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Chapter 3 Recording of Transactions - 1

Bills that provide evidence of a transaction are called source documents on the basis of the source documents, entries are first recorded on the vouchers and then on the basin of the vouchers, entries are made in journal. Accounting equation means assets are equal to liabilities plus capital. Left hand side records sources of funds (liabilities), while right hand side records application of funds (Assets).

There are three types of accounts viz. real account, nominal account and personal account. The rule of Accounting: 

  • Real Account : Real account is debit what comes in and credit what goes out.
  • Personal Account : Personal account is debit the gives and credit the received.
  • Nominal Account : Nominal account is debit all expenses and losses and credit all profits and gains.

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Exercise 1

  • Q1

    State the three fundamental steps in the accounting process.

    Ans:

    The fundamental steps in the accounting process are diagrammatically presented below.


    Q2

    Why is the evidence provided by source documents important to accounting?

    Ans:

    Evidence provided by source documents is important to accounting because for recording transactions, it is necessary that these transactions are evidenced by an appropriate document such as cash memo, purchase invoice, sales invoice, pay-in-slip, cheque book, pass book etc. Such a document is called the Source Document.


    Q3

    Should a transaction be first recorded in a journal or ledger? Why?

    Ans:

    A transaction should be recorded first in a journal because journal provides complete details of a transaction in one entry. Further, a journal forms the basis for posting the transactions into their respective accounts into ledger. Transactions are recorded in journal in chronological order, i.e. in the order of occurrence with the help of source documents. Journal is also known as ‘book of original entry’, because with the help of source document, transactions are originally recorded in books. The process of recording the transactions in journal and then in ledger is presented in the below given flow chart.


    Q4

    Are debits or credits listed first in journal entries? Are debits or credits indented?

    Ans:

    As per the rule of double entry system, there are two columns of ‘Amount’ in the journal format namely ‘Debit Amount’ and ‘Credit Amount’. The way of recording in a journal is quite different from normal recording. Journal entry is recorded in journal format in which the ‘Debit Amount’ column is listed before the ‘Credit Amount’ column.

    Credits are indented. Indentation is leaving a space before writing any word. Journal entry has its own jargon. While journalising, in the ‘Particulars’ column of journal format, debited account is written first and credited account is in the next line leaving some space, which is indentation.


    Q5

    Why are some accounting systems called double accounting systems?

    Ans:

    Some accounting systems are called double accounting systems because every business transaction has a two-fold effect and that it affects two accounts in opposite directions and if a complete record were to be made of each such transaction, it would be necessary to debit one account and credit another account. It is this recording of the two fold effect of every transaction that has given rise to the term Double Entry System.


    Q6

    Give a specimen of an account.

    Ans:
                                                Account
     Dr.                                                                                               Cr.
    Date Particular J.F. Amount Rs. Date Particulars J.F. Amount Rs.

     

     

     

     

     

     

                 

    Q7

    Why are the rules of debit and credit same for both liability and capital?

    Ans:

    Every business acquires funds from internal as well as from external sources. According to the business entity concept, the amount borrowed from the external sources together with the internal sources like, capital invested by the proprietor, is termed as liability to the business. Business entity concept treats business and business owner separately. Capital of the owner is treated as liability to the business because the business has to repay the amount of capital to the owner, in case of closure of the business. As liability incurred is credited, in the same way, fresh capital introduced and net profit increases the owner’s capital, and so, capital is credited. On the other hand, if liability is paid, it reduces liability, and so, it is debited. Similarly, drawings from capital and net loss reduce the capital, and so, capital is debited. Thus the rules of debit and credit are same for both liability and capital.


    Q8

    What is the purpose of posting J.F numbers that are entered in the journal at the time entries are posted to the accounts?

    Ans:

    J.F. number is the number that is entered in the ledger at the time of posting entries into their respective accounts. It helps in determining whether all transactions are properly posted in their accounts. It is recorded at the time of posting and not at the time of recording the transactions.

    The purpose of entering J.F. number in the ledger is because of the below given benefits.

    1. J.F. number helps in locating the entries of accounts in the journal book. In other words, J.F number helps to locate the position of the related journal entry and subsidiary book in the journal book.
    2. J.F. number in accounts ensures that recording in the books of original entry has been posted or not.

    Q9

    What entry (debit or credit) would you make to:
    (a) increase revenue
    (b) decrease in expense,
    (c) record drawings
    (d) record the fresh capital introduced by the owner.

    Ans:

    (a) Increase in revenue: Increase in revenue is credited as it increases the capital. Capital has credit balance and if capital increases, then it is credited.

    (b) Decrease in expense: Decrease in expense is credited as all expenses have debit balance. If expense decreases, then it is credited.

    (c) Record drawings: Capital has credit balance; if the capital increases, then it is credited. If capital decreases, then it is debited. Drawings are debited as they decrease the capital.

    (d) Record of fresh capital introduced by the owner− credit: Capital has credit balance, if capital increases, then it is credited. The introduction of fresh capital increases the balance of capital, and so, it is credited.


    Q10

    If a transaction has the effect of decreasing an asset, is the decrease recorded as a debit or as a credit? If the transaction has the effect of decreasing a liability, is the decrease recorded as a debit or as a credit?

    Ans:

    If a transaction has a decreasing effect on an asset, then this decrease is recorded as credit. This is because, as all assets have debit balance and if assets decrease, then it is credited. For example, sale of furniture results in decrease in furniture (asset); so, the sale of furniture will be credited.

    If a transaction has a decreasing effect on a liability, then this decrease is recorded as debit. This is because all liabilities have credit balance. If the liability increases, then it is credited and if the liability decreases, then it is debited. For example, payment to the creditors results in a decrease in the creditors (liability); so, the creditors account will be debited.


Exercise 2

  • Q1

    Describe the events recorded in accounting systems and the importance of source documents in those systems?

    Ans:

    Source documents are written and authentic proof of the correctness of recorded transaction.They are required for audit of accounts and tax assessments.They also serve as legal evidence in case of a dispute.

    Source documents are the first record about the details of a business transaction. Such documents report the date, the amount, parties involved and the nature of the transaction. Entries in the books are always made from the source documents.


    Q2

    Describe how debits and credits are used to analyse transactions.

    Ans:

    Debit originated from the Italian word debito, which in turn is derived from the Latin word debeo, which means ‘owed to proprietor’ and credit comes from the Italian word credito, which is derived from the Latin word credo, which means belief, i.e., ‘owed by proprietor’.

    According to the dual aspect concept, all the business transactions that are recorded in the books of accounts, have two aspects- debit and credit. The dual aspect can be better understood by the help of an example; bought goods worth Rs 500 on cash. This transaction affects two accounts with the same amount simultaneously. As goods are brought in exchange of cash, so the cash balances in the business reduce by Rs 500, i.e. why the cash account is credited. Simultaneously, the amount of goods increases by Rs 500, so purchases account will be debited. Debit and credit depend on the nature of accounts involved; such as assets, expenses, income, liabilities and capital. There are five types of Accounts.

    1.    Assets- These include all properties or legal rights owned by a firm for its operations, such as cash in hand, plant and machinery, bank, land, building, etc. All assets have debit balance. If assets increase, they are debited and if assets decrease, they are credited.

    For example, furniture purchased and payment made by cheque. The journal entry is:
    Payment worth Rs 1,200 through bank, supported by cheques

    Deposits into bank worth Rs 500, supported by pay-in slips.

    Out of the above events, only those events that can be expressed in monetary terms, are recorded in the books of accounts. However, the non-monetary events are not recorded in accounts; for example, promotion of manger cannot be recorded but increment in salary can be recorded at the time when salary is paid or due.

    Source document in accounting is important because of the below given reasons.

    1.    It provides evidence that transaction has actually occurred.
    2.    It provides information about the date, amount and parties involved and other details of a particular transactions.
    3.    It acts as an evidence in the count of law.
    4.    It helps in verifying the transaction during the auditing process.

     Furniture A/c  Dr.
            To Bank A/c  


    2.    Expense− It is made to run business smoothly and to carry day to day business activites.Here, furniture and bank balance, both are assets to the firm. As furniture is purchased, so furniture account will increase, and will be debited. On the other hand, payment of furniture is being made by cheque that reduces the bank balance of the business, so bank account will be credited.

    All expenses have debit balance. If an expense is incurred, it must be debited.

    For example, rent paid. The journal entry is:

     Rent A/c Dr.
            To Cash A/c  

    3.    Liability− Liability is an obligation of business. Increase in liability is credited and decrease in liability is debited.Here, rent is an expense. All expenses have debit balance. Hence, rent is debited. On the other hand, as rent is paid in cash that reduces the cash balances, so cash account is credited.

    For example, loan taken from bank. The journal entry is:

     Bank A/c Dr.
            To Bank Loan A/c  

    4.    Income− Income means profit earned during an accounting period from any source. Income also means excess of revenue over its cost during an accounting period. Income has credit balance because it increases the balance of capital.Here, loan from bank is a liability to the firm. As all liabilities have credit balance, so loan from bank has been credited because it increases the liabilities.

    For example, rent received from tenant. The journal entry is:

     Cash A/c Dr.
            To Rent A/c  

    5.    Capital− Capital is the amount invested by the proprietor in the business. Capital has credit balance. Increase in capital is credited and decrease in capital is debitedHere, rent is an income; hence, rent account has been credited and cash has been debited, as rent received increases the cash balances.

    For example, additional capital introduced by owner. The journal entry is:

     Cash A/c Dr.
            To Capital A/c  

    As additional capital is introduced, so the amount of capital will increase, i.e. why, capital account is credited. On the other hand, as capital is introduced in form of cash, so the cash balances decrease, i.e. why, cash account is debited.


    Q3

    Describe how accounts are used to record information about the effects of transactions?

    Ans:

    Every transaction is recorded in the original book of entry (journal) in order of their occurrence; however, if we want to know that how much we receive from our debtors or how much to pay to the creditors, it is not possible to determine at a single movement. Hence, we prepare accounts to know the position of business activities in the meantime.

    There are some steps to record transactions in accounts; it can be easily understood with the help of an example.

    Sold goods to Mr A worth Rs 50,000 on 12th April and received payment Rs 40,000 on 25th April. The following journal entries will be recorded:

     

    Step 1− Locate the account in ledger, i.e., Mr A’s Account.

    Step 2− Enter the date of transaction in the date column of the debit side of Mr A’s Account.

    Step 3− In the ‘Particulars’ column of the debit side of Mr A’s Account, the name of corresponding account is to be written, i.e., ‘Sales’.

    Step 4− Enter the page number of the ledger in the Journal Folio (J.F.) column of Mr A’s Account.

    Step 5− Enter the amount in the ‘Amount’ column.

    Step 6− Same steps are to be followed to post entries in the credit side of Mr A’s Account.

    Step 7− After entering all the transactions for a particular period, balance the account by totalling both sides and write the difference in shorter side, as ‘Balance c/d’.

    Step 8− Total of account is to be written on either sides.


    Q4

    What is a journal? Give a specimen of journal showing at least five entries.

    Ans:

    Journal is derived from the French word Jour, means daily records. In this book, transactions are recorded in order of their occurrence, i.e., in chronological order from the source document. It is also termed as the book of original entry and each transaction is termed as journal entry.

    Performa of Journal
    In the books of.....

    Date Particulars L.F.

    Debit
    Amount
    Rs

    Credit
    Amount
    Rs

           

     

     

    Date− Date of transaction is recorded in the order of their occurrence.

    Particulars− Details of business transactions like, name of the parties involved and the name of related accounts, are recorded.

    L.F.− Page number of ledger account when entry is posted.

    Debit Amount− Amount of debit account is written.

    Credit Amount− Amount of credit account is written.

    Recording of a Journal Entry

     

     

    Date

    1)

    Started business with cash Rs 1,00,000

    April 01

    2)

    Open a bank account Rs 20,000

    April 03

    3)

    Purchase goods for cash Rs 25,000

    April 04

    4)

    Goods sold for cash Rs 30,000

    April 05

    5)

    Goods sold to Mr. X Rs 2,000

    April 06

                                                                         Books of Mr A

                                                                           Journal

    Date

    Particulars

    L.F.

    Debit Amount Rs

    Credit Amount Rs

    April1

    Cash A/c

    Dr.

     

    1,00,000

     

     

     

    To Capital A/c

     

     

     

    1,00,000

     

    (Started business with cash)

     

     

     

     

     

     

     

     

     

     

     

     

    April 3

    Bank A/c

    Dr.

     

    20,000

     

     

     

    To Cash A/c

     

     

     

    20,000

     

    (Bank account opened with cash)

     

     

     

     

     

     

     

     

     

     

     

    April 4

    Purchase A/c

    Dr.

     

    25,000

     

     

     

    To Cash

     

     

     

    25,000

     

    (Goods purchased for cash)

     

     

     

     

     

     

     

     

     

     

     

    April 5

    Cash A/c

    Dr.

     

    30,000

     

     

     

    To Sales A/c

     

     

     

    30,000

     

    (Goods sold for cash)

     

     

     

     

     

     

     

     

     

     

     

    April 6

    Mr. X's A/c

    Dr.

     

    2,000

     

     

     

    To Sales

     

     

     

    2,000

     

    (Goods sold to Mr. X on credit)

     

     

     

     

     

     

     

     

     

     

     

     

    Total

     

    177,000

    177,000

     

     

     

     

     

     


    Q5

    Differentiate between source documents and vouchers.

    Ans:

    Basis of Difference

    Source Documents

    Vouchers

    Meaning

    It refers to the documents in writing, containing the details of events or transactions.

    When source document is considered as evidence of an event or transaction, then it is called voucher.

    Purpose

    It is used for preparing accounting vouchers.

    It is used for analysing the transactions.

    Recording

    It acts as a basis for preparing accounting voucher that helps in recording.

    It acts as a basis for recording transactions.

    Preparation

    It is prepared at the time when an event or a transaction occurs.

    It can be prepared either when an event or a transaction occurs, or later on.

    Legality/Validity

    It can be used as evidence in the court of law.

    It can be used for assessing the authentication of transactions.

    Prepared By

    It is prepared by the persons who are directly involved in the transactions, or who are authorised to prepare or approve these documents.

    It is prepared by the authorised persons or by the accountants.

    Examples

    Cash memo, invoice, and pay-in-slip, etc.

    Cash memo, invoice, pay-in-slip (if used as evidence), debit note, credit note, cash vouchers, transfer vouchers, etc.

     


    Q6

    Accounting equation remains intact under all circumstances. Justify the statement with the help of an example.

    Ans:

    According to the dual-aspect concept, every transaction simultaneously, has two effects of equal amount, i.e. debit and credit. However, in any case, the equality of total assets with the total claims of business (sum of capital and liabilities) is not disturbed. This equality is algebraically represented as:

    Asset = Total Claims

    or 

    Asset = Liabilities + Capital

    or, Liabilities = Asset − Capital

    or, Capital = Assets − Liabilities

    In any circumstance the above equation cannot be changed. For example,

     


    Q7

    Explain the double entry mechanism with an illustrative example.

    Ans:

    Double Entry mechanism is the most progressive, scientific and complete system of recording the financial transactions of a business. According to this system there are two accounts involved in every business transaction.One account receiving a benefit and the other account yielding a benefit. The person or the account receiving a benefit is debited and the person or the account who gives something to the business is credited.

    For example- we received ₹20,000 from Mohan. This transaction affects two accounts- Cash Account and the Johan's Account.

    Cash account is receiving a benefit (as cash is coming in) and hence Cash account will be debited, whereas Mohan is yielding a benefit and hence his account will be credited.


Exercise 20

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