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Step 1: Journal Entry

The accounting process begins with recording entries in a journal – which is a record of transactions sequentially (date-wise basis), as they occur.

A page of a journal is known as a journal folio. This is how a journal folio looks:



Description of Transaction

Ledger Folio






Purchases A/c

 To Mr. Swamy A/C(Being goods purchased on credit from Mr. Swamy)







The table above represents a journal entry for a purchase from Mr. Swamy of INR 10,000 on credit basis, made on April 29.

Based on the journal entries, a ledger (see below) of various accounts is maintained which helps in preparing the various financial statements at the end of the financial year, for example, income and expenditure statement, profit and loss account, trial balance and balance sheets.

Step 2: Ledger

After recording in the journal, entries are made in another book known as a ‘ledger’ (the process is technically called ‘posting’), which shows the transactions on the basis of the each account-head. A ledger is like a record book where different heads of accounts are opened and debit and/or credit entries under each account head are posted. This helps in giving a birds-eye view of the various account heads compiled at one place. The debit entries are recorded using “To” and credit entries are recorded using “By”.

Note that accounting softwares like Tally can automatically generate a ledger account (and even final accounts) once you make correct journal entries.

Consider that X is a supplier to business Y, which regularly purchases goods on credit (say, of 45 days).  The ledger account (in the books of Y) will show all the transactions which X had with the business. The transactions will indicate the days on which it purchased goods (and amount of goods), and the days on which it made the payment. At the end of the account, you will be able to see the balance that it is to pay the supplier, after netting off all the transactions.


For example, if goods worth INR 10,000 and INR 12,000 have been purchased from Mr. Swamy on April 29 and June 1, and he has been paid INR 8,000 on May 10, his ledger account in the books of the business will appear as follows:

                                                   Ledger of the business

                                                        Swamy A/C

Dr.(Debit)                                                                                                                                 Cr.(Credit)


Name of Account

Journal Folio



Name of Account

Journal folio



To Cash




By Purchases








By Purchases












The amount of INR 14,000 is the balance amount that is due from him.

Step 3: Trial Balance

Trial balance is a statement of ledger balances under each account head. It may be prepared at the end of the month to reconcile the cash at bank and cash in hand and the amount owed to creditors and due from debtors. It is generally prepared at the end of the financial year (before preparation of the balance sheet) to total and if all the debit and credit balances add up to the same figure. If they do not, there could have been a book-keeping error which needs to be checked. Thus, a trial balance helps in reconciling the accounts and to rectify any mistake in recording accounting entries. It is prepared to check the accuracy of accounting and has a fixed format of its own.

The most common format of a trial balance is as below:



Note: This column will contain names of all the accounts in the ledger

Ledger Folio

Debit Amount

Credit Amount

Goods A/c




Salaries A/c




Mr. Agarwal A/c









Note on the Bank Reconciliation Statement

Every month, the bank where an account in maintained, either personal or business, provides a bank statement recording each and every transaction that took place using the bank account. Ideally, the balance in the bank account as per the statement provided by the bank must be identical to the balance in the ledger account of the business (or in the bank column of the cash book).  However, that is not typically the case - the balance in the bank as per the ledger (or the bank column of the cash book), and the actual balance as per the bank statement often vary. Therefore, the Bank Reconciliation Statement is prepared in respect of the business to match the balance in the bank account (as maintained in the ledger) of the business with the balance as per the bank statement. The purpose is to detect any discrepancy between the records kept by the bank and in your ledger account.

Some of the reasons for the discrepancy in the balances of the accounts are as follows:

  • The bank may have received interest which was not recorded in the ledger
  • The bank may have deducted money towards interest, or overdraft, or for commission (for collecting cheques), any incidental charges, etc. which have not been entered in the ledger book
  • If cheques that were issued by the business were not credited by the receiver. This can be best explained through an example. As per the accrual system of accounting, if the business must pay its suppliers Rs. 1000 on Day X and issues a cheque (of Rs. 1000) on that day, its bank balance as per its books of account will be reduced by Rs. 1000. However, if the receiver does not go to the bank to credit the cheque into his account till the date of preparation of the bank statement, the bank account of the entity will show an extra Rs. 1000, as compared to its ledger/ cash book.
  • Similarly, if cheques/ drafts that were deposited with the bank have not been realised by the date of preparation of the bank statement.



Step 4: Preparation of final accounts, i.e. the financial statements

a. Profit & Loss Statement

An annual profit and loss statement shows annual sales income out of which annual costs and other expenses are deducted to arrive at the net profit (or loss) a company has incurred.  profit and loss sheet will usually look something like this:



Rs 50,000

Less discounts and allowances


Net income


Less direct costs (cost of sales)


Gross profit


Less indirect costs (fixed overheads)


Operating profit


Plus other income


Less other expenses


Profit before tax


Less tax


Net profit (or net loss)


b. Balance Sheet


A balance sheet provides a summary of the company’s assets and liabilities, the value of its business and its ability to pay back what it owes. The important thing to remember is that the total assets and total liabilities (including shareholders equity and the profit or loss from the previous year) must always balance, hence the term balance sheet.

Specimen of a Balance Sheet

Balance Sheet as at December 31, 1997






Loans Payable




Contributed Capital




Retained Earnings




Total Liabilities and Owner’s Equity


Total Assets



c. Statement of Cash Flows

Cash flow statements only track the payments and receipts of cash. It consists of receipts such as revenue from sales, capital influx; outgoings such as cost of raw materials, salaries and wages, interest payments, etc.; and the balance at the end of the month.

It enables a business to analyse when cash is expected to be received and payment to be made so that cash requirements can be ascertained.  A shortage of cash indicates the business may suffer from a liquidity crunch – that is, it may not be able to meet its immediate liabilities on time (such as payments to suppliers, employees, etc.). An excess of cash (which is beyond what the business ordinarily needs to meet short term liabilities and expenses) indicates that the business managers should consider increasing investments (for instance, in inventory, technology upgrade or financial instruments).

d. Statement of Retained Earnings

The Statement of Retained Earnings is also called as Profit and Loss Appropriation Account. One purpose of this statement is to connect the Profit & Loss Account and the Balance Sheet. The statement of retained earnings explains the changes in retained earnings between the current and the previous date of preparation of balance sheet. These changes usually arise due to addition of net income of the current year and the deduction of dividend.


Assume that a company makes a profit of Rs. 1 lakh in the financial year 2009-2010, and that it pays 60,000 as dividend. Next year (i.e. financial year 2010-2011), it makes a profit of Rs. 75,000 and pays 20,000 as dividend.
Its retained earnings for financial year 2009-2010 will be Profits – Dividend, i.e. Rs. 100,000 – Rs. 60,000 = Rs. 40,000.
Its Statement of Retained Earnings (explaining the difference in the retained earnings) for the year 2010-2011 will indicate the retained earnings as:
Past year’s retained earning + Present year’s Income – Present year’s dividend
i.e. Rs. 40,000 + Rs. 75,000 – Rs. 20,000 = Rs. 95,000


e. Notes to Accounts

Notes to Accounts (Notes) are contained in a separate heading at the end of financial statements. They contain additional information to explain in detail certain specific items in the financial statements as necessary and to provide a more comprehensive assessment of a company's financial condition.

Notes can include information on debt, guarantees issued by the business, going concern criteria, accounts, contingent liabilities or contextual information explaining the financial numbers. Notes can also include details of fixed assets of the company, inventory, sundry debtors, etc.

Assume that X Ltd. takes a loan of Rs. 1 lakh from a bank. Now, assume that Y Ltd., a company which is owned by the same set of promoters as X Ltd., is required to provide a guarantee for the loan if X Ltd. fails to repay. In this case, the balance sheet of Y Ltd. will not record the loan transaction as a liability, because the loan has been taken by X Ltd. and not by Y Ltd. Y will be liable to pay Rs. 1 lakh only if X Ltd. fails to repay. Thus, the liability of Y Ltd. is actually contingent upon X’s failure to pay. Invocation of the guarantee will have a financial impact on Y Ltd. This is one kind of information that is disclosed in the Notes to Accounts.


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