Chapter 2-accounting-process-part-2

CHAPTER - 2
Unit 5
Cash Book
ACCOUNTING
PROCESS
© The Institute of Chartered Accountants of India

CASH BOOK
2.68 COMMON PROFICIENCY TEST
Learning Objectives
After studying this unit you will be able to :
 Understand that a Cash Book is a type of subsidiary book but treated as a principal
book.
 Be familiar with various kinds of Cash Books, viz., Simple Cash Book, Two-column Cash
Book and Three-column Cash Book.
 Learn the technique of preparation of Simple Cash Book and how to balance it.
 See how Double-Column Cash Book is a prepared adding discount column alongwith
cash column.
 Understand the techniques of preparing Three-column Cash Book.
 Understand what is a Petty Cash Book and the Imprest System of Petty Cash.
 Note the advantages of the Petty Cash Book.
 Learn how to maintain a Petty Cash Book and how to post the entries of the Petty Cash
Book in the ledger.
 Understand the accounting of credit/debit sales transactions.
1. CASH BOOK - A SUBSIDIARY BOOK AND A PRINCIPAL BOOK
Cash transactions are straightaway recorded in the Cash Book and on the basis of such a record,
ledger accounts are prepared. Therefore, the Cash Book is a subsidiary book. But the Cash Book
itself serves as the cash account and the bank account; the balances are entered in the trial balance
directly. The Cash Book, therefore, is part of the ledger also. Hence, it has also to be treated as the
principal book. The Cash Book is thus both a subsidiary book and a principal book.
2. KINDS OF CASH BOOK
The main Cash Book may be of the three types:
(i) Simple Cash Book;
(ii) Two-column Cash Book;
(iii) Three-column Cash Book.
In addition to the main Cash Book, firms also generally maintain a petty cash book but that is
purely a subsidiary book.
2.1 SIMPLE CASH BOOK
Such a cash book appears like an ordinary account, with one amount column on each side. The
left-hand side records receipts of cash and the right hand side the payments.
Balancing of the Cash Book: The cash book is balanced like other accounts. The total of receipts
column is always greater than total of payments column. The difference is written on the credit

FUNDAMENTALS OF ACCOUNTING 2.69
side as ‘By balance c/d’. The totals are then entered in the two columns opposite one another and
then on the debit side the balance is written as “To Balance b/d”, to show cash balance in hand
in the beginning of next period.
Illustration 1
Enter the following transactions in a Simple Cash Book:
2011 `
Jan.1 Cash in hand 1,200
“5 Received from Ram 300
“7 Paid Rent 30
“8 Sold goods for cash 300
“10 Paid to Shyam 700
“27 Purchased Furniture 200
“31 Paid Salaries 100
“31 Rent due, not yet paid, for January 30
Solution
CASH BOOK
Dr.
Date
2011
Receipts L.F. Amount
`
Date
2011
Payments L.F.
Cr.
Amount
`
Jan. 1 To Balance b/d 1,200 Jan. 07 By Rent A/c 30
“ 5 To Ram A/c 300 “ 10 By Shyam A/c 700
“ 8 To Sales A/c 300 “ 27 By Furniture A/c 200
“ 31 By Salaries A/c 100
“ 31 By Balance c/d 770
1,800 1,800
2011
Feb. 1 To Balance b/d 770
Note: One can see the following:
(i) In the simple cash book only the cash receipts and cash payment are recorded.
(ii) The total of debit side is always greater than the total of credit side since the payment cannot
exceed the available cash.
(iii) The simple cash book is like an ordinary account.

CASH BOOK
2.2 DOUBLE- COLUMN CASH BOOK
If along with columns for amounts to record cash receipts and cash payments another column is
added on each side to record the cash discount allowed or the discount received, or a column on
the debit side showing bank receipts and another column on the credit side showing payments
through bank. It is a double column cash book.
Cash discount is an allowance which often accompanies cash payments. For example, if a customer
owes ` 500 but is promised that 2% will be deducted if payment is made within a certain period,
the customer can clear his account by paying promptly ` 490. Cash received will be ` 490 and ` 10
will be the discount for the firm receiving the payment discount is a loss; for the person making
the payment it is a gain. Since cash discount is allowed only if cash is paid, it is convenient to add
a column for discount allowed on the receipt side of the cash book and a column for discount
received on the payment side of the cash book.
In the cash column on the debit side, actual cash received is entered; the amount of the discount
allowed, if any, to the customer concerned is entered in the discount column. Similarly, actual cash
paid is entered in the cash column on the payments side and discount received in the discount
column. Also the bank column on the debit side records all receipts through bank and the same
column on the credit side shows payment through bank.
Balancing: It should be noted that the discount columns are not balanced. They are merely totalled.
The total of the discount column on the receipts side shows total discount allowed to customers
and is debited to the Discount Account. The total of the column on the payments side shows
total discount received and is credited to the Discount Account. The Cash columns are balanced,
as already shown. The bank columns are also balanced and the balancing figure is called bank
balance. Thus a double column cash book should have two columns on each side comprising of
either cash and discount transaction or cash and bank transactions.
Illustration 2
Ganesh commenced business on 1st April, 2011 with ` 2,000 as capital. He had the following cash
transactions in the month of April 2011:
` `
April 1 Purchased furniture April 7 Paid for petty expenses 15
and paid cash 250 “ 8 Cash purchases 150
“2 Purchased goods 500
“4 Sold goods for cash 950
13 Paid for Typewriter 1,000
“5 Paid cash to Ram Mohan 560
“6 He allowed discount 10 “” Paid Ali & Sons 400
“6 Received cash from
Krishna & Co. 600 “” They allowed discount 8
Allowed discount 20
Make out the two-column Cash Book (Cash and discount column) for the month of April, 2011.

Solution
CASH BOOK
Dr.
Date
2011
Receipts L.F. Discount
`
Amount
`
Date
2011
Payments L.F. Discount
`
Cr.
Amount
`
April1 To Capital A/c 2,000 April 1 By Furniture A/c 250
“ 4 To Sales A/c 950 “ 2 By Purchases A/c 500
“ 6 To Krishna A/c 20 600
“ 5 By Ram Mohan 10 560
“ 7 By Petty
Expenses A/c 15
“ 8 By Purchases A/c 150
“ 13 By Typewriter A/c 1,000
“ 13 By Ali & Sons 8 400
“ 30 By Balance c/d 675
20 3,550 18 3,550
May 1 To Balance b/d 675
To summarise :
(i) the discount columns in the cash book are not accounts;
(ii) they are not balanced; and
(iii) their totals are entered in the discount received/paid account in the ledger.
Note : The person who pays, is credited by both the cash paid by him and the discount allowed
to him. Similarly, the person to whom payment is made, is debited with both the amount paid
and the discount allowed by him.
2.3 THREE-COLUMN CASH BOOK
A firm normally keeps the bulk of its funds at a bank; money can be deposited and withdrawn
at will if it is current account. Probably payments into and out of the bank are more numerous
than strict cash transactions. There is only a little difference between cash in hand and money at
bank. Therefore, it is very convenient if, on each side in the cash book, another column is added
to record cash deposited at bank (on the receipt side of the cash book) and payments out of the
bank (on the payment side of the cash book).
For writing up the three-column cash book the under mentioned points should be noted:
1. While commencing a new business, the amount is written in the cash column if cash is
introduced and in the bank column if it is directly put into the bank with the description “To
Capital Account”. If a new cash book is being started for an existing business, the opening
balances are written as : “To Balance b/d”.

CASH BOOK
2. All receipts are written on the receipts side, cash in the cash column and cheques in the bank
column. If any discount is allowed to the party paying the amount, the discount is entered in
the discount column. In the particulars column the name of the account in respect of which
payment has been received is written.
3. All payments are written on the payments side, cash payment in the cash column and
payments by cheques in the bank column. If some discount has been received from the party
receiving the payment, it is entered in the discount column.
4. Contra Entries: Often cash is withdrawn from bank for use in the office. In such a case the
amount is entered in the bank column on the payments side and also in the cash column on
the receipts side. In the reverse case of cash being sent to the bank, the amount is recorded
in the bank column on the receipts side and in cash column on payment side. Against such
entries, the letter “C” should be written in the LF. column, to indicate that these are contra
transaction and no further posting is required for them.
Note : If initially cheques received are entered in the cash column and then sent to the
bank, the entry is as if cash has been sent to the bank.
While recording contra entries, the basic but important rules should be followed -
(a) The Receiver Dr.
The Giver Cr.
(b) All what comes in Dr.
All what goes out Cr.
e.g. where a Cash Book with separate columns for Bank Account is maintained.
(a) If cash is deposited in Bank Account, the Bank will be the Receiver, hence it will be
Debited and as the cash is going out, cash will be credited.
(b) If cash is withdrawn from the Bank Account, the Bank will be the Giver, hence it will
be Credited and, as the cash is coming in, cash will be Debited.
5. If some cheque sent to the bank is dishonoured, i.e., the bank is not able to collect the amount,
it is entered in the bank column on the credit side with the name of the related party in the
particulars column.
6. If some cheque issued by the firm is not paid on presentation, it is entered in the Bank column
on the debit side with the name of the party to whom the cheque was given.
7. In a rare case, a cheque received may be given to some other party, i.e., endorsed. On receipt,
it must have been entered in the bank column on the debit side; on endorsement the amount
will be written in the bank column on the credit side.
The advantages of such type of Cash Book are that -
(a) the Cash Account and the Bank Account are prepared simultaneously, therefore the
double entry is completed in the Cash Book itself. Thus the contra entries can be easily
cross-checked in Cash column in one side and the Bank column in the other side of the
Cash Book. Also the chances of error are reduced.

(b) the information regarding Cash in Hand and the Bank Balance can be obtained very
easily and quickly as there is no need to prepare Ledger of the Bank Account.
In case of maintaining more than one Bank Account, separate column can be add for each Bank
Account. Transactions between these two or more Bank Accounts can be recorded and tallied
with a much less effort.
Suppose, there are two Bank Accounts namely PNB Current Account and SBI-Cash Credit Account.
Now, if a cheque is deposited from PNB cheque Book to SBI Account, the receiver - i.e., PNB
Account will be debited and the giver i.e. the SBI Account shall be credited.
Balancing: The discount columns are totalled but not balanced. The cash columns are balanced
exactly in the same manner as indicated for the simple cash book. The process is similar for
balancing the bank columns also. It is possible, however, that the bank may allow the firm to
withdraw more than the amount deposited i.e., to have an overdraft, In such a case, the total of the
bank column on the credit side is bigger than the one on the debit side. The difference is written
on the debit side as “To Balance c/d.” Then the totals are written on the two sides opposite one
another, the balance is then entered on the credit side as “By Balance b/d.”
However, the usual case is that payments into the bank will exceed the withdrawals or payments
out of the bank. Then the bank columns are balanced just like the cash columns.
Illustration 3
Enter the following transactions in Cash Book with Discount and Bank Columns. Cheques are
first treated as cash receipt.
2011 `
Jan.1 Chandrika commences business with Cash 20,000
“3 He paid into Current A/c 19,000
“4 He received cheque from Kirti & Co. on account 600
“7 He pays in bank Kirty & Co’s cheque 600
“10 He pays Rattan & Co. by cheque and is allowed discount ` 20 330
“12 Tripathi & Co pays into his Bank A/c 475
“15 He receives cheque from Warshi and allows him discount ` 35 450
“20 He receives cash ` 75 and cheque ` 100 for cash sale
“25 He pays into Bank, including cheques received on 15th and 20th 1,000
“27 He pays by cheque for cash purchase 275
“30 He pays sundry expenses in cash 50

CASH BOOK
Solution
CASHBOOK
Dr.
Date
ReceiptsL.F.
Discount
`
Cash
`
Bank
`
DatePaymentsL.F.
Discount
`
Cash
`
Cr.
Bank
`
20112011
Jan.1ToCapitalA/c20,000Jan.3ByBankA/cC19,000
3ToCashC19,0007ByBankA/cC600
4ToKirti&Co.60010ByRatan&Co.20330
7ToCashC60025ByBankA/cC1,000
12ToTripathi&Co.47527ByPurchasesA/c275
15ToWarshi3545030ByS.Exp.A/c50
20ToSalesA/c175
25ToCashC1,000
31ByBalancec/d30020,745
3521,22521,0752021,22521,075
Feb.1ToBalanceb/d30020,745

3. POSTING THE CASH BOOK ENTRIES
Students would have seen that the cash columns in the cash book is actually the cash account
and the bank column is actually bank account. Also, the discount columns are memorandum
columns, meant only to provide information about the total discount allowed and total discount
received.
The debit side columns for cash and bank indicate receipts. Therefore, the amounts debited in the
cash book should be put to the credit of the account in respect of which cash or cheque has been
received. For instance, in the cash book given above we see that ` 175 have been received for sale
of goods. For posting, the amount is credited to the Sales Account as “By Cash ` 175.” We also
see M/s. Warsi have paid ` 450 and also they have been allowed ` 35 as discount; thus they have
discharged a debt of ` 485. In the account of M/s. Warsi, the posting is on the credit side as
By Cash ` 450
By Discount ` 35
or as :
By Sundries ` 485
All payments are recorded on the credit side. The particulars columns show on what account
payments have been made. In the ledger accounts concerned the amount in put on the
debit side. For example, the cash book shows that a cheque for ` 330 has been issued to
M/s. Ratan & Co. and also that they have allowed a discount of ` 20; thus an obligation of ` 350
has been met. In the account of M/s. Ratan & Co. the posting is :
To Bank ` 330
To Discount ` 20
Or
To Sundries ` 350
The rule thus develops: From the debit side of the cash book credit the various accounts
with their respective amounts (including any discount that may have been allowed); from
the credit side of cash book the posting will be to the debit of the accounts mentioned in the
particular column with their respective amounts (including the discount which may have
been received).
As has been shown already, the total of the discount columns on the debit side is debited to the
discount account; the total of the column on the credit side is credited to the discount account.
From the cash book given on the previous page ` 35 is debited and ` 20 be credited to the discount
account.
4. PETTY CASH BOOK
In a business house a number of small payments, such as for telegrams, taxi fare, cartage, etc.,
have to be made. If all these payments are recorded in the cash book, it will become unnecessarily
heavy. Also, the main cashier will be overburdened with work. Therefore, it is usual for firms to
appoint a person as ‘Petty Cashier’ and to entrust the task of making small payments say below

CASH BOOK
` 25, to him. Of course he will be reimbursed for the payments made. Later, on an analysis, the
respective account may be debited.
4.1 IMPREST SYSTEM OF PETTY CASH
It is convenient to entrust a definite sum of money to the petty cashier in the beginning of a period
and to reimburse him for payments made at the end of the period. Thus, he will have again the
fixed amount in the beginning of the new period. Such a system is known as the imprest system
of petty cash.
The system is very useful specially if an analytical Petty Cash Book is used. The book has one
column to record receipt of cash (which is only from the main cashier) and other columns to
record payments of various types. The total of the various columns show why payments have
been made and then the relevant accounts can be debited.
(i) The amount fixed for petty cash should be sufficient for the likely small payments for a
relatively short period, say for a week or a fortnight.
(ii) The reimbursement should be made only when petty cashier prepares a statement showing
total payments supported by vouchers, i.e., documentary evidence and should be limited
to the amount of actual disbursements.
(iii) The vouchers should be filed in order.
(iv) No payment should be made without proper authorization. Also, payments above a certain
specified limit should be made only by the main cashier.
(v) The petty cashier should not be allowed to receive any cash except for reimbursement.
In the petty cash book the extreme left-hand column records receipts of cash. The money column
towards the right hand shows total payments for various purposes; a column is usually provided
for sundries to record infrequent payments. The sundries column is analysed. At the end of the
week or the fortnight the petty cash book is balanced. The method of balancing is the same as
for the simple cash book.
Illustration 4
Shri Ramaswamy maintains a Columnar Petty Cash Book on the Imprest System. The imprest
amount is ` 500. From the following information, show how his Petty Cash Book would appear
for the week ended 12th September, 2011:
`
7-9-2011 Balance in hand 134.90
Received Cash reimbursement to make up the imprest 365.10
Stationery 49.80
8-9-2011 Miscellaneous Expenses 20.90
9-9-2011 Repairs 156.70
10-9-2011 Travelling 68.50
11-9-2011 Stationery 71.40
12-9-2011 Miscellaneous Expenses 6.30
Repairs 48.30

Solution
PETTYCASHBOOK
Date
2011
ReceiptsAmount
`
Date
2011
PaymentsTotal
Amount
`
Stationery
`
Travelling
`
MiscExps.
`
Repairs
`
Sept.7ToBalanceb/d134.907ByStationery49.8049.80
ToReimbursement365.108ByMisc.Expenses20.9020.90
9ByRepairs156.70156.70
10ByTravelling68.5068.50
11ByStationery71.4071.40
12ByMisc.Expenses6.306.30
ByRepairs48.3048.30
421.90121.2068.5027.20205.00
ByBalancec/d78.10
500.00500.00
13ToBalanceb/d78.10

CASH BOOK
Illustration 5
Prepare a Petty Cash Book on the imprest System from the following:
2011 `
Jan. 1 Received ` 100 for petty cash
“ 2 Paid bus fare .50
“ 2 Paid cartage 2.50
“ 3 Paid for Postage & Telegrams 5.00
“ 3 Paid wages for casual labourers 6.00
“ 4 Paid for stationery 4.00
“ 4 Paid tonga charges 2.00
“ 5 Paid for the repairs to chairs 15.00
“ 5 Bus fare 1.00
“ 5 Cartage 4.00
“ 6 Postage and Telegrams 7.00
“ 6 Tonga charges 3.00
“ 6 Cartage 3.00
“ 6 Stationery 2.00
“ 6 Refreshments to customers 5.00

Solution
PETTYCASHBOOK
Receipts
`
Date
2011
V.No.ParticularsTotal
`
Con-
veyance
`
Cartage
`
Statio-
nery
`
Postage&
Telegrams
`
Wages
`
Sundries
`
100Jan.1ToCash
21ByConveyance.50.50
2ByCartage2.502.50
33ByPostageandTelegrams5.005.00
4ByWages6.006.00
45ByStationery4.004.00
6ByConveyance2.002.00
57ByRepairstoFurniture15.0015.00
8ByConveyance1.001.00
9ByCartage4.004.00
610ByPostageandTelegrams7.007.00
“11ByConveyance3.003.00
“12ByCartage3.003.00
“13ByStationery2.002.00
“14ByGeneralExpenses5.005.00
60.006.509.506.0012.006.0020.00
ByBalancec/d40.00
100100.00
40.00ToBalanceb/d
60.008ToCash

CASH BOOK
4.2 ADVANTAGES OF PETTY CASH BOOK
There are mainly three advantages:
(i) Saving of time of the chief cashier;
(ii) Saving in labour in writing up the cash book and posting into the ledger; and
(iii) Control over small payments.
4.3 POSTING THE PETTY CASH BOOK
In the ledger, a petty cash account is maintained; when an amount is given to the petty cashier, the
petty cash account is debited. Each week or forthnight, the total of the payments made is credited
to this account. The petty cash account will then show the balance in the hand of the cashier; on
demand he should be able to produce it for counting. At the end of the year, the balance is shown
in the balance sheet as part of cash balance.
Of course, the payments must be debited to their respective amounts as shown by the petty cash
book. For this two methods may be used:
(i) From the petty cash book the total of the various columns may be directly debited to the
concerned accounts; or
(ii) A journal entry may first be prepared on the basis of the petty cash book, debiting the accounts
shown by the various analysis columns, and crediting the total of the payment of the petty
cash accounts.
For Illustration 5 the journal entry and relevant accounts are as follows:
2011 ` `
Jan. 6 Conveyance Account Dr. 6.50
Cartage account Dr. 9.50
Stationery account Dr. 6.00
Postage and Telegrams account Dr. 12.00
Wages Account Dr. 6.00
Repairs Account Dr. 15.00
General Expenses Account Dr. 5.00
To Petty Cash Account 60.00
(Being the analysis of the Petty Cash Book for
the week ending Jan. 6)
Entry for cash handed over to the Petty Cashier
Petty Cash Account Dr. 100
To Cash Account 100
(Being Cash received)

Petty Cash Account
Date
2011
Particulars Folio Amount
`
Date
2011
Particulars Folio Amount
`
Jan.1 To Cash 100.00 Jan.6 By Sundries:
“8 To Cash 60.00 Conveyance 6.50
Cartage 9.50
Stationery 6.00
Postage and Telegrams 12.00
Wages 6.00
Repairs 15.00
General Expenses 5.00
5. ENTRIES FOR SALE THROUGH CREDIT/DEBIT CARDS
Now-a-days sales through Credit/Debit Cards are issued by almost every Bank in India either
directly or with collaboration of some other agencies. HSBC Card, SBI Card, BOB Card, ICICI
Bank Card, HDFC Card and Andhra Bank Card are some of the popular Cards.
The procedure for issuing Credit/Debit Cards are as follows -
1. A small Plastic Card, called Credit Card is issued by bank to a prospective customer, after
verifying his credibility, which is generally measured by his income sources. Debit Card is
issued by bank to a customer who has an account with the bank, maintaining a minimum
balance. Now a days ATM Card issued by the bank can also be used as Debit Card. This
card would contain an embossed 16 digit number and also the name of the cardholder.
2. Generally Bank charges annual subscription fees from the credit card holder. No fee is charged
in case of Debit Card, though some banks charge a nominal fee on Debit Card.
3. When the Card holder intends to buy some goods or services through Credit or Debit Card,
the seller fills in a form, generally in triplicate, the details of the goods a with the amount of
sales and uses the embossed card with the help of the Credit Card machine to print the data
on that form. Also the customer has to countersign the form. One carbon copy of the form
is given to the customer for the record.
4. The seller sums up the different amounts sold like this and submits, generally everyday, to
his bank all the forms. The amount is credited by the bank to the seller’s account and debited
to the account of the Bank or the company issuing the Credit/Debit Card.
5. The bank issuing the Card, charges commission for each such transaction, which varies
between 1% to 4% and is immediately debited to seller’s bank account.
6. The bank sends a monthly statement to the card holder. In case of Debit Card the account
is immediately debited to the card holder’s account, whereas in case of Credit Card, card

CASH BOOK
holder has to pay the amount in full or part. However, if not paid in full, the interest is
charged.
5.1 ACCOUNTING FOR CREDIT/DEBIT CARD SALE
From the seller’s point of view, this type of sale is equivalent to a cash sale. Commission charged
by the bank will be treated as selling expenses. The following journal entries will be made in the
seller’s books of accounts
1. Bank A/c Dr.
To Sales Account
(Sales made through Credit/Debit Card)
2. Commission Account Dr.
To Bank Account
(Commission charged by bank)
Illustration 7
Enter the following transaction in Cash Bank with Discount and Bank columns. Cheques are first
treated as cash receipts -
2011 `
March 1 Cash in Hand 15,000
Overdraft in Bank 6,000
2 Cash Sales 3,000
3 Paid to Sushil Bros. by cheque 3,400
Discount received 100
5 Sales through credit card 2,800
6 Received cheque from Srijan 6,200
7 Endorsed Srijan’s cheque in favour of Adit
9 Deposit into Bank 6,800
10 Received cheque from Aviral
and deposited the same into Bank
by allowing discount of ` 50 3,600
11 Adit informed that Srijan’s cheque is dishonoured
15 Sales through Debit Card 3,200
24 Withdrawn from Bank 1,800
28 Paid to Sanchit by cheque 3,000
30 Bank charged 1% commission on sales through
Debit/Credit Cards

Solution
CASHBOOK
Dr.
DateParticularsL.F.Discount
`
Cash
`
Bank
`
DateParticularsL.F.Discount
`
Cash
`
Cr.
Bank
`
20112011
March1ToBalancec/d15,000March1ByBalanceb/d6,000
2ToSales3,0003BySushilBros.1003,400
5ToSales2,8007ByAdit6,200
6ToSrijan6,2009ByBankC6,800
9ToCashA/cC6,80012BySrijan6,200
10ToAviral503,60024ByCashA/cC1,800
12Adit6,20028BySanchit3,000
15ToSalesA/c3,20030ByCommission60
24ToBankA/cC1,80031ByBalancec/d13,0002,140
5032,20016,40010032,20016,400

CASH BOOK
SELF EXAMINATION QUESTIONS
Pick up the correct answer from the given choices:
1. (i) The total of discounts column on the debit side of the cash book, recording cash discount
deducted by customers when paying their accounts, is posted to the
(a) Credit of the discount allowed account.
(b) Debit of the discount received account.
(c) Credit of the discount received account.
(d) Debit of the discount allowed account.
(ii) Which of the following is the kind of a cash book ?
(a) Simple column cash book
(b) Double-column cash book
(c) Three-column cash book
(d) All of the above
(iii) Cash book is a type of __________ but treated as a ____________ of accounts.
(a) Subsidiary book, principal book
(b) Principal book, subsidiary book
(c) Subsidiary book, subsidiary book
(d) Principal book, principal book
(iv) Which of the following is not a column of a three-column cash book?
(a) Cash column
(b) Bank column
(c) Petty cash column
(d) Discount column
(v) Salaries due for the month of March will appear
(a) On the receipt side of the cash book
(b) On the payment side of the cash book
(c) As a contra entry
(d) Nowhere in the cash book
(vi) Contra entries are passed only when
(a) Double-column cash book is prepared
(b) Three-column cash book is prepared
(c) Simple cash book is prepared
(d) None of the above

2. Choose the most appropriate answer from the given choices.
(i) The Cash Book records
(a) All cash receipts
(b) All cash payments
(c) All cash receipts and payments
(d) Cash and credit sale of goods.
(ii) The balance in the petty cash book is
(a) An expense
(b) A profit
(c) An asset
(d) A liability.
(iii) If Ram has sold goods for cash, the entry will be recorded
(a) In the Cash Book
(b) In the Sales Book
(c) In the Journal
(d) In the Inventory Book.
ANSWERS
1
(i) (d) (ii) (d) (iii) (a) (iv) (c) (v) (d) (vi) (b)
2
(i) (c) (ii) (c) (iii) (a)

CHAPTER - 2
Unit 6
Capital and Revenue
Expenditures
and Receipts
ACCOUNTING
PROCESS

Learning Objectives
 Learn the criteria for identifying Revenue Expenditure and distinguishing from Capital
Expenditure.
 Be familiar with the term Deferred Revenue Expenditure.
 Learn the distinction between capital and revenue receipts.
 Understand the linkage of such distinction with the preparation of final accounts.
1. INTRODUCTION
Accounting aims in ascertaining and presenting the results of the business for an accounting period.
For ascertaining the periodical business results, the nature of transactions should be analysed
whether they are of capital or revenue nature. The Revenue Expense relates to the operations of
the business of an accounting period or to the revenue earned during the period or the items of
expenditure, benefits of which do not extend beyond that period. Capital Expenditure, on the
other hand, generates enduring benefits and helps in revenue generation over more than one
accounting period. Revenue Expenses must be associated with a physical activity of the entity.
Therefore, whereas production and sales generate revenue in the earning process, use of goods
and services in support of those functions causes expenses to occur. Expenses are recognised in
the Profit & Loss Account through matching principal which tells us when and how much of the
expenses to be charged against revenue. A part of the expenditure can be capitalised only when
these can be traced directly to definable streams of future benefits.
The distinction of transaction into revenue and capital is done for the purpose of placing them in
Profit and Loss account or in the Balance Sheet. For example: revenue expenditures are shown in
the profit and loss account as their benefits are for one accounting period i.e. in which they are
incurred while capital expenditures are placed on the asset side of the balance sheet as they will
generate benefits for more than one accounting period and will be transferred to profit and loss
account of the year on the basis of utilisation of that benefit in particular accounting year. Hence,
both capital and revenue expenditures are ultimately transferred to profit and loss account.
Revenue expenditures are transferred to profit and loss account in the year of spending while
capital expenditures are transferred to profit and loss account of the year in which their benefits
are utilised. Therefore we can conclude that it is the time factor, which is the main determinant
for transferring the expenditure to profit and loss account. Also expenses are recognized in profit
and loss account through matching concept which tells us when and how much of the expenses
to be charged against revenue. However, distinction between capital and revenue creates a
considerable difficulty. In many cases borderline between the two is very thin.

CAPITAL AND REVENUE EXPENDITURES AND RECEIPTS
2. CONSIDERATIONS IN DETERMINING CAPITAL AND
REVENUE EXPENDITURES
The basic considerations in distinction between capital and revenue expenditures are:
(a) Nature of business: For a trader dealing in furniture, purchase of furniture is revenue
expenditure but for any other trade, the purchase of furniture should be treated as capital
expenditure and shown in the balance sheet as asset. Therefore, the nature of business is a very
important criteria in separating an expenditure between capital and revenue.
(b) Recurring nature of expenditure: If the frequency of an expense is quite often in an accounting
year then it is said to be an expenditure of revenue nature while non-recurring expenditure is
infrequent in nature and do not occur often in an accounting year. Monthly salary or rent is the
example of revenue expenditure as they are incurred every month while purchase of assets is
not the transaction done regularly therefore, classified as capital expenditure unless materiality
criteria defines it as revenue expenditure.
(c) Purpose of expenses: Expenses for repairs of machine may be incurred in course of normal
maintenance of the asset. Such expenses are revenue in nature. On the other hand, expenditure
incurred for major repair of the asset so as to increase its productive capacity is capital in nature.
However, determination of the cost of maintenance and ordinary repairs which should be
expensed, as opposed to a cost which ought to be capitalised, is not always simple.
(d) Effect on revenue generating capacity of business: The expenses which help to generate
income/revenue in the current period are revenue in nature and should be matched against the
revenue earned in the current period. On the other hand, if expenditure helps to generate revenue
over more than one accounting period, it is generally called capital expenditure.
When expenditure on improvements and repair of a fixed asset is done, it has to be charged to Profit
and Loss Account if the expected future benefits from fixed assets do not change, and it will be
included in book value of fixed asset, where the expected future benefits from assets increase.
(e) Materiality of the amount involved: Relative proportion of the amount involved is another
important consideration in distinction between revenue and capital. Even, if expenditure does
not increase the productive capacity of an asset, it may be capitalised because the amount is
material or expenditure may increase the asset value and yet to be expensed because the amount
is immaterial.
3. CAPITAL EXPENDITURES AND REVENUE EXPENDITURES
As we have already discussed, capital expenditure contributes to the revenue earning capacity
of a business over more than one accounting period whereas revenue expense is incurred to
generate revenue for a particular accounting period. The revenue expenses either occur in direct
relation with the revenue or in relation with accounting periods, for example cost of goods sold,
salaries, rent, etc. Cost of goods sold is directly related to sales revenue whereas rent is related to
the particular accounting period. Capital expenditure may represent acquisition of any tangible
or intangible fixed assets for enduring future benefits. Therefore, the benefits arising out of capital
expenditure last for more than one accounting period whereas those arising out of revenue
expenses expire in the same accounting period.

4. DEFERRED REVENUE EXPENDITURES
Deferred revenue expenditure is that expenditure for which payment has been made or a
liability incurred but which is carried forward on the presumption that it will be of benefit over
a subsequent period or periods. In short, it refers to that expenditure that is, for the time being,
deferred from being charged against income. Such suspension of ‘charging of’ operation may be
due to the nature of expenses and the benefits expected there from.
Deferred revenue expenditure should be revenue expenditure by nature in the first instance.
But its matching with revenue may be deferred considering the benefits to be accrued in future.
A thin line of difference exists between deferred revenue expenses and prepaid expenses. The
benefits available from prepaid expenses can be precisely estimated but that is not so in case of
deferred revenue expenses. For example, insurance premium paid say, for the year ending 30th
June, 2011 when the accounting year ends on 31st March, 2011 will be an example of prepaid
expense to the extent of premium relating to three months’ period i.e. from 1st April, 2011 to 30th
June, 2011. Thus the insurance protection will be available precisely for three months after the
close of the Year and the amount of the premium to be carried forward can be calculated exactly.
As per para 56 of AS 26 “Intangible Assets”, in some cases expenditure is incurred to provide
future economic benefits (for more than one accounting period) which does not create an asset
to be recognized in the books of an entity. Such expenses, should be charged to profit and loss
account in the year the amount is incurred.
However, it may be noted that accounting issues of specialised nature such as accounting for
discount or premium relating to borrowings and ancillary costs incurred in connection with the
arrangement of borrowings, share issue expenses and discount allowed on the issue of shares
may be deferred for more than one accounting period.
Illustration 1
State with reasons whether the following statements are ‘True’ or ‘False’.
(1) Overhaul expenses of second-hand machinery purchased are Revenue Expenditure.
(2) Money spent to reduce working expenses is Revenue Expenditure.
(3) Legal fees to acquire property is Capital Expenditure.
(4) Amount spent as lawyer’s fee to defend a suit claiming that the firm’s factory site belonged
to the plaintiff’s land is Capital Expenditure.
(5) Amount spent for replacement of worn out part of machine is Capital Expenditure.
(6) Expense incurred on the repairs and white washing for the first time on purchase of an old
building are Revenue Expenses.
(7) Expenses in connection with obtaining a license for running the cinema is Capital
Expenditure.
(8) Amount spent for the construction of temporary huts, which were necessary for construction
of the Cinema House and were demolished when the cinema house was ready, is Capital
Expenditure.

Solution
(1) False: Overhaul expenses are incurred to put second-hand machinery in working condition
to derive endurable long-term advantage. So it should be capitalised.
(2) False: It may be reasonably presumed that money spent for reducing revenue expenditure
would have generated long-term benefits to the entity. It becomes part of intangible fixed
assets if it is in the form of technical know-how and tangible fixed assets if it is in the form
of additional replacement of any of the existing tangible fixed assets. So this is capital
expenditure.
(3) True: Legal fee paid to acquire any property is part of the cost of that property. It is incurred
to possess the ownership right of the property and hence a capital expenditure.
(4) False: Legal expenses incurred to defend a suit claiming that the firm’s factory site belongs to
the plaintiff is maintenance expenditure of the asset. By this expense, neither any endurable
benefit can be obtained in future in addition to that what is presently available nor the
capacity of the asset will be increased. Maintenance expenditure in relation to an asset is
revenue expenditure.
(5) False: Amount spent for replacement of any worn out part of a machine is revenue expense
since it is part of its maintenance cost.
(6) False: Repairing and white washing expenses for the first time of an old building are incurred
to put the building in usable condition. These are the part of the cost of building. Accordingly,
these are capital expenditure.
(7) True: The Cinema Hall could not be started without license. Expenditure incurred to obtain
the license is pre-operative expense which is capitalised. Such expenses are amortised over
a period of time.
(8) True: Cost of temporary huts constructed which were necessary for the construction of the
cinema house is part of the construction cost of the cinema house. Therefore such costs are
to be capitalised.
Illustration 2
State with reasons whether the following are Capital or Revenue Expenditure:
(1) Expenses incurred in connection with obtaining a license for starting the factory for
` 10,000.
(2) ` 1,000 paid for removal of Inventory to a new site.
(3) Rings and Pistons of an engine were changed at a cost of ` 5,000 to get fuel efficiency.
(4) Money paid to Mahanagar Telephone Nigam Ltd. (MTNL) ` 8,000 for installing telephone
in the office.
(5) A factory shed was constructed at a cost of ` 1,00,000. A sum of ` 5,000 had been incurred
in the construction of temporary huts for storing building material.

Solution
(1) Money paid ` 10,000 for obtaining license to start a factory is a capital expenditure. This is
an item of expenditure incurred to acquire the right to carry on business.
(2) ` 1,000 paid for removal of Inventory to a new site is revenue expenditure. This is neither
bringing enduring benefit nor enhancing the value of the asset.
(3) ` 5,000 spent in changing Rings and Pistons of an engine to get fuel efficiency is capital
expenditure. This is an expenditure on improvement of a fixed asset. It results in increasing
profit-earning capacity of the business by cost reduction.
(4) Money deposited with MTNL for installation of telephone in office is not expenditure. This
is treated as an asset and the same is adjusted over a period of time against actual telephone
bills.
(5) Cost of construction of building including cost of temporary huts is capital expenditure.
Building is fixed asset which will generate enduring benefit to the business over more than
one accounting period. Construction of temporary huts is incidental to the main construction.
Such cost is also capitalised with the cost of building.
5. CAPITAL RECEIPTS AND REVENUE RECEIPTS
Just as a clear distinction between Capital and Revenue expenditure is necessary, in the same
manner capital receipts must be distinguished from revenue receipts.
Receipts which are obtained in course of normal business activities are revenue receipts (e.g.
receipts from sale of goods or services, interest income etc.). On the other hand, receipts which
are not revenue in nature are capital receipts (e.g. receipts from sale of fixed assets or investments,
secured or unsecured loans, owners’ contributions etc.). Revenue and capital receipts are
recognised on accrual basis as soon as the right of receipt is established. Revenue receipts should
not be equated with the actual cash receipts. Revenue receipts are credited to the Profit and Loss
Account.
On the other hand, Capital receipts are not directly credited to Profit and Loss Account.
For example, when a fixed asset is sold for ` 92,000 (cost ` 90,000), the capital receipts
` 92,000 is not credited to Profit and Loss Account. Profit/Loss on sale of fixed assets is calculated
and credited to Profit and Loss Account as follows:
Sale Proceeds ` 92,000
Cost (` 90,000)
Profit ` 2,000
Illustration 3
Good Pictures Ltd., construct a cinema house and incur the following expenditure during the
first year ending 30th June, 2011.
(i) Second-hand furniture worth ` 9,000 was purchased; repainting of the furniture costs ` 1,000.
The furniture was installed by own workmen, wages for this being ` 200.

(ii) Expenses in connection with obtaining a license for running the cinema worth ` 20,000.
During the course of the year the cinema company was fined ` 1,000, for contravening rules.
Renewal fee ` 2,000 for next year also paid.
(iii) Fire insurance, ` 1,000 was paid on 1st January, 2011 for one year.
(iv) Temporary huts were constructed costing ` 1,200. They were necessary for the construction
of the cinema. They were demolished when the cinema was ready.
Point out how you would classify the above items.
Solution
1. The total cost of the furniture should be treated as ` 10,200 i.e., all the amounts mentioned
should be capitalised since without such expenditure the furniture would not be available
for use. If ` 1,000 and ` 200 have been respectively debited to the Repairs Account and the
Wages Account, these accounts will be credited to the Furniture Account.
2. License for running the cinema house is necessary, hence its cost should be capitalised. But
the fine of ` 1,000 is revenue expenditure. The renewal fee for the next year is also revenue
expenditure but pertains to the next year; hence, it is a prepaid expense.
3. Half of the insurance premium pertains to the year beginning on 1st July, 2011. Hence such
amount should be treated as prepaid expense. The remaining amount is revenue expense
for the current year.
4. Since the temporary huts were necessary for the construction, their cost should be added to
the cost of the cinema hall and thus capitalised.
Illustration 4
State with reasons, how you would classify the following items of expenditure:
1. Overhauling expenses of ` 25,000 for the engine of a motor car to get better fuel efficiency.
2. Inauguration expenses of ` 25 lacs incurred on the opening of a new manufacturing unit in
an existing business.
3. Compensation of ` 2.5 crores paid to workers, who opted for voluntary retirement.
Solution
1. Overhauling expenses are incurred for the engine of a motor car to derive better fuel efficiency.
These expenses will reduce the running cost in future and thus the benefit is in form of
endurable long-term advantage. So this expenditure should be capitalised.
2. Inauguration expenses incurred on the opening of a new unit may help to explore more
customers This expenditure is in the nature of revenue expenditure, as the expenditure may
not generate any enduring benefit to the business over more than one accounting period.
3. The amount paid to workers on voluntary retirement is in the nature of revenue expenditure.
Since the magnitude of the amount of expenditure is very significant, it may be better to
defer it over future years.

Illustration 5
Classify the following expenditures and receipts as capital or revenue:
(i) ` 10,000 spent as travelling expenses of the directors on trips abroad for purchase of capital
assets.
(ii) Amount received from Trade receivables during the year.
(iii) Amount spent on demolition of building to construct a bigger building on the same site.
(iv) Insurance claim received on account of a machinery damaged by fire.
Solution
(i) Capital expenditure.
(ii) Revenue receipt.
(iii) Capital expenditure.
(iv) Capital receipt.
Illustration 6
Are the following expenditures capital in nature?
(i) M/s ABC & Co. run a restaurant. They renovate some of the old cabins. Because of this
renovation some space was made free and number of cabins was increased from 10 to 13.
The total expenditure was ` 20,000.
(ii) M/s New Delhi Financing Co. sold certain goods on installment payment basis. Five
customers did not pay installments. To recover such outstanding installments, the firm spent
` 10,000 on account of legal expenses.
(iii) M/s Ballav & Co. of Delhi purchased a machinery from M/s Shah & Co. of Ahmedabad.
M/s Ballav & Co. spent ` 40,000 for transportation of such machinery.
(iv) M/s Dogra & Co. installed a machinery for ` 5,00,000 on 1.1.2005. They were charging
deprecation on straight line basis taking useful life of the machine as 10 years In December,
2011 they found that the machine became obsolete which could not be used. The machine
can fetch only ` 50,000.
Solution:
(i) Renovation of cabins increased the number of cabins. This has an effect on the future revenue
generating capability of the business. Thus the renovation expense is capital expenditure in
nature.
(ii) Expense incurred to recover installments due from customer do not increase the revenue
generating capability in future. It is a normal recurring expense of the business. Thus the
legal expenses incurred in this case is revenue expenditure in nature.
(iii) Expenses incurred on account of transportation of fixed asset is capital expenditure in nature.
(iv) Loss arising out of obsolescence of machinery is revenue expenditure. This loss is to be
charged against revenue of the year in which such loss is recognised. In this case, loss due
to obsolescence is:

`
Cost 5,00,000
Less: Depreciation 2005-2011 (3,50,000)
Written down value at the end of 2011 1,50,000
Less: Estimated scrap value (50,000)
1,00,000
This loss is revenue loss in nature.
Illustration 7
Are the following expenses capital in nature?
(i) Wages paid for installation of fixed assets.
(ii) Expenses of trial run of a newly installed machine.
(iii) Money deposited with the wholesaler as security.
(iv) Money paid to Mahanagar Telephone Nigam Ltd. (MTNL) ` 8,000 for installing Telephone
in the office.
(v) Diwali advance to employees.
(vi) Money advanced to suppliers for booking of goods.
Solution:
(i) Expenses incurred including wages for installation of any fixed asset is capital expenditure
in nature.
(ii) Expenses incurred for trial run of a newly installed machinery is capital expenditure in
nature.
(iii) Money deposited as security is not an expenditure item.
(iv) Money deposited with MTNL for installation of telephone is not expenditure item. This is
treated as an asset.
(v) Diwali advance to employees is not an expense item.
(vi) Money advanced to supplies for booking goods is not an expense item.
1. Classify the following expenditures and receipts as capital or revenue:
(i) Money spent ` 10,000 as traveling expenses of the directors on trips abroad for purchase
of capital assets is
(a) Capital expenditures (b) Revenue expenditures
(c) Deferred revenue expenditures (d) None of the above

(ii) Amount of ` 5,000 spent as lawyers’ fee to defend a suit claiming that the firm’s
factory site belonged to the plaintiff’s land is
(c) Deferred revenue expenditures (d) None of the above
(iii) Entrance fee of ` 2,000 received by Ram and Shyam Social Club is
(a) Capital receipt (b) Revenue receipt
(c) Capital expenditures (d) Revenue expenditures
(iv) Subsidy of ` 40,000 received from the government for working capital by a manufacturing
concern is
(v) Insurance claim received on account of machinery damaged completely by fire is
(vi) Interest on investments received from UTI is
(vii) Amount received from IDBI as a medium term loan for augmenting working capital is
(c) Capital receipt (d) Revenue receipt
(viii) A bad debt recovered during the year will be
(c) Capital receipt (d) Revenue receipt
(ix) A second hand car is purchased for ` 10,000, the amount of ` 1,000 is spent on its repairs,
` 500 is incurred to get the car registered in owner’s name and ` 1,200 is paid as dealer’s
commission. The amount debited to car account will be
(a) ` 10,000. (b) ` 10,500. (c) ` 11,500. (d) ` 12,700.
(x) Revenue from sale of products, ordinarily, is reported as part of the earning in the period
in which
(a) The sale is made. (b) The cash is collected.
(c) The products are manufactured. (d) The planning takes place.
(xi) If repair cost is ` 25,000, whitewash expenses are ` 5,000, cost of extension of building
is ` 2,50,000 and cost of improvement in electrical wiring system is ` 19,000; the amount
to be expensed is
(a) ` 2,99,000. (b) ` 44,000. (c) ` 30,000. (d) ` 49,000.

[Ans. 1: (i)-(a), (ii)-(b), (iii)-(a), (iv)-(b), (v)-(a), (vi)-(b), (vii)-(c), (viii)-(d), (ix)-(d), (x)-(a), (xi)-(c)]
2. Out of the following which are (1) capital expenditure; (2) revenue expenditure; and (3)
deferred revenue expenditure?
(i) ` 1,200 spent on the repairs of machine is
(a) Capital expenditure; (b) Revenue expenditure;
(c) Deferred revenue expenditure; (d) None of the above.
(ii) ` 2,500 spent on the overhaul of machines purchased second-hand is
(iii) Whitewashing expenses are
(iv) Paper purchased for use as stationery is
[Ans: 2: (ii) Is a capital expenditure and Item no. and remaining items are revenue expenditures.]

CHAPTER - 2
Unit 7
Contingent Assets
and Contingent
Liabilities
ACCOUNTING
PROCESS

CONTINGENT ASSETS AND CONTINGENT LIABILITIES
Learning Objectives
 Understand the meaning of the terms 'Contingent Assets' and 'Contingent Liabilities'.
 Distinguish 'Contingent Liabilities' with 'Liabilities' and 'Provisions'.
1. CONTINGENT ASSETS
A contingent asset may be defined as a possible asset that arises from past events and whose
existence will be confirmed only after occurrence or non-occurrence of one or more uncertain
future events not wholly within the control of the enterprise. It usually arises from unplanned
or unexpected events that give rise to the possibility of an inflow of economic benefits to the
business entity. For example, a claim that an enterprise is pursuing through legal process, where
the outcome is uncertain, is a contingent asset.
As per the concept of prudence as well as the present accounting standards, an enterprise should
not recognise a contingent asset. These assets are uncertain and may arise from a claim which an
enterprise pursues through a legal proceeding. There is uncertainty in realisation of claim. It is
possible that recognition of contingent assets may result in recognition of income that may never
be realised. However, when the realisation of income is virtually certain, then the related asset
no longer remains as contingent asset.
A contingent asset need not be disclosed in the financial statements. A contingent asset is
usually disclosed in the report of the approving authority (Board of Directors in the case of a
company, and the corresponding approving authority in the case of any other enterprise), if
an inflow of economic benefits is probable. Contingent assets are assessed continually and if
it has become virtually certain that an inflow of economic benefits will arise, the asset and the
related income are recognised in the financial statements of the period in which the change
occurs.
2. CONTINGENT LIABILITIES
The term ‘Contingent liability’ can be defined as
“(a) a possible obligation1
that arises from past events and the existence of which will be confirmed
only by the occurrence or non-occurrence of one or more uncertain future events not wholly
within the control of the enterprise; or
(b) a present obligation2
that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
(ii) a reliable estimate of the amount of the obligation cannot be made.”
1
Possible Obligation: An obligation is a possible obligation if, based on the evidence available, its existence at the balance sheet
date is considered not probable.
2
Present Obligation: An obligation is a present obligation if, based on the evidence available, its existence at the balance sheet date
is considered probable, i.e., more likely than not.

A contingent liability is a possible obligation arising from past events and may arise in future
depending on the occurrence or non-occurrence of one or more uncertain future events [part (a)
of the definition]. A contingent liability may also be a present obligation that arises from past
events [(part (b) of the definition)].
An enterprise should not recognise a contingent liability. A Contingent liability is required to
be disclosed unless possibility of outflow of a resource embodying economic benefits is remote.
These liabilities are assessed continually to determine whether an outflow of resources embodying
economic benefits has become probable. If it becomes probable that an outflow or future economic
benefits will be required for an item previously dealt with as a contingent liability, a provision is
recognised in financial statements of the period in which the change in probability occurs except
in the extremely rare circumstances where no reliable estimate can be made.
3. DISTINCTION BETWEEN CONTINGENT LIABILITIES AND
LIABILITIES
The distinction between a liability and a contingent liability is generally based on the judgement
of the management. A liability is defined as the present financial obligation of an enterprise, which
arises from past events. The settlement of a liability results in an outflow from the enterprises of
resources embodying economic benefits. On the other hand, in the case of contingent liability,
either outflow of resources to settle the obligation is not probable or the amount expected to be
paid to settle the liability cannot be measured with sufficient reliability. Examples of contingent
liabilities are claims against the enterprise not acknowledged as debts, guarantees given in respect
of third parties, liability in respect of bills discounted and statutory liabilities under dispute etc.
In addition to present obligations that are recognised as liabilities in the balance sheet, enterprises
are required to disclose contingent liability in their balance sheets by way of notes.
4. DISTINCTION BETWEEN CONTINGENT LIABILITIES AND
PROVISIONS
Provision means “any amount written off or retained by way of providing for depreciation, renewal
or diminution in the value of assets or retained by way of providing for any known liability of
which the amount cannot be determined with substantial accuracy”.
It is important to know the difference between provisions and contingent liabilities. The distinction
between both of them can be explained as follows:

CONTINGENT ASSETS AND CONTINGENT LIABILITIES
Provision Contingent liability
(1) Provision is a present liability of
uncertain amount, which can be
measured reliably by using a substantial
degree of estimation.
A Contingent liability is a possible
obligation that may or may not crystallise
depending on the occurrence or non-
occurrence of one or more uncertain future
events.
(2) A provision meets the recognition
criteria.
A contingent liability fails to meet the same.
(3) Provision is recognised when (a) an
enterprise has a present obligation
arising from past events; an outflow of
resources embodying economic benefits
is probable, and (b) a reliable estimate
can be made of the amount of the
obligation.
Contingent liability includes present
obligations that do not meet the recognition
criteria because either it is not probable that
settlement of those obligations will require
outflow of economic benefits, or the amount
cannot be reliably estimated.
(4) If the management estimates that
it is probable that the settlement of
an obligation will result in outflow
of economic benefits, it recognises a
provision in the balance sheet.
If the management estimates, that it is less
likely that any economic benefit will outflow
the firm to settle the obligation, it discloses
the obligation as a contingent liability.
Let us take an example to understand the distinction between provisions and contingent liabilities.
The Central Excise Officer imposes a penalty on Alpha Ltd. for violation of a provision in the
Central Excise Act. The company goes on an appeal. If the management of the company estimates
that it is probable that the company will have to pay the penalty, it recognises a provision for the
liability. On the other hand, if the management anticipates that the judgement of the appellate
authority will be in its favour and it is less likely that the company will have to pay the penalty,
it will disclose the obligation as a contingent liability instead of recognising a provision for the
same.
1. (i) Contingent asset usually arises from unplanned or unexpected events that give rise to
(a) The possibility of an inflow of economic benefits to the business entity.
(b) The possibility of an outflow of economic benefits to the business entity.
(c) Either (a) or (b)
(d) None of the above.

(ii) If an inflow of economic benefits is probable then a contingent asset is disclosed
(a) In the financial statements.
(b) In the report of the approving authority (Board of Directors in the case of a company,
and the corresponding approving authority in the case of any other enterprise).
(c) In the cash flow statement.
(iii) In the case of ___________, either outflow of resources to settle the obligation is not
probable or the amount expected to be paid to settle the liability cannot be measured
with sufficient reliability.
(a) Liability.
(b) Provision.
(c) Contingent liabilities.
(d) Contingent assets.
(iv) Present liability of uncertain amount, which can be measured reliably by using a
substantial degree of estimation is termed as ________.
(a) Provision.
(b) Liability.
(c) Contingent liability.
(v) In the financial statement, contingent liability is
(a) Recognised
(b) Not recognised.
(c) Adjusted.
ANSWERS
(i) (a) (ii) (b) (iii) (c) (iv) (a) (v) (b)

CHAPTER - 2
Unit 8
Rectification of
Errors
ACCOUNTING
PROCESS

Learning Objectives
After studying this unit, you will be able to :
 Understand different types of errors which may occur in course of recording transactions
and events.
 Be familiar with the steps involved in locating errors.
 Learn the nature of one-sided errors and two-sided errors.
 Understand why suspense account is opened for rectification of errors.
 Understand the technique of correcting errors of one period in the next accounting
period.
1. INTRODUCTION
Unintentional omission or commission of amounts and accounts in the process of recording the
transactions are commonly known as errors These various unintentional errors can be committed
at the stage of collecting financial information/data on the basis of which financial statements
are drawn or at the stage of recording this information. Also errors may occur as a result of
mathematical mistakes, mistakes in applying accounting policies, misinterpretation of facts,
or oversight. To check the arithmetic accuracy of the journal and ledger accounts, trial balance
is prepared. If the trial balance does not tally, then it can be said that there are errors in the
accounts which requires rectification thereof. Some of these errors may affect the Trial Balance
and some of these do not have any impact on the Trial Balance although such errors may affect
the determination of profit or loss, assets and liabilities of the business.
Illustrative Case of Errors and their Nature
We have seen that after preparing ledger accounts a trial balance is taken out where debit and
credit balances are separately listed and totalled. If the two totals do not agree, it is definite that
there have been some errors We shall now study the types of errors which may be committed
and how they may be rectified. For this purpose, the working of the following illustrative cases
should be carefully seen.
Illustrative Cases of Errors
(a) Wrong Entry: Let us start from the first phase in the accounting process. Wrong entry of
the value of transactions and events in the subsidiary books, Journal Proper and Cash Book may
occur.
Example 1: Credit purchases ` 17,270 are entered in the Purchases Day Book as ` 17,720. Credit
sales of ` 15,000 gross less 1% trade discount are wrongly entered in Sales Day Book at ` 15,000.
Cheque issued ` 19,920 are wrongly entered in the credit of bank column in the Cash Book as
` 19,290.
(b) Wrong positing from subsidiary books: Subsidiary books are totalled periodically and
posted to the appropriate ledger accounts. There may arise totalling errors. Totalling errors may
arise due to wrong entry or simply these may be independent errors.
Example 2: For the month of January, 2011 total of credit sales are ` 1,75,700, this is wrongly
totalled as ` 1,76,700 and posted to sales account as ` 1,76,700.

RECTIFICATION OF ERRORS
(c) Wrong casting of subsidiary book: For example, wrong castings of the Cash Book result in
balancing error.
Example 3: The following cash transactions of M/s Tularam & Co. occurred:
2011
Jan. 1 Balance - cash ` 1,200 bank ` 16,000;
Jan. 2 Cheque issued to M/s Bholaram & Co., a supplier, for ` 22,500;
Jan. 6 Cheque collected from M/s Scindia & Bros. ` 42,240 and deposited for clearance;
Jan. 7 Cash sales ` 27,200 paid wages ` 12,400;
Jan. 8 Cash sales ` 37,730 cash deposited to bank ` 35,000.
The following Cash Book entries are passed:
Cash Book

Dr. Cr.
Date Particulars Cash Bank Date Particulars Cash Bank
` ` ` `
2011 2011
Jan. 1 To Balance b/d 1,200 16,000 Jan. 2 By M/s Bholaram & Co.
A/c
22,500
Jan. 6 To M/s Scindia & Bros
A/c
42,420 By Wages A/c 12,200
Jan. 7 To Sales A/c 27,200 By Bank A/c 34,500
Jan. 8 To Sales A/c 37,370 By Balance c/d 19,070 71,420
Jan. 8 To Cash A/c 34,500
65,770 93,920 65,770 93,920
Wrong entries and casting are shown in bold prints. However, errors of cash entries generally are
not carried. Usually cash balances are tallied daily. So errors are identified at an early stage. But
bank balance cannot be checked daily and thus errors may be carried until bank reconciliation is
made. In the above example, there are four wrong entries and one wrong casting Bank and cash
balances are affected by these errors.
(d) Wrong casting of ledger balances: Likewise Cash Book, any ledger account balance may be
cast wrongly. Obviously wrong postings make the balance wrong; but that is not wrong casting
of balances. Whenever there arises independent casting error as in the case of bank column in
the Cash Book of example (4), that is called wrong casting of ledger balances.

Example 4: The following are the credit purchases of M/s Ballav Bros.:
2011
Jan. 1 Purchases from M/s Saurabh & Co.- gross ` 1,00,000 less 1% trade discount.
Jan. 3 Purchases from M/s Netai & Co.- gross ` 70,000 less 1% trade discount.
Jan. 6 Purchases from M/s Saurabh & Co.- gross ` 60,000 less 1% trade discount
Let us cast M/s Saurabh & Co.’s Account:
M/s Saurabh & Co. Account
Dr. Cr.
Date Particulars Amount
`
`
2011 2011
Jan. 1 To Balance c/d 1,55,000 Jan. 1 By Purchases A/c 99,000
Jan. 6 By Purchases A/c 59,000
1,55,000 1,55,000
While casting the credit side an error has been committed and so the account is wrongly
balanced.
Example 5: Goods are purchased on credit from M/s Saurabh & Co. for ` 27,030 and from M/s
Karnataka Suppliers for ` 28,050. The following Day Book is prepared:
Purchases Day Book
`
M/s Saurabh & Co. 27,050
M/s Karnataka Suppliers 28,030
55,080
In the Day Book both the transactions are entered wrongly but the first error has been compensated
by the second. Even if these errors are not rectified Trial Balance would tally.
Trial Balance
Particulars Dr. Cr.
` `
M/s Saurabh & Co. 27,050
M/s Karnataka Suppliers 28,030
Purchases Account 55,080
55,080 55,080

2. STAGES OF ERRORS
Errors may occur at any of the following stages of the accounting process:
2.1 AT THE STAGE OF RECORDING THE TRANSACTIONS IN JOURNAL
Following types of errors may happen at this stage:
(i) Errors of principle,
(ii) Errors of omission,
(iii) Errors of commission.
2.2 AT THE STAGE OF POSTING THE ENTRIES IN LEDGER
(i) Errors of omission:
(a) Partial omission,
(b) Complete omission.
(ii) Errors of commission:
(a) Posting to wrong account,
(b) Posting on the wrong side,
(c) Posting of wrong amount.
2.3 AT THE STAGE OF BALANCING THE LEDGER ACCOUNTS
(a) Wrong Totalling of accounts,
(b) Wrong Balancing of accounts.
2.4 AT THE STAGE OF PREPARING THE TRIAL BALANCE
(a) Errors of omission,
(b) Errors of commission:
1. Taking wrong account,
2. Taking wrong amount,
3. Taking to the wrong side.
On the above basis, we can classify the errors in four broad categories:
1. Errors of Principle,
2. Errors of Omission,
3. Errors of Commission,
4. Compensating Errors.

3. TYPES OF ERRORS
Basically errors are of two types:
(a) Errors of principle: When a transaction is recorded in contravention of accounting principles,
like treating the purchase of an asset as an expense, it is an error of principle. In this case
there is no effect on the trial balance since the amounts are placed on the correct side, though
in a wrong account. Suppose on the purchase of a typewriter, the office expenses account is
debited; the trial balance will still agree.
(b) Clerical errors: These errors arise because of mistake committed in the ordinary course of
the accounting work. These are of three types:
(i) Errors of Omission: If a transaction is completely or partially omitted from the books of
account, it will be a case of omission. Examples would be: not recording a credit purchase
of furniture or not posting an entry into the ledger.
(ii) Errors of Commission: If an amount is posted in the wrong account or it is written on
the wrong side or the totals are wrong or a wrong balance is struck, it will be a case of
“errors of commission.”
(iii) Compensating Errors: If the effect of errors committed cancel out, the errors will be called
compensating errors. The trial balance will agree. Suppose an amount of ` 10 received
from A is not credited to his account and the total of the sales book is ` 10 in excess. The
omission of credit to A’s account will be made up by the increased credit to the Sales
Account.
From another point of view, error may be divided into two categories:
(a) Those that affect the trial balance - because of the errors that trial balance does not agree;
and
(i) Wrong casting of the subsidiary books [see (b) above.]
(ii) Wrong balancing of an account [see (a) above.]
(iii) Posting an amount on the wrong side [see (d) above.]
(iv) Wrong posting, ie., writing the wrong amount [see (d) above.]
(v) Omitting to post an amount from a subsidiary book.
(vi) Omitting to post the totals of subsidiary book.
(vii) Omitting to write the cash book balances in the trial balance.
(viii) Omitting to write the balance of an account in the trial balance.
(ix) Writing a balance in wrong column of the trial balance.
(x) Totalling the trial balance wrongly.
(b) The errors that do not affect the trial balance are the following:
(i) Omitting an entry altogether from the subsidiary book [see (i) above.]
(ii) Making an entry in the wrong subsidiary book [see (ii) above.]
(iii) Posting an amount in a wrong account but on the correct side, e.g., an amount to be
debited to A is debited to B, the trial balance will still agree.

Achartofthetypesoferrorsisgivenbelow:
ERRORS

Writingthewrong
amountinthe
subsidiarybooks.
TrialBalance
willagree.
Wrongcasting
ofsubsidiary
books.
Postingthe
wrongamount
intheledger.
Postingan
amounton
thewrongside.
Wrong
balancing
ofanaccount
ClericalErrorsErrorsofPrinciple(Treatinga
revenueexpenseascapital
expenditureorviceversaor
thesaleofafixedassetas
ordinarysale).TrialBalance
willagree.ErrorsofOmissionErrorsof
CommissionCrrors
Compensating
ErrorsTrial
Balancewill
agree.
Omittinganentry
completelyfromthe
subsidiarybooks.Trial
Balancewillagree.
Omittingtopostthe
ledgeraccountfrom
thesubsidiarybooks.
TrialBalancewillnotagree.
TrialBalancewillnotagree.

4. STEPS TO LOCATE ERRORS
Even if there is only a very small difference in the trial balance, the errors leading to it must be
located and rectified. A small difference may be the result of a number of errors. The following
steps will be useful in locating errors :
(i) The two columns of the trial balance should be totalled again. If in place of a number of
accounts, only one amount has been written in the trial balance the list of such accounts
should be checked and totalled again. List of Trade receivables is the example from which
Trade receivable balance is derived.
(ii) It should be seen that the cash and bank balances have been written in the trial balance.
(iii) The exact difference in the trial balance should be established. The ledger should be gone
through; it is possible that a balance equal to the difference has been omitted from the trial
balance. The difference should also be halved; it is possible that balance equal to half the
difference has been written in the wrong column.
(iv) The ledger accounts should be balanced again.
(v) The casting of subsidiary books should be checked again, especially if the difference is
` 1, ` 100 etc.
(vi) If the difference is very big, the balance in various accounts should be compared with the
corresponding accounts in the previous period. If the figures differ materially the cases
should be seen; it is possible that an error has been committed. Suppose the sales account
for the current year shows a balance of ` 32,53,000 whereas it was ` 36,45,000 last year; it is
possible that there is an error in the Sales Account.
(vii) Postings of the amounts equal to the difference or half the difference should be checked. It
is possible that an amount has been omitted to be posted or has been posted on the wrong
side.
(viii) If there is still a difference in the trial balance, a complete checking will be necessary. The
posting of all the entries including the opening entry should be checked. It may be better to
begin with the nominal accounts.
5. RECTIFICATION OF ERRORS
Errors should never be corrected by overwriting. If immediately after making an entry it is clear
that an error has been committed, it may be corrected by neatly crossing out the wrong entry
and making the correct entry. If however the errors are located after some time, the correction
should be made by making another suitable entry, called rectification entry. In fact the rectification
of an error depends on at which stage it is detected. An error can be detected at any one of the
following stages:
(a) Before preparation of Trial Balance.
(b) After Trial Balance but before the final accounts are drawn.
(c) After final accounts, i.e., in the next accounting period.

5.1 BEFORE PREPARATION OF TRIAL BALANCE
There are some errors which affect one side of an account or which affect more than one account
in such a way that it is not possible to pass a complete rectification entry. In other words, there are
some errors which can be corrected, if detected at this stage, by making rectification statement in
the appropriate side(s) of concerned account(s). It is important to note here that such errors may
involve only one account or more than one account. Read the following illustrations:
(i) The sales book for November is undercast by ` 200. The effect of this error is that the Sales
Account has been credited short by ` 200. Since the account is posted by the total of the sales
book, there is no error in the accounts of the customers since they are posted with amounts
of individual sales. Hence only the Sales Accounts is to be corrected. This will be done by
making an entry for ` 200 on the credit side: “By undercasting of Sales Book for November
` 200”.
(ii) While posting the discount column on the debit side of the cash book the discount of
` 10 allowed to Ramesh has not been posted. There is no error in the cash book, the total of
discount column presumably has been posted to the discount account on the debit side. The
error is in not crediting Ramesh by ` 10. This should now be done by the entry “By omission
of posting of discount on ----- ` 10”.
(iii) ` 200 received from Ram has been entered by mistake on the debit side of his account. Since
the cash book seems to have been correctly written, the error is only in the account of Ram
- he should have been credited and not debited by ` 200. Not only is the wrong debit to be
removed but also a credit of ` 200 is to be given. This can be done now by entering ` 400 on
the credit side of his account. The entry will be “By Posting on the wrong side - ` 400”.
(iv) ` 50 was received from Mahesh and entered on the debit side of the cash book but was
not posted to his account. By the error, which affects only the account of Mahesh, ` 50 has
been omitted from the credit side of his account. The rectification will be by the entry. “By
Omission of posting on the ` 50.”
(v) ` 51 paid to Mohan has been posted as ` 15 to the debit of his account. Mohan has been
debited short by ` 36. The rectifying entry is “To mistake in posting on ` 36”.
(vi) Goods sold to Ram for ` 1,000 was wrongly posted from sales day book to the debit of purchase
account. Ram has however been correctly debited. Here the error affects two accounts, viz.,
purchases account and sales account but we cannot pass a journal entry for its rectification
because both the accounts need to be credited . The rectification will be by the entry “By
wrong posting on ` 1,000” in the credit of purchases account and also “By omission of posting
on - ` 1,000” in the credit sales account.
(vii) Bills receivable from Mr. A of ` 500 was posted to the credit of Bills payable Account and
also credited to A account. Here also although two accounts are involved we cannot pass
a complete journal entry for rectification. The rectification will be by the entry “To wrong
posting on ` 500” in debit of Bills payable Account and also “To omission of posting on
` 500” in the debit of Bills Receivable Account.
(viii) Goods purchased from Vinod for ` 1,000 was wrongly credited to Vimal account by
` 100. Again we cannot pass a complete journal entry for rectification even though two

accounts are involved. The rectification will be done by the entry “To wrong posting on
` 100” in the debit of Vimal account and “By omission of posting on ` 1,000” in the credit
of Vinod account.
Thus, from the above illustrations we are convinced that the general rule that errors affecting two
accounts can always be corrected by a journal entry is not always valid.
Illustration 1
How would you rectify the following errors in the book of Rama & Co.?
1. The total to the Purchases Book has been undercast by ` 100.
2. The Returns Inward Book has been undercast by ` 50.
3. A sum of ` 250 written off as depreciation on Machinery has not been debited to Depreciation
Account.
4. A payment of ` 75 for salaries (to Mohan) has been posted twice to Salaries Account.
5. The total of Bills Receivable Book ` 1,500 has been posted to the credit of Bills Receivable
Account.
6. An amount of ` 151 for a credit sale to Hari, although correctly entered in the Sales Book,
has been posted as ` 115.
7. Discount allowed to Satish ` 25 has not been entered in the Discount Column of the Cash
Book. It has been posted to his personal account.
Solution
1. The Purchases Account should receive another debit of ` 100 since it was debited short
previously :
“To Undercasting of Purchases Book for the month of --- ` 100.”
2. Due to this error the Returns Inward Account has been posted short by ` 50 : the correct
entry will be :
“To Undercasting of Returns Inward Book for the month of --- ` 50.”
3. The omission of the debit to the Depreciation Account will be rectified by the entry :
“To Omission of posting on ` 250”.
4. The excess debit will be removed by a credit in the Salaries Account by the entry :
“By double posting on ` 75”.
5. ` 1,500 should have been debited to the Bills Receivable Account and not credited. To correct
the mistake, the Bills Receivable Account should be debited by ` 3,000 by the entry:
“To Wrong posting of B/R received on ` 3,000”
6. Hari’s personal A/c is debited ` 36 short. The rectification entry will be :
“To Wrong posting ` 36”.
7. Due to this error, the discount account has been debited short by ` 25. The required entry
is :
“To Omission of discount allowed to Satish on ` 25.”
So far we have discussed the correction of errors which affected only one Account of more than
one account but for which rectifying entries were not complete journal entries in fact that rectifying
entry is made directly in the account(s) concerned. We shall now take up the correction of errors

which affect more than one account in such a way that complete journal entries are possible for
their rectification. Read the following illustrations :
(i) The purchase of machinery for ` 2,000 has been entered in the purchases book. The effect
of the entry is that the account of the supplier has been credited by ` 2,000 which is quite
correct. But the debit to the Purchases Account is wrong : the debit should be to Machinery
Account. To rectify the error, the debit in the purchases Account has to be transferred to the
Machinery Account. The correcting entry will be to Credit Purchases Account and debit the
Machinery Account. Please see the three entries made below: the last entry rectifies the error:
Wrong Entry : ` `
Purchases Account Dr. 2,000
To Trade Payable 2,000
Correct Entry :
Machinery Account Dr. 2,000
To Trade Payable 2,000
Rectifying Entry :
Machinery Account Dr. 2,000
To Purchases Account 2,000
(ii) ` 100 received from Kamal Kishore has been credited in the account of Krishan Kishore. The
error is that there is a wrong credit in the account of Krishan Kishore and omission of credit
in the account of Kamal Kishore; Krishan Kishore should be debited and Kamal Kishore be
credited. The following three entries make this clear :
Wrong Entry : ` `
Cash Account Dr. 100
To Krishan Kishore 100
Correct Entry :
To Kamal Kishore 100
Rectifying Entry :
Krishan Kishore Dr. 100
To Kamal Kishore 100
(iii) The sale of old machinery, ` 1,000 has been entered in the sales book. By this entry the account
of the buyer has been correctly debited by ` 1,000. But instead of crediting the Machinery
Account. Sales Account has been credited. To rectify the error this account should be debited
and the Machinery Account credited. See the three entries given below:
Wrong Entry : ` `
Buyer’s Account Dr. 1,000
To Sales Account 1,000
Correct Entry :
Buyer’s Account Dr. 1,000
To Machinery Account 1,000
Rectifying Entry :
Sales Account Dr. 1,000
To Machinery Account 1,000

Illustration 2
The following errors were found in the book of Ram Prasad & Sons. Give the necessary entries
to correct them.
(1) ` 500 paid for furniture purchased has been charged to ordinary Purchases Account.
(2) Repairs made were debited to Building Account for ` 50.
(3) An amount of ` 100 withdrawn by the proprietor for his personal use has been debited to
Trade Expenses Account.
(4) ` 100 paid for rent debited to Landlord’s Account.
(5) Salary ` 125 paid to a clerk due to him has been debited to his personal account.
(6) ` 100 received from Shah & Co. has been wrongly entered as from Shaw & Co.
(7) ` 700 paid in cash for a typewriter was charged to Office Expenses Account.
Solution
JOURNAL
Particulars L.F. Dr.
`
Cr.
`
(1) Furniture A/c Dr. 500
To Purchases A/c 500
(Correction of wrong debit to Purchases A/c
for furniture purchased)
(2) Repairs A/c Dr. 50
To Building A/c 50
(Correction of wrong debit to building A/c for
repairs made)
(3) Drawings A/c. Dr. 100
To Trade Expenses A/c 100
(Correction of wrong debit to Trade Expenses
A/c for cash withdrawn by the proprietor for
his personal use)
(4) Rent A/c Dr. 100
To Landlord’s Personal A/c 100
(Correction of wrong debit to landlord’s A/c
for rent paid)
(5) Salaries A/c Dr. 125
To Clerk’s (Personal) A/c 125
(Correction of wrong debit to Clerk’s personal
A/c for salaries paid)

`
Cr.
`
(6) Shaw & Co. Dr. 100
To Shah & Co. 100
(Correction of wrong credit to Shaw & Co.
Instead of Shah & Co.)
(7) Typewriter A/c Dr. 700
To Office Expenses A/c 700
(Correction of wrong debit to Office Expenses
A/c for purchase of typewriter)
Illustration 3
Give journal entries to rectify the following :
(1) A purchase of goods from Ram amounting to ` 150 has been wrongly entered through the
Sales Book.
(2) A Credit sale of goods amounting ` 120 to Ramesh has been wrongly passed through the
Purchase Book.
(3) On 31st Dec. 2011 goods of the value of ` 300 were returned by Hari Saran and were taken
inventory on the same date but no entry was passed in the books.
(4) An amount of ` 200 due from Mahesh Chand, which had been written off as a Bad Debt in
a previous year, was unexpectedly recovered, and had been posted to the personal account
of Mahesh Chand.
(5) A Cheque for ` 100 received from Man Mohan was dishonoured and had been posted to the
debit of Sales Returns Account.
Solution
JOURNAL
`
Cr.
`
(1) Purchases A/c Dr. 150
Sales A/c Dr. 150
To Ram 300
(Correction of wrong entry in the sales Book
for a purchases of goods from Ram)
(2) Ramesh Dr. 240
To Purchases A/c 120
To Sales A/c 120
(Correction of wrong entry in the Purchases
Book of a credit sale of goods to Ram)
(3) Returns Inwards A/c Dr. 300
To Hari Saran 300
(Entry of goods returned by him and taken in
Inventory omitted from records)

`
Cr.
`
(4) Mahesh Chand Dr. 200
To Bad Debts Recovered A/c 200
(Correction of wrong credit to Personal A/c in
respect of recovery of previously written off bad debts)
(5) Man Mohan Dr. 100
To Sales Return A/c 100
(Correction of wrong debit to Sales Returns A/c
for dishonour of cheque received from Man Mohan)
Thus it can be said that errors detected before the preparation of trial balance can be rectified
either through rectification statements (not entries) or through rectification entries.
5.2 AFTER TRIAL BALANCE BUT BEFORE FINAL ACCOUNTS
The method of correction of error indicated so far is appropriate when the errors have been
located before the end of the accounting period. After the corrections the trial balance will agree.
Sometimes the trial balance is artificially made to agree inspite of errors by opening a suspense
account and putting the difference in the trial balance to the account - the suspense account will be
debited if the total of the credit column in the trial balance exceeds the total of the debit column;
it will be credited in the other case.
One must note that such agreement of the trial balance will not be real. Effort must be made to
locate the errors.
The rule of rectifying errors detected at this stage is simple. Those errors for which complete
journal entries were not possible in the earlier stage of rectification (i.e., before trial balance) can
now be rectified by way of journal entry(s) with the help of suspense account, for it these errors
which gave rise to the suspense account in the trial balance. The rectification entry for other type
of error i.e. error affecting more than one account in such a way that a complete journal entry
is possible for its rectification, can be rectified in the same way as in the earlier stage (i.e. before
trial balance).
In a nutshell, it can be said that each and every error detected at this stage can only be corrected
by a complete journal entry. Those errors for which journal entries were not possible at the earlier
stage will now be rectified by a journal entry(s), the difference or the unknown side is being taken
care of by suspense account. Those errors for which entries were possible even at the first stage
will now be rectified in the same way.
Suppose, the sales book for November, 2010 is cast ` 100 short; as a consequence the trial balance
will not agree. The credit column of the trial balance will be ` 100 short and a Suspense Account
will be credited by ` 100. To rectify the error the Sales Account will be credited (to increase the
credit to the right figure. Since now one error remains, the Suspense Account must be closed- it
will be debiting the Suspense Account. The entry will be :
Suspense Account Dr. ` 100
To Sales Account ` 100
(Correction of error of undercasting the sales
Book for Nov. 2010)

Illustration 4
Correct the following errors (i) without opening a Suspense Account and (ii) opening a Suspense
Account :
(a) The Sales Book has been totalled ` 100 short.
(b) Goods worth ` 150 returned by Green & Co. have not been recorded anywhere.
(c) Goods purchased ` 250 have been posted to the debit of the supplier Gupta & Co.
(d) Furniture purchased from Gulab & Bros, ` 1,000 has been entered in Purchases Day Book.
(e) Discount received from Red & Black ` 15 has not been entered in the Discount Column of
the Cash Book.
(f) Discount allowed to G. Mohan & Co. ` 18 has not been entered in the Discount Column of
the Cash Book. The account of G. Mohan & Co. has, however, been correctly posted.
Solution
If a Suspense Account is not opened.
(a) Since sales book has been cast ` 100 short, the Sales Account has been similarly credited
` 100 short. The correcting entry is to credit the Sales Account by ` 100 as “By wrong totalling
of the Sales Book ` 100”.
(b) To rectify the omission, the Returns Inwards Account has to be debited and the account of
Green & Co. credited. The entry :
Returns Inward Account Dr. ` 150
To Green & Co. ` 150
(Goods returned by the firm, previously
omitted from the Returns Inward Book)
(c) Gupta & Co. have been debited ` 250 instead of being credited. This account should now be
credited by 500 to remove the wrong debit and to give the correct debit. The entry will be
on the credit side... “By errors in posting ` 500”.
(d) By this error Purchases Account has to be debited by ` 1,000 whereas the debit should have
been to the Furniture Account. The correcting entry will be :
Furniture Account Dr. ` 1,000
To Purchases Account ` 1,000
(Correction of the mistake by which
purchases Account was debited instead
of the Furniture Account)
(e) The discount of ` 15 received from Red & Black should have been entered on the credit
side of the cash book. Had this been done, the Discount Account would have been credited
(through the total of the discount column) and Red & Black would have been debited. This
entry should not be made :

Red & Black Dr. ` 15
To Discount Account ` 15
(Rectification of the error by which the discount
allowed by the firm was not entered in Cash Book)
(f) In this case the account of the customer has been correctly posted; the Discount Account has
been debited ` 18 short since it has been omitted from the discount column on the debit side
of the cash book. The discount account should now be debited by the entry; “To Omission
of entry in the Cash Book ` 18.”
If a Suspense Account is opened :
`
Cr.
`
(a) Suspense Account Dr. 100
To Sales Account 100
(Being the correction arising from under-
casting of Sales Day Book)
(b) Return Inward Account Dr. 150
To Green & Co . 150
(Being the recording of unrecorded returns)
(c) Suspense Account Dr. 500
To Gupta & Co. 500
(Being the correction of the error by
which Gupta & Co. was debited instead
of being credited by ` 250).
(d) Furniture Account Dr. 1,000
(Being the correction of recording purchase
of furniture as ordinary purchases)
(e) Red & black Dr. 15
To Discount Account 15
(Being the recording of discount omitted to be recorded)
(f) Discount Account Dr. 18
To Suspense Account 18
(Being the correction of omission of the
discount allowed from Cash Book
customer’s account already posted correctly).

Suspense Account
Dr.
Date
Particulars
Amount
`
Date Particulars
Cr.
Amount
`
To Sales A/c 100 By Difference in
To Gupta & Co. 500 Trial Balance 582
By Discount A/c 18
600 600
Note :
(i) One should note that the opening balance in the Suspense Account will be equal to the
difference in the trial balance.
(ii) If the question is silent as to whether a Suspense Account has been opened, the student
should make his assumption, state it clearly and then proceed.
Illustration 5
Correct the following errors found in the books of Mr. Dutt. The Trial Balance was out by
` 493 excess credit. The difference thus has been posted to a Suspense Account.
(a) An amount of ` 100 was received from D. Das on 31st December, 2011 but has been omitted
to enter in the Cash Book.
(b) The total of Returns Inward Book for December has been cast ` 100 short.
(c) The purchase of an office table costing ` 300 has been passed through the Purchases Day
Book.
(d) ` 375 paid for Wages to workmen for making show-cases had been charged to “Wages
Account”.
(e) A purchase of ` 67 had been posted to the trade payables’ account as ` 60.
(f) A cheque for ` 200 received from P. C. Joshi had been dishonoured and was passed to the
debit of “Allowances Account”.
(g) ` 1,000 paid for the purchase of a motor cycle for Mr. Dutt had been charged to “Miscellaneous
Expenses Account”.
(h) Goods amounting to ` 100 had been returned by customer and were taken in to Inventory,
but no entry in respect there of, was made into the books.
(i) A sale of ` 200 to Singh & Co. was wrongly credited to their account.
Solution
(a) Journal Entries
Particulars L.F. ` `
To D. Das 100
(Being the amount received)

(b) Returns Inward Account Dr. 100
(Being the mistake in totalling the Returns Inward Book
corrected)
(c) Furniture Account Dr. 300
To Purchases Account 300
(Being the rectification of mistake by which purchase
of furniture was entered in Purchases book and hence
debited to Purchases Account)
(d) Furniture Account Dr. 375
To Wages Account 375
(Being the wages paid to workmen for making show-
cases which should be capitalised and not to be charged
to Wages Account)
(e) Suspense Account Dr. 7
To Trade Payables (personal) Account 7
(Being the mistake in crediting the Trade payables
Account less by ` 7, now corrected)
(f) P.C. Joshi Dr. 200
To Allowances Account 200
(Being the cheque of P.C. Joshi dishonoured, previously
debited to Allowances Account)
(g) Drawings Account Dr. 1,000
To Miscellaneous Expenses 1,000
(Being the motor cycle purchased for Mr. Dutt debited
to his Drawings Account instead of Miscellaneous
Expenses Account as previously done by mistake)
(h) Returns Inward Account Dr. 100
To Customer’s (Personal) Account 100
(Correction of the omission to record return of goods
by customers)
(i) Singh & Co. Dr. 400
(Being the correction of mistake by which the account
of Singh & Co. was credited by ` 200 instead of being
debited)

Suspense Account
Dr. Cr.
Date Particulars Amount Date Particulars Amount
2011 ` 2011 `
Dec.31 To Difference in Dec. 31 By Returns
Trial Balance 493 Inwards A/c 100
“ “ To Trade Payables A/c 7 “ “ By Singh & Co. 400
500 500
Illustration 6
The following errors, affecting the account for the year 2011 were detected in the books of Jain
Brothers, Delhi:
(1) Sale of old Furniture ` 150 treated as sale of goods.
(2) Receipt of ` 500 from Ram Mohan credited to Shyam Sunder.
(3) Goods worth ` 100 brought from Mohan Narain have remained unrecorded so far.
(4) A return of ` 120 from Mukesh posted to his debit.
(5) A return of ` 90 to Shyam Sunder posted as ` 9 in his account.
(6) Rent of proprietor’s residence, ` 600 debited to rent A/c.
(7) A payment of ` 215 to Mohammad Sadiq posted to his credit as ` 125.
(8) Sales Book added ` 900 short.
(9) The total of Bills Receivable Book ` 1,500 left unposted.
You are required to pass the necessary rectifying entries and show how the trial balance would
be affected by the errors.
Solution
JOURNAL
Amount
`
Cr.
Amount
`
(1) Sales Account Dr. 150
To Furniture Account 150
(Rectification of sales of furniture treated
as sales of goods)
(2) Shyam Sunder Dr. 500
To Rama Mohan 500
(Rectification of a receipt from Ram Mohan
credited to Shyam Sunder)

(3) Purchases Account Dr. 100
To Mohan Narain 100
(Purchases of goods from Mohan
Narain unrecorded)
(6) Drawing Account Dr. 600
To Rent Account 600
(Rectification of Payment of rent of
proprietor’s residence treated as payment
of office rent)
N.B. : For 4, 5, 7, 8, 9 no journal entry can be passed as they affect a single account. The correction
will be as under:
(4) Credit Mukesh’s Account with ` 240.
(5) Debit the account of Shyam Sunder by ` 81.
(7) Debit the account of Mohammad Sadiq by ` 340.
(8) Credit Sales Account by ` 900.
(9) Debit Bills Receivable Account with ` 1,500.
Effect of the Errors on Trial Balance
1. No effect
2. No effect
3. No effect
4. Trial Balance credit total short by ` 240.
5. Trial Balance debit total short by ` 81.
6. No effect
7. Trial Balance debit total short by ` 340.
8. Trial Balance credit total short by ` 900.
9. Trial Balance debit total short by ` 1,500.
Illustration 7
The trial balance of Mr. W & H failed to agree and the difference ` 20,570 was put into suspense
pending investigation which disclosed that :
(i) Purchase returns day book had been correctly entered and totalled at ` 6,160, but had been
posted to the ledger.
(ii) Discounts received ` 1,320 had been debited to discounts allowed.
(iii) The Sales account had been under added by ` 10,000.
(iv) A credit sale of ` 1,470 had been debited to a customer account at ` 1,740.
(v) A vehicle bought originally for ` 7,000 four years ago and depreciated to ` 1,200 had been
sold for ` 1,500 in the beginning of the year but no entries, other than in the bank account
had been passed through the books.

(vi) An accrual of ` 560 for telephone charges had been completely omitted.
(vii) A bad debt of ` 1,560 had not been written off and provision for doubtful debts should
have been maintained at 10% of Trade receivables which are shown in the trial balance at
` 23,390 with a credit provision for bad debts at ` 2,320.
(viii) Tools bought for ` 1,200 had been inadvertently debited to purchases.
(ix) The proprietor had withdrawn, for personal use, goods worth ` 1,960. No entries had been
made in the books.
Required :
(i) Pass rectification entries without narration to correct the above errors before preparing annual
accounts.
(ii) Prepare a statement showing effect of rectification on the reported net profit before correction
of these errors.
Solution
Particulars Dr. Cr.
(i) Suspense Account Dr. 6,160
To Return Outward A/c 6,160
(ii) Suspense Account Dr. 2,640
To Discount Allowed Account 1,320
To Discount Received Account 1,320
(iii) Suspense Account Dr. 10,000
To Sale Account 10,000
(iv) Suspense Account Dr. 270
To Customer Account 270
(v) Suspense Account Dr. 1,500
To Vehicle Account 1,200
To Profit on Sale of Vehicle Account 300
(vi) Telephone Charges Account Dr. 560
To Outstanding Expenses Account 560
(vii) Bad Debts Account Dr. 1,5601
To Trade receivables Account 1,560
Provision for Doubtful Debts Account Dr. 1642
To Profit and Loss Account 164
(viii) Loose Tools Account Dr. 1,200
(ix) Drawings Account Dr. 1,960
1
Bad debts will be debited in the profit and loss account.
2
Provision @ 10% of ` 2,156; Excess provision ` 164.

Working Notes :
(i) Trade receivables as per books 23,390
Deduction vide item (iv) 270
Bad Debts 1,560 1,830
21,560
(ii) Suspense Account
` `
To Return outward Account 6,160 By balance b/d 20,570
To Discount allowed Account 1,320
To Discount Received Account 1,320
To Sales 10,000
To Customers 270
To Vehicles 1,200
To Profit on Sale of Vehicle 300
20,570 20,570
Illustration 8
Show by means of Journal entries how the following matters should be adjusted when preparing
the Annual Accounts of a firm for the year ended 30th September, 2011.
(a) Goods sold and recorded as sales for ` 4,000, were packed. However, Inventory taking
intervened and the parcel of goods was not despatched but was included in Inventories.
The title of goods has not been transferred to the buyer.
(b) Several employees took their salary in advance in the month of September, 2011 which was
payable to them in October, 2011 amounting to ` 2,500.
(c) A cheque of ` 2,500 received for a loss of Inventory sustained by fire has been paid by the
proprietor into his private bank account and not recorded in the business books.
(d) A cheque for ` 1,250 received as Insurance claim for loss of goods in transit at the time of
import was recorded in the books. However, the same was deposited by the proprietor into
his private bank account. The full value of the invoice was passed through the purchase
book.
(e) A purchase was made for a staff member of ` 1,000 and the cost was included in purchases.
A deduction of similar amount was made from his salary and the net payment to him posted
to salaries account.
(f) Bill received from Mr. Anup for repairs to furniture ` 300 and new furniture supplied for `
1,000 was entered in the invoice book as ` 1,100.
(g) Furniture which stood in the books at ` 500 was sold for ` 275 in part exchange of new
furniture costing ` 875 and the new invoice of ` 600 was passed through the purchase book.

Solution
JOURNAL
Adjustment Entries
Date
2011
Particulars Dr.
`
Cr.
`
Sep. 30
(a) Sales Account* Dr. 4,000
To Trade receivables Account 4,000
(Entry for credit sales reversed as goods have not been
despatched to the customer)
(b) Prepaid Salaries Account Dr. 2,500
To Salaries Account 2,500
(Salaries paid in advance for Oct. and debited to Salaries
Account, now transferred to Prepaid Salaries Account)
(c) Drawings Account Dr. 2,500
To Insurance Company Account 2,500
(Being the rectification of cheque received for loss of Inventory
due to fire deposited in the private account of the proprietor)
(d) Drawings Account Dr. 1,250
(Being the rectification of cheque received as insurance claim
for loss of goods in transit deposited into private bank
Account of the proprietor)
(e) Salaries Account Dr. 1,000
(Goods purchased for staff-member recorded as trade
purchases, new charged to Salaries Account)
(f) Repairs Account Dr. 300
Furniture Account Dr. 1,000
To Mr. Anup 200
Note : * In (a) above, goods recorded as sales may not be reversed, instead may be excluded from closing
Inventory, as the goods have been ascertained and appropriated according to the contract if the title in
the goods would have already passed to customer.

(Being the rectification of Bill received from Mr. Anup for repairs
to furniture ` 300 and new furniture supplied for ` 1,000 entered
in the purchases book at ` 1,100)
(g) Furniture Account Dr. 375
Loss on sale of Furniture Account Dr. 225
(Being the rectification of net exchange of old and new
furniture passed through purchases day book)
Illustration 9
On going through the Trial balance of Ball Bearings Co. Ltd. you find that the debit is in excess
by ` 150. This was credited to “Suspense Account”. On a close scrutiny of the books the following
mistakes were noticed:
(1) The totals of debit side of “Expenses Account” have beeen cast in excess by ` 50.
(2) The “Sales Account” has been totalled in short by ` 100.
(3) One item of purchase of ` 25 has been posted from the day book to ledger as ` 250.
(4) The sale return of ` 100 from a party has not been posted to that account though the Party’s
account has been credited.
(5) A cheque of ` 500 issued to the Suppliers’ account (shown under Trade payables) towards
his dues has been wrongly debited to the purchases.
(6) A credit sale of ` 50 has been credited to the Sales and also to the Trade receivables Account.
(i) Pass necessary journal entries for correcting the above;
(ii) Show how they affect the Profits; and
(iii) Prepare the “Suspense Account” as it would appear in the ledger.
JOURNAL ENTRIES
`
Cr.
`
Suspense Account Dr. 50
To Expenses Account 50
(Being the mistake in totalling of Expenses Account, rectified)

*
It is assumed that the day-book is the Purchase Day Book in which case only the supplier’s account would be posted wrongly
(creditor of ` 250 instead of ` 25). If however, by day-book is meant a book in which all transactions are recorded and posted at
the ledger therefrom, it would mean that both the Supplier’s Account and Purchases Account are wrongly posted.
Suspense Account Dr. 100
To Sales Account 100
(Being the mistake in totalling of Sales Accounts rectified)
Supplier* Dr. 225
(Being the mistake in posting from Day Book to Ledger
rectified)
Sales Returns Account Dr. 100
(Being the sales return from a party not posted to “Sales
Returns” now rectified)
Trade payables Account Dr. 500
(Being the payments made to supplier wrongly posted to
purchases now rectified)
Trade receivables Account Dr. 100
(Being the sales wrongly credited to Customer’s Account now
rectified)
Suspense Account
Dr.
`
Cr.
`
To Expenses Account 50 By Difference in Trial Balance 150
To Sales Account 100 By Trade payables 225
To Balance c/d 425 By Sales Returns Account 100
By Trade receivables 100
575 575
By Balance b/d 425

Since the Suspense Account does not balance, it is clear that all the errors have not been traced.
As a result of the above corrections the Net Profit will be :
Increased by
`
Decreased by
`
Mistake in totalling in “Expenses” 50
Mistake in totalling in “Sales” 100
Mistake in posting from day book to Ledger under
“Purchases” 500
Omission in posting under “Sales Returns” 100
650 100
Net Increase 550
As a result of these adjustments, the Profits will be increased by ` 550.
Illustration 10
Write out the Journal Entries to rectify the following errors, using a Suspense Account.
(1) Goods of the value of ` 100 returned by Mr. Sharma were entered in the Sales Day Book and
posted therefrom to the credit of his account;
(2) An amount of ` 150 entered in the Sales Returns Book, has been posted to the debit of
Mr. Philip, who returned the goods;
(3) A sale of ` 200 made to Mr. Ghanshyam was correctly entered in the Sales Day Book but
wrongly posted to the debit of Mr. Radheshyam as ` 20;
(4) Bad Debts aggregating ` 450 were written off during the year in the Sales ledger but were
not adjusted in the General Ledger; and
(5) The total of “Discount Allowed” column in the Cash Book for the month of September, 2011
amounting to ` 250 was not posted.
Solution
JOURNAL
`
Cr.
`
(1) Sales Account Dr. 100
Sales Returns Account Dr. 100
(The value of goods returned by Mr. Sharma
wrongly posted to Sales and omission of debt
to Sales Returns Account, now rectified)

(2) Suspense Account Dr. 300
To Mr. Philip 300
(Wrong debit to Mr. Philip for goods
returned by him, now rectified)
(3) Mr. Ghanshyam Dr. 200
To Mr. Radheshyam 20
(Omission of debit to Mr. Ghanshyam and wrong credit
to Mr. Radhesham for sale of ` 200, now rectited)
(4) Bad Debts Account Dr. 450
(The amount of Bad Debts written off not
adjusted in General Ledger, now rectified)
(5) Discount Account Dr. 250
(The total of Discount allowed during
September, 2011 not posted from the Cash
Book; error now rectified)
Illustration 11
The Trial balance of Messrs. A, B and C did not agree. A Suspense Account was opened with the
amount of the difference. The following errors were discovered on scrutiny:
(1) The addition of the Analysis Column of the Tabular Purchase Journal posted to Goods
Purchased for Resale Account was found to be short by ` 150 though the addition of the
total column was correct.
(2) A dishonoured B/R for ` 400 returned to the firm by bank had been credited to Bank Account
for collection of bills and debited to B/R Account. A cheque was later received from the
customer for ` 400 and was duly paid into the firm’s bank account.
(3) An amount of ` 450 treated as paid in advance on account of insurance in the previous year
was not brought forward.
(4) Sales on approval amounting to ` 2,000 were included in the Sales Account. Half of these
were returned but no entries were passed in respect of these goods. However, the returned
goods have been included in the closing Inventory at their cost price of ` 500.
(5) ` 1,260 represent credits given to customers when the payments against sales invoices were
received. However, these invoices themselves were not entered in the books. A discount of
10% is allowed on the selling price in all such invoices.

You are required to pass rectifying entries making use, of the Suspense Account, wherever
necessary.
Solution
Journal of M/s. A, B and C
`
Dr.
`
1. Purchase for Resale A/c Dr. 150
(Short debit to ‘purchases for Resale Account’ on
account of undercasting on now corrected)
2. Customers A/c Dr. 400
To Bill Receivable A/c 400
(Amount of dishonoured bill receivable previously
debited to Bills Receivable Account, error now rectified)
3. Insurance Account Dr. 450
(Prepaid insurance in the previous year not brought
forward now debited to the Insurance Account)
4. Sales Accounts Dr. 1,000
To Customer’s Account 1,000
(Goods worth ` 1,000 returned by a customer on
sale or return basis, previously omitted to be recorded;
error now rectified)
5. Discount Account Dr. 140
Customers Account Dr. 1,260
To Sales Account 1,400
(Credit sales of ` 1,400 previously omitted from the
books, error now corrected)
Note : Payment being equal to 90% of the gross sale is ` 1,400, i.e., 1,260 × 100/90. 1/10 of this
amount is discount.
Since the discount of 10% is allowed in all cases, it would be better to treat the sale to be
` 1,260 and not ` 1,400, the discount is trade discount for which no account is opened, the sales
being recorded, at the net amount.

Illustration 12
The trial balance of Anil Traders did not agree. The difference was put in the Suspense Account
and the following trial balance was drafted :
Trial Balance as on 31st March, 2011
Dr. Cr.
Capital Account 45,000
Drawing Account 6,500
Sales Account 1,07,200
Salaries and Wages Account 12,250
Furniture and Fittings Account 17,500
Trade receivables Account 30,250
Trade payables Account 21,250
Stationery Account 1,250
Cash at Bank 5,700
Cash in Hand 2,300
Bills Receivable Account 15,750
Bills Payable Account 9,000
Rent and Rates Account 3,200
Suspense Account 5,000
1,87,450 1,87,450
On scrutiny the following errors were subsequently detected :
(a) Goods drawn by Mr. Anil, the proprietor, for personal consumption of ` 1,500 have not at
all been recorded.
(b) Goods sold to Ram for ` 1,250 on credit was debited to Rahim account for ` 250 only.
(c) Wages paid for fittings ` 500 was debited to salaries and wages account.
(d) Goods purchased from Atul for ` 2,500 on credit was wrongly debited to his account.
(e) Bill received from Arun, a debtor/customer, for ` 500 was debited to Ajay’s account.
(f) A credit sale of ` 1,500 was recorded in Purchased Day Book and a credit purchase of ` 2,000
was entered in Sales Day Book.

You are required to pass the rectification entries and redraft the trial balance.
Solution
M/s Anil Traders
Journal
Particulars L.F. Cr.
`
Dr.
`
(a) Drawings Account Dr. 1,500
(Goods withdrawn for personal consumption
by the proprietor, now recorded)
(b) Ram (debtor/customer) Account Dr. 1,250
To Rahim (debtor/customer) Account 250
To Suspense Account 1,000
(Goods sold to Ram for ` 1,250 wrongly
debited to Rahim account for ` 250, now rectified)
(c) Furniture and Fittings Account Dr. 500
To Salaries and Wages Account 500
(Wages paid for fittings wrongly debited to
salaries and wages account, now rectified)
(d) Suspense Account Dr. 5,000
To Atul (Creditor) Account 5,000
(Goods brought on credit from Atul wrongly
debited to his account, now rectified)
(e) Suspense Account Dr. 1,000
To Arun (debtor/customer) Account 500
To Ajay (debtor/customer) Account 500
(Bill received from Arun wrongly debited to
Ajay Account, now rectified)
(f) Purchases Account Dr. 500
Sales Account Dr. 500
To Trade receivables Account* 500
To Trade payables Account* 500
(A credit sale and a credit purchase wrongly
entered in purchases day book and sales day
book respectively, now rectified)
* In the trade receivable’ ledger and trade payables’ ledger, the affected individual accounts should be rectified with
the full amount. In other words, in the trade receivable’ ledger the concerned trade receivable account should be
debited by ` 1,500 for credit sales and the trade receivable account wrongly debited for credit purchase should be
credited by ` 2,000.

Trial Balance of M/s. Anil Traders as on 31.3.2011
Particulars Dr.
`
Cr.
`
Capital Account 45,000
Drawings Account 8,000
Sales Account 1,06,700
Salaries and Wages Account 11,750
Furniture and Fittings Account 18,000
Trade receivables Account 29,750
Trade payables Account 26,750
Stationery Account 1,250
Cash at Bank 5,700
Cash in Hand 2,300
Bills Receivable Account 15,750
Bills Payable Account 9,000
Rent and Rates Account 3,200
1,87,450 1,87,450
Working Notes :
1. Suspense Account
Dr.
`
Cr.
`
To Atul Account (entry ‘d’) 5,000 By Balance b/d 5,000
To Arun Account (entry ‘e’) 500 By Ram Account (entry ‘b’) 1,000
To Ajay Account (entry ‘e’) 500
6,000 6,000

2. Corrected Ledger Balances
Balance as per
given trial
balance
Rectification
effect
Reference
(entry no.)
Rectified
balance
` ` `
Drawings 6,500 (+) 1,500 (a) 8,000
Purchases 92,750 (-) 1,000 (a) & (f) 91,750
Trade receivables 30,250 (-) 500 (b), (e) & (f) 29,750
Furniture & Fittings 17,500 (+) 500 (c) 18,000
Salaries & Wages 12,250 (-) 500 (c) 11,750
Trade payables 21,250 (+) 5,500 (d) & (f) 26,750
Sales 1,07,200 (-) 500 (f) 1,06,700
5.3 CORRECTION IN THE NEXT ACCOUNTING PERIOD
Rectification of errors discussed so far assumes that it was carried out before the books were
closed for the concerned year. However, sometimes, the rectification is carried out in the next
year, carrying forward the balance in the Suspense Account or even transferring it to the Capital
Account. Suppose, the Purchase Book was cast short by ` 1,000 in December, 2010 and a Suspense
Account was opened with the difference in the trial balance. If the error is rectified next year and
the entry passed is to debit Purchase Account (and credit Suspense Account), it will mean that
the Purchases Account for year 2011 will be ` 1,000 more than the amount relating to year 2011
and thus the profit that year 2011 will be less than the actual for that year. Thus, correction of
errors in this manner will ‘falsify’ the Profit and Loss Account.
To avoid this, correction of all amounts concerning nominal accounts, i.e., expenses and incomes
should be through a special account styled as “Prior Period Items” or “Profits and Loss Adjustment
Account”. The balance in the account should be transferred to the Profits and Loss Account.
However, these Prior Period Items should be charged after deriving net profit of the current year.
‘Prior Period items’ are material income or expenses which arise in the current period as a result
of errors or omissions in the preparation of the financial statements of one or more periods. Prior
Period Items should be separately disclosed in the current statement of profit and loss together with
their nature and amount in a manner that their impact on current profit or loss can be perceived.
Illustration 13
Mr. A closed his books of account on September 30, 2010 in spite of a difference in the trial balance.
The difference was ` 830 the credits being short; it was carried forward in a Suspense Account.
In 2011 following errors were located :
(i) A sale of ` 2,300 to Mr. Lala was posted to the credit of Mrs. Mala.
(ii) The total of the Returns Inward Book for July, 2010 ` 1,240 was not posted in the ledger.
(iii) Freight paid on a machine ` 5,600 was posted to the Freight Account as ` 6,500.

(iv) White carrying forward the total in the Purchases Account to the next page, ` 65,590 was
written instead of ` 56,950.
(v) A sale of machine on credit to Mr. Mehta for ` 9,000 was not entered in the books at all. The
book value of the machine was ` 7,500. The firm has the practice of writing off depreciation
@10% on the balance at the end of the year.
Pass journal entries to rectify the errors. Have you any comments to make?
Solution
Journal of Mr. A
Date Particulars L.F. Dr. Cr.
` `
2011 (i) Mrs. Mala Dr. 2,300
Mr. Lala Dr. 2,300
To Suspense A/c 4,600
(Correction of error by which a sale of ` 2,300
to Mr. Lala was posted to the Credit of Mrs. Mala)
(ii) Profit and Loss Adjustment A/c Dr. 1,240
To Suspense A/c 1,240
(Rectification of omission to post the total of
Returns Inward Book for July, 2010)
(iii) (a) Machinery A/c Dr. 5,600
Suspense A/c Dr. 900
To Profit & Loss Adjustment A/c 6,500
(Correction of error by which freight paid for
a machine ` 5,600 was posted to Freight
Account at ` 6,500 instead of capitalising it)
(b) Profit & Loss Adjustment A/c Dr. 560 560
To Plant and Machinery A/c
(Depreciation @ 10% charged on freight paid
on a machine capitalised)
(iv) Suspense A/c Dr. 8,640
(Correction of wrong carry forward
of total in the purchase Account to
the next page ` 65,590 instead of ` 56,950)
(v) Mr. Mehta Dr. 9,000
To Plant & Machinery A/c 6,750
(Correction of omission of a sale of machine
on credit to Mr. Mehta for ` 9,000 with a
book value of ` 7,500 on which depreciation
@ 10% has been charged in 2010)

Comments
The Suspense Account will now appear as shown below :
Suspense Account
Dr.
`
Date Particulars
Cr.
Amount
`
2011 To Profit and Loss 2010 By Balance b/d 830
Adjustment A/c 900 Oct. 1 By Sundries
To Profit and Loss Mrs. Mala 2,300
Adjustment A/c 8,640 Mr. Lala 2,300
By Profit and Loss
Adjustment A/c 1,240
By balance c/d 2,870
9,540 9,540
Since the Suspense Account still shows a balance, it is obvious that there are still some errors left
in the books.
Profit & Loss Adjustment A/c
(For Prior Period Items)
Dr.
Date
2011
Particulars Amount
`
Date
2011
Particulars
Cr.
Amount
`
To Suspense A/c 1,240 By Machinery A/c 5,600
To Plant and By Suspense A/c 900
Machinery A/c 560 By Suspense A/c 8,640
To Balance c/d 15,590 By Mr. Mehta 2,250
17,390 17,390
Illustration 14
A merchant’s trial balance as on June 30, 2010 did not agree. The difference was put to a Suspense
Account. During the next trading period, the following errors were discovered :
(i) The total of the Purchases Book of one page, ` 4,539 was carried forward to the next page as
` 4,593.
(ii) A sale of ` 573 was entered in the Sales Book as ` 753 and posted to the credit of the customer.
(iii) A return to a creditor, ` 510 was entered in the Returns Inward Book; however, the creditor’s
account was correctly posted.
(iv) Cash received from C. Dass, ` 620 was posted to the debit of G. Dass.

(v) Goods worth ` 840 were despatched to a customer before the close of the year but no invoice
was made out.
(vi) Goods worth ` 1,000 were sent on sale or return basis to a customer and entered in the Sales
Book. At the close of the year, the customer still had the option to return the goods. The sale
price was 25% above cost.
You are required to give journal entries to rectify the errors in a way so as to show the current
year’s profit or loss correctly.
Solution
Journal Entries
`
Cr.
`
(i) Suspense Account Dr. 54
To Profit and Loss Adjustment A/c 54
(Correction of error by which Purchase
Account was over debited last year- ` 4,593
carried forward instead of ` 4,539)
(ii) Profit & Loss Adjustment A/c Dr. 180
Customer’s Account Dr. 1,326
(Correction of the entry by which (a) Sales
A/c was over credited by ` 180 (b)
customer was credited by ` 753 instead of
being debited by ` 573)
(iii) Suspense Account Dr. 1,020
(Correction of error by which Returns
Inward Account was debited by ` 510
instead of Returns Outwards Account being
credited by ` 510)
(iv) Suspense Account Dr. 1,240
To C. Dass 620
To G. Dass 620
(Removal or wrong debit to G. Dass and
giving credit to C. Dass from whom cash
was received).

(v) Customer’s Account Dr. 840
To Profit & Loss Adjustment A/c 840
(Rectification of the error arising from non-
preparation of invoice for goods delivered)
(vi) Profit & Loss Adjustment A/c Dr. 200
Inventory Account Dr. 800
To Customer’s Account 1,000
(The Customer’s A/c credited with ` 1,000
for goods not yet purchased by him; cost of
the goods debited to Inventory and “Profit”
debited to Profit & Loss Adjustment Account)
(vii) Profit & Loss Adjustment A/c Dr. 1,534
To Capital Account 1,534
(Transfer of the Profit & Loss Adjustment A/c
balance to the Capital Account)
Will the students find out the difference in the Trial Balance?1
Illustration 15
Mr. Roy was unable to agree the Trial Balance last year and wrote off the difference to the Profit
and Loss Account of that year. Next Year, he appointed a Chartered Accountant who examined
the old books and found the following mistakes :
(1) Purchase of a scooter was debited to conveyance account ` 3,000.
(2) Purchase account was over-cast by ` 10,000.
(3) A credit purchase of goods from Mr. X for ` 2,000 entered as a sale.
(4) Receipt of cash from Mr. A was posted to the account of Mr. B ` 1,000.
(5) Receipt of cash from Mr. C was posted to the debit of his account, ` 500.
(6) ` 500 due by Mr. Q was omitted to be taken to the trial balance.
(7) Sale of goods to Mr. R for ` 2,000 was omitted to be recorded.
(8) Payment of ` 2,395 for purchase was wrongly posted as ` 2,593.
1
Credit side is short by ` 808

Mr. Roy used 10% depreciation on vehicles. Suggest the necessary rectification entries.
Solution
Journal Entries in the books of Mr. Roy
Date Particulars Dr.
`
Cr.
`
(1) Motor Vehicles Account Dr. 2,700
To Profit and Loss Adjustment A/c 2,700
(Purchase of scooter wrongly debited to
conveyance account now rectified-capitalisation
of ` 2,700, i.e., ` 3,000 less 10% depreciation)
(2) Suspense Account Dr. 10,000
(Purchase Account overcast in the previous
year; error now rectified).
(3) Profit & Loss Adjustment A/c Dr. 4,000
To P’s Account 4,000
(Credit purchase from P ` 2,000, entered
as sales last year; now rectified)
(4) B’s Account Dr. 1,000
To A’s Account 1,000
(Amount received from A wrongly posted to
the account of B; now rectified)
(5) Suspense Account Dr. 1,000
To C’s Account 1,000
(` 500 received from C wrongly debited to
his account; now rectified)
(6) Trade receivables (Q) Dr. 500
(` 500 due by Q not taken into trial
balance; now rectified)
(7) R’s Account Dr. 2,000
(Sales to R omitted last year; now adjusted)
(8) Suspense Account Dr. 198
To Profit & Loss Adjustment A/c 198
(Excess posting to purchase account last
year, ` 2,593, instead of ` 2,395, now adjusted)
(9) Profit & Loss Adjustment A/c Dr. 10,898
To Roy’s Capital Account 10,898
(Balance of Profit & Loss Adjustment A/c
transferred to Capital Account)
(10) Roy’s Capital Account Dr. 10,698
(Balance of Suspense Account transferred
to the Capital Account)
Note : Entries No. (2) and (8) may even be omitted; but this is not advocated, Entry (6) will not
be posted in Q’s Account.

Profit and Loss Adjustment Account
(Prior Period Items)
` `
To P 4,000 By Motor Vehicles A/c 2,700
To Roy’s Capital (transfer) 10,898 By Suspense A/c 10,000
By R 2,000
By Suspense Account 198
14,898 14,898
Suspense Account
` `
To Profit & Loss Adjustment By Trade Receivables (Q) 500
Account 10,000 By Roy’s Capital Account 10,698
To C 1,000 (Transfer)
To Profit & Loss Adjustment
Account 198
11,198 11,198
I. Pick up the correct answer from the given choices:
1. (i) Goods purchased from A for ` 10,000 passed through the sales book. The error will
result in
(a) Increase in gross profit. (b) Decrease in gross profit.
(c) No effect on gross profit. (d) Either (a) or (b).
(ii) If a purchase return of ` 1,000 has been wrongly posted to the debit of the sales returns
account, but has been correctly entered in the suppliers’ account, the total of the
(a) Trial balance would show the debit side to be ` 1,000 more than the credit
(b) Trial balance would show the credit side to be ` 1,000 more than the debit.
(c) The debit side of the trial balance will be ` 2,000 more than the credit side.
(d) The credit side of the trial balance will be ` 2,000 more than the debit side.
(iii) If the amount is posted in the wrong account or it is written on the wrong side of the
account, it is called
(a) Error of omission. (b) Error of commission.
(c) Error of principle. (d) Compensating error.
[Ans 1 : (i)-(a), (ii)-(c), (iii)-(b)]

2. Choose the most appropriate option from the given choices:
(i) ` 200 paid as wages for erecting a machine should be debited to
(a) Repair account. (b) Machine account.
(c) Capital account. (d) Furniture account
(ii) On purchase of old furniture, the amount of ` 1,000 spent on its repair should be debited
to
(a) Repair account; (b) Furniture account;
(c) Cash account; (d) Bank account
(iii) Goods worth ` 50 given as charity should be credited to
(a) Charity account; (b) Sales account;
(c) Purchase account. (d) Cash account
(iv) Goods worth ` 100 taken by proprietor for domestic use should be credited to
(a) Sales account; (b) Proprietor’s personal expenses;
(c) Purchases account (d) Expenses account.
(v) Errors of commission do not permit;
(a) Correct totalling of the balance sheet; (b) Correct totalling of the trial balance;
(c) The trial balance to agree. (d) None of the above.
(vi) The preparation of a trial balance is for:
(a) Locating errors of commission; (b) Locating errors of principle;
(c) Locating clerical errors. (d) All of the above
(vii) ` 200 received from Smith whose account, was written off as a bad debt should be
credited to :
(a) Bad Debts Recovered account; (b) Smith’s account;
(c) Cash account. (d) Bad debts account
(viii) Purchase of office furniture ` 1,200 has been debited to General Expense Account. It
is :
(a) A clerical error; (b) An error of principle;
(c) An error of omission. (d) Compensating error.

(ix) Sales of office furniture should be credited to
(a) Sales Account; (b) Furniture Account.
(c) Purchase Account. (d) Cash Account
[Ans: 2 : (i) (b); (ii) (b); (iii) (c); (iv) (c); (v) (c); (vi) (c); (vii) (a); (viii) (b); (ix) (b)]
II. From the given information, choose the most appropriate answer.
1. Classify the following errors under (a) Errors of omission, (b) Errors of commission and
(c) Errors of principle, (d) Compensating errors
(i) The total of sales book was not posted to the ledger.
(ii) Sales to Heena ` 143 was posted to Meena as ` 143.
(iii) Goods taken away by the proprietor for personal use not recorded anywhere.
(iv) The total of a folio in the sales book ` 1,000 was carried forward as ` 100.
(v) Repairs of newly purchased second-hand machinery debited to repairs accounts.
[Ans: 1: (i)-(a), (ii)-(b), (iii)-(a), (iv)-(b), (v)-(c)]
2. Point out the type of the errors given below: (put 1 against errors of omission, 2 against errors
of commission, 3 against errors principle, 4 if it is not an error).
(a) Sale of ` 120 was written in the purchases book.
(b) Salary paid to Ram, has been debited to his account.
(c) Purchase of furniture has been entered in the purchases book.
(d) ` 120 received from Ganesh has been debited to his account.
(e) Freight paid on machinery has been debited to the freight account.
(f) The discount columns of the cash book have not been posted.
(g) Repairs to buildings have been debited to the buildings account.
(h) The total of the Sales Book is ` 100 short.
(i) The sale of worth ` 337 has been posted as ` 373.
(j) The amount of a dishonoured bill has been debited to general expenses account.
[Ans : 2 : - 1 : (f); 2 : (a) (d) (h) (i); 3 : (b) (c) (e) (g) (j)]

III. Given below are the questions containing multiple answers. Choose the correct answer(s).
1. Which of the following errors will not be revealed by the Trial Balance:
(a) Compensating errors; (b) Errors of principle;
(c) Wrong balancing of an account; (d) Wrong totalling of an account;
[Ans : 1 : (a) and (b) will not be revealed]
2. Which of the following errors will be revealed by the Trial Balance:
(a) Compensating errors; (b) Errors of principle;
(c) Wrong balancing of an account; (d) Wrong totalling of an account;
[Ans : (c) and (d) will be revealed]

NOTES

Chapter 2-accounting-process-part-2

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