a manager, transaction takes place, such transaction should be
evidenced by a document.
Because, to record a
transaction into the books of account, a bookkeeper needs an
evidence of proper approval of transaction
and authorization of documents, therefore, a
voucher
is prepared on which all of the descriptions of
the
transaction are written up and with which all of the evidences
of approvals and authorized document are
attached. Such voucher is finally authorized by accounts manager
which is then recorded in the books of
accounts by a bookkeeper.
To have a more clear understanding of the above paragraph, lets
have a step by step example of purchasing
an air conditioning plant for workshop.
1. Production manager will send a
requisition
to the general manager for air conditioning the
workshop
to improve the working environment.
2. The general manager will
approve the requisition
(if he gets convinced that workshop is in real
need of
air conditioning plant) and will send this approval to the
purchase department.
3. The purchase department will call a
tender
and after having received several
quotations
the purchase
department will place a
purchase order
to the vendor quoting lowest rate. (All of the
above procedure
is properly documented).
4. The vendor company (supplier) will send an
invoice
(purchase invoice) to the business along with the
air conditioning plant. Such air conditioning plant will be
inspected by the expert
and finally the invoice
will be approved
for payment.
5. Now all of the documents along with the purchase invoice
shall be send to the bookkeeping office
where a voucher
will be prepared and will also be
approved
by the concerned manager for recording
this transaction in the books of accounts.
Source Documents:
Following are the few examples of source documents which are
required to support different types of
transactions.
Sr. No. Transaction Source Documents
1 Sales Sales Invoice issued
2 Purchase Purchase Invoice received
3 Sales Return Credit Note issued
4 Purchase Return Credit Note received
5 Cash received Cash Memo/receipt issued
6 Cash paid Cash Memo/receipt received
7 Leases/Hire purchase Agreements
8 Staff Salaries Approved Payrolls
9 Electricity, Gas, Water, Tele. Phone Metered Bills/Invoices.
Recording in the Books
Approved voucher are recorded in the books of accounts, many
businesses now a days use computers for
recording of transactions. However, an understanding of book of
accounts is necessary whether
transactions are recorded manually or electronically.
Basically, there are two types of books of accounts which are
used to record the business transactions
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25
Purchases
Journal
Sales Journal Returns
Inward
Journal
Returns
Outward
Journal
General
Journal
For credit
purchases
For credit
sales
For sales
return
For
purchases
return
For all other
transactions
Source Documents
Invoices
Issued
Credit
Note
Issued
Credit Note
Received
Depends upon
the nature of
Transaction
Invoices
Received
Figure 3.1
To record credit transaction
BOOKS OF ACCOUNT
Books of Original
Entries (Journal)
Cash
Book
For cash
receipts &
payments
Main Ledger Subsidiary Ledger
Other
Ledger
Debtors
Ledge
Creditors
Ledger
Materials
Ledger
To extract trial balance and to
prepare financial statements
To keep memorandum
Books of Secondary
Entries (Ledger)
To record cash transaction
Cash
Memos
1. Books of original entries.
2. Books of secondary entries.
These are further subdivided according to the needs of the
business and/or complexity of the transaction.
Following diagram best describes the different books of accounts
which are used in the business for
recording transactions.
Just after analyzing a transaction or event for its debit and
credit effects it is required to record them in a
systematic way. So the books of accounts in which Debit and
Credit are initially recorded in a systematic
way are known as books of original entry (BOE). In accounting
system of business concern books of
original entries possess a very important position.
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26
JOURNAL:
It depends upon the complexity of transactions and size of the
business that what books of original entries
are required to record the transactions. For a very little
business, having very few cash and credit
transactions, a
general purpose journal is sufficient
to record each type of transactions.
Journal is the very
first book of account in which all of the business transactions and events are
recorded. In
this book transactions and events are recorded in a
chronological (date) sequence. Both of the accounting
effects (Debit & Credit) are recorded in it in a systematic way.
Information recorded in the journal for a
transaction or an event is known as
journal entry.
Sketch of a Journal & Journal Entry
Date
2003
Particulars Post
Ref.
Debit
(Rs)
Credit
(Rs)
Jan. 10 Salaries Account
(Debit)
Cash Account
(Credit)
(Staff salaries paid in cash).
39
10
50,000
50,000
Figure 3.2
From the above illustration we can understand that on
10th
January 2003, business paid cash
Rs.50,000 as staff
salaries. It is
customary that the accounting head analyzed as
debit
is written firstly in the particulars’ column
and its amount is written in the debit column whereas the
accounting head analyzed as
credit is written under
the debit accounting head but after indenting a little space
from the left side, its amount is written in the
credit column. The column of post reference cannot be very well
understood without having knowledge of
Ledger, any how, the column post reference shows
page numbers of
the Ledger in which salaries and cash
accounts are posted. Words written within the parenthesis in the
particulars column are known as
“Narration of a transaction or event”; it is an integral part of
a journal entry. Narration explains the
accounting treatments to a layman.
Subdivision of Journal:
As discussed earlier in 1.2 that the journal is sub-divided
based on complexity of the transactions or size of
business. This happens only when there are a number of cash
transactions in a day and also there are so
many transactions for credit purchases and credit sales. This
large numbers of transactions create a mess in
bookkeeping office; therefore, separate bookkeeping clerks are
given responsibilities for separate types of
transactions along with separate journals. For example,
For cash transactions there is a separate cash office in which
only cash transactions are analyzed and
recorded in a book named as
cash book.
For purchases there is a
purchase journal
in which only and only credit transactions for
purchases are
recorded. In the same way
sales journal
for credit transaction of sales is maintained.
And if there are a large
number of returns then separate
journals for sales return and purchase
return are also maintained.
Now that, after having separate journals for credit sales,
credit purchases, sales & purchases return and cash
transactions, all of the remaining transactions and events like
sale and purchase of assets on credit, loss by
fire etc. shall be recorded in
general journal.
To learn more about subdivision of journal, firstly have a
re-look on figure 3.1.
SALES JOURNAL:
Need for Sales Journal
In case of a small business, there is very little number of
transactions of credit sales. As we can have an
example of a barber’s shop, a tailor, a retailer etc. they
mostly sell their services or goods on cash terms. But
as business expands, the sales of it also grow in terms of cash
as well as in terms of credit. The cash sales are
now recorded in the cash book as a receipt, and the credit sales
are recorded in a separate journal named as
sales journal (sales day book). In sales journal, no other
transactions are recorded except the transaction for
sales on credit terms.
Supporting Document:
As shown in the figure 3.1 the source document supporting credit
sales is sale invoice.
It is made up in
duplicate or triplicate (depending upon the accounting systems
developed for the recording of credit sales)
Cash
Memos
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one of these copies is sent to the debtor (credit customer)
along with the goods/services sold. A standard
format of sales
invoice looks like below;
Name of Vendor Co.
Address of Vendor Co.
Sale Invoice No. Date:
Name & Address of Customer
Purchase Order Ref. No.
Sr. No. Particulars/Description Quantity Rate Amount
Trade discount
Total
***
(***)
***
Settlement terms.
2/10, n/30
Figure 3.3
Purchase Order Reference No:
When a customer asks a vendor for supply of some goods, such
order is evidenced through a purchase
order form. Purchase order form discloses the quantity and
quality of goods ordered along with its rates and
discounts both trade and settlement. Each purchase order has its
unique number which is put on the sales
invoice for reference.
Trade Discount:
Amount of trade discount is not required to be recorded in the
books of accounts. Actually it is the
discount which is agreed before entering into the transaction of
sales or purchase, therefore, it is just
formally show on the face of the invoice, otherwise it has no
other financial effects.
Settlement Terms:
It is also known as prompt payment terms. These terms are in
fact offered to lure the customer for having
more discounts by making payment for the invoice earlier. In
this term, for example 2/10, n/30,
the first
part 2/10
contemplates that if customer pays cash
within 10 days of the invoice, he will be offered a
discount of 2%, the second part of it
n/30
contemplates that after 10 days there will be no
discount offer
but the customer has to pay the amount of invoice net of trade
discount within the thirty days of the date of
invoice.
This term sounds as
two ten net thirty (2/10, n/30).
How this will sound 5/20, n/60 and what do you understand by
this term?
Entering the Transaction of Credit Sales in Sale Journal:
In case of credit sales the business is very much interested in
the name and addresses of the credit customer
(Debtor), therefore, sales journal is so designed to cover
following information;
Date---------------------
Date of invoice
Name of Debtor
-------Mentioned in the invoice
Invoice number -------
It helps to trace the other details of invoice.
Post reference
---------
page number of subsidiary ledger (will be discussed later on)
Amount of invoice ----
Net of Trade Discount
Brain Storming
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Sketch of Sales Journal
Date Name of Debtor Invoice
No.
Post.
Ref.
Amount
Rs.
You would have noticed in the sales journal, there is only one
column for amount. It might have created
confusion in your mind that why we are not having two columns
for amount, one for debit and other for
credit, like in journal. Remember, here in sales journal all of
the transactions are of same nature (credit sales)
and the purpose of sales journal is just to avoid over working
for recording the debits and credits of each
transaction again & again. So, the role of sales journal in an
accounting system is to precise all of the credit
transactions of sales for a month or so and give effect of debit
to debtors and credit to sales with total
amount of such period.
Purchase Journal:
Need for a Purchase Journal
After knowing the need of sales journal (as discussed in
previous section) it will be very easy to understand
that for a large business having frequent transactions of credit
purchases it is necessary to maintain a
separate book for recording the transactions of purchases on
credit terms. This book is named as purchase
day book. Obviously like a sales journal no cash transactions
relating to purchase shall be recorded in this
book.
Supporting Document:
As shown in the diagram the supporting document for transactions
of credit purchases is purchase invoice.
It is exactly the same document as we looked into the diagram of
previous section. Purchase invoice is in
fact the copy of sales invoice in the hands of customer. It is
issued to the purchaser by the
seller/vendor/supplier. So from the stand point of a purchasing
business, the business after having received
the invoice will put an internal number on it and will file it
as evidence of the transaction and also for the
purpose to remember that amount of this invoice is still
outstanding for payment according to the
settlement terms as discussed in section.
Entering the Transaction of Credit Purchases in Purchase
Journal:
The basic contents of a purchase journal are exactly the same as
discussed in the case of a sales journal with
the exception of one thing that now in the second column there
is the name of Creditors instead of
Debtors. Obviously, we remember the person from whom goods are
purchased on credit is creditor of the
business.
Sketch of Purchase Journal
Date Name of creditor Inv.
No.
Post.
Ref.
Amount
Rs
A purchase journal is a list of all credit purchases in a
stipulated time period. All of the credit purchases
recorded in a purchased journal during a period is totaled and
then for such total amount debit effect is
given to the purchases account and credit effect is given to the
creditors account. You noticed here that the
rules of debit and credit remain same all the time.
Sales Return Journal: (Returns Inward Journal)
Need for Sales Return Journal
As the business expands the number of complaints and returns
inwards also increases. Such return inwards
can be recorded in the sales journal as a negative entry if
these are very little in number. But because of its
reverse nature it is recommended to maintain a separate journal
to record sales return. Here one very
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important concept should be remembered that in sales return
journal only the returns against credit sales
(from Debtors) are recorded. Normally, it doesn’t happen that
return of goods sold against cash are
accepted by a business because certainly against such return the
business would have to make refund of
money already received. That’s why in coming practice you will
not find any such transaction.
But obviously if
you have any example of such transaction in your business, it
will be recorded in cash book as a payment.
Supporting document:
When a business receives back its sold goods it issues a “credit
note” to the debtor returning goods, which
evidences that we have received the returned goods and accept
that money for such sales will not be
received in future. A “credit note” issued is an evidence of
reduction in sales income and also in the amount
of debtors. It is also said that a “credit note” is a reversal
document of an “invoice” which cancels the effect
of it. Like an “invoice”, a credit note is also given a
number
and also possesses a
reference of sales invoice
against
which such return were made. Rest of the contents of credit note
are commonly understood, such as:
Name &
Address of the business (Seller)
Name &
Address of the customer
Date
Particulars
Quantity
Rate
Amount
Sketch of Credit Note
Name of Vendor Co.
Address of Vendor Co.
Credit Note No: Date:
Customer’s Name
Customer’s Address
Ref. Invoice No Account No:
Item No. Description Quantity Rate Trade
Discount
Net Amount
Total
Figure 3.6
Purchase return journal: (Returns outward journal)
Need for a Purchase Return Journal?
Purchase return journal has the same story as we just have
discussed in previous unit. The only thing to
remember is that it is also known as return outward
journal/daybook. Obviously these transactions (for
purchase returns) could also be recorded in the purchase journal
as negative entry but same as for sales
return journal it is required to have a separate journal for
purchase returns because of its reverse nature to
the purchases. The total of purchase return journal will cause a
reduction in the purchases expenses and also
a reduction in the amount of creditors.
Supporting document:
Although purchase returns are evidenced by a copy of
credit note
received from the seller, which is treated as
a reversal document against purchase invoice. But here we shall
also discuss the need of a “Debit
Note”. A
“debit note”
is in fact a request, put to the seller by the purchaser business, for issuance
of a credit note.
A copy
of debit note
is sent to the seller along with the
rejected goods, in which all of the particulars of goods
rejected and returned along with the reference of relevant
invoice number are entered. Remember, a
business cannot record purchases returns considering a
debit note
as a supporting document because the
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effects of purchase invoice are not considered cancelled unless
acceptance of rejected goods is received
from the seller in shape of a copy of
credit note.
Entering Transactions in Purchases Return Journal:
you will find nothing new in this section except the treatment
of total of purchase return journal which is
debited to the creditors account and credited to the purchases
return account.
Sketch of a Purchase Return Journal
Date Creditor Name Credit
Note No.
Post.
Ref.
Amount
Figure 3.7
Cash Book:
Cash book is a book of original entries in which all of the cash
transactions are recorded very firstly. If we
refer to the figure 3.1, we can notice that the (books of
original entry) journal is subdivided for two types of
transactions i.e. credit transactions and cash transactions. As
discussed in previous units, all credit
transactions are recorded in different journals. The cash
transaction of a concern needs a separate book
named as cash book.
A cash book is divided into two sections, one for cash receipts
and the other for cash payments. Each of
the section is formatted for
date, particulars, post reference
and
amount.
See below for its proper sketch;
Cash book
Date Particulars Post
Ref.
Amount Date Particulars Post
Ref.
Amount
Figure 3.8
Left hand side of a cash book is known as receipt side and right
hand side is known as payment side. In a
way, we can say that within a cash book, we prepare two cash
journals, one, cash receipt
journal and second,
cash payment journal.
Supporting Documents:
For Cash Receipts
All cash receipts are evidenced by a copy of cash memo/receipts
retained by the business. These cash
memos/receipt are already serially pre-numbered and for each
receipt of cash, the cash office issues an
original copy of the cash memo/receipt to the person making
payment and retains a carbon copy or
counterfoil of it within the office which are used to record
receipts of cash in the cash book.
For Cash Payments
All cash payments are evidenced by an original copy of cash
memo/receipts issued by the recipient
business. These are attached with a cash voucher as evidence
that cash was paid to recipient who issued this
cash memo/receipt.
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