module 4.docx

**Module 3** **RECORDING TRANSACTIONS** SOME IMPORTANT TERMS IN ACCOUNTANCY CAPITAL: The amount invested in business is known as capital. It refers to the financial resources utilised for acquisition of assets for the purpose of generating revenue. It is the liability to its proprietor. Liabilit...

**Module 3** **RECORDING TRANSACTIONS** SOME IMPORTANT TERMS IN ACCOUNTANCY CAPITAL: The amount invested in business is known as capital. It refers to the financial resources utilised for acquisition of assets for the purpose of generating revenue. It is the liability to its proprietor. Liability: Liability is the debts owing by business to others. Equity: Equity is the total claim against the assets of the business. It is classified into owners\' equity and creditors\' equity: Owners\' equity refers to owners\" claim against the assets of the business (generally known as capital). Creditors equity refers to creditors\' claim against the assets of the business (generally known as liabilities). Assets: Assets are valuable things or properties owned by a business. It also includes the amount due to the business by others. In short, assets are the resources owned by the business. Expense: Expense is the amount spent on any item by the businessman to acquire benefits out of it. It is the cost consumed (used or utilized) in generating revenue. It is an expired cost. It is the cost relating to the operation of an accounting period. Expenditure: Incurring a liability or disbursement of cash for the purpose of obtaining assets Revenue: It is the amount realized or receivable from the sale of goods or assets or both. It also includes the receipts of rent, commission, discount etc. Income: It is the excess of revenue over expense. Goods: Goods are those articles which are purchased for resale or for producing the finished products which are meant for sale. These include articles or things in which the enterprise deals in. For example, a cloth merchant deals in cloth (goods). Purchase: It refers to purchase of goods in which business deals in for cash or on credit basis. Sales: It refers to sales of goods in which business deals in for cash or on credit. Turnover: It refers to sale in relation to any specific period. It is the sales made during an accounting period. Stock: It is the value of goods lying unsold on a particular date. Inventories: It includes value of raw materials, semi-finished goods and finished goods meant for resale. Debtors: Debtors are those persons who owe money to the business. Trade debtors are those persons who owe money on account of goods sold on credit Trade creditors : Trade creditors are those who supply goods to the business on credit basis (i.e. goods are purchased from them on credit). Drawings: It is the amount of cash or goods withdrawn by the proprietor from business for his personal use Account: It is a summary of various business transactions relating to a particular person, asset, expense or income for a given period of time. **Business Transactions** Every business activity is not an accounting activity. That is why every activity is not recorded in the books of accounting. We record only business transactions in accounting. Transaction is an event which involves transfer (exchange) of money or money\'s worth between the business and outsiders including the owner. For example, a business sells goods to a person for cash or on credit is a transaction. This event involves transfer of goods from the business to an outsider. The word \'transaction\' is mathematically defined as follows: Transaction Action + Money **Features of Business Transactions** 1\. They are financial in nature. 2\. They are supported by documentary evidence. 3\. They are expressed in numerical and monetary terms. 4\. They cause an effect on assets, liabilities, capital, revenue and expenses. **Types of Business Transactions** Business transactions are of the following types: \(a) Cash transaction: Any business transaction which involves immediate payment or receipt of cash is known as cash transaction. For example, sale of goods for cash is a cash transaction. \(b) Credit transaction: In a credit transaction, there is no immediate payment or receipt or cash. The settlement of payment or receipt of cash is done at a later date. For example, goods are purchased on credit is a credit transaction. \(c) Non-cash transaction: This transaction does not involve any payment or receipt of cash either immediately or at a later date. Examples of such transactions are depreciation, return of goods etc. **Identification of Cash Transactions or Credit Transactions** There are certain rules to identify whether a transaction is cash or credit. When the name of a person or party is given in the transaction, and nothing is mentioned about cash, then it should be treated as a credit transaction. When cash is mentioned in a transaction (name of the party is given or not), it should be treated as a cash transaction. There are certain transactions in which payment of cash or receipt of cash is implied in them (even if name of party is is given), such transactions should be treated as cash transactions. For example, transactions such as \'paid salary\', \'received commission\', \'received commission from Mohan\', \'purchased assets\' etc. are cash transactions. When the transaction contains the word \'paid\', definitely it is a cash transaction. Example 1 Indicate whether the following transactions are cash or credit: \(a) Started business with Rs. 20,000 \(b) Purchased goods for Rs. 7,500 \(c) Sold goods for Rs. 5,000 \(d) Purchased goods from Rsju for Rs. 2,500 \(e) Purchased goods from Shiju for cash Rs. 1,000 \(f) Sold goods to Anil for Rs. 1,000 \(g) Paid Salaries Rs. 4,000 \(h) Received commission Rs. 500 \(i) Paid rent to Raghavan (land lord) Rs. 1,500 \(j) Bought furniture for cash Rs. 2,000 Solution \(a) This is a cash transaction because business is started with cash (i.e. capital). Cash comes in the business. \(b) This is a cash transaction because the name of the party is not given. This means goods are purchased by paying cash. If goods are purchased on credit, the name of the party from whom goods are bought should have been given. \(c) This is a cash transaction because name of the party is not given. This means goods are sold for cash. If goods are sold on credit, the name of the party to whom goods are sold should have been mentioned. \(d) This is a credit transaction because name of the person from whom goods are bought is given. \(e) This is a cash transaction because cash is mentioned in it. When cash and name of party are given in a transaction, it should be treated as a cash transaction (name of party becomes irrelevant). \(f) This is a credit transaction because name of the person is mentioned in the transaction. \(g) This is a cash transaction because salaries are paid in cash. (h) This is a cash transaction because commission is received in cash. \(i) This is a cash transaction because rent is paid in cash. The name of the party (land lord) to whom rent is paid in immaterial. \(l) This is a cash transaction. Even if cash is not mentioned in the transaction, it will be a cash transaction unless and until the name of the party is given. **Double Entry System** Double entry system is as old as business itself. It has existed since time immemorial. But it was in 1494, the modern system of bookkeeping took its birth in Venice (in Italy) when Luca Pacioli (Italian Monk and Mathematician) published his book titled \'Summa De Arithmetica Geometrica Proportioni et Proportionalita\'. He is considered to be the father of modern accounting. He published his later work \'De Divina Proportione\' in 1509. Thereafter, a series of works were published. The most important of them was the one published in 1795 by Edward Jones. For every transaction, two parties are required. Between these parties there is the exchange of equal values. Accordingly, every transaction has two aspects or elements or effects. One is receiving aspect and the other is giving aspect. (The receiving aspect of a transaction is known as debit and the giving aspect of the transaction is known as credit. Thus, every transaction has two aspects, namely debit aspect and credit aspect. For example, when A sells goods to B for Rs. 20,000, A exchanges goods for money. A gets money and he gives away goods. In this transaction, cash is the receiving aspect (debit) and goods is the giving aspect (credit). In order to record a transaction completely, it is necessary to record both aspects of the transaction. The method of recording the two fold aspects of every transaction is called double entry system. When the two-fold aspects of a transaction are recorded, we can say that \"every debit has an equal and corresponding credit\". To conclude, double entry system is the system of recording both aspects of every transaction in order to maintain the equality between debit and credit. **Meaning of Debit and Credit** The word debit is derived from the Latin word \'Debitum\'. It means, due for that. In short, receiving aspect of a transaction is known as debit. The word \'Credit\' is derived from the Latin word \'Creder\', It means \"Due to that. In short, the giving aspect of a transaction is known as credit. The abbreviations \'Dr.\' for debit and \'Cr.\' for credit are generally used. **Advantages or Merits of Double Entry** The main advantages of double entry system are as follows: 1\. It provides a complete record of each and every transaction because both aspects of every transaction are recorded. 2\. It is scientific system of accounting. 3\. In double entry system, a total debit is always equal to total credits. Hence a trial balance can be prepared to check the arithmetical accuracy of accounts. 4\. With the help of trial balance, a trader can prepare Trading and Profit and Loss Account to know the profit or loss earned by the business during a particular period. 5\. It is possible to find out the exact reasons for the profit earned or loss incurred. 6\. Under this system, all business transactions are recorded completely, perfectly and systematically. Therefore, chances of errors and frauds are reduced. 7\. It is possible to judge the progress of the business by comparing the results of the previous year with those of the current year. 8\. It is easy to prepare a balance sheet. It is helpful in ascertaining the financial position of the business. **ACCOUNTING EQUATION** Accounting equation is another form of dual aspect concept. It was derived by the American accountants. We know that every business transaction has two aspects, namely, debit and credit. These two aspects give birth to accounting equation. Accounting equation indicates the fact that for every debit there is a corresponding and equal credit. Thus accounting equation is a statement of equality between debit and credit. The accounting equation tells that the assets of a business are always equal to equities. The relation between assets and equities expressed in the form of an equation is known as Accounting Equation. The basic accounting equation is as follows: ει το σ Assets = Equities Assets are the resources on which the business is carried on. If there are assets, there are also claims against the assets. The claims against the assets (i.e. right to assets or properties) are known as equities. Equities may be divided into two equity of owners and equity of creditors. Equity of owners (internal equity) is called capital. It represents the owners\' claims (rights) in the assets. Equity of creditors represents the debit of the business. These are known as liabilities or external equity. External equity represents the outsiders\' claims in the assets. Now the accounting equation may be restated as follows: Assets = Liabilities + Capital Or Capital = Assets - Liabilities Or Liabilities =Assets -- Capital The accounting equation gives a foundation to the double entry system. It forms the basis of recording business transactions in the books of account. In is on the basis of accounting equation, Balance Sheet is prepared. Hence accounting equation is also known as balance sheet equation. Even if there is a change in any asset or any liability or capital, assets will be equal to liabilities plus capital. The following points may be noted: \(a) One asset increases and another asset decreases due to a transaction (total remains the same). \(b) One asset increases and a liability also increases due to a transaction. \(c) One asset decreases and another asset increases due to a transaction (total remains the same) \(d) One asset decreases and a liability also decreases due to a transaction. \(e) One liability increases and another liability decreases on account of a transaction (total remains the same). \(f) One liability increases and an asset also increases due to a transaction. \(g) One liability decreases and another liability increases on account of a transaction (total remains the same) \(h) One liability decreases and an asset also decreases due to a transaction. In all the above cases assets are equal to total of capital and liabilities. **Effect of Transactions on Accounting Equation** Every business transaction has an effect on assets or equities or both. This means each and every transactions has an effect on the accounting equation (sometimes total of equation remains the same). Let us understand the effect of the given transactions on the accounting equation: 1\. Ravi started business with a capital of Rs. 1,00,000- As a result of this transaction, assets (worth Rs. 1,00,000) in the form of cash come in. In the same time business owes Rs. 1,00,000 to Ravi. This is the capital. This is the claim of the owner in the business assets (i.e. internal equity). Now there is no external equity. The accounting equation is Assets Cash = Equities (Equity Capital + Liabilities) = Capital (Internal equity) 2\. Purchased furniture for cash Rs. 25,000- Business receives furniture and ash goes out from the business. This reduces cash balance by Rs. 25,000 while a new asset (furniture) comes in. This transaction will affect only the assets (total of equation remains the same). The equation would be: Assets - Equities Cash + Furniture Capital 75,000+25,000 = 1,00,000 3\. Purchased goods worth Rs. 10,000 from Sreenivas - By purchasing goods on credit, goods (stock) come into the business as an asset. On the other side, liabilities (creditors) will be increased. Now the accounting equation is: Assets Equities (Equities include both internal and external) Cash+ Furniture + Stock Capital + Liabilities 75,000+25,000+10,000 = 1,00,000+10,000 1,10,000 1,10,000 Outsiders have a claim of Rs. 10,000 in the assets. This is the external equity or liabilities. 4\. Goods costing Rs. 4,000 sold to Shaji for Rs. 6,000- On account of goods sold on credit the stock (goods) will be reduced by Rs. 4,000 (i.e. cost) and assets (i.e. debtors) will be increased by Rs. 6,000. On the other side capital or equities will be increased by Rs. 2,000 (i.e. profit on sale). The profit (selling price cost price) goes to the owner and becomes a part of capital or internal equity. Now the accounting equation would be: Assets Equities Cash + Furniture + Stock + Debtors Capital + Profit + Liabilities 75,000+25,000+6,000+6,000 1,12,000-1,12,000 1,00,000+2,000+ 10,000 Now the total assets are worth Rs. 1,12,000. Out of this, owners\' claim is Rs. 1,02,000 and creditors claim is Rs. 10,000. 5\. Paid expenses Rs. 1,500-As a result of this transaction, cash (asset) will be reduced by Rs. 1,500. On the other side profit will be reduced by Rs. 1,500 due to expenses. Now the profit will be Rs. 500 only. The accounting equation is: Assets =Equities Cash Furniture Stock Debtors Capital Profit Liabilities 73,500 25,000+6,000 6,000-1,00,000+500+10,000 1,10,500=1,10,500 The accounting equation may also be stated as follows: Assets =Liabilities +Capital +Incomes -- Expenses 73,500+25,000+6,000+6,000-10,000+ 1,00,000+2,000-1,500 Conclusion: Every transaction has two aspects. But in all cases assets are equal to equities. Hence accounting equation is true in all cases. **Account** In accounting we keep a separate record of each and individual assets, liabilities, expenses, incomes, equities etc. The place where such a record is maintained is known as an account. It is a place where similar transactions which take place during a period are summarized and accumulated. For example, all cash transactions will be summarized and accumulated in a separate account called cash account. Similarly, all transactions relating to an asset will be recorded in that asset account, all transactions relating to a person will be recorded in that person\'s account, etc. **Classification or Types of Accounts** The accounting equation reminds us that into the following five categories: nts can be classified 1.Asset accounts. 2\. Liability accounts. 3\. Capital accounts. 4\. Revenue accounts, 5\. Expense accounts. The account can also be classified in a different manner, as given below: 1\. Real accounts: These are the accounts of assets or properties of business. Examples of real accounts are cash account, land and building account, furniture account, machinery account etc. 2\. Personal accounts: These are the accounts relating to persons with whom business deals. Personal accounts may be of the following three types: \(a) Natural person\'s account: These are the accounts of human beings. Examples include Midhun\'s account, Joseph\'s account, Thufail\'s account etc. b\) Artificial person\'s account: These are the accounts of artificial persons created by law. Examples include firm\'s account, company\'s account, educational institution\'s account, bank account, co-operative society\'s account etc. \(c) Representative person\'s account: An account indirectly representing a person or persons is known as representative person\'s account. Outstanding expense account, prepaid expense account, outstanding incomes account etc. are examples of representative personal account. 3\. Nominal accounts: Accounts relating to income, revenue, gain, expenses and losses are called nominal accounts. These are also known as fictitious account (accounts in name only). Rent account, salaries account, wages account, discount account, commission account etc. are some of the examples of nominal accounts This classification of accounts is common classification. **ACCOUNTING PROCESS** Accounting process begins with recording transactions either in the journal or in the subsidiary books and ends with preparation of trial balance and final accounts**.** **Accounting cycle** When a businessman stars his business, he records the day to day transactions in the \'Journal\' or Subsidiary Books. From the journal, the transactions move further to \"Ledger\'. Here entries are posted in the appropriate accounts. Then accounts are balanced to get the effect of debit and credit. These balances move to a statement called \'Trial Balance\'. From the trial balance the account balances travel to Trading and Profit and Loss Account. Remaining balances (including the balance of P/L A/c) will move to the destination of the period i.e., Balance Sheet. Thus the journey of the transaction ends. During this journey the transactions reach at different stages or stations till they reach at the final accounts (Trading and Profit and Loss Account). The different stages through which the transactions travel until the final accounts are prepared are collectively known as \'Accounting Cycle\'. The cyclic movement of the transactions through the books of accounts in a continuous process is known as Accounting Cycle. In short, starting from transactions and ending with the preparation of a balance sheet is known as Accounting Cycle. It is also known as Accounting Process. **JOURNAL** The word \'Journal\' is derived from the French word Jour. It means \'Day\'. Therefore, journal means daily record. It is the daily record of business transactions in a chronological order. It is a chronological record in the sense that transactions are recorded in the journal in the order in which they occur i.e. in the order of dates. It is a book of original entry because transactions are first recorded in the journal. In short, journal is a primary record of business transactions. The five columns of journal are explained as follows: 1\. Date: In the first column, date of the transaction is recorded. The year is recorded at the top. Below it month and day are recorded. 2\. Particulars: In the second column, the names of the account will be debited and credited (debit aspect and credit aspect) are to be recorded. First the name of the account to be debited (debit aspect or debit entry) is entered in the extreme left of the particulars column. The symbol \'Dr\' (Debtor) is written at the right end of the particulars column on the same line of the debit entry. This indicates that the account is debited. In the next line the name of the account to be credited (Credit aspect or Credit entry) should be written after leaving some space to the left. The credit entry begins with \'To\'. This indicates that the account is credited. Then 2ma brief explanation should be given as to why one account is debited and the other is credited. This is known as \'Narration\' It is given in brackets 20 3\. Ledger Folio (L.F): This column is not filled at the time of recording in the journal. It is used for recording page number of the ledger to which the journal entry is posted or transferred. 4\. Debit Amount: The fourth column is used to record the debit amount. I is written on the same line of debit entry. 5\. Credit Amount: The fifth column is used o record the credit amount. It is written on the same line of credit entry. Note: The recent trend is to omit the word \'Dr\' and \"To\' from journal entries. **Important Terms** Journalising: The process of record known as journalizing. of recording transactions in the journal is bloof 2\. Journal Entry: The record of each transaction in a journal is known as journal entry. Every transaction has two aspects. Therefore, there are two entries. One is debit entry and the other is credit entry. Thus, a journal entry consists of debit entry and credit entry for a transaction. 3\. Narration: A brief explanation of a transaction given in brackets below the journal entry in the particulars column is called narration. **Steps in Journalising** The following are the different steps to be followed in journalizing transactions: 1\. First read the transaction carefully and find out the two accounts (aspects) involved in the transaction. 2\. Then find out which category these accounts belong, i.e, real, or personal, or nominal. 3\. Apply the rules of debit and credit and find out which account is to be debited and which is to be credited. 4\. Enter the date of the transaction in the date column. 5\. In the particulars column write the debit entry and in the next line write the credit entry. 6\. Give narration below the journal entry in the particulars column. 7\. Enter the amount in the \'Debit\' and \'Credit\" columns. 8\. After every journal entry, a thin line should be drawn in particular column, so that each entry is separated. **Points to be Noted while Passing Journal Entries** 1. While passing journal entries, the proprietor should be considered as a separate person with whom business deals. All transactions are recorded in the books of the business and not in the books of the proprietor. 2\. It is not necessary to use the word A/c or Account after the personal accounts. The modern trend is to omit the word A/c 'Account' after all accounts (real, nominal and personal accounts). 3\. When it is not clearly started in the problem whether a transaction is on cash basis or on a credit basis, and when the name For example, sold goods Rs.5000, it should be of the party is not giver. considered as on cash basis. 4\. When the name of the party is given and there is no mention of cash paid or received, it should be considered as a credit transaction. For example purchased goods from Lal, should be treated as on credit. 5\. When the word \'received\' or \'paid\' appears in the transaction, it mears cash is received or paid. For example, received dividend means cash s received by way of dividend. 6\. The articles or products in which a firm deals are called goods. For example, a clothes merchant deals in cloths (goods), a furniture company deals in furniture (goods) 7\. When goods are purchased, the term \'Purchase Account\' should be used (Purchase A/c is debited). When assets are purchased, Assets Accounts are debited (not Purchase A/c). 8\. When goods are sold, the term \"Sale Account\' should be used (Sales A/c is credited). When assets are sold, Assets Accounts are credited (not Sales A/c) 9\. In case of nominal accounts if the name of the receiver or giver is given in the transaction, then there is no need to bother. For example, salary paid to Shyam should be debited in salary account and not in Shyam\'s account. Similarly, commission received from Raju is credited in commission account and not in Raju\'s account. 10\. Whenever the proprietor of a business brings cash or any other assets into the business an account called Capital Account should be opened in the name of the proprietor. Suppose the proprietor introduces cash into hi business. Here the two accounts involved are Cash A/c and Capital A/c (A c is the short form of Account). When business is started with assets alon with cash, the assets are to be debited and the total amount brought in credited to capital account. **Objects of journal** 1. To simplify ledger 2\. To provide an adequate explanation of each entry (through narration) from journal itself. 3\. To ensure observance of double entry system 4\. To help in solving misunderstanding and disputes in the business. **Advantages/Uses/Importance of Journal** 1\. It provides date wise record of all the transactions. This facilitates quick and easy reference of any transaction. 2\. It provides complete record of all the transaction at one place. 3\. By providing narration to each entry, journal helps to understand the purpose and nature of the entry. 4\. Since the amounts to be debited and credited are written side by side, the two can be compared to see that they are equal. This reduces the possibility of errors. 5\. Journal is a book of prime entry or original entry. Hence in legal matters, journal is treated as main evidence in a court of law. **Types of Journal Entries** There are two types of journal entries-simple journal entry and compound journal entry. Simple Journal Entry: If a journal entry contains only one debit and one credit it is known as simple journal entry. Compound Journal Entry: When two or more transactions of similar nature occurring on the same day are recorded by means of a combined entry, it is known as compound entry. Thus, compound journal entry is a combination of two or more simple journal entries. **Return of Goods** Return of goods may be purchase return or sales return **Purchase Return:** Sometimes the goods bought on credit are damaged or substandard or unsuitable. Such goods are returned to suppliers. This is called purchase returns or returns outward. Thus, purchase returns or returns outward refers to that part of goods (purchased on credit) which are returned to suppliers by the business due to certain reasons. The journal entry for purchase return is. Creditors/Suppliers A/c Dr To Purchase Returns when goods are returned to suppliers, their account will be debited with the value of goods returned. The accounting rule \"Debit the receiver (personal account). is followed here. When goods are purchased, purchase account will be debited. Therefore, when such goods are returned, purchase return account will be credited. **Sales Returns**: Goods sold on credit may be be returned by the buyer to the seller if they are damaged or substandard. This is called sales returns or returns inward. Thus sales return or return inward refers to that part of goods (sold on credit) which are returned by the customers to the business due to certain reasons. The journal entry for sales return is: Sales Return A/c Dr To Debtors/Customers **Withdrawal of Cash or Goods by Proprietor** Sometimes proprietor withdraws cash from business for his personal or private use. Similarly he may take goods from business for his personal or domestic use. Such withdrawals should be debited to a separate account called \"Drawings Account\'. Thus Drawings Account is an account meant for recording the personal or private transactions of proprietor (paying Income Tax, Life Insurance Premium, purchasing assets for personal use etc) of a business. The following journal entries are required to be passed. \(e) For withdrawal of cash for personal purpose Drawing A/c Dr. To Cash A/c (Withdrew cash for personal use) When the proprietor withdrew cash from business, cash goes out of the business. That is why cash account is credited. \(b) For withdrawal of goods for personal or domestic purpose: Drawing A/c Dr. To Purchase/Stock A/c When the proprietor takes goods for domestic purpose, purchase or stock is reduced. That is why purchase or stock account is credited 211000 When the proprietor invests money or assets in business, his capital account is credited. When he takes something out of it for his private use, his investment or capital will be reduced. Therefore, at the end of the period, Drawings Account will be closed by transferring it to Capital Account. The journal entry is: Capital A/c Dr To Drawings **Distribution of Goods as Samples** Sometimes goods are distributed to customers as samples (at free of cost). In such a case the value of goods distributed as samples should be debited to \"Advertisement Account. The journal entry is: Advertisement A/c Dr To Purchase/Stock A/c If goods are given for charitable purpose, Charity Account is debited and Purchase Account is credited. **Loss of Stock/Goods by Theft or by Fire** Loss by Fire/Loss by Theft A/c Dr. To Purchase/Stock A/cs According to rule applicable in case of nominal account, all losses are to be debited. That is why \'Loss by Fire A/c\' or \'Loss by Theft A/c\' is debited. When there is a loss of goods, there is a reduction in stock. Hence Purchase/ Stock A/c is credited. **Bad Debts** When goods are sold to a customer (s) on credit, he may fail to pay the amount to the firm. The amount not recovered is called bad debts. In short, irrecoverable amount from debtors is known as bad debts. Thus, bad debt is a business loss. Hence it is debited. The journal entry is: Bad Debt A/c Dr To-Debtors A/c. **Bad Debts Recovered** Sometimes it happens that the amount written off as bad debt is recovered now. In such a case the following entry may be passed Cash A/c Dr To Bad Debts Recovered A/c When bad debt is recovered, cash comes in the business. Hence cash account is debited. Bad debt recovered is a gain. So it is credited. It should be noted that in case of bad debts recovered, debtors account should not be credited because debtors account has already been closed. **Loans** Sometimes the proprietor takes loan from outside. Sometimes he gives loan to outsiders. The journal entry for loan taken from outside is as follows: Cash A/c Dr. To Loan from outsider When loan is taken from outside, the loan becomes a liability. Hence it is credited. In the meantime, cash comes in the business (in the form of loan). That is why cash account is debited. The journal entry for loan advanced to outsider is as follows: Loan to outsiders Dr To Cash A/c When loan is advanced (money lent) to outsiders, the loan becomes an asset. Hence it is debited (asset comes in). In the mean time cash goes out (cash decreases). Hence cash account is credited. **Banking Transactions** A business enterprise shall have transactions with banks. Transaction between banks and business enterprises are like transactions-between-debtors and creditors. While journalizing the banking transactions, the point to be kept in mind is that when the bank balance increases, bank account should be debited and when the bank balance decreases, bank account should be credited. **Opening Entry** On the commencement of a new business, Cash Account is debited and Capital Account is credited. A firm closes its books of account at the end of each year and starts a new set of books in the beginning of each year. The first entry in the journal at the beginning of the new year is to record previous year\'s closing balances. This entry is known as Opening Entry. Thus, opening entry is the journal entry passed through the journal to open the new books of account for a new year. In this entry all the opening balances of assets are debited and the liabilities are credited along with the amount of capital. In the case of a going concern, the excess of assets over liabilities is the capital. The opening entry is: Opening Assets A/c Dr (Individually) (The entry to record the opening assets and liabilities, the balancing figure being capital) **LEDGER** In the journal all the transactions are recorded as and when they take place. It does not provide all the information regarding a particular person or item (assets, liabilities, expenses, incomes etc) at one place. Hence it is not possible to know the net effect of the various transactions of a person, asset, liability etc. To know this, all transactions of similar nature should be brought together at one place. This means transactions should be classified according to nature. This is done in Ledger. **Meaning of Ledger** The word \'Ledger\' is derived from the Dutch word \'Legger\", It means to \'Lie\'. Therefore, ledger means a book in which various accounts are kept. It is a summary of similar transactions at one place. In the ledger all transactions are classified and recorded under suitable heads of accounts in a summarised form. Thus, it contains accounts of assets, expenses, incomes or persons which have taken place during a specified period. In short, Ledger is a collection of accounts. Ledger is defined as, \"a book in which all the personal, real and nominal accounts of business are kept for permanent record so that up-to-date state of any account can be easily known\". **Posting** Separate accounts are opened for each person and each item on separate pages in the ledger. Then all transactions related to that person or item as recorded in the journal are transferred to the concerned account. For example, all transactions relating to a particular debtor, say Kamal, are transferred to Kamal\'s Account. Similarly all cash payments and cash receipts are transferred to Cash Account. This process is known as posting. Thus posting refers to the process of recording the transaction from journal to ledger. It is the process of transferring the debit and credit items from the journal to the respective accounts in the ledger. **Advantage or Importance of Ledger** Ledger is the second stage in the accounting cycle. It is considered to be the principal book of accounts. The need and importance of ledger may be stated as below: 1\. It provides a permanent record of all the transactions 2\. It gives complete information of all accounts in one book 3\. It helps to know the final balance or position of each account on any date 4\. It helps to prepare trial balance. 5\. It helps to prepare final accounts. In short, ledger helps a trader to achieve the objects of book keeping **Difference between Journal and Ledger** +-----------------------------------+-----------------------------------+ | **Journal** | **Ledger** | | | | | 1\. Book of first or prime entry | 1\. Book of final entry | | | | | 2\. Chronological record | 2\. Analytical record | | | | | 3\. The process of recording is | 3\. The process of recording is | | known | known as posting | | | | | as journalising | 4\. It is a principal or main | | | book | | 4\. It is a subsidiary book | | | | 5\. Final accounts can be | | 5\. Final accounts cannot be | prepared | | prepared | | | | 6\. Unit of classification is | | 6\. Unit of classification is | account | | transaction | | | | 7\. No narrations is given | | 7\. Narration is written after | | | every entry | | +-----------------------------------+-----------------------------------+ **FORMAT OF LEDGER** Each ledger account is divided into two equal parts. The left hand side is known as debit side and right hand side is known as credit side. The debit side is meant for recording the debit aspect of a transaction and the credit side is meant for recording the credit aspect of a transaction. Each side is divided into four columns. They are date, particulars, J.F and amount. It may be kept in bound ledger or loose leaf form. A proforma of a ledger account is given below: 1\. Date: In the date column the date of the transactions is recorded 2\. Particulars: These columns are used for recording the details of the transactions (i.e., debit and credit entries) 3\. J. F (Journal Folio): These are used for recording the page numbers of the journal from where the entries are posted 4\. Amount: These are meant for writing the amount of the transactions. **Procedure of Posting to Ledger Accounts** Ledger is a book wherein all accounts are opened. The following steps are to be taken while posting the entries to the ledger: 1\. Open separate ledger accounts for each account found in the journal. For example, consider the transaction cash sales. This transaction involves two accounts namely, cash account and sales account. First cash account is opened and then sales account is opened. Subsequent transactions are considered (refer the journal and see the accounts involved) and accounts should be opened. It should be noted that all the transactions relating to a particular account should be recorded in the account already opened. No new account for the same should be opened in the ledger. Name of the account should be written at the top and in the centre of each account. 2\. Write the word \'Dr\' on the top left corner of the account, indicating the debit side. Similarly write the word \'Cr\' on the right hand top corner of the account, indicating the credit side. 3\. The journal entry should be posted in the order of their dates. 4\. In the account opened in the ledger in the name of the debit account, write the date of the transaction in the date column, then write the other account (i.e. the account to be credited) in the particulars column. Then record the page number of the journal from where the entry is taken, in the JF column. After this, record the amount of the debit entry in the amount column. Now all these are recorded in the four columns on the left hand side (debit side). In this way the debit aspect is posted.) Then post the credit aspect of the transaction. For this, open the account to be credited. We now turn our attention to the right hand side because the account is to be credited. Write the date of the transaction in the date column, then record the other account (i.e. the account which has been debited earlier) in the particulars column. After this, fill the JF column and then write the amount of the credit entry in the amount column. Now all these are recorded in the four columns on the right hand side (credit side). In this way the credit aspect is posted and the posting of a journal entry is over. In short, the debit account in the journal is posted on the debit side of that account in the ledger by the name of credit account and the credit account in the journal is posted on the credit side of that account in the ledger by the name of debit account. Continue this procedure till all entries are posted from journal. It may be noted that every entry on the debit side of the account begins with the word \'To\' in the \'Particulars\' column. Similarly every entry on the credit side ef an account begins with the word \'By\' in the \'Particulars\' column. Now-a-days the words \'To\' and \'By\' are not compulsory. **Balancing of accounts (closing of accounts)** After all transactions have been posted to the various accounts in the ledger, the next step is to balance the ledger accounts. The difference between the two sides of an account is known as balance. In the words of Kohler \"Balance is the difference between the total debits and total credits of an account or total of an account containing only debits or credits\" If debit side of an account is more than the credit side, the balance is called debit balance. If credit side is more than the debit side, the balance is called \'credit balance\'. The following steps should be taken in balancing an account. 1\. Take totals of both the sides roughly. 2\. Find out the difference between total debit and total credit. 3\. If the total debit is more (i.e. closing debit balance) put the difference on the credit side amount column by writing the words \'By Balance c/d (c/d indicates \'carried down\') in particulars column. If the total credit is more (i.e. closing credit balance) put the difference on the debit side amount column by writing the words \"To Balance c/d\' in particulars column 4\. After putting the difference in the appropriate side of an account, add both the sides of the account (alternatively put the larger total on both sides). Draw a line above and below the total. 5\. Bring down the debit balance on the debit side by writing the words \"To Balance b/d (b/d indicates brought down) in the particulars column. Similarly bring down the credit balance on the credit side by writing the words \'By Balance b/d\' in the particulars column. Thus \'c/d\' indicates closing balance and \"b/d\' indicates opening balance. Closing debit balance is first written on the credit side (i.e. on closing date). On the next or opening date it becomes on opening balance and it appears on the debit side i.e. opening debit balance is shown on the debit side. Similarly closing credit balance is first written on the debit side (i.e. on closing date). On the next or opening date it becomes an opening credit balance and it appears on the credit side i.e. opening credit balance is shown on the credit side. Posting the Opening Entry: Separate accounts should be opened for each opening asset, opening liability and capital. All opening assets show debit balances while, opening liabilities and capital (unless there is deficiency) show credit balances. In each account of opening assets opening debit balance should be written with the words \"To Balance b/d\" Similarly in each account of opening liabilities and also in capital account, opening credit balance should be written with the words \"By Balance b/d. **Balancing of Different Types of Accounts** Balancing and closing of personal accounts: Some personal account are closed (i.e. nil balance). Others may show either a debit balance or a credit balance. If a personal account shows a debit balance, it indicates the amount owing from him (i.e. he is a debtor). On the contrary, if a personal account shows a credit balance it indicates the amount owing to him (i.e. he is a creditor) Capital is a personal account. It generally shows a credit balance, If there is a deficiency in capital it will show a debit balance. Similarly drawings account is a personal account. It always shows a debit balance. Bank account may show either a debit balance (i.e. deposit) or a credit balance (i.e. overdraft) **Balancing and Closing of Real Accounts**: Real accounts are the accounts of assets. Asset accounts will not be closed if they are existing in the business. These show debit balances. **Balancing of Nominal Accounts**: Nominal accounts are not balanced. At the end of every accounting period they are closed by transferring to Trading A/c or Profit and Loss A/c. Accounts of all direct expenses are closed by transferring the balance to trading A/c by writing the words \'By Trading A/c\' on the credit side of the accounts of direct expenses. Sales account is closed by transferring the balance to Trading A/c by writing the words \'To Trading A/c on the debit side of sales account. All accounts of indirect expenses are closed by transferring the balance to Profit and Loss A/c by writing the words \'By Profit and Loss A/c on the credit side of indirect expense accounts. All accounts of incomes are closed by transferring the balance to Profit and Loss A/c by writing the words \'To Profit and Loss A/c\' on the debit side of income accounts. **Nature of Balance in Ledger Accounts** The nature of ledger account balances may be summarized as follows: Asset accounts - Debit balances Liability accounts - Credit balance Capital and reserves - Credits balances Revenue accounts (income) - Credit balances Expense accounts- Debit balances **Classification of Ledger (Subdivisions of Ledger)** In a small business concern, all ledger accounts can be maintained in one ledger. But in larger concerns it is convenient to subdivide the ledger as follows: 1\. Debtors Ledger: It contains personal accounts of customers or debtors to whom goods are sold on credit. It is also known as \'sold ledger\' or \'customers ledger\'. 2\. Creditors Ledger: It contains the accounts of creditors or suppliers from whom goods are bought on credit. It is also called bought ledger or suppliers ledger. 3\. General Ledger; It contains all accounts other than debtors and creditors. It includes accounts of properties, capital, expenses, incomes, drawings etc. 4\. Private Ledger: Sometimes the capital account and drawings account of the proprietor many be separately maintained in another ledger called private ledger. **SUBSIDIARY BOOKS** In small concerns there is only limited number of transactions. Hence all transactions are recorded in a single journal. But in big organization there is large number of transactions. If all the transactions are recorded in one journal, the journal would become overburdened or bulky. This necessitates the subdivisions of journal. Thus, in large enterprises it would be better and convenient to divide the journal into various parts. These subdivisions of journal are called subsidiary books. These are also known as Special Journals. **Meaning of Subsidiary Books** The subdivisions of journal for recording transactions of similar nature are known as subsidiary books. These books are books of original entry. This is so because transactions are first recorded in these books and later on transferred or posted to respective ledger accounts. This is the practical system of accounting. This is also known as English System. **Advantages of Subsidiary Books** The advantages of maintaining special journals may be summarized and follows: 1\. It facilitates division of work and specialization because different persons handle different journals. 2\. Due to division of work, it is possible to perform accounting processes simultaneously. Thus, lesser time is required to complete accounting work. In the meantime, efficiency is increased, 6110 3\. It reduces the possibility of errors and frauds. It also helps is location of errors, if any. 4\. A lot of useful data like credit sale, credit purchase, cash payment, cash receipt etc are available at one place. 5\. Each employee is entrusted to maintain a particular book. Hence he can be held responsible for the errors committed in that book. **Types of Subsidiary Books** The following are the main subsidiary books generally maintained by business enterprises: Subsidiary Books Nature of Transactions Recorded 1\. Cash Book 1. Cash and bank transactions 2\. Purchase Book 2. Credit purchase of goods 3\. Sales Book 3. Credit sale of goods 4\. Sales Returns Book 4. Goods returned by customers 5\. Purchase Returns Book 5. Goods returned to suppliers 6\. Bills Receivable Book 6. Bills drawn on customers 7\. Bills Payable Book 7. Bills accepted in favour of suppliers 8\. Journal Proper 8. All remaining transactions These books are discussed here under: **Cash Book** In every business concern generally, there is large number of cash transactions. For the purpose of recording all such transactions a separate book is maintained. This is called cash book. Thus cash book is a subsidiary book meant for recording all cash transactions. In this book all cash receipts and cash payments are recorded in a chronological order. Cash Book is a subsidiary book as well as a principal book. It is a subsidiary book (or book of original or prime entry) because transactions are directly recorded in this book. It is a principal book (or book of final entry) because one aspect of the transactions relating to cash is completed in the Cash Book itself and only the second aspect has to be posted into the ledger. Another reason is that it is ruled like a ledger and only one type of transaction is recorded in it. When Cash Book is prepared there is no need to prepare cash account in the ledger. Thus Cash Book plays the double role of Journal as well as Ledger. In short, Cash Book is both a Journal and a Ledger. In fact, it is a Journalized Ledger A Cash Book has two sides- debit side and credit side. All receipts are recorded on the debit side and all payments are recorded on the credit side **Advantages or Importance of Cash Book** Cash Book is a very important and popular book for every business whether big or small. The following are the main advantages of Cash Book: 1. It is useful for recording all cash receipts and cash payments during a given period. Simple or Single Column Cash Book. This is the simplest form of cash book. It has only one column (cash column) for amount on each side. On the debit side all receipts are recorded. On the credit side all payments are recorded. **Points to Remember while preparing Simple Cash Bank** 1\. If opening balance of Cash Book is given, it should be written first on the debit side as \'To Balance b/d\'. 2 Every entry made on the debit side should begin with the word \'To\' and every entry made on the credit side should begin with the word \'By\' in the particulars column. 3\. All receipts should be recorded on the debit side and all payments on the credit side 4\. Only one amount column (cash column) should be provided on either side 5\. It is balanced like other accounts. Cash columns are balanced. The receipt column (cash column on the debit side) will always be bigger than the payment column. Hence the debit side is totalled first and written there. Then this total is written on the credit side also. The difference between total debit (receipts) and total credit (payments) is the closing balance of cash. This is written on the credit side as \'By Balance c/d\'. On the next opening date it becomes To Balance b/d\'. It will always show a debit balance. This is so because no one can pay more than what he has got. **Posting of Simple Cash Book** The opening and closing balance of Cash Book is not to be posted to any account. The entries on the debit side of the Cash Book are posted to the credit of the respective accounts in the Ledger as \'By Cash A/c\'. The entries on the credit side of the Cash Book are posted to the debit side of the respective accounts in the ledger as \'To Cash A/c\'. **Two Column Cash Book (Cash Book with Discount Column)** In the two column Cash Book one additional column for \'Discount \'is provided on either side to record cash discount. Thus two column cash book has two columns on each side- cash column and discount column. In the additional column added on the debit side discount allowed is recorded. In the extra column added on the credit side, discount received is recorded. Hence two column cash book is also known as cash book with cash and discount column. Some firms maintain Two Colunin Cash Book and a separate bank account in the ledger. Point to remember while preparing Two Column Cash Book 1. Two columns should be provided on each side -cash column and discount column 2. Opening balance of cash is recorded on the debit side (in the cash column) as \'To Balance b/d\'. 3. When cash is received it is recorded in the cash column on the debit side. The discount allowed is recorded in the discount allowed column on the debit side. 4. All other receipts are recorded in the cash column on the debit side. 5. When cash is paid it is recorded in the cash column on the credit side. The discount received is shown in the discount received column on the 6. All other payments are written in the cash column on the credit side. 7. Cash columns are balanced. This has already been discussed. 8. Discount columns are not balanced. They are merely totaled. The total of the discount column on the debit side shows the total discount allowed to customers. The total of the discount column on the credit side shows the total discount received from the suppliers. **Point to remember while preparing Three Column Cash Book** 1\. In the case of a newly started business, the amount of capital is shown in the cash column on the debit side with the description \'To Capital A/c\' in the particulars column. In the case of an existing business the opening balance of cash is shown in the cash column on the debit side with the description \'To Balance b/d\'. The opening balance of bank many be debit (if deposit) or credit (If overdraft). If it is debit balance, it is recorded in the bank column on the debit side as \'To Balance b/d. If it is credit balance, it is recorded in the bank column on the credit side as \'By Balance b/d\'. 2\. There are certain transactions which affect both Cash account and bank account. Hence they are shown on both sides of the cash book (i.e. on the debit side as well as on the credit side). These are called Contra entries. Thus contra entries are those journal entries which appear on both sides of a Cash Book. Examples of contra entries are as follows: \(a) Cash paid into bank (Cash deposited with bank): This transaction involves both cash and bank accounts. Therefore it is entered on both sides of the cash book (remember the journal entry). The effect of the transaction is that the cash goes out (decreases) and bank balance increases (Bank is the receiver). Therefore bank account is to be debited and cash account is to be credited. It is recorded in the bank column on the debit side (bank balance increases) by writing \'To Cash A/c\'. The same is shown in the cash column on the credit side (Cash balance decreases)by writing \'By Bank A/c (b) Cash withdrawn from bank (for office use): This transaction also involves cash and bank accounts. The effect of the transaction is that cash comes in (increases) and bank balance decreases (bank is the giver). Therefore, cash account is to be debited and bank account is to be credited. This is recorded in the cash column on the debit side (Cash increases) by writing \'To Bank A/c\'. The same is shown in the bank column on the credit side (bank balance decreases) by writing \'By Cash A/c\'. \(c) Cheque received but paid it into bank at a later date: If cheque received is sent to bank for collection at a later date, the cheque received is shown in cash column on the debit side (cheque received may be treated as cash received) with the words \'To Personal A/c (from whom cheque is received). When the cheque is deposited in the bank for collection on a subsequent date, a contra entry is recorded. In this case the amount is shown in the bank column on the debit side (bank balance increases) with the words \"To Cash A/c\'. The same is shown in the cash column on the credit side (cheque goes away) with the words \'By Bank A/c When the cheque received is paid into bank on the same day, it is entered in the bank column on the debit side (without entering in in cash column) with the words \"To Customer\'s A/c (this is not a contra entry). Contra entries are indicated by the letter \'C\' on both sides. The term contra is a Latin phrase. It means \'opposite side\'. It indicates that the other aspect of the transaction can be found on the opposite side 3\. If the cheque sent to bank for collection is dishonoured, it is recorded in the bank column on the credit side (customer or debtor account is to be debited and bank account is credited). 4\. All receipts whether in cash or in cheques are written on the debit side and all payments are written on the credit side. Payment made in cash is recorded in the cash column (credit side). Payment made in cheque is shown in the bank column (credit side) 5\. If the bank makes payment on behalf of its customer (insurance premium, rent, interest on loan etc.) These are recorded in the bank column on the credit side (bank balance decreases). Similarly, when bank collects incomes on behalf of its customer (interest, dividend etc.) these will be recorded in the bank column on the debit side (bank balance increases). 6\. Bank charges and commission should be entered in the bank column on the credit side (bank balance reduces) (d) 7\. If any customer remits directly into bank it should be entered in the bank ecolumn on the debit side. 8\. Bank and Cash columns are: separately balanced. Cash column always shows a debit balance. In bank column it can be either debit balance (deposit) or credit balance (overdraft). Therefore totals of bank columns are taken on rough sheet and balance is found. If the debit total is more than the credit total, it will be debit balance. It is shown in the bank column on the credit side with the words \'By Balance c/d\'. If the credit total is bigger than the debit total, it will be credit balance (overdraft). It is shown in the bank column on the debit side with the words \"To Balance c/d.