Chapter 4a

Accounting Process — Journal

OBJECTIVE 1: CONCEPT OF ACCOUNTING PROCESS AND STAGES

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.

OBJECTIVE 2: RECORDING OF BUSINESS TRANSACTIONS AND ITS CLASSIFICATION

2.1 Meaning of Business Transaction

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.

2.2 Classification of Business Transactions

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:

1. Cash transactions
2. Credit transactions
3. Non-cash transactions

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:

2.3 Another Way of Classification of Business Transactions

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.

OBJECTIVE 3: MEANING OF ACCOUNT AND ITS CLASSIFICATION

3.1 Meaning of Account

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

1. individuals, firms, companies,
2. properties, goods or cash,
3. items of revenue (income, profit or gain) and expense (loss).

3.2 Classification of Accounts

Accounts are classified into personal, real and nominal, accordingly. The classification of accounts may be illustrated as follows:

OBJECTIVE 4: CLASSIFICATION OF ACCOUNTS

4.1 Personal Accounts

Business transactions that occur between a business entity and other persons are “personal accounts.” These personal accounts may further be classified into:

1. Natural person’s account: Accounts relating to natural persons are called natural persons accounts.

   Example: Raj’s Account, Vasu’s Account and so on.

2. Artificial or legal person’s account: Accounts relating to legal entities — partnership firms, limited companies, government agencies, institutions, clubs, societies and so on.
3. Group or representative personal accounts: These are accounts of different persons of same nature but more than one in number. As the persons involved are of the same nature, they are grouped into one account that is one head.

   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.

4.2 Impersonal Accounts

These accounts would not affect persons (natural or artificial) but affect the business concerns. These accounts are re-classified into two broad categories:

1. Real accounts: These accounts consist of properties and assets owned by business concern, which may further be classified into two categories:
   1. Tangible accounts: These consist of real tangible and concrete things or properties, which can be seen, felt, measured, purchased and sold.

      Example: Accounts of land, building, stock and so on.

   2. Intangible accounts: These accounts consists of things, which cannot be felt but can be measured in money.

      Example: Goodwill, trade marks, copyrights.

2. Nominal accounts: These accounts consist of items, which do not have any existence, form or shape. They cannot be seen or felt. These are called as temporary accounts because they are transferred to other bigger nominal account — Trading and Profit and Loss Account, when final accounts are prepared.

   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

1. Provision for Depreciation on Fixed Assets when they are recorded at their original cost.
2. Provision for Doubtful Debts when Debtors are shown at their gross amount.
3. Stock Reserve Account against the original cost of inventories.

4.3 Nominal Accounts Treated as Personal Accounts

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 Prepaid Rent is Personal A/c Rent Received in Advance is Personal A/c
	2. Salary A/c is Wages A/c is Nominal A/c	→	Outstanding Salary is Personal A/c Outstanding Wages is Personal A/c Salary Paid in Advance is Personal A/c
	3. Interest A/c is Nominal A/c	→	Outstanding Interest is Personal A/c Accrued Interest is Personal A/c Interest Received in Advance is Personal A/c
	4. Discount A/c is Nominal A/c	→	Discount Received in Advance is Personal A/c Rebate is Personal A/c Unexpired Discount is Personal A/c Bills Discounted is Personal A/c
	5. Commission A/c is Nominal A/c	→	Commission Received in Advance is Personal A/c Outstanding Commission is Personal A/c
	6. Subscription A/c is Nominal A/c	→	Accrued Subscriptions is Personal A/c Subscriptions Received in Advance is Personal A/c
	7. Insurance Premium is Nominal A/c	→	Prepaid Insurance is Personal A/c Received in Advance is Personal A/c

Illustration: 1

Classify the following accounts:

1. Capital
2. Sales
3. Drawings
4. Outstanding Rent
5. Purchases
6. Cash Received
7. Cash Paid
8. Rent
9. Wages
10. Interest Paid
11. Discount Received
12. State Bank of India
13. Commission Paid
14. Commission Received
15. Bad Debts written off
16. Advertisement
17. Carriage Inward
18. Carriage Outward
19. Interest Received
20. Land Purchased
21. Building Purchased
22. Discount Allowed
23. Conveyance Charges
24. Subscription Outstanding
25. Insurance Premium Paid

Solution

1. Personal Account: 1, 3, 4, 12, 24
2. Real Account: 2, 6, 7, 20, 21
3. Nominal Account: 5, 8, 9, 10, 11, 13, 14, 15, 16, 17, 18, 19, 22, 23, 25

OBJECTIVE 5: MEANING OF DOUBLE ENTRY AND DOUBLE ENTRY SYSTEM

What is an “Entry”? Recording of business transactions in an account is called an entry.

5.1 Meaning of Double 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:

1. The receiving of value on one hand
2. The giving of same value on the other

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.

OBJECTIVE 6: METHODS OF RECORDING BUSINESS TRANSACTIONS

There are two approaches for recording a transaction:

• Traditional Approach
• Accounting Equation approach

6.1 Traditional Approach

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.

6.2 Accounting Equation Approach

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.

OBJECTIVE 7: TRADITIONAL APPROACH FOR RECORDING BUSINESS TRANSACTIONS AND DEBIT—CREDIT RULES FOR THREE TYPES OF ACCOUNTS

All the accounts are classified as:

1. Personal Accounts
2. Real Accounts or Property Accounts
3. Nominal Accounts or Fictitious Accounts

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:

1. Capital brought in
2. Land purchased
3. Goods purchased
4. Carriage inward paid
5. Cash received
6. Interest paid
7. Commission received
8. Advertisement expenses
9. Subscription received
10. Mobile charges (post-paid)
11. Repairs
12. Bad debts written off
13. Data-card purchased
14. Laptop purchased
15. Pen drive purchased
16. Indian Bank A/c
17. Wages and salaries paid
18. Outstanding salary
19. Pre-paid insurance premium
20. Interest accrued

Solution

1. Capital brought in: Type of Account: Personal Account

   Rule: Debit: The Receiver

        Credit: The Giver

2. Land purchased: Type of Account: Real Account

   Rule: Debit: What comes in

        Credit: What goes out

3. Goods purchased: Type of Account: Nominal Account

   Rule: Debit: All expenses and losses

        Credit: All gains and profits

   (Here Purchases A/c is taken and “Goods” ignored)

4. Carriage inward paid: Type of Account: Nominal Account

   Rule: Debit: All expenses and losses

        Credit: All gains and profits

5. Cash received: Type of Account: Real Account

   Rule: Debit: What comes in

        Credit: What goes out

6. Interest paid: Type of Account: Nominal Account

   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

OBJECTIVE 8: MEANING AND FORMAT OF JOURNAL

8.1 Meaning of Journal

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.

8.2 Format of Journal

1. Date Column: Under this first column, the date of transaction is entered. The year and the month is written once, till they change. The sequence (of months and dates) should be strictly adhered to.
2. Particulars Column: Under this column, the name of the account to be debited is written first and the word “Dr.” is to be written at the end of this line. In the second line, the name of account to be credited is written, starting with the word “To,” providing space away from the margin in the Particulars column to make it distinct from the debit account.
3. After each entry, a brief explanation of the transaction together with brief details is written in the Particulars column within brackets. This is called “Narration.”
4. Ledger Folio (L.F.) Column: All entries from the journal are posted to Ledger Accounts, later. The ledger page number containing the relevant account is entered at the time of posting. Till then, this column remains blank.
5. Debit Amount Column: In this column, the amount to be debited is entered.
6. Credit Amount Column: In this column, the amount to be credited is entered.

OBJECTIVE 9: MEANING OF JOURNALISING

9.1 Meaning

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.”

9.2 Process in 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

OBJECTIVE 10: ANALYSIS OF BUSINESS TRANSACTIONS

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.

OBJECTIVE 11: RECORDING THE RESULTS OF ANALYSIS

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. Bought goods— Purchases Account For cash — Cash Account
Step 2:	Classify the accounts. Purchase Account → Real Account Cash Account → Cash Account
Step 3:	Find out the rules of Debit and Credit. Purchase Account → Goods come in → Debit it Cash Account → Goes out → Credit it
Step 4:	Write down the account to be debited and credited. Purchase A/c     Dr.    To Cash A/c
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.”

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:

1. See, whether the name of the supplier is given.

   In this case it is not given.

2. Then ascertain whether the goods have been purchased for cash or on credit.

   Clue

   1. Supplier is not given.
   2. The word “Paid” or “For Cash” is shown. If the key word is given, it is cash transaction, if the keyword is missing, the transaction will be said to be on credit basis.

   In this case, it is cash purchase.

3. In case, if the name of the supplier is given along with the words “cash” — then it is said to be a cash purchase. (Note that the name of the supplier is immaterial for cash purchases.)

Solution

This transaction is of cash purchase.

 

Step 1:	The two accounts affected are Purchase Account Cash Account
Step 2:	Next, accounts are classified as Purchase Account: Real Account Cash Account: Real Account
Step 3:	Apply the Rules of Debit and Credit Real Account — What comes in — Goods comes in — To be debited Next part — Real Account — What Goes out — Cash has gone out — To be credited
Step 4:	Write the account to be debited and credited Purchase Account: Debit Cash Account: Credit

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 and Jain Account
Step 2:	Classify the accounts Purchase Account — Goods — a thing of value — so Real Account Jain Account — Personal Account
Step 3:	Apply the Rules of Debit and Credit Real Account — Goods come in — Debit Personal Account — Giver — Jain — Credit
Step 4:	Write the account to be debited and credited Purchase Account — Debit Jain Account — Credit

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 Raj Cash
Step 2:	Classify the accounts Raj — Personal Account Cash — Real Account
Step 3:	Apply the Rules of Debit and Credit Personal Account — Raj — the Giver — Credit the giver Real Account — Cash — Comes in — Debit what comes in
Step 4:	Write the name of the account to be debited and credited Cash A/c — Debit Raj’s A/c — Credit

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 Cash Account Sales Account
Step 2:	Classify the accounts Cash Account — Real Account Sales Account — Real Account
Step 3:	Cash comes in — Debit what comes in Goods goes out of business — Credit what goes out
Step 4:	Write the account to be credited and debited Cash Account — Debit Sales Account — Credit

Transaction 5

On Jan 7, 2009, goods sold to Kashyap for Rs 2,00,000.

Solution

 

Step 1:	Identify the two accounts Sales Account Kashyap Account
Step 2:	Classify the accounts Sales Account — Real Account (goods are affected) Kashyap — Personal Account
Step 3:	Apply the Rules of Debit and Credit Real Account — Goods goes out — Credit what goes out Personal Account — Debit the receiver
Step 4:	Write the account to be debited and credited Kashyap A/c — Debit Sales A/c — Credit

Transaction 6

On Jan 8, 2009, Bought Laptop from “E-Top Enterprises” for Rs 50,000.

Solution

 

Step 1:	Identify the two accounts Laptop and “E Top Enterprises”
Step 2:	Classify the accounts Laptop — Property — Real Account “E Top Enterprise” — Personal Account
Step 3:	Apply the Rules of Debit and Credit Laptop coming in — Debit what comes in “E Top Enterprise” — Credit the giver
Step 4:	Write the name of account to be debited and credited Laptop A/c — Debit “E Top Enterprises” A/c — Credit

Transaction: 7

On Jan 9, 2009, paid Rs 60,000 for goods received from Sun Textiles.

Solution

 

Step 1:	Identify the accounts affected Purchases Account Cash Account
Step 2:	Classify the accounts Purchase Account — Real Account Cash Account — Real Account
Step 3:	Apply the Rules of Debit and Credit Goods come in — Debit what comes in Cash goes out — Credit what goes out
Step 4:	Write the name of the account to be debited and credited Purchase A/c — Debit Cash A/c — Credit

Transaction: 8

On Jan 10, 2009, paid into Indian Bank Rs 15,000.

Solution

 

Step 1:	Identify the accounts affected Cash Account Bank Account
Step 2:	Classify the accounts Cash — Real Account Indian Bank — Personal Account
Step 3:	Apply the Rules of Debit and Credit Cash goes out — Credit what goes out Indian Bank — Debit the receiver
Step 4:	Write the name of the account to be credited and debited Indian Bank A/c — Debit Cash A/c — Credit

Transaction: 9

On Jan 11, 2009, withdrawn from the Bank Rs 15,000.

Solution

 

Step 1:	Identify the accounts affected Cash Account Bank Account
Step 2:	Classify the accounts Cash — Real Account Bank — Personal Account
Step 3:	Apply the Rules of Debit and Credit Cash Account — Real Account — Debit what comes in (cash comes in Bank Account — Personal Account — Giver — Credit the giver
Step 4:	Write the name of the account to be debited and credited Cash Account — Debit Bank Account — Credit

Transaction: 10

On Jan 12, 2009, Borrowed from the Bank Rs 3,00,000.

Solution

 

Step 1:

Identify the two accounts Cash Account Bank Loan Account

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 Cash Account is a Real Account Bank Loan Account is a Personal Account
Step 3:	Apply the Rules of Debit and Credit Cash Account — Real Account — Cash comes in — Debit what comes in Bank Loan Account — Personal Account — Giver — Credit the giver
Step 4:	Write the name of the account to be credited and debited Cash Account — Debit Bank Loan Account — Credit

Transaction: 11

On Jan 14, 2009, paid by cheque for the rent Rs 5,000.

Solution

 

Step 1:	Two accounts affected are Bank Account Rent Account
Step 2:	Classify the accounts Bank — Personal Account Rent — Nominal Account
Step 3:	Apply the Rules of Debit and Credit Nominal A/c — Rent — expense — Debit all expenses Personal Account — Bank — Giving for rent — Credit
Step 4:	Write the name of account to be credited and debited Rent Account — Debit Bank Account — Credit

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 Bank Account (State Bank of India A/c) Cash Account
Step 2:	Classify the accounts State Bank of India Account — Personal Account Cash Account — Real Account
Step 3:	Apply the Rules of Debit and Credit State Bank of India A/c — Personal Account — Receiver — Debit the receiver Cash Account — Real Account — Goes out — Credit what goes out
Step 4:	Write the name of the account to be credited and debited State Bank of India Account — Debit Cash Account — Credit

Transaction: 13

On Feb 15, 2009, received cheque from Gupta for Rs 15,000.

Solution

 

Step 1:	Identify the two accounts Cash Account Gupta Account
Step 2:	Classify the accounts Real Account Personal Account
Step 3:	Apply the Rules of Debit and Credit Real Account — Cash — Comes in — Debit what comes in Personal Account — Gupta — Giver — Credit the giver
Step 4:	Write the name of the account to be credited and debited Cash Account — Debit Gupta Account — Credit

Transaction: 14

On Feb 20, 2009, cheque received from Sekhar for Rs 20,000 and banked immediately.

Solution

 

Step 1:	Identify the two accounts Bank Account Sekhar Account
Step 2:	Classify the accounts Bank A/c — Personal Account Sekhar A/c — Personal Account
Step 3:	Apply the Rules of Credit and Debit Personal Account — Bank — Receives — Debit the receiver Personal Account — Sekhar — Gives — Credit the giver
Step 4:	Write the name of the account to be credited and debited Bank Account — Debit Sekhar Account — Credit

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 Bills Receivable Account Sharma’s Account
Step 2:	Classify the accounts Bills Receivable Account — Real Account Sharma’s Account — Personal Account
Step 3:	Apply the Rules of Credit and Debit Bills Receivable Account — Real A/c — Comes in — Debit Sharma’s Account — Personal A/c — Gives — Credit the giver
Step 4:	Write the name of the account to be credited and debited Bills Receivable Account: Debit Sharma’s Account: Credit

Transaction: 17

On Mar 5, 2009, Accepted the bill drawn by Shree for Rs 15,000.

Solution

 

Step 1:	Identify the two accounts Bills Payable Account Shree’s Account
Step 2:	Classify the accounts Bills Payable Account — Real Account Shree’s Account — Personal Account
Step 3:	Apply the Rules of Credit and Debit Real A/c — Goes out — Credit Personal A/c — Receiver — Debit
Step 4:	Write the name of the account to be credited and debited Shree’s Account: Debit Bills Payable Account: Credit

(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 Drawings Account Cash Account
Step 2:	Classify the accounts Drawings Account — Personal Account Cash Account — Real Account
Step 3:	Apply the Rules of Debit and Credit Personal A/c — Receives — Debit the receiver Real A/c — Cash goes out — Credit what goes out
Step 4:	Write the name of the account to be credited and debited Drawing A/c: Debit Cash A/c: Credit

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 Bank Account Group Insurance Account
Step 2:	Classify the accounts Bank Account — Personal Account — Gives — Credit the giver Group insurance A/c — Nominal A/c — Business expense — Debit the expenses
Step 3:	Apply the Rules of Credit and Debit Bank — Giver — Personal A/c — Credit the giver Group Insurance Premium — Nominal A/c — Business expenses — Debit the expenses
Step 4:	Write the name of the accounts to be credited and debited Group Insurance Account — Debit Bank Account — Credit

Transaction: 20

On Mar 10, 2009, Renu paid life insurance premium of Rs 1,200.

Solution

 

Step 1:	Identify the two accounts Cash Account L.I.C. Premium — Personal expense — it is to be taken as Drawings
Step 2:	Classify the accounts Cash — Real Account Drawings — Personal Account
Step 3:	Apply the Rules of Debit and Credit Drawings A/c — Receiver — Debit the receiver Cash A/c — Goes out — Credit
Step 4:	Write the name of the account to be credited and debited Drawings A/c — Debit Cash A/c — Credit

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 Investment Account (Purchase of shares is to be treated as investment) Cash Account
Step 2:	Classify the accounts Investment Account — Real Account Cash Account — Real Account
Step 3:	Apply the Rules of Debit and Credit Real Account — Investment — Property comes in — Debit what comes in Cash Account — Cash goes out — Credit what goes out
Step 4:	Write the name of the account to be credited and debited Investment Account — Debit Cash Account — Credit

Transaction: 22

On Mar 20, 2009, Bank collected dividends on Renu’s investments Rs 15,000.

Solution

 

Step 1:	Identify the two accounts Dividends Account Bank Account
Step 2:	Classify the accounts Dividend — Nominal Account (Business income — received on investments) Bank — Personal Account
Step 3:	Apply the Rules of Debit and Credit Bank A/c — Personal A/c — Receiver — Debit the receiver Dividend A/c — Nominal A/c — Income — Credit the income
Step 4:	Write the name of the accounts to be debited and credited Bank A/c — Debit Dividend A/c — Credit

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.

OBJECTIVE 12: TYPES OF ENTRIES

12.1 Simple Entry

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.

12.2 Compound Entry

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

12.3 Opening Entry

1. At the beginning of each accounting period, the business enterprises will have to record their transactions in the new books of account.
2. The accounts with balances in the previous year, will have to be recorded with the help of an entry — known as Opening Entry.
3. In this entry:
   • All assets are to be debited
   • All liabilities are to be credited
   • The difference between assets and liabilities will have to be credited as “Capital Account”¹

Example

OBJECTIVE 13: SOURCE DOCUMENTS — FORMATS, USES AND METHODS OF RECORDING

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.

13.1 Cash Memo

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.

13.2 Invoice

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

1. Term 5% 30 days means if the amount stated in the invoice is paid within 30 days, the purchaser will be entitled to a cash discount of 5% of the amount paid.
2. E and O.E. means if there is an overcharge or undercharge in the invoice due to any error or omissions, it is excepted. (Errors and Omissions Expected).

13.2.1 Trade Discount and Cash Discount

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

13.2.2 Distinction between Trade Discount and Cash Discount

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

13.3 Receipt

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.

 

 

13.4 Debit Note

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.

 

13.5 Credit Note

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.

 

13.6 Voucher

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.

 

 

13.7 Pay-in-slip

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.

13.8 Cheque

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.

OBJECTIVE 14: RECORDING OF TRADE DISCOUNT AND CASH DISCOUNT

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.

 

Notes:

(*1) List Price	Rs 50,000
Less 12% trade discount	Rs  6,000 Rs 44,000
(*2) List Price	Rs 2,00,000
Less 5% trade discount	Rs  10,000 Rs 1,90,000
(*3) Payment	Rs 95,000
(50% of Rs 1,90,000)	Rs  4,750
Less: Cash Discount @5%	Rs 90,250

Important Notes

1. As trade discount is shown in the invoice itself, no separate entry is needed.
2. For cash discount, it is entered as “Discount Received.”

For goods purchased and purchase returns, the following principles should be remembered always:

1. Total value of goods purchased is ALWAYS DEBITED to Purchases Account. If trade discount is allowed, then calculate the trade discount and deduct this from the total value of goods purchased and then enter this amount. (Refer transaction on Feb 10, 2009 in the above illustration.)
2. If cash discount is allowed, calculate the cash discount and credit the amount under “Discount Allowed” separately. (Because cash discount in no way after the purchase price). Here customer’s account (otherwise called Debtor’s Account) is to be debited with the total value of purchase. (Refer transaction on Feb 12, 2009 in the above illustration.)
3. In case of purchase returns, Purchase Returns Account is to be credited because purchase return is a real account. Goods Go out — What goes out is to be credited. Accordingly total value of goods returned is ALWAYS credited to Purchase Returns Account.

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

 

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
	Less: Trade
	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

1. Total value of goods sold is ALWAYS TO BE CREDITED.
2. Trade discount is always calculated at invoice price.
3. Trade discount is NEVER recorded in the books of account.
4. Goods are sold to customers on cash discount is allowed to customers (Debtors). Discount is allowed to customers for early payment. It is a loss to the seller. So it is debited here. But the account of customer (Debtor) has to be credited with full amount (including cash discount).
5. Profit of 25% on Cost = Profit of 20% on Sales. As such, the list price is to be calculated @ 25% on cost for both the transactions on 13.3.2009 and 15.3.2009.
6. Expenses not to be charged from customers, will not be included in the total invoice price. If it is to be charged from customer, then such expenses form part of invoice price.
7. “Sales Returns” Account is to be debited because “what comes in” has to be debited for real accounts. Accordingly, total value (invoice price) of goods returned is ALWAYS DEBITED TO SALES Returns Account.

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:

1. For transaction on April, two separate entries are needed because one relating to Gopal’s “Purchase” and the other relating to Thomas’s “Sales.”
2. In practise, goods supplied to travelling salesman for sale is noted in a separate book. No accounting entry is recorded. When he sells the goods, only for that entry is made. Here travelling expenses have to be borne by the seller, hence it is shown separately but forms part of the sales account.
3. Actual loss caused by fire is Rs 72,000 — Goods value is Rs 1,20,000. The insurance company pays proportionately. Hence, 1/6th of the claim not admitted. That amount (1/6 of Rs 72,000) is transferred to Profit and Loss Account.

	(i.e.) Proportionate amount Rs1,	=
		=	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

 

Notes:

1. If both sale price and cost price are given, always ignore sale price. Amount relating to cost alone has to be recorded.
2. All the transactions shown in this illustration relate to selling activity. Due to the cause mentioned. purchase account is credited (goods moved out of the business).
3. Any loss incurs, it is a loss to business and as such it has to be debited.
4. In making furniture, amount spent related to furniture.
5. Charity is a business expense. It is a nominal account. All expenses are to be debited.

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.

 

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.

 

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.     Bad Debt — Nominal Account — Loss — All losses have to be debited.
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:

1. Wages A/c     Dr.     1,000

   To Cash A/c           1,000

   (Wages paid for erection of plant)

2. Plant A/c     Dr.     1,000

   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

OBJECTIVE 15: ACCOUNTING EQUATION APPROACH — MEANING AND CLASSIFICATION OF ACCOUNTS

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:

 

15.1 Meaning 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.

15.2 Classifications of Accounts

Accordingly, accounts are classified into five categories.

1. Assets Account
2. Liabilities Account
3. Capital Account
4. Account of Expenses and Loss items
5. Account of Income and Gain items or Revenue Account

Illustration: 13

Classify the following accounts as per accounting equation approach:

1. Capital brought in
2. Land purchased
3. Purchases
4. Sales
5. Cash paid
6. Cash received
7. Subscription received
8. Furniture purchased
9. Sales returns
10. Purchase returns
11. Bank A/c
12. Wages paid
13. Bank overdraft
14. Outstanding salary
15. Interest accrued

Solution

1. Capital A/c
2. Assets A/c
3. Expenses A/c
4. Revenue A/c
5. Assets A/c
6. Assets A/c
7. Revenue A/c
8. Assets A/c
9. Revenue A/c
10. Expenses A/c
11. Assets A/c
12. Expenses A/c
13. Liabilities A/c
14. Liabilities A/c
15. Assets A/c

OBJECTIVE 16: RULES OF DEBIT AND CREDIT AS PER ACCOUNTING EQUATION APPROACH

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 Credit the decrease.
7. Subscription received	Revenue Account or Income and Gains Account	Debit the decrease and Credit the increase.
8. Furniture purchased	Assets Account	Debit the increase and Credit the decrease.
9. Sales returns	Revenue Account or Income and Gains Account	Debit the decrease and Credit the increase.
10. Purchase returns	Expenses Account	Debit the increase and Credit the decrease.
11. Bank A/c	Assets Accounts	Debit the increase and Credit the decrease.
12. Wages	Expenses Account	Debit the increase and Credit the decrease.
13. Bank overdraft	Liabilities Account	Debit the decrease and Credit the increase.
14. Outstanding salary	Liabilities Account	Debit the decrease and Credit the increase.
15. Interest accrued	Assets Account	Debit the increase and Credit the decrease.

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.

16.1 Accounting Equation Reaming and Features

	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.

OBJECTIVE 17: ANALYSIS OF BUSINESS TRANSACTIONS APPLYING ACCOUNTING EQUATION TECHNIQUE

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:

1. Items comprising assets (as shown in the equation) are written under the column “Assets.”
2. Similarly items comprising liabilities (as shown in the equation) are written under the column “ Liabilities.”
3. The total of Assets and the total of Liabilities will always be equal.

• Accounting Process: This process starts with recording of business transactions and ends with preparation of final accounts.
• Business Transactions: Transactions between two or more persons resulting in exchange of money or money’s worth. Every business transaction has a two-fold fact which affects the parties involved — one party extends benefit and the other party receives the benefit.
• Business transactions are classified into — Cash Transactions — Credit Transactions and — Non-cash Transactions.
• Account: It is a summary of relevant business transactions at one place relating to a particular head. Accounts are classified into Personal, Real and Nominal Accounts — Examples.
• Entry: Recording of business transactions in an account is referred to as “entry.”
• Double Entry: The system which recognises the two-fold aspects for every business transaction is known as Double Entry System.
• Methods of Recording Business Transactions — traditional and accounting equation.
• Traditional Approach: Golden Rules of Debit — Credit:
  1. Personal Accounts: Debit the receiver and Credit the Give.
  2. Real Accounts: Debit what comes in and Credit what goes out
  3. Nominal Accounts: Debit all expenses and losses and Credit all incomes, gains and profits.
• Journal: A Journal is a book in which transactions are originally recorded in the chronological order as per the principles of Double Entry System.
• Journalising: 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.”
• Process of journalising involves two stages — Analysing the business transactions and Recording the result of analysis in the book of Journal.
• Types of Entries — Simple Entry, Compound Entry and Opening Entry.
• Source Documents: These are evidences of business transactions which provide information about the nature of transaction — the date, the amount and the parties involved.
• Cash Memo, Invoice, Receipt, Debit Note, Credit Note, Pay-in-slip, Cheque and Vouchers are source documents. Specimen features and method of recording are explained (Refer Main Text).
• Purchases Returns Account is to be credited and Sales Returns Account is to be debited.
• Cash Discount: It is the reduction offered by the supplier from the invoice price for immediate payment or in a stipulated time. It is shown in the invoice and not shown in ledger.
• Trade Discount: It is the reduction in payment offered by a supplier from the list price of goods or services on business considerations other than prompt payment. It is not shown in invoice but shown in the ledger accounts.
• Accounting Equation Approach: Transactions are to be recorded on the basis of accounting equation:

   

  Assets = Liabilities + Capital

   

• As per approach, accounts are classified into five categories: (i) Assets Accounts, (ii) Liabilities Account, (iii) Capital Account, (iv) Accounts of Expenses and Loss items and (v) Accounts of Income and Gain items or Revenue Account.
• Rules for Debit and Credit as per Accounting Equation basis:
  1. Assets Account: Debit the increase and Credit the decrease
  2. Liabilities Account: Debit the decrease and Credit the increase
  3. Capital Account: Debit the decrease and Credit the increase
  4. Incomes and Gains: Debit the decrease and Credit the increase
  5. Expenses and Loss: Debit the increase and Credit the decrease

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)

1. There must be at least __________ parties to a transaction.
2. One party __________ the benefit and the other party gives such benefit in a business transaction, in exchange for an equivalent value.
3. The business transaction involves an exchange or transfer of _____ or _____ relating to goods or services.
4. An account is a _____ of business transactions.
5. Recording of a business transaction in an account is called __________.
6. There are two main types of accounts namely __________ and Impersonal accounts.
7. Persons to whom the goods have been sold on credit are called __________.
8. Persons who have supplied goods on credit (or) who have advanced loans to the business enterprises are called __________.
9. Accounts in the name of natural persons accounts is a __________.
10. Accounts of legal entities or (artificial) is __________.
11. Accounts of different persons of the same nature but more than one, is referred to as __________.
12. Real account consists of both tangible real accounts and __________ accounts.
13. Accounts of income and gains, and expenses and losses are known as __________ accounts.
14. Valuation accounts are also known as __________ accounts.
15. Items of expenses (such as salary account, rent account, interest account) account are nominal accounts whereas the respective item is shown as outstanding expenses (such as outstanding salary, outstanding rent and outstanding interest) are __________.
16. The accounting system which recognises the twofold aspect of every business transaction is known as “__________”.
17. The two aspects of each business transaction are depicted in terms of __________ and __________.
18. The golden rule of double entry system is:
    1. _____ the account that receives the benefit
    2. _____ the account that gives the benefit
19. For personal accounts __________ the receiver and __________ the giver.
20. For real accounts: debit what __________ and credit what __________.
21. For nominal accounts: all incomes and gains are __________ and all expenses and losses are __________.
22. A daily record in which all daily transactions are first recorded chronologically is referred to as “__________”.
23. For every debit, there should be a corresponding __________.
24. American way of journalising is also based on “__________”.
25. In all cases of entries the sum of debits must be equal to the __________.
26. Accounting Equation is expressed as: Assets = __________ + Capital.
27. Accounting Equation must remain __________ at all times.
28. As per Accounting Equation approach, the assets and the __________ are always equal.

Answers

1. Two
2. Receives
3. Money or money’s worth
4. Summarised record
5. Entry
6. Personal
7. Debtors
8. Creditors
9. Personal account
10. Personal account
11. Representative Personal A/c
12. Intangible real
13. Nominal
14. Contra
15. Personal
16. Double Entry System
17. Dr. (Debit) and Cr. (Credit)
18. 1. Debit
    2. Credit
19. Debit; Credit
20. Comes in; goes out
21. Credited; debited
22. Journal
23. Credit
24. Double entry
25. Sum of credits
26. Liabilities
27. Balanced
28. Claims on the assets

II. State whether the following statements are True or False

1. A business transaction not necessarily involves an exchange of money or money’s worth.
2. Business transactions are classified into Cash Transactions, Credit Transactions and Non-cash Transactions.
3. Depreciation is a credit transaction.
4. Only one account is prepared for all transactions and it is not prepared for each and every item.
5. Credit transactions are always nominal account.
6. Accounts of legal entities in the nature of limited companies accounts belong to groups or representative personal accounts.
7. Goodwill is a tangible account.
8. Bad debt is a nominal account.
9. Valuation accounts are also known as Contra Accounts.
10. Interest received in advance is a Personal Account.
11. Insurance Premium Account is a Personal Account.
12. The giving and receiving aspects take place between accounts and in different account books and not in the same set of books.
13. The giving and receiving aspects of a business transaction must be recorded simultaneously and at the same time.
14. Double Entry System means recording each transaction twice.
15. Every debit must have a corresponding credit
16. A Goods account is generally not opened.
17. In accounting, transactions are recorded on the basis of business entity concept.
18. The business transactions are not recorded chronologically.
19. The terms “General Journal” and “Journal Paper” both denote the same meaning.
20. A Journal is a permanent record of the business
21. Each transaction is provided with an explanation (written at the end of transaction briefly within brackets) is referred to as “narration.”
22. The application of debit-credit rules do not apply to American approach of journalising.
23. The accounts with the balances in the previous year, comprising Real and Personal Accounts are entered in the new books of account with the help of “Opening Entry.”
24. In an Accounting Equation Approach, transactions are analysed in terms of variables: assets, liabilities, capital, revenues and expenses.
25. In an Accounting Equation Approach, decrease in an asset item is debited
26. In an Accounting Equation Approach, decrease in liability is debited
27. In an Accounting Equation Approach, increase in Capital is debited
28. In an Accounting Equation Approach, increase in an expense item is debited
29. Increase in an income item is debited as per American procedure.
30. Journal entry will be the same for both the conventional approach and accounting equation approach in recording business transactions.

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

1. Define Double Entry System.
2. Explain the principles of Double Entry System.
3. What are the advantages of Double Entry System?
4. What are the two different approaches of recording of business transactions?
5. How are accounts classified?
6. Write short notes on personal accounts.
7. Give examples to real accounts.
8. Explain nominal accounts with examples.
9. What are the golden rules of accounting?
10. What do you mean by an “entry”? What is an Opening Entry?
11. How accounts are classified under accounting equation approach?
12. What is a “journal”?
13. What are special journals? Name any four of the Special Journals.
14. Distinguish between a simple entry and a compound entry.
15. What do you mean by “double compound entry”?
16. Explain “Accounting Equation Approach.”

1. Define “journal.” What are its special characters? What are the advantages of a “journal”?
2. Explain the term, “journalising.” Explain with a simple illustration, the procedure to be followed for making entry in the general rule.
3. What do you mean by the American way of journalising? How accounts are classified under this approach? Explain the debit and credit rules to be applied under this category.

1. Analyse the following business transactions: accounts affected, classification of accounts, apply rules of debit and credit
   1. Sri Ram commences a business with a capital of Rs 5,00,000 in the name of Ram Enterprises.
   2. Bought goods for Rs 1,00,000.
   3. Bought goods from Jain for Rs 75,000.
   4. Goods sold to Gupta for Rs 90,000.
   5. Goods sold to Lal for cash Rs 60,000.
   6. Bought machinery for cash Rs 2,20,000.
   7. Paid into State Bank of India Rs 55,000.
   8. Bought office furniture from Modern Furn Mart for Rs 45,000.
   9. Received rent Rs 3,000.
   10. Paid salary to staff Rs 65,000.
   11. Bought shares in Real Ltd for Rs 15,000.
   12. Paid Ram’s insurance premium Rs 3,300.
   13. Withdraw from Bank Rs 10,000.
   14. Bank collected dividends on investments on our behalf Rs 6,200.
   15. Received from Ashok a bill at two months for Rs 25,000.
   16. Accepted the bill drawn by Sathyam Rs 55,000.
   17. Paid by cheque for an advertisement Rs 7,500.
   18. Paid by cheque for rent Rs 11,000.
   19. Received commission from Balu and Co. Rs 3,500.
   20. Paid for repairs (office) Rs 3,000.
2. Journalise the following transactions in the books of Mr. Vas.
   1. Vas started his business with cash Rs 1,00,000.
   2. Purchased goods from Star and Co for cash Rs 20,000.
   3. Bought office furniture for cash Rs 7,500.
   4. Bought from Kumar, goods on credit for Rs 30,000.
   5. goods to Ravi for Rs 5,000 against a cheque.
   6. Purchased machinery from Biswas and Co. for Rs 1,00,000 out of which Rs 40,000 was paid by cheque.
   7. Paid office rent Rs 6,000.
   8. Received from Shekar Rs 4,850 in full settlement of his account for Rs 5,000.
   9. Salary to a salesman paid by cheque Rs 9,000.
   10. Received as commission Rs 350.
   11. Withdrawn cash from bank Rs 6,000 for personal use.
   12. Cash deposited into Bank Rs 10,000.
   13. Received on sale of investments Rs 37,000.
   14. Bank paid directly insurance premium Rs 1,100 for Vas.
   15. Paid Rs 300 for repair to furniture.
   16. Wages paid for erection of machinery Rs 600.
   17. Purchase of a computer on credit from Aditya and Co for Rs 40,000.
   18. Issued a cheque in favour of Aditya and Co for the purchase of a computer.
   19. Paid rent by cheque Rs 2,900.
   20. Paid electricity bill Rs 700 for the month.
   21. Paid for stationery Rs 250.
   22. Bank collected interest on our investments Rs 1,200.
   23. Bought shares in XY Ltd. for Rs 20,000.
   24. Received Rs 15,000 from Devi by cheque.
   25. Paid Devi’s cheque into Bank for Rs 15,000.
3. Analyse the following transactions by applying Accounting Equation Approach.
   1. Mr. Roy started his business with Rs 1,70,000 from his personal funds.
   2. He invested additionally in the form of machinery worth Rs 50,000.
   3. He purchased additional machinery for cash Rs 10,000.
   4. He purchased goods for Rs 15,000.
   5. Creditors were paid Rs 5,000.
   6. He sold goods costing Rs 10,000 for Rs 15,000.
   7. He paid for the following expenses:

      Salaries — Rs 3,000

      Rent — Rs 1,500

      Repairs — Rs 500

      Electricity — Rs 600

   8. He withdraws Rs 2,500 cash for his personal use.
   9. Machinery was depreciated by Rs 1000.
   10. Sold goods for cash Rs 30,000.