MGT101 - Financial Accounting - I - Lecture Handout 07

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BASIC BOOKS OF ACCOUNTS

Areas Covered in this lecture:

  • Cash book and bank book.
  • Accounting Period.
  • Trial Balance and its limitations

Flow of Transactions:

  1. In Financial Accounting, any business transaction flows as follows The business transaction is recorded in a voucher. The voucher is the first document prepared in the financial accounting.
  2. All financial transactions are then posted in the journal from vouchers.
  3. In these days, voucher is directly fed in the books of accounts by means of computers.Otherwise ledgers are prepared for each account from the Journal.
  4. From the books of accounts, trial balance is prepared, which shows the arithmetic accuracy of the accounting system.
  5. Finally, financial statements. i.e., Profit & Loss Account and Balance Sheet is prepared from trial balance.

Cash Book & Bank Book

Cash book and bank book are part of general ledger. All entries including payables and receivables are recorded in the general ledger. Expenses, income, assets and liabilities are recorded in different head of accounts to analyze the expenses incurred in different head of accounts. Due to large volume o transactions, entries related to cash and banks are recorded in the separate books.

Cash Book

All cash transactions (receipts and payments) are recorded in the cash book. Cash book balance shows the amount of cash in hand at a particular time.

Format of cash book is here under:

Cash Book Account Code 01
Receipt Side Payment Side
Date No. Narration Particulars Ledger Code Receipt Amount Date No. Narration Particulars Ledger Code Payment Amount
                   
                   

OR

Cash Book Account Code 01
Date Voucher Number Narration Particulars Ledger Code Receipt Amount Payment Amount Balance Dr/(Cr)
             
             

Two formats of cash book are shown above. In the first format, receipt side and payment side are shown separately. In the second format, two columns are shown for receipt and payment with an extra column of balance. The balance column shows the net balance of cash available for use. The ledger code shows the code of that head of account which contains the second effect of the cash transactions because debits and credits are always equal in financial accounting.

Both of these formats are correct. A business can use any format considering its policies and requirements.

Bank Book

All bank transactions (receipts & payments) are recorded in the bank book. The balance of bank book reflects the cash available at bank at a particular time.

Format of bank book is hereunder:

Bank Book (Bank Account Number) Account Code 02
Date Voucher Number Chq. No. Narration / Particulars Ledger Code Receipt Amount Payment Amount Balance Dr/(Cr)

The format of bank book is same as that of cash book except the column of cheque no. This column is added in the format because all payments are made by cheque and the number of cheque is written in that column in order to keep the accounting record updated.

Accounting Period

Accounting period is any period for which a Financial Statements are prepared. The length of the accounting period can be anything between one day to one year. The legal or statutory definition of accounting year is a maximum of one year. The only exception in this case is the formation of a new company which is formed before the start of accounting period.

Financial year (A period of 12 month duration)

In Pakistan, financial year starts from 1st of July and ends on 30th of June. Exceptions are for specialized business such as textile mills, banks, Sugar mills etc. Financial reports can be made for a week or a month, depending upon the requirements of the company.

Debit & Credit Balances

It has already been mentioned that both sides i.e. Debit and credit side of a ledger must be equal. If debit side of a ledger is greater than credit side, the balance will be written on the credit side and it will be called

Debit Balance. The reason being, the balance is written on the credit side because of excessive debit balance. Therefore, it is called Debit Balance. For example:

A Debit Balance

Title of Account Account Code 01
Debit Side Credit Side
Date No. Narration / Particulars Receipt Amount Date No. Narration Particulars Payment Amount
  1   100,000   3   80,000
  2   20,000   4   30,000
      120,000       110,000
            Balance 10,000

A Credit Balance

Title of Account Account Code 01
Date No. Narration / Particulars Receipt Amount Date No Narration / Particulars Payment Amount
  1   80,000   3   100,000
  2   30,000   4   20,000
      110,000       120,000
    Balance 10,000        

Similarly, if credit side is greater than debit side, the balance will be written on the debit side. This balance is called. Credit Balance. For Example:

Trial Balance

At the end of accounting period, a list of all ledger balances is prepared. This list is called trial Balance.

Trial balance is a listing of the accounts in your general ledger and their balances as of a specified date. A trial balance is usually prepared at the end of an accounting period and is used to see if additional adjustments are required to any of the balances. Since the basic accounting system relies on double-entry bookkeeping, a trial balance will have the same total debit amount as it has total credit amounts. Both sides of trial balance i.e. Debit side and credit side must be equal. If both sides are not equal, there are some errors in the books of accounts. Trial balance shows the mathematical accuracy of the books of accounts.

Limitations of Trial Balance

  1. Trial balance only shows the mathematical accuracy of the accounts.
  2. If both sides of trial balance are equal, books of accounts are considered to be correct. But this might not be true in all the cases.
  3. If any transaction is not recorded at all, trial balance can not detect the omitted transaction.
  4. If any transaction is recorded in the wrong head e.g. if an expense is debited to an assets account.
    Trial balance will not be able to detect that mistake too.

A Sample Trial Balance

Title Balance
Trial Balance As on 31st Dec. 200------
Title of Account Account Code Debit Amount Credit Amount
Cash in Hand 01 xy  
Cash at bank 02 xy  
Capital 03   xy
Assets 04 xy  
Liabilities 05   xy
Income 06   xy
Expenses 07 xy  
Total   xyz xyz

 

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