Recording of Transactions - I — Study Notes

1. Introduction

Recording of transactions is the most important step in the accounting process. Every business transaction must be recorded first in the book of original entry, known as the Journal, before it is posted to the ledger. The entire system of recording is based on the double entry system, in which every transaction affects at least two accounts, one being debited and the other credited with equal amounts. This chapter explains the classification of accounts, the golden rules of accounting, the journal, the journal entries with examples, source documents and the ledger, along with the balancing of accounts.

The recording of transactions is not merely a mechanical exercise; it requires a proper understanding of the nature of each account. Before writing a journal entry, an accountant must decide whether the account involved is a personal account, a real account or a nominal account, and then apply the corresponding golden rule. A mistake at this stage will carry forward into the ledger, the trial balance and the final accounts, so accuracy in recording is essential.

2. The Accounting Equation Revisited

The double entry system is based on the accounting equation:

$$Assets = Liabilities + Capital$$

Every transaction affects at least two elements of this equation and the equation always remains balanced. For example, when goods are purchased for cash, cash (an asset) decreases while stock (an asset) increases, so the total remains unchanged. When furniture is purchased on credit, an asset increases and a liability also increases. When capital is introduced, both cash and capital increase. The journal entries are simply a detailed expression of these changes in the equation.

3. Classification of Accounts

The golden rules of accounting are understood only after accounts are classified. There are three types of accounts:

3.1 Personal Accounts

Accounts related to persons, firms, companies and institutions are called personal accounts. They are of three types: - Natural persons: accounts of individuals such as Ram's account or Shyam's account. - Artificial persons: accounts of companies, banks, partnership firms and clubs. - Representative persons: accounts that represent people indirectly, such as outstanding salary account, prepaid rent account and accrued income account.

3.2 Real Accounts

Accounts related to assets and properties are called real accounts. They may be: - Tangible real accounts: land, building, machinery, furniture, stock and cash. - Intangible real accounts: goodwill, patents, trademarks and copyrights.

3.3 Nominal Accounts

Accounts related to expenses, losses, incomes and gains are called nominal accounts. Examples are salary account, rent account, interest account, purchase account and sales account. These accounts are closed at the end of every accounting year.

4. Meaning of Debit and Credit

• Debit (Dr.): an entry made on the left-hand side of an account. It records an increase in assets and expenses or a decrease in liabilities and capital.
• Credit (Cr.): an entry made on the right-hand side of an account. It records an increase in liabilities, capital and income or a decrease in assets.

5. Golden Rules of Accounting

The three golden rules of accounting for the three types of accounts are:

Examples:

1. Furniture purchased for cash: Furniture (real, comes in) is debited and Cash (real, goes out) is credited.
2. Cash received from Ram: Cash (real, comes in) is debited and Ram (personal, giver) is credited.
3. Salary paid: Salary (nominal, expense) is debited and Cash (real, goes out) is credited.

6. The Journal

The journal is the book in which business transactions are recorded for the first time in chronological order. It is also called the book of original entry or the day book. Each transaction is recorded as a journal entry in the following columns:

1. Date: the date of the transaction.
2. Particulars: names of the accounts involved, with the account to be debited written first and the account to be credited written with the prefix "To".
3. L.F.: the ledger folio number to which the entry is posted.
4. Debit amount: amount to be debited.
5. Credit amount: amount to be credited.

The format of a journal entry is:

A brief narration explaining the transaction is written below every entry.

7. Steps for Passing a Journal Entry

1. Identify the two accounts involved in the transaction.
2. Determine the type of each account (personal, real or nominal).
3. Apply the relevant golden rule.
4. Decide which account is to be debited and which is to be credited.
5. Write the entry in the journal with a proper narration.

8. Source Documents

Source documents are the original documents that support a transaction and provide evidence of its occurrence. Important source documents are:

1. Cash memo: issued for cash sales or purchases.
2. Invoice or bill: prepared for credit sales and purchases.
3. Receipt: evidence of money received.
4. Debit note: sent by the buyer to the seller for goods returned.
5. Credit note: sent by the seller to the buyer for goods returned.
6. Cheque and pay-in-slip: for payments and deposits through the bank.
7. Voucher: the written authorisation or proof of every transaction.

9. Journal Entries - Solved Examples

Example 1: Introduction of Capital

Ram started business with cash of Rs 50,000. - Cash comes in (real) -> Debit - Ram's capital (personal, giver) -> Credit - Entry: Cash A/c Dr. 50,000; To Ram's Capital A/c 50,000

Example 2: Credit Purchase of Goods

Goods purchased on credit from Radha for Rs 20,000. - Purchases (nominal, expense) -> Debit - Radha's account (personal, giver) -> Credit - Entry: Purchases A/c Dr. 20,000; To Radha's A/c 20,000

Example 3: Cash Sale

Goods sold for cash Rs 5,000. - Cash comes in (real) -> Debit - Sales (nominal, income) -> Credit - Entry: Cash A/c Dr. 5,000; To Sales A/c 5,000

Example 4: Payment of Rent

Rent paid Rs 2,000. - Rent (nominal, expense) -> Debit - Cash goes out (real) -> Credit - Entry: Rent A/c Dr. 2,000; To Cash A/c 2,000

Example 5: Drawings

Owner withdrew Rs 3,000 cash for personal use. - Drawings (personal, receiver) -> Debit - Cash goes out (real) -> Credit - Entry: Drawings A/c Dr. 3,000; To Cash A/c 3,000

10. The Ledger

The ledger is the principal book of accounts in which all the entries from the journal are posted into classified accounts. It is also called the book of final entry. Each account in the ledger has two sides, the debit side and the credit side. Posting means transferring the debit and credit amounts from the journal to the respective accounts. After all postings are complete, each account is balanced to find the net debit or credit balance.

The process of posting involves: 1. Opening the account for each type of transaction. 2. Transferring the amount from the journal to the appropriate side of the account. 3. Writing the reference of the journal page and date.

11. Balancing of Accounts

Balancing an account means making the total of the two sides equal by putting the difference on the smaller side. If the debit side is larger, the account shows a debit balance, and the difference is written on the credit side as "By balance c/d". If the credit side is larger, the account shows a credit balance. Cash account normally shows a debit balance, personal accounts may show debit or credit balances, and expense accounts show debit balances. Balanced accounts are carried forward to the next period as "To balance b/d" or "By balance b/d".

Quick Revision Tables

Table 1: Golden Rules of Accounting

Table 2: Journal Columns

Table 3: Source Documents

Mind Map

Important Diagrams (SVG)

Diagram 1: Types of Accounts and Golden Rules

Diagram 2: Flow of Recording - Journal to Ledger

Common Mistakes

1. Students debit the giver instead of the receiver in personal accounts; for a personal account always debit the receiver and credit the giver.
2. The two types of real accounts, tangible and intangible, are confused; goodwill and patents are intangible real accounts, not nominal accounts.
3. Purchases and purchases returns are mixed up; purchases are expenses (debited) while purchases returns are a reduction in purchases (credited).
4. The narration is skipped or written incorrectly; a proper narration explaining the transaction is compulsory in the journal.
5. Drawings are treated as an expense, but drawings reduce capital and are debited to a personal account of the owner.
6. Balancing is done incorrectly by putting the difference on the wrong side; the difference is always put on the smaller side.
7. The ledger folio column is left blank; L.F. must be filled with the page number of the ledger where the account is posted.

Exam Tips

1. Memorise the three golden rules with the exact words: debit the receiver, credit the giver; debit what comes in, credit what goes out; debit all expenses and losses, credit all incomes and gains.
2. In exam entries, always write the debit account first and then the credit account with the word "To".
3. Give at least one solved journal entry for each type of account to demonstrate your understanding.
4. While describing source documents, give one example of the use of each document.
5. In the ledger, practise balancing every account and writing balance c/d on the smaller side and balance b/d on the next period.
6. Present the journal in a proper table format with columns Date, Particulars, L.F., Debit and Credit.
7. Remember that the cash account can never show a credit balance unless there is an overdraft.

Conclusion

Recording of transactions is the foundation of the entire accounting cycle. The double entry system, based on the accounting equation, records each transaction through journal entries guided by the golden rules for personal, real and nominal accounts. Source documents provide the evidence for these entries, while the ledger classifies them into individual accounts. Correct recording and balancing of accounts are essential because every later stage, from the trial balance to the final accounts, depends on the accuracy of this first stage.