After studying this chapter, you will be able to understand
Concept of Accounting Process — Important Stages
Meaning of Business Transaction and Its Classification
Meaning of Account and Its Classification
Classification of Accounts — Identification of Category
Meaning of Double Entry
Methods of Recording Business Transactions
Traditional Approach for Recording Business Transaction and Debit-Credit Rules for Three Types of Accounts
Meaning and Format of Journal
Meaning of Journalising
To Analyse Business Transactions
To Record the Result of Analysis in Journal
Types of Entries
Source Documents — Format and Uses
Trade Discount and Cash Discount — Features and Method of Recording in Journal
Meaning of Purchase Returns and Sales Returns and Methods of Recording them in Journal
Accounting Equation Approach — Meaning and Classification of Accounts as per this Approach
Rules for Debit and Credit when Accounts are Classified on Accounting Equation Approach
Analyse Business Transactions Applying Accounting Equation Technique
Accounting process is a long journey — starts with recording of business transactions and ends with preparation of final accounts. The important milestones in the journey are
Recording of business transactions (in source documents, journal paper or subsidiary books)
Transferring these transactions from General Journal (or special subsidiary books) and posting to Ledger
Preparing Trial Balance from these ledger accounts
Preparing Profit and Loss Accounts (after proper adjustments)
Preparing final accounts (financial statements)
Let us discuss the above accounting process in stages.
Transaction between two or more persons (including natural, artificial or juridical) resulting in the exchange of money and goods or services for money, may be referred to as business transaction.
Every business transaction has a two-fold fact and that it affects the parties involved — one party extends the benefit whereas the other party receives the benefit in terms of money or money’s worth. It should be noted here that these can be measured objectively in the accounting process.
Accounting process starts with identifying the business transactions to be recorded in the books of accounts. For easy identification, the business transactions are classified into three categories:
Cash Transactions: Cash/money is involved in exchange.
Example: Purchase/sale of any goods for cash, payment of any expense, receipt of any income by cash.
Credit Transactions: Cash/money is not involved on the date of transaction. Receipt or payment is postponed to a future date or promised to pay later.
Example: Any purchase/sale of goods on credit.
Non-cash Transactions: Cash/money is not involved either on the date of transaction or on a future date (credit) in these transactions. Money/cash is NEVER involved either as receipt or payment.
Example: Depreciation, loss due to natural calamities.
The classification of business transactions may be represented diagrammatically as:
External Transactions: These transactions occur between business entity and any other third party.
Example: Purchase/sale of goods to customers, salary paid to employees, interest received from bank, dividend received from limited companies. These may be called as external transactions.
Internal Transactions: These transactions occur within the business entity and no other party is involved.
Example: Depreciation, obsolescence, loss due to natural calamities, provision for doubtful debts and so on.
Every business transaction has two aspects and each aspect has an account. An account is “a summary of relevant business transactions at one place relating to a particular head.” It is a summarised record of business transactions relating to
Accounts are classified into personal, real and nominal, accordingly. The classification of accounts may be illustrated as follows:
Business transactions that occur between a business entity and other persons are “personal accounts.” These personal accounts may further be classified into:
Example: Raj’s Account, Vasu’s Account and so on.
Example: Salary, Creditors, Debtors. This is classified under this category because it represents a group of same category involved. The following are also included in this classification — Outstanding Expenses, Expenses Paid in Advance, Accrued Income, Income Received in Advance and so on.
These accounts would not affect persons (natural or artificial) but affect the business concerns. These accounts are re-classified into two broad categories:
Example: Accounts of land, building, stock and so on.
Example: Goodwill, trade marks, copyrights.
Example: Salary Account, Dividend Account.
In addition to the above classification of accounts, now a new category — Valuation Accounts — is adopted in accounting procedure. These accounts are shown in the opposite side of the respective main account and as such they are called as CONTRA ACCOUNTS.
Example
But some accounts are classified as Nominal Account, based on the characteristic features of transaction, may be treated as Personal Accounts. They are:
|
1. Rent A/c is Nominal A/c |
→ |
Outstanding Rent is Personal A/c |
|
2. Salary A/c is Wages A/c is Nominal A/c |
→ |
Outstanding Salary is Personal A/c |
|
3. Interest A/c is Nominal A/c |
→ |
Outstanding Interest is Personal A/c |
|
4. Discount A/c is Nominal A/c |
→ |
Discount Received in Advance is Personal A/c |
|
5. Commission A/c is Nominal A/c |
→ |
Commission Received in Advance is Personal A/c |
|
6. Subscription A/c is Nominal A/c |
→ |
Accrued Subscriptions is Personal A/c |
|
7. Insurance Premium is Nominal A/c |
→ |
Prepaid Insurance is Personal A/c |
Illustration: 1
Classify the following accounts:
Solution
What is an “Entry”? Recording of business transactions in an account is called an entry.
In any business transaction two parties are involved. One party gives some value while the other party receives the same in exchange for an equivalent value.
Example: Mr. Khan purchases a laptop from Modern Computers for Rs 40,000. In this transaction, Mr. Khan gives cash (Rs 40,000) and receives a laptop in exchange. From the other angle, it may be said that Modern Computers gives laptop and receives cash in exchange. There is a reciprocal exchange of value between the two parties. This can be illustrated:
|
(Modern Computers) |
→ |
(Mr. Khan) (Cash Rs 40,000) |
|
↓ |
← |
↓ |
|
Party I |
|
Party II |
|
Giving |
|
Receiving |
From Party I (laptop) to Party II (Cash Rs 40,000)
From Party II (Cash Rs 40,000) to Party I (laptop)
This principle applies to transactions on Credit basis also. Every business transaction results in two aspects:
These two-fold aspects (receiving and giving) are to be recorded for transactions simultaneously.
The system, which recognises this TWO-FOLD ASPECT for each and every business transaction is known as Double Entry System.
Each business transaction reveals two aspects. One aspect is “receiving aspect” or “incoming aspect” or “expense/loss aspect.” This is referred to as “Debit aspect.”
The other aspect is “giving aspect” or “outgoing aspect” or “income/gain/profit.” This is referred to as “Credit aspect.”
These two aspects viz., “DEBIT ASPECT” and “CREDIT ASPECT” form the basis of DOUBLE ENTRY SYSTEM.
Debit means to enter an amount of transaction on the left side of an account and Credit means to enter an amount of transaction on the right side of an account. In the abbreviated form Debit is written as Dr. and Credit is written as Cr.
There are two approaches for recording a transaction:
This approach is also known as the British Approach. Recording under this method is formed on the basis of the existence of two aspects namely debit and credit in each of the transaction. This method is also called as Double Entry System.
This approach is also called as the American approach. Under this method, transactions are recorded on the basis of the following accounting equation.
This approach is discussed later, in this chapter.
All the accounts are classified as:
Debit—Credit rules for three types of accounts are:
Type of Account | Debit | Credit |
---|---|---|
1. Personal Accounts |
THE RECEIVER |
THE GIVER |
2. Real Accounts |
WHAT COME IN |
WHAT GOES OUT |
3. Nominal Accounts |
ALL EXPENSES and LOSSES |
ALL INCOMES, GAINS and PROFITS |
Illustration: 2
Classify the following accounts stating which item has to be debited and which aspect to be credited:
Solution
Rule: Debit: The Receiver
Credit: The Giver
Rule: Debit: What comes in
Credit: What goes out
Rule: Debit: All expenses and losses
Credit: All gains and profits
(Here Purchases A/c is taken and “Goods” ignored)
Rule: Debit: All expenses and losses
Credit: All gains and profits
Rule: Debit: What comes in
Credit: What goes out
Rule: Debit: All expenses and losses
Credit: All gains and profits
Like this, classify the account and apply the rules for Debit and Credit. The remaining items, that is, from Item No. 7 to Item No. 20 are presented in the summarised form as below:
Item Nos. | Type of A/c | Debit and Credit Aspects |
---|---|---|
7, 8, 9, 10, 11, 12, 17 |
Nominal A/c |
Debit: All expenses and losses |
|
|
Credit: All income and profit |
13, 14, 15 |
Real A/c |
Debit: What comes in |
|
|
Credit: What goes out |
16, 18, 19, 20 |
Personal A/c |
Debit: The Receiver |
|
|
Credit: The Giver |
A Journal is a book in which transactions are originally recorded in the chronological order, i.e. in the order in which they are occurred, according to the principles of Double Entry System.
A Journal is also called a Book of Original Entry or Prime Entry.
The books in which a transaction is recorded for the first time from a source document are called the Books of Original Entry or Prime Entry.
A Journal is a data-wise record of all transactions with details of the account debited and credited and the amount of each transaction.
Journal
The process of analysing the business transactions under the heads of debit and credit and recording them in the book of Journal is called “Journalising.”
The steps to be followed in journalising business transactions are as follows. For easy understanding, the process can be carried on in two stages:
Stage I: |
Analysis of transaction |
Stage II: |
Recording them (result of analysis) in Journal |
The steps to be followed in the analysis of transactions are:
Step 1: |
Determine the two accounts which are involved in the transaction. |
Step 2: |
Classify the above two accounts under Personal, Real or Nominal. |
Step 3: |
Find out the rules of debit and credit for the above two accounts. |
Step 4: |
Identify which account is to be debited and which account is to be credited. |
After this, draw the format of Journal
Step 5: |
Record the date of transaction in the “Date Column.” |
Step 6: |
Enter the name of the account to be debited in the “Particulars Column” very close to the left hand side (the line which separates the “Date Column” and “Particulars Column”) along with the abbreviation “Dr.” in the same line. Amount to be debited is written in the “Debit Amount Column” in the same line. |
Step 7: |
Write the name of the account to be credited in the next line preceded by the word “To,” a little space away from the line in the “Particulars Column.” Write amount to be credited in the “Credit Amount Column” in that same line. |
Step 8: |
Write the “narration” (a brief description of the transaction) within brackets in the next line in the “Particulars Column.” |
Step 9: |
Draw a line across the entire “Particulars Column” to separate one journal entry from the other. |
Illustration: 3
On June 15, 2009, Vasanth started business with Rs 5,00,000. Analyse this transaction and pass Journal Entry.
Solution
Stage I: Analysis of Transactions
Stage II: Now draw the format of Journal
Step 5: |
Enter the date. |
Step 6: |
Write the name of the account to be debited with “Dr.” at the end and Rs 5,00,000 in the Debit Column. |
Step 7: |
Write the name of the account to be credited starting with the word “To” leaving space and Rs 5,00,000 in the Credit Column. |
Step 8: |
Write narration (brief description of transaction). |
Step 9: |
Draw a line across the entire Particulars Column. |
Note: L.F. Column is not to be recorded at the time of journalising.
Illustration: 4
Bought goods for cash Rs 1,00,000 on March 15, 2009.
Solution
Step 1: |
Determine the two accounts involved in the transactions. |
Step 2: |
Classify the accounts. |
Step 3: |
Find out the rules of Debit and Credit. |
Step 4: |
Write down the account to be debited and credited. |
Step 5: |
Draw the format of Journal and enter the date in “Date Column.” |
Step 6: |
Enter the name of the account — Purchases A/c to be debited in the “Particulars Column” followed by the word “Dr.” in the same line. Against this, the amount to be debited Rs 1,00,000 is written in the “Debit Column.” |
Step 7: |
Enter the name of the account to be credited in the next line starting with the word “To,” that is, To Cash A/c in the Particulars Column. Against this, the amount to be credited Rs 1,00,000 is written in the “Credit Column” in the same line. |
Step 8: |
Write the narration within brackets. |
Step 9: |
Draw a line across the entire “Particulars Column.” |
Journal
The procedure for journalising business transactions have been explained in detail in the preceding illustration.
Now, in order to make the readers to understand effectively the concepts of “Double Entry,” how to analyse the transactions (i.e., analysing the transactions, four steps involved in Stage I) will be dealt with by way of a number of examples — in the foregoing part of this chapter. Once they acquire the skill, then it will be easy to record them in the journal (from Step 5 to Step 9 — Stage II).
Illustration: 5 Analysis of some business transactions
Transaction 1
On Jan 1, 2009, Goods bought for Rs 50,000.
Important Note:
In this case it is not given.
Clue
In this case, it is cash purchase.
Solution
This transaction is of cash purchase.
Step 1: |
The two accounts affected are
|
Step 2: |
Next, accounts are classified as
|
Step 3: |
Apply the Rules of Debit and Credit
|
Write the account to be debited and credited
|
Goods — is a thing of value — so it is a real account
Transaction 2
On Jan 2, 2009, goods bought from Sri Jain for Rs 70,000.
Solution
In this transaction supplier name is given. But the keyword “Paid” or “for cash” is missing. So it is to be treated as transaction, on credit basis.
Step 1: |
Find two accounts affected: Purchase Account |
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the account to be debited and credited |
Transaction 3
On Jan 4, 2009, Raj commences a business enterprise under the name of “Good Luck Enterprises” with a capital of Rs 5,00,000.
Solution
Step 1: |
Find out the accounts affected in the transaction
|
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of the account to be debited and credited |
Transaction 4
On Jan 5, 2009, Goods sold to Sathyan for cash Rs 1,00,000.
Solution
This transaction is on cash basis.
Step 1: |
Identify the accounts affected
|
Step 2: |
Classify the accounts |
Step 3: |
Cash comes in — Debit what comes in |
Step 4: |
Write the account to be credited and debited |
Transaction 5
On Jan 7, 2009, goods sold to Kashyap for Rs 2,00,000.
Solution
Step 1: |
Identify the two accounts
|
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the account to be debited and credited |
Transaction 6
On Jan 8, 2009, Bought Laptop from “E-Top Enterprises” for Rs 50,000.
Solution
Step 1: |
Identify the two accounts |
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of account to be debited and credited |
Transaction: 7
On Jan 9, 2009, paid Rs 60,000 for goods received from Sun Textiles.
Solution
Step 1: |
Identify the accounts affected
|
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of the account to be debited and credited |
Transaction: 8
On Jan 10, 2009, paid into Indian Bank Rs 15,000.
Solution
Step 1: |
Identify the accounts affected
|
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of the account to be credited and debited |
Transaction: 9
On Jan 11, 2009, withdrawn from the Bank Rs 15,000.
Solution
Step 1: |
Identify the accounts affected
|
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of the account to be debited and credited |
Transaction: 10
On Jan 12, 2009, Borrowed from the Bank Rs 3,00,000.
Solution
Step 1: |
Identify the two accounts
|
Note: Compare this with the previous one, Transaction 9. As it is a withdrawal, that is, from his own fund mere bank A/c was mentioned. Here, it is borrowed, obtained by way of loan from the bank. Hence, the term “Bank Loan A/c” is used here.
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of the account to be credited and debited |
Transaction: 11
On Jan 14, 2009, paid by cheque for the rent Rs 5,000.
Solution
Step 1: |
Two accounts affected are
|
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of account to be credited and debited |
Transaction: 12
On Jan 15, 2009, opened a Current Account with the State Bank of India for Rs 25,000.
Solution
Step 1: |
Identify the two accounts
|
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of the account to be credited and debited |
Transaction: 13
On Feb 15, 2009, received cheque from Gupta for Rs 15,000.
Solution
Step 1: |
Identify the two accounts
|
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of the account to be credited and debited |
Transaction: 14
On Feb 20, 2009, cheque received from Sekhar for Rs 20,000 and banked immediately.
Solution
Step 1: |
Identify the two accounts
|
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Credit and Debit |
Step 4: |
Write the name of the account to be credited and debited |
Transaction: 15
On Feb 27, 2009, paid Verma Rs 5,000 in lieu of a cheque.
Solution
Strictly speaking, two transactions occur which have to be recorded simultaneously.
First transaction: Receipt of a cheque from Verma and
Second transaction: Payment of cash to Verma
First transaction: |
Bank Account: Debit |
|
Verma Account: Credit |
Second transaction: |
Verma Account — Personal A/c — Receives |
|
Cash Account — Real A/c — Goes out |
|
Verma’s Account — Debit |
|
Cash Account — Credit |
Transaction: 16
On Mar 1, 2009, received from Sharma a bill at 3 months for Rs 30,000.
Solution
Step 1: |
Identify the two accounts |
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Credit and Debit |
Step 4: |
Write the name of the account to be credited and debited |
Transaction: 17
On Mar 5, 2009, Accepted the bill drawn by Shree for Rs 15,000.
Solution
Step 1: |
Identify the two accounts
|
Step 2: |
Classify the accounts
|
Step 3: |
Apply the Rules of Credit and Debit
|
Step 4: |
Write the name of the account to be credited and debited |
(Bills Receivable and Bills Payable. Features are explained later, in this chapter.)
It is important to note that all business transactions have to be analysed from the business point of view and not from the owner’s (proprietor’s) point of view.
The proprietor (owner) of the business may withdraw a certain amount from the business by way of cash or cheque or goods for personal use. It is called Drawings.
Drawings from Business
Cash | Cheque | Goods |
---|---|---|
Cash goes out |
Bank (involves) |
Value (Purchases) |
|
Bank → Giver |
Decreases |
Credit → Cash A/c |
Credit → Bank A/c |
Credit → Purchase A/c |
Debit → Drawings A/c |
Debit → Drawings A/c |
Debit → Drawings A/c |
Note: Drawings Account is to be debited in all categories. Credit A/c differs depending on cash, cheque or goods.
Transaction: 18
On Mar 7, 2009, Narayan withdrew for personal use Rs 15,000.
Solution
In this transaction, drawings in the form of cash is given
Step 1: |
Identify the two accounts
|
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of the account to be credited and debited |
Transaction: 19
On Mar 9, 2009, paid by cheque for Group Insurance Premium (for employees in a business concern) Rs 25,000.
Solution
Step 1: |
Identify the two accounts
|
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Credit and Debit |
Step 4: |
Write the name of the accounts to be credited and debited |
Transaction: 20
On Mar 10, 2009, Renu paid life insurance premium of Rs 1,200.
Solution
Step 1: |
Identify the two accounts
|
Step 2: |
Classify the accounts
|
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of the account to be credited and debited |
Note: If it is by way of cheque, instead of Cash A/c — Bank A/c has to be credited
Transaction: 21
On Mar 15, 2009, bought shares in VRV Ltd. for Rs 60,000.
Solution
Step 1: |
Identify the accounts
|
Step 2: |
Classify the accounts
|
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of the account to be credited and debited |
Transaction: 22
On Mar 20, 2009, Bank collected dividends on Renu’s investments Rs 15,000.
Solution
Step 1: |
Identify the two accounts
|
Step 2: |
Classify the accounts |
Step 3: |
Apply the Rules of Debit and Credit |
Step 4: |
Write the name of the accounts to be debited and credited |
Now, we can move on to the next state (Stage II), journalising the business transactions. The transactions (from Transactions 1 to Transactions 22) discussed so far are now recorded in the Journal.
Journal
In simple entry, only two accounts are affected. One account is to be debited and another account is to be credited with an equal amount.
Example: The transactions we have discussed so far fall under this type.
In compound entry, more than two accounts are affected. There are three types under this category.
Several accounts (more than one) will have to be debited and only one account to be credited.
Only one account is to be debited and several accounts (more than one) to be credited. 1 and 2 are called “Single Compound Entries.”
Several accounts will have to be debited and several accounts to be credited. This is called “Double Compound Entry.”
Note: In all the compound entries, the sum of debits will always be equal to the sum of credits.
Example: Single Compound Entry.
Transaction
A business concern pays rent Rs 6,000, salaries Rs 12,000, electricity charges Rs 600, carriage account Rs 1,000 on Dec 31, 2008. Journalise.
Solution
In this example, transaction, the business entity pays expenses on a single day Dec 31. Four transactions took place on the same day. Moreover they are of same nature. In such situation a compound entry is passed instead of separate journal entry for each item.
All expenses — Nominal Account — to be Debited
Cash Account — Real A/c — What goes out to be Credited
Example: A business concern receives payment of Rs 80,000 consisting of Rs 20,000 cash and Rs 60,000 as cheque in return of, for sale of goods for Rs 25,000 and an old machine of Rs 55,000 on Mar 30, 2009. Pass the entry.
Solution
Journal
Example
Journal
The origin of a transaction is derived from the source document. Source documents are the evidences of business transitions which provide information about the nature of the transaction, the date, the amount and the parties involved in it. Each transaction recorded in the books of accounts must have enough proof to support it. These supporting documents provide proof for the accuracy of the recorded transactions. These source documents play a major role for audit purpose and tax assessment. They also serve as a legal evidence, in case of a dispute. Cash Memo, Invoice or Bill, Receipt, Debit Note, Credit Note, Pay-in-slip, cheque and vouchers are some common source documents.
When a trader sells goods for cash, he gives a cash memo. When he purchases goods for cash, he receives a cash memo. It contains details regarding the items, quantity, rate and price. Specimen of cash memo is given below.
Invoice is another source document. This is prepared by the seller to inform the purchaser about the quantity supplied, rates and payment terms, trade discount, incidental charges and the total amount payable by him. It is also known as “Sales Invoice” or “Outward Invoice.” Similarly, when a trader purchases goods on credit it is called a “Purchase Invoice” or “Inward Invoice.”
Entries in the Sales Book are recorded on the basis of sales invoices, and entries in the Purchase Book and recorded on the basis of purchase invoices received.
Invoice sent means Invoice is sent by the seller to the purchaser when goods are supplied by the seller. Specimen of an invoice is depicted below.
Explanation
At this stage we have to understand two more concepts — Cash Discount and Trade Discount.
Cash Discount: It is a reduction offered by the supplier from the invoice price in consideration of immediate payment or payment within a stipulated period.
Example: Take the case shown in the specimen invoice.
Term 5% 30 days. The buyer gets 5% discount if he settles the amount within 30 days. The cash discount is calculated (if the buyer pays the full payment) as:
Amount payable as per invoice |
= |
Rs 82,000 |
Less: Cash Discount @ 5% |
= |
Rs 4,100 |
Buyer can pay, after cash discount |
= |
Rs 77,900 |
Trade Discount: It is a reduction in payment offered by a supplier from the list of price of goods or services on business considerations other than prompt payment.
Example: Take the same case shown in the specimen invoice. Take the item table top grinders. If 5 table top grinders are sold at the list price of Rs 4,000, subject to trade discount 10%.
Then
5 table top grinders @ Rs 4,000 |
= |
Rs 20,000 |
Less: Trade Discount @ 10% |
= |
Rs 2,000 |
Buyer can pay, after trade discount |
= |
Rs 18,000 |
Basis of Distinction | Trade Discount | Cash Discount |
---|---|---|
1. Reduction |
It is a reduction from the LIST PRICE of goods and services. |
It is a reduction from the INVOICE PRICE. |
2. Main objective |
Its main objective is to promote sale. |
Its main objective is to encourage prompt payment. |
3. Disclosure |
It is shown in the invoice itself |
It is not shown in the invoice. |
4. Time limit |
It is granted on the date of purchase. |
It is granted on immediate payment or within a stipulated period. |
5. Ledger posting |
Trade account finds no place in the ledger accounts. So, no posting in ledger arises |
Cash discount is shown in the ledger and its posting in the ledger accounts also essential. Basis of Distinction |
In business transaction, when a trader receives cash from a customer, he issues a receipt. It contains the date, the name of the customer and the amount. Similarly, when the customer makes any payment, a receipt is obtained from the party to whom we make payment.
No: 1995 |
Date: _____ |
Received with thanks, a sum of Rs 40,000 (Rupees Forty thousand only) from Sri Krishna Medical Stores towards the supply of medicines as per the list enclosed.
Cheque No.
Dated:
State Bank of India, Trichy |
Signature with Seal |
A debit note is prepared by the purchaser. A debit note contains the date of goods returned, name of the seller (supplier), details of the goods returned and reasons for returning the goods. On the basis of debit note, the supplier’s account is debited in the books.
Specimen
A credit note is prepared by the seller. It contains the date on which goods are returned, name of the customer, details of the goods received back, amount of the goods and reasons for returning the goods. Each such credit note is numbered serially. On the basis of credit note, the customer’s account is credited in the books.
Specimen
A voucher is a written document in support of a business transaction. It is prepared by the accountant of the business organisation. Each voucher is countersigned by an authorised person of the organisation. The vouchers are to be maintained properly so that the auditors may have an easy access to vouch them. They are the documentary evidences for any business transaction.
VOUCHER
No _____
Dates: _____
Rs _____
Pay to __________
Rs (in words) __________
being __________
and debit __________
Authorised by/ |
Received the above sum of Rs |
Sign of the receiver
Payment by: Cash/Cheque
Cheque drawn on—Bank
Date:
Now-a-days, business transactions, almost all receipts and payments are affected through bank. For depositing cash or cheque in the bank account, a particular “form” has to be filled, which is known as “pay-in-slip.” This source document contains details regarding date, name and account number, amount deposited (cash/cheque). It contains a counterfoil, which is returned to the customer (depositor) duly signed and sealed by the bank official.
A cheque is a (source) document, for using to withdraw money from the bank. It is issued in blank forms by the bank to the account holder. The depositor writes the name of the party (after the words “Pay” printed) to whom payment is to be made. At the end of the Pay line, the word “or Bearer” is printed, which means payment is to be made to the person whose name was written or the bearer of that particular cheque. It is payable on demand to that person or the bearer of the cheque. In case, if the words “or bearer” is struck off, payment has to be made only to the person whose name was written in that line written after the words “Pay.”
Cheques are crossed. It it is crossed the payment for such cheques can be made only through (the accounts of such person in whose name the cheque stands for) the bank and cannot be encashed straight across the counter. What is “cross”? If two parallel lines are drawn on the corner of the cheque (left side — top corner), it is said to be crossed. This is being done to ensure safety to payments. There are different ways of crossing a cheque as shown below:
Only a bearer cheque can be passed on mere delivery. If it is crossed as A/c Payee, it can be deposited only in the account of the person whose name appears on the cheque. The last type of crossing (5), by writing the name of the bank, is rare in practise, which means such cheques can be encashed only through the bank written. An order cheque may be transferred by endorsement and delivery. Endorsement means mere writing of instructions to pay the cheque to a particular person and signing on the back side of the cheque. Crossing the cheques ensures safety to payments.
Besides these, the most important source documents are Bills Receivable — discussed in the appropriate place in this book.
Illustration: 6 Journalise the following transactions:
Feb 1, 2009 |
Bought goods for Rs 1,00,000. |
Feb 2, 2009 |
Bought goods from Banerjee for Rs 30,000. |
Feb 5, 2009 |
Bought goods from Lal for Rs 25,000 against a current dated cheque. |
Feb 10, 2009 |
Purchased goods from Khan of the list price of Rs 50,000, at a trade discount of 12%. |
Feb 12, 2009 |
Purchased goods of the list price of Rs 2,00,000 from Chopra less 5% trade discount and 5% cash discount and paid 50% by cheque. |
Feb 15, 2009 |
Rejected and returned 5% of goods supplied by Banerjee. |
Feb 16, 2009 |
Rejected and returned 10% of goods bought from Khan. |
Solution
Transactions relate to Purchases (Cash and Credit), Purchase Returns, Trade Discount and Cash Discount.
Transactions are directly entered in the Journal (at this stage, it is hoped that the students may have thorough knowledge on analysing transactions) and for important transactions, explanations are provided under the head “Note,” after passing entries.
Journal
Notes:
(*1) List Price |
Rs 50,000 |
Less 12% trade discount |
Rs 6,000 |
(*2) List Price |
Rs 2,00,000 |
Less 5% trade discount |
Rs 10,000 |
(*3) Payment |
Rs 95,000 |
(50% of Rs 1,90,000) |
Rs 4,750 |
Less: Cash Discount @5% |
Rs 90,250 |
Important Notes
For goods purchased and purchase returns, the following principles should be remembered always:
Illustration: 7
Journalise the following transactions:
1.3.2009 |
Sold goods for Rs 1,25,000. |
3.3.2009 |
Sold goods to Sathyan for Rs 25,000. |
5.3.2009 |
Sold goods to Kashyap for Rs 20,000 against a cheque. |
7.3.2009 |
Sold goods to Ajay of the list price of Rs 50,000 at a trade discount of 10%. |
9.3.2009 |
Sold goods to Vas of the list price of Rs 90,000, less with 10% trade discount and received a cheque under a cash discount of 5%. |
11.3.2009 |
Sold goods to Dev of list price of Rs 90,000, less with 10% trade discount and 5% cash discount and paid 50% by cheque. |
13.3.2009 |
Sold goods to Gopi costing Rs 1,00,000 for cash at a profit of 25% on cost less 10% trade discount and charged VAT @ 12% and paid package charge Rs 1000 (not to be charged from customer). |
15.3.2009 |
Sold goods costing Rs 1,00,000 to Ram at a profit of 20% on sales, less 10% trade discount and charged VAT @ 12% and paid cartage Rs 1000 (to be charged from customer). |
17.3.2009 |
Sathyan rejected and returned 5% of goods. |
19.3.2009 |
Ajay rejected and returned 10% of goods. |
Solution
Journal
Notes:
|
|
Rs |
|
|
(*1) List Price |
50,000 |
|
|
Less: Trade discount @10% |
5,000 |
|
|
|
45,000 |
|
|
(*2) List Price |
90,000 |
|
|
Less: Trade discount @10% |
9,000 |
|
|
Invoice price |
81,000 |
|
|
Less: Cash discount @5% |
4,050 |
|
|
|
76,950 |
|
|
(*3) and (*4) List Price |
90,000 |
|
|
Less: Trade discount @10% |
9,000 |
|
|
Invoice price |
81,000 |
(*3) |
|
50 % of Rs 81,000 |
40,500 |
|
|
(Cheque payment) |
|
|
|
Less: Cash discount @5% |
2,025 |
|
|
|
38,475 |
(*4) |
|
(*5) Cost Price |
1,00,000 |
|
|
Add: 25% on cost |
25,000 |
[20% on sale = 25% on cost] |
|
List Price |
1,25,000 |
|
|
|
|
|
|
Discount @10% |
12,500 |
|
|
Invoice Price |
1,12,500 |
|
|
Add: VAT @12% |
13,500 |
|
|
Total Invoice Price |
1,26,000 |
|
|
(*6) Invoice Price |
1,12,500 |
|
|
Add: Cartage |
1,000 |
|
|
Sales |
1,135,00 |
|
VAT @12% on Rs 1,12,500 = Rs 13,500
Important Notes
Illustration: 8
Apr 1, 2009: |
Bought goods worth Rs 6,000 from Gopal and sold the same to Thomas for Rs 7,500. |
Apr 3, 2009: |
Paid salaries to staff Rs 5,000 and recovered from travelling salesman Rs 1,000 for goods supplied to him after deducting his travelling expenses Rs 175. |
Apr 5, 2009: |
Goods destroyed by fire (Sale price Rs 4,000, Cost Rs 3,200). |
Apr 6, 2009: |
Goods worth Rs 1,20,000 are insured against loss by fire. The policy is for Rs 1,00,000. Actual loss caused by fire is Rs 72,000. The insurance company admits the claim and pays proportionately. |
Solution
Notes:
|
|
|
|
|
|
= |
Rs 60,000:Cash A/ c |
|
(Rs 72,000 − 60,000 |
= |
12,000: P and L A/ c) |
Illustration: 9
Feb 15, 2009 |
Goods costing Rs 1,000 supplied as charity (Sale price Rs 1250) |
Feb 16, 2009 |
Goods used in making of furniture costing Rs 1,000 (Sale price Rs 2,500) |
Feb 17, 2009 |
Goods costing Rs 2,000 distributed as free samples (Sale price Rs 2,500) |
Feb 18, 2009 |
Goods stolen in transit costing Rs 500 (Sale price Rs 750) |
Feb 19, 2009 |
Goods stolen by storekeeper costing Rs 2,200 |
Solution
Journal
Notes:
Illustration: 10
Journalise the following transactions:
Jan 1, 2009: |
Cash-in-hand: Rs 20,000; Machinery Rs 40,000; Furniture Rs 3,000; Land and Building Rs 1,75,000; Bills Receivable Rs 10,000; Bills Payable Rs 7,500; Lal — Rs 10,000 (Debtor); Chand — Rs 7,000 (Debitor); Krish — Rs 8,000 (Creditor). |
Jan 3, 2009: |
Bought a buffalo for Rs 20,000 and a wooden cart for Rs 20,000 for supply of goods to remote rural customers. |
Jan 5, 2009: |
A customer’s cheque for Rs 10,000 returned dishonoured for insufficient funds in his accounts. The customer had availed cash discount of Rs 500. |
Jan 30, 2009: |
The buffalo bought was dead. Its carcass was sold for Rs 800. |
Journal
Notes:
(*1) It is opening entry to record the balances of previous accounting period.
Capital is not given
Capital = Assets — Liabilities
= (Rs 2,65,000 — Rs 15,500) = Rs 2,49,500
(*2) All animals are classified under livestock. It is treated as Fixed Assets. Wooden cart is also fixed asset.
(*3) The customer’s cheque is dishonoured. Its original entry is restored. Cash discount, which would have been allowed earlier is cancelled.
(*4) Death of an animal is a loss. That loss is transferred to Profit and Loss Account. Sale of carcass is treated as sale and that amount is debited.
Illustration: 11
Journalise the following transactions:
Apr 1, 2009 |
Capital Rs 2,00,000; Debtors — Rs 20,000; Cash-in-hand — Rs 5,000; Cash at Bank — Stock Rs 7,000; Creditors Rs 25,000; Rs 15,000; Machinery Rs 1,50,000; Furniture and Fixtures — Rs 25,000. |
Apr 2, 2009 |
Received Rs 1,500 from Mohamed in full settlement of his account Rs 2,000. |
Apr 3, 2009 |
Received Rs 1,500 from Xavier on his account for Rs 2,000. |
Apr 4, 2009 |
Paid Rs 1,400 to Guru in full settlement of his account for Rs 1500. |
Apr 5, 2009 |
Paid Rs 1,400 to Veer Singh on his account for Rs 1,500. |
Apr 6, 2009 |
Received a first and final dividend of 70 paise in the rupee from the official receiver of Mr. Rao who owed Rs 3,000. |
Apr 7, 2009 |
Wages paid Rs 1000 for erection of plant. |
Journal
Note:
(1) In transaction on Apr 1, 2009, the opening entry was made to record the balances of assets and liabilities of the last year. In this case the difference between the total of assets and the total of liabilities is treated as goodwill and the same has been debited to its account.
|
Goodwill |
= |
All liabilities + Capital – All assets |
|
|
= |
(Rs 25,000 + Rs 2,00,000 – Rs 2,22,000) |
|
|
= |
Rs 3,000 |
Apr 2 |
Difference is treated as discount allowed and it is debited as Rs (2000 — 1500) 500. |
Apr 3 |
This transaction shows that the amount was received on his account. In such a case, discount allowed is not shown separately and the actual amount received alone, that is, Rs 1,500 is debited. |
Apr 4 and 5 |
Same principle for the above two transactions are followed. Here cash is paid, as such Cash A/c is credited. |
Apr 6 |
Mr. Rao is an insolvent. He is not in a position to pay the entire amount of his debt. Only 70 paise in a rupee is received, that is, Out of Rs 3,000 — Rs 2,100 was only received. Remaining Rs 900 is a loss. It should be noted and differentiated from the discount allowed illustrated in the above transactions. It is not a concession. It is a loss like Bad Debts. |
Apr 7 |
Wages paid to erect a plant forms part of the cost of the plant. As plant purchased are of capital nature, they are not entered straight in the Journal. In practise, two entries have to be made for such transactions as: |
To Cash A/c 1,000
(Wages paid for erection of plant)
To Wages A/c 1,000
(Payment of wages transferred to Plant A/c)
Illustration: 12
Journalise the following transactions:
Apr 10, 2009 |
Purchased 200 shares of VRV Ltd @ Rs 90 per share (Face value Rs 100 per share); brokerage paid 2%. |
Apr 17, 2009 |
Sold 100 shares of VRV Ltd @ Rs 95 per share brokerage paid Rs 190. |
Apr 20, 2009 |
Sold personal scooter for Rs 25,000 and bought a new car for business plus Rs 1,80,000 from office cash. |
Apr 25, 2009 |
Damaged goods worth Rs 3,000 are sold for Rs 1,000. |
Apr 27, 2009 |
Exchanged old Metador van for a new Piageo tempo carrier. The old van was valued at Rs 35,000. The price of new tempo is Rs 2,70,000. The balance was paid in cash. |
Solution
Journal
This is another approach for recording a business transaction. This approach is also called as the American Approach. Under this method transactions are recorded on the basis of accounting equation:
Accounting equation is based on dual (debit and credit) aspect concept. Though the Americans make use of double entry system, the procedure of recording the business transaction in the general journal is different.
Accordingly, accounts are classified into five categories.
Illustration: 13
Classify the following accounts as per accounting equation approach:
Solution
Category of Accounts | Debit the | Credit the |
---|---|---|
1. Assets Accounts |
Increase |
Decrease |
2. Liabilities Accounts (Creditors Equities) |
Decrease |
Increase |
3. Capital Accounts (Owner’s Equities) |
Decrease |
Increase |
4. Incomes and Gain A/c (Revenue Account) |
Decrease |
Increase |
5. Expenses and Losses |
Increase |
Decrease |
Illustration: 14
Apply the Rules of Debit and Credit for each of the accounts as given in Illustration 13 under modern approach.
Solution
|
1. Capital brought in |
|
|
|
Category |
: |
Capital Accounts |
|
Rule |
: |
Debit the decrease and Credit the increase |
|
2. Land purchased |
: |
|
|
Category |
: |
Assets Accounts |
|
Rule |
: |
Debit the increase and Credit the decrease |
|
3. Purchases A/c |
|
|
|
Category |
: |
Expenses Accounts |
|
Rule |
: |
Debit the increase and Credit the decrease |
|
4. Sales A/c |
|
|
|
Category |
: |
Revenue Accounts or Income and Gains A/c |
|
Rule |
: |
Debit the decrease and Credit the increase |
|
5. Cash paid |
|
|
|
Category |
: |
Assets Accounts |
|
Rule |
: |
Debit the increase and Credit the decrease |
Transactions 6 to 15 are shown in the tabular form as follows:
Transaction | Category of Account | Rules of Debit and Credit |
---|---|---|
6. Cash received |
Assets Account |
Debit the increase and |
7. Subscription received |
Revenue Account or Income and Gains Account |
Debit the decrease and |
8. Furniture purchased |
Assets Account |
Debit the increase and |
9. Sales returns |
Revenue Account or Income and Gains Account |
Debit the decrease and |
10. Purchase returns |
Expenses Account |
Debit the increase and |
11. Bank A/c |
Assets Accounts |
Debit the increase and |
12. Wages |
Expenses Account |
Debit the increase and |
13. Bank overdraft |
Liabilities Account |
Debit the decrease and |
14. Outstanding salary |
Liabilities Account |
Debit the decrease and |
15. Interest accrued |
Assets Account |
Debit the increase and |
Important Note
Journal entry is same for both approaches.
Following conventional rules relating to Personal, Real and Nominal Accounts
(OR)
Following modern (American) approach relating to Assets, Liabilities, Capital Expenses and Losses and Income and Gains Accounts (in terms of increase or decrease) the Net Result — the journal entry is the SAME.
Accounting equation is based on dual aspect (Debit and Credit) concept. Every business transaction has a two-fold fact — on the assets and claims on the assets. The net effect will be that these aspects, that is, the assets and the total claims are always equal. The claims may arise from the proprietors or from outsiders (creditors). The claims are also known as (i) Owner’s equity (Capital) (ii) Outsider’s equity (Liability). From such a concept, the equation is originated.
|
Assets |
= |
Equities |
|
Assets |
= |
Owner’s Equity + Outsider’s Equity |
|
Assets |
= |
Capital (owners) + Liabilities (creditors) |
This equation forms the basis in this procedure, for analysing business transactions.
Illustration: 15: Transaction — 1
Raj started his business Raj and Co. with Rs 50,000 from his own funds.
Solution
The business unit Raj and Co. received assets in terms of cash, that is, Rs 50,000. Result capital increase to the same extent of Rs 50,000. Now, the claims against the enterprise (here owner’s claim) is also Rs 50,000 in the form of capital. The transaction is expressed in terms of accounting equation as:
|
Assets |
= |
Capital |
+ |
Liabilities |
|
↓ |
|
↓ |
|
|
|
Cash |
|
Capital |
+ |
0 |
|
Rs 50,000 |
= |
Rs 50,000 |
+ |
0 |
Note: There is always an equality between Assets (resources) and Liabilities + Capital (sources).
Transaction 2
Raj purchased machinery and accessories for Rs 10,000.
Solution
In this transaction, cash is reduced by Rs 10,000, but at the same time increases the other asset machinery with the same amount, leaving the total of the assets of the business unchanged. To put in other words, this transaction changes the composition of the assets but not change the total value. As a result, the accounting equation will be:
Transaction 3
He purchased goods for cash Rs 5,000.
Solution
This is cash purchase. As such, cash balance will be reduced by Rs 5,000 and increased by the same amount in the form of goods or stock (Asset). The total value of assets will remain unchanged.
Transaction 4
He purchased goods on credit Rs 10,0000.
Solution
This transaction is based on credit. This will create a new liability in the form of creditors. Effect will be, increased in liability and assets by Rs 10,000.
Apply the Accounting Equation:
Transaction 5
Rent paid Rs 2,000.
Solution
Rent is paid by cash.
It is an expense.
Reduces cash (Asset) and decreases value of capital.
Reduces the Asset and Capital.
Equation
Transaction 6
Raj sold goods costing Rs 10,000 for Rs 12,000.
Solution
Cash is increased by Rs 12,000.
Goods (stock) is reduced by Rs 10,000.
Capital is increased by gain of (12,000 — 10,000): Rs 2000.
Equation
Transaction 7
Goods costing Rs 3,000 was sold on credit for Rs 8,000.
Solution
This transaction was based on credit basis.
This gives rise to new asset in the form of debtors.
The stock of goods is reduced.
The net increase (Rs 8,000 — Rs 3,000) is of revenue to be added to the capital.
Equation
Transaction 8
Raj withdraws Rs 2,000 cash for his personal use.
Solution
Drawings is not a business expense.
But withdrawal will decrease the cash balance.
Also it decreases the value of capital.
Equation
Transaction 9
Machinery was to be depreciated by Rs 1,000.
Solution
The decrease in the usefulness of an asset is a business expense.
Due to this there will be a decrease in asset as well as capital.
Equation
The above transactions may be presented in the following table:
The last equation in the process of Analysis of Transactions, may also be depicted in the form of a statement called “Balance Sheet” (features of Balance Sheet will be discussed later in this book). It appears as follows:
Notes:
Accounting Equation: It is one method of recording business transactions. It lays stress on maintaining equality between (resources) assets and (sources) capital and liabilities. Assets (resources) = Liabilities + Capital (Sources)
Business Transaction: It involves the exchange of money and goods or services for money, which can be quantified objectively.
Double Compound Entries: Debiting more than one account and simultaneous crediting of more than one account are termed as Double Compound Entries
Double Entry System: A system of recording of transactions which takes into account both the debit and credit aspects of business transaction.
Journal: A record of business transactions (listed in chronological order) showing for each transaction the details and credits, later to be entered into specific accounts. This is also called “Book of Original Entry,” as transactions are entered first in this record.
Journalising: Recording business transactions in the book of original entry under double entry system is termed as journalising.
Narration: The explanation of the transaction entered in the Particulars column of a Journal (below the amount credited).
Nominal Account: Account of expenses, income, losses and gains.
Opening Entry: The accounts with the balances in the previous year (Real and Personal Accounts) are entered in the new books of account by debiting all assets accounts and crediting all liabilities by entry known as opening entry.
Personal Account: Accounts opened to enter all transactions with persons (natural and artificial).
Real Account: Accounts relating to assets and liabilities. This is also called Property Accounts.
Single Compound Entry: Debiting one account and crediting more than one account (or) debiting more than one account and crediting one account, such compound is made.
I: Fill in the blanks with suitable word(s)
Answers
II. State whether the following statements are True or False
Answers
1. False |
2. True |
3. False |
4. False |
5. False |
6. False |
7. False |
8. True |
9. True |
10. True |
11. False |
12. False |
13. True |
14. False |
15. True |
16. True |
17. True |
18. False |
19. True |
20. True |
21. True |
22. False |
23. True |
24. True |
25. False |
26. True |
27. False |
28. True |
29. False |
30. True |
Salaries — Rs 3,000
Rent — Rs 1,500
Repairs — Rs 500
Electricity — Rs 600
3.15.206.105