Steps of Bookkeeping Process Part-2

Welcome Friends, you are welcome to learnvern. I am Anshu Sachan.

In the last session we saw the steps of the bookkeeping process. In today’s session we will talk about what will happen once we have opened the ledger. The ledger has been made now what? What we will do is, during the year, whatever transaction that will be happening. We will be posting them, ledger wise. By following the same system. Any transaction happened. Identify, in that transaction what types of account types are there, either that is nominal, or real, or personal. According to that, decide the accounting rule. Whichever ledgers are being affected. Show that effect in that particular ledger. If I give you a quick recap then, What happens in a ledger is, there is a debit side, and there is a credit side. I had also shown an entry, Purchase account debit, to trade creditors. Right?

If we are making the Purchase ledger. So in that debit side we will write the date, and in the narration we will write, the name of the creditor, and amount. We call this whole process ledger posting. Okay. During the year whichever transaction keeps on happening, we will be posting it properly in an appropriate ledger. And on the date when the reporting period is ending, Means end of the reporting date. Right? As we have decided we want to keep March to April as a reporting period. The first of April 2021, to 31st March 2022. So on the 31st March 2022, On that day what we will do is, we will close every ledger. What does closing ledger mean? As I told you there is a purchase ledger. So there would be debit entries as well as credit entries. Debit entry would be our purchase, and credit entries would be the return of a purchase or any discount. Whatever transition occurs during the years we will be posting all the entries in that ledger. Then at the end of the date, that is called the year end date. The year end date, that is 31st of March. We will be closing all the ledgers, then totalling all the debit and credit, to calculate the closing balance. Understood?

For instance the total balance of the debit is 15000 and for the credit it is 5000. So, the Debit balance means the balance, that is 10000. In this manner we will be writing the closing balance of all the ledgers. Like for the purchase account, the closing balance is 10000 rupees. Cash balance that is 5000 rupees. Purchase return that is 4000 in minus, right? In the similar manner sales ledger, sales return, debtors, creditors. So whichever ledger you have opened you need to close that ledger. Then you need to write whatever the balance is there. Then a summary will be made, and what will this summary be called? It will be called the trial balance. Okay. What is it called? Trial Balance.

Now if we come to the definition of the trial balance, then, It is the summary of the closing balance of all the Ledgers. Meaning whichever ledgers we have created, whether it is debit or credit. A summary would be made and that summary will be known as trial balance. So whenever you are making a trial balance the title would be “Trial balance of ABC Pvt. Ltd.” Meaning, whatever the name of your business, as on 31st March 2020. Meaning for the date of 31st March 2020, this is an “As on date”, it is the balance for that particular date. Because we have closed the ledger. On which date we have closed the ledger? On 31st March 2020. So whatever summary is made or trial balance is made will be made on “as on date”. Guys look, whatever the title is here it is very important. What will be the trial balance, there will be an as on date.

Suppose if someone is saying, I want the trial balance for 31st May 2020. What does he want to say? He wants to say that he wants the trial balance of 31st May 2020, The last year you closed the balance, Suppose you closed it in March . So he is trying to say, As he only said till May, So he needs the trial balance of two months. That is April and May. Whenever we say “as on date”. Suppose we say as on December, so the data is required from the closing of the last year till December. Similarly for as on January, as on February. It is known as quimility, from the last day of closing to the as on date. Like we just saw, as on 31st March 2022, means, In the last year we closed the account on 31st March 2021. So, 31st March 2022 means, from 1st of April 2021 till 31st March 2022. We need the summary or the trial balance from this period. So in the title we need to focus on, “ as on date”. That will be a cumulative effect.

As on doesn't mean till 31st March, it does not contain just the transaction of March. It's not like that. If it is written, trial balance as on 31st December 2020. Meaning, it is from January to December, and not just of the December. Do remember this, it is based on cumulative basis. It is from the last closing time to the current mention of the trial balance. Okay?

Then what happens with the trial balance further is, there is a process, we make two statements out of it, the first one is a profit and loss account and the second one is a balance sheet. First we will be focusing on Profit and loss account. We know that the certain transactions or the certain ledgers are revenue type Ledger. For instance purchase or sales. You know the profit and loss item. What are the profit and loss account items? It is for the particular year, like the purchase and the sales, electricity expense, or clearing expense, or closing stock, opening stock, material purchase, office expense. What are all these, for the end of the year. So from there, the revenue income or revenue expense will be shown in the profit and loss account. And the assets and liabilities will be shown in the balance sheet. Okay?

Look, in the trial balance the closing balance of every ledger will be shown. Either that ledger is falling in the balance sheet or profit and loss account, it does not matter, in the trial balance everything will be there. The thing that comes after the trial balance is, profit and loss account and balance sheet. Now how do we make it? The trial balance that you have, contains the summary of all the closing balances. We will pick things out, such as which will go in the profit and loss account and which will go in the balance sheet. Remember, before doing that, the total of the trial balance, that is the debit and the credit of every ledger. It should match. Do you understand what I am trying to say? The debit and credit should be matching. If in your trial balance, the debit and credit are not matching then there is a mistake there. Means in some ledger you had not given the proper effect. Either you have not written the debit properly or the credit properly. Understanding me? The trial balance should always match. It is a cross check, it is sort of a checkpoint. So if you have closed all the ledgers properly then only in your trial balance, the total of credit and debit matches, otherwise it would not.

Now comes the question as, what are the instances when the trial balance should match. and if the trial balance matches does that mean that the account is correct. No! It is not correct all the time. If the trial balance matches that means the account is correct mathematically. What I'm trying to say is that, when the trial balance matches, that does not mean that in your account, whatever you have written is correct. That only means that mathematically your account is right. Whatever needed to be added, it was added and whatever needed to be subtracted, is subtracted. It is not like the trial balance is right then everything is right. Getting me? Now in which situations would it be like the balance matches but the accounts are incorrect? Suppose you forgot to write the balance of two ledgers. And just by chance, the amount on the debit and credit was the same. It is called compensating error. The errors are being compensated. Understood? If we omit something, like stock omit. The opening stock and the closing stock were omitted by you, the amount was the same and it got omitted by you. So, what will happen is, in the trial balance, your debit and credit would match, but the opening stock and closing stock would not be there in your trial balance. So always keep in mind, if your trial balance is matching then it does not mean that your account is right. Still, we can say that your account is mathematically correct. So before making the profit and loss account and balance sheet do look at your trial balance carefully. To check if all the ledgers are closed properly and for the debit balance have I written debit and for the credit balance have I written credit or not. Sometimes people make mistakes during the making of the trial balance. Okay. Debit balance on the debit side and the credit balance on the credit side. Remember it.

Now the trial balance is done and we will progress towards a profit and loss account. we will see how to make a profit and loss account. So what we will do is we will pick items from the trial balance. We will pick the ledgers, that will go in the profit and loss account, and which one will go into the balance sheet. The title for the profit and loss would be, “Profit and Loss for the Year”, the title for the trial balance was, “Trial Balance as on 31 March”. Okay? Till the 31st March. If I am saying Profit and Loss then it’s title will be, “Profit and Loss Account for ABC Pvt. Ltd.” Meaning the name of the business, “For the year ending on 31 March, 2022”. Meaning it is for the ending of the year 31st March, 2022. Okay?

This title has a lot of importance, as whoever reads this title, sees the profit and loss account then, how would the person know for which year this is made for? From the title. This is the reason that the title is extremely important. So please whenever you are writing the title then, write it very carefully. “As on date” will be used for the trial balance and “For the year” will be used for the profit and loss account. So when we look at the profit and loss account statement, Whatever expense that you have will be on the debit side and whatever income that you have will be on the credit side. Okay. Then the net balance, either the debit will be more or the credit will be more. Then the net result would be net profit or net loss. Okay. If the Debit balance is more, that means you have higher expenses. Then there would be net loss, and if the credit balance is more, that means you have more income then, there will be net profit. Understood.

The final output of this profit and loss account, after it closes would be, either Net Profit, when the credit items would be more than the debit items. Then there would be your net income or you can also say net income. Then after that, if the debit balance is more, and the credit balance is less then what will happen is, net loss. Means your expenses are more than your income. Then there would be a net loss. So, what would we know from the profit and loss account? For the year, of which I am making a profit and loss account. What kind of performance it has. Understanding me? Am I in profit or loss? How would I know? From the profit and loss account. Understood?

This profit and loss account, or you can also call it a profit and loss statement. Look, in theoretical life, what happens is, a trading account will be made and then the profit and loss account is made and then there is Profit and Loss Appropriation Account. But all of these are theoretical concepts. In a trading account, you might have been taught, as materials, goods and whatever items are there for the COGS, or whatever item is there for the Gross Profit. You need to make all of that in the Trading Account, then the gross profit or gross from there would be taken to the Profit and Loss Account. But when you come into practical life. Then there are only three things that are made. Profit and Loss account and Balance Sheet. There are no concepts of the Trading Account. Trading account is a theoretical concept. Okay.

Now, Profit and Loss accounts for the year have been made. The net profit or the net loss figure have been added. Again, the balance should be matching, the balance would be matched as this is a profit and loss account.

12/33

Once this P and L is made, this would go in the balance sheet. What will we write in the balance sheet? We will write profit for the year. Your previous profit is called retained earnings. In that we will add the profit for the year, and if it is a loss then we will subtract it, as loss for the year. Now, we will come to a balance sheet. As we have made the trial balance. Okay. Then from the trial balance we made the profit and loss account. Right? From the trial balance whichever ledgers were falling in the profit and loss account, we kept them in the profit and loss account. Then the remaining ledgers that were left, that were the balance sheet items. What kinds of things are they? These ledgers are not for the whole year. Those get carried forward.

Like trade debtors. What are trade debtors? The people who I sell the product to.Those will be continuous, its not like I sold them my product for 1 year and then stopped selling. I will continuously keep on selling the products. My customers will keep on changing. But my trade debtors are my main thing, I will not stop giving my product in credit. Right. So, my trade debtors will keep on functioning.

Now, my trade debtors are the balance that I will be carrying forward for the next year. It will go in the balance sheet item. Okay. Similarly, there are fixed assets, it's not like I have bought a vehicle for my business today and I will sell it tomorrow. So, this asset will be carried forward. So, air conditioning, refrigerators, these are the components of the balance sheet, these are fixed assets, current assets, and your stock.

Then if we look at the liability side, there are capital accounts and your loans. All of these things are not for the year, they are not just for one year. They are for more than 1 year. Hence, it will go in the balance sheet. Therefore what happens is, balance in the ledger is carried forward. Understood?

So the ledgers that will be created will have, opening balance and movement for the year, or the transaction during the year would be there. Then at last there would be closing balance. Okay. The closing balance for debit or credit would be decided based on, if the balance is asset or liability. Okay. Ultimately, your balance sheet should match. Getting me?

Look, if the trial balance is made correctly, then the profit and loss account and the balance sheet would automatically match. Clear? Now, what if I make the profit and loss from the trial balance only, would it be right? No. Sometimes there are adjustments there. Like, during the year, I have not provided the depreciation. Meaning, the fixed assets that I have used, I have not provided the depreciation during the year. That is called year end journals, Meaning, in the year end, or you closed something for the year end. Then at that time you pass a journal adjustment. So, depreciation is a part of it, in which the adjustment is passed. Okay.

Trial Balance and Adjustments, that is, your profit and loss account. Then the balance sheet would be properly made. Okay. Now, if we see this in a pictorial view. You might have clearly understood this, and if you want a quick recap, then you can see this flowchart of the bookkeeping process.

The first one is recording, then there is ledger preparation, then there is posting and after that there is, closing ledger, trial balance, profit and loss account and then balance sheet at last. So we have seen the complete process from the recording till the balance sheet. Identifying it, transacting it, posting it, then recording it, closing it, and making a trial balance and then making a profit and loss account and then balance sheet. You only need to remember one more thing. What happens with the balance sheet is, it is “as on date”. Just like the trial balance, which has “as on date”, the balance sheet also has “as on date”. Like, 31st March 2022. So this is showing the balance sheet for the year of 2022.

Similarly, from the profit and loss account, what would I be able to know? I can understand the performance. As for this year, from 2021 to 2022, how was the performance, was there a loss or profit. Which one was it. Similarly, the balance sheet would be telling you, on that particular day, on 31 March 2022, what is the position of your business. Are your assets more or your liabilities. Okay.

So, a balance sheet would help you check the position of the business, that too for a particular date. As on date 31 March 2022. What does the profit and loss show? It shows the performance for that particular year.

Therefore, for performance, profit and loss account and for position, balance sheet. Okay.

If you have any queries or comments……

In the next topic we will be learning about, importance of bookkeeping, as what are the benefits of things ranging from recording to balance sheet.

Until then, Thank You.