Recording of Transactions - IClass 11 Financial Accounting 1 Notes

Recording of Transactions－I

The process of accounting involves several key steps: identifying and analyzing business transactions, recording them, classifying them, summarizing their effects, and finally, communicating this information to users. This chapter focuses on the initial steps of this process: identifying transactions, preparing source documents, recording them in a Journal, and then posting them into a Ledger.

Business Transactions and Source Document

A business transaction is an exchange of economic value between two or more parties. Every transaction has a "Give and Take" aspect, meaning it affects at least two accounts.

To ensure accuracy and provide proof, business transactions are supported by documents. A Source Document is a written document that provides evidence that a transaction has occurred.

Common examples of source documents include:

• Cash Memo: For cash purchases or sales.
• Invoice or Bill: For credit purchases or sales.
• Pay-in-slip: For depositing cash or cheques into a bank.
• Cheque: For making payments through a bank.
• Salary Slip: As proof of salary paid to an employee.

These documents, also called Vouchers, are the foundation for recording transactions. They are typically arranged in chronological order, numbered serially, and filed for future reference, especially for audits and tax assessments.

Preparation of Accounting Vouchers

An accounting voucher is a document prepared based on the source document, indicating which accounts are to be debited and credited. While there is no single fixed format, all vouchers must contain essential details.

Types of Accounting Vouchers:

• Transaction Voucher: Used for simple transactions involving one debit and one credit.
• Compound Voucher: Used for transactions with multiple debits and one credit, or multiple credits and one debit. These can be further classified as Debit Vouchers or Credit Vouchers.
• Complex Voucher (Journal Voucher): Used for transactions involving multiple debits and multiple credits.

Essential Elements of an Accounting Voucher:

• It must be printed on good quality paper with the firm's name at the top.
• It must include the date of the transaction (not the date of recording).
• Vouchers should be serially numbered.
• It must clearly state the names of the accounts to be debited and credited.
• The amounts for debit and credit must be written in figures.
• A brief description (narration) of the transaction should be provided.
• It must be signed by the person who prepared it and an authorized person.

Accounting Equation

The Accounting Equation is the foundation of the double-entry accounting system. It shows that a business's assets are always equal to the sum of its liabilities and capital.

The basic equation is: Assets = Liabilities + Capital (A = L + C)

• Assets: Resources owned by the business (e.g., cash, bank balance, furniture, machinery).
• Liabilities: Claims of outsiders against the business; what the business owes to others (e.g., creditors, loans).
• Capital: The claim of the owner against the business; what the business owes to the proprietor (also known as Owner's Equity).

This equation must always remain balanced after every transaction. Because it reflects the components of a balance sheet, it is also known as the Balance Sheet Equation.

• The business now has an Asset (Cash) of ₹5,00,000.
• The business also has a claim from the owner (Capital) of ₹5,00,000.
• The equation is: Assets (₹5,00,000) = Liabilities (₹0) + Capital (₹5,00,000). It is balanced.

Any profit earned by the business increases the capital, while any loss or drawings (owner's personal withdrawals) decreases the capital.

Using Debit and Credit

In accounting, every transaction has two effects, which are recorded in at least two accounts. The terms Debit (Dr.) and Credit (Cr.) are used to record these effects.

An account is often visualized as a 'T' shape, known as a T-account.

• The left side is the Debit side.
• The right side is the Credit side.

To "debit an account" means to enter an amount on the left side. To "credit an account" means to enter an amount on the right side. For every transaction, the total amount debited must equal the total amount credited.

Rules of Debit and Credit

To correctly record transactions, all accounts are classified into five categories. The rules for debit and credit depend on the category of the account and whether it is increasing or decreasing.

1. For Assets and Expenses/Losses:

• Debit an increase in an Asset or Expense.
• Credit a decrease in an Asset or Expense.

2. For Liabilities, Capital, and Revenues/Gains:

• Credit an increase in a Liability, Capital, or Revenue.
• Debit a decrease in a Liability, Capital, or Revenue.

• Assets & Expenses: Increase with a Debit (+ Dr.), Decrease with a Credit (- Cr.).
• Liabilities, Capital & Revenue: Increase with a Credit (+ Cr.), Decrease with a Debit (- Dr.).

Books of Original Entry

Instead of recording transactions directly into individual accounts, businesses first record them chronologically in a special book. The book where a transaction is recorded for the first time is called the book of original entry or a Journal. This ensures a complete record of each transaction in one place.

The journal is often subdivided into specialized books for frequent transactions:

• Journal Proper: For transactions not recorded in any other special journal.
• Cash Book: For all cash and bank transactions.
• Other Day Books: Including Purchases Book, Sales Book, Purchase Returns Book, Sales Returns Book, etc., for credit transactions of goods.

Journal

The Journal is the primary book of original entry where transactions are recorded in chronological order. The process of recording a transaction in the journal is called journalising.

Format of a Journal Entry: A journal has five columns:

1. Date: The date the transaction occurred.
2. Particulars: This column contains the names of the accounts to be debited and credited, along with a brief explanation called a Narration. The debited account is written first, followed by "Dr.". The credited account is written on the next line, indented, and starts with "To".
3. L.F. (Ledger Folio): The page number of the ledger where the entry is posted. This is filled in during posting, not during journalising.
4. Debit Amount (₹): The amount debited.
5. Credit Amount (₹): The amount credited.

Types of Journal Entries:

• Simple Journal Entry: An entry involving only two accounts (one debit, one credit).
• Compound Journal Entry: An entry involving more than two accounts.

Accounting Entries under Goods and Services Tax (GST)

When recording transactions involving GST, separate accounts are maintained for the tax component.

• Input GST: The tax paid on purchases (e.g., Input CGST, Input SGST, Input IGST). This is an asset as it can be used to offset tax liability.
• Output GST: The tax collected on sales (e.g., Output CGST, Output SGST, Output IGST). This is a liability that needs to be paid to the government.

The journal entry for a purchase with GST would debit the Purchases account, the relevant Input GST accounts, and credit the supplier or cash. The entry for a sale would debit the customer or cash and credit the Sales account and the relevant Output GST accounts.

The Ledger

The Ledger is the principal or main book of the accounting system. It is a collection of all accounts (asset, liability, capital, revenue, and expense accounts). After transactions are recorded in the journal, they are transferred to their respective accounts in the ledger. This process is called Posting.

Utility of the Ledger: The ledger provides a complete, classified record of all transactions related to a specific account. While the journal records transactions chronologically, the ledger records them analytically. For example, to find out the total amount owed by a customer, you would look at their account in the ledger, which consolidates all sales and payments related to them.

Format of a Ledger Account: A ledger account is in the T-account format with two identical sides: a debit (left) side and a credit (right) side. Each side has columns for:

• Date
• Particulars (referencing the other account in the journal entry)
• J.F. (Journal Folio): The page number of the journal from where the entry was posted.
• Amount (₹)

Distinction between Journal and Ledger

Classification of Ledger Accounts

Ledger accounts can be classified into two main groups:

• Permanent Accounts: These are accounts related to Assets, Liabilities, and Capital. Their balances are carried forward to the next accounting period and appear in the Balance Sheet.
• Temporary Accounts: These are accounts related to Revenues/Gains and Expenses/Losses. They are closed at the end of the accounting period by transferring their balances to the Trading and Profit and Loss Account.

Posting from Journal

Posting is the crucial step of transferring information from the journal to the ledger. This groups all transactions of a similar nature under one account.

Steps for Posting:

1. Locate the account to be debited in the ledger as mentioned in the journal entry.
2. On the debit side of that account, enter the transaction date.
3. In the 'Particulars' column, write the name of the account that was credited in the journal entry.
4. In the 'J.F.' column, enter the page number of the journal.
5. Enter the relevant amount in the 'Amount' column.
6. Repeat the same process for the account to be credited, making the entry on the credit side of that account in the ledger. In the 'Particulars' column, write the name of the account that was debited.