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STRUCTURE
3.0 Objective
3.1 Introduction
3.2 Accounting Equation
3.3 Rules of Debit and Credit
3.4 Meaning and format of Journal.
3.4.1 Meaning of Journalising
3.4.2 Compound Journal Entry
3.4.3 Opening Entry
3.4.4 Goods Account
3.5 Ledger
3.5.1 Relationship between Journal and Ledger
3.5.2 Posting
3.5.3 Rules of Posting
3.5.4 Balancing of an Account
3.6 Summary
3.7 Keywords
3.8 Self Assessment Questions
3.9 Suggested Readings

3.0 OBJECTIVE

After reading this lesson, you should be able to

(a) Define accounting equation
(b) Make the classification of accounts
(c) Explain the stages in accounting process
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3.1 INTRODUCTION

Any economic transaction or event of a business which can be expressed in

monetary terms should be recorded. Traditionally, accounting is a method of
collecting, recording, classifying, summarizing, presenting and interpreting
financial data of an economic activity. The series of business transactions occurs
during the accounting period and its recording is referred to an accounting process/
mechanism. An accounting process is a complete sequence of accounting
procedures which are repeated in the same order during each accounting period.
Therefore, accounting process involves the following steps :

i) Identification of Transaction : In accounting, only financial transactions

are recorded. A financial transaction is an event which can be expressed in terms
of money and which brings change in the financial position of a business enterprise.
An event is an incident or a happening which may or may not bring any change in
the financial position of a business enterprise. Therefore, all transactions are
events but all events are not transactions. A transaction is a complete action, to an
expected or possible future action. In every transaction, there is movement of
value from one source to another. For example, when goods are purchased for
cash, there is a movement of goods from the seller to the buyer and a movement
of cash from buyer to the seller. Transactions may be external (between a business
entity and a second party, e.g., goods sold on credit to Hari or internal (do not
involve second party, e.g., depreciation charged on the machinery).

Illustration 1

State with reasons whether the following events are transactions or

not to Mr. Nikhil, Proprietor, Delhi Computers

(i) Mr. Nikhil started business with capital (brought in cash)Rs. 40,000.
(ii) Paid salaries to staff Rs. 5,000.
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(iii) Purchased machinery for Rs. 20,000 in cash.

(iv) Placed an order with Sen & Co. for goods for Rs. 5,000.
(v) Opened a Bank account by depositing Rs. 4,000.
(vi) Received pass book from bank.
(vii) Appointed Sohan as Manager on a salary of Rs. 4,000 per month.
(viii)Received interest from bank Rs. 500.
(ix) Received a price list from Lalit.

Solution :

Here, each event is to be considered from the view point of Mr.

Nikhil's business. Those events which will change the financial position of the
business of Mr. Nikhil, should be regarded as transaction.

(i) It is a transaction, because it changes the financial position of Mr. Nikhil's

business. Cash will increase by Rs. 40,000 and Capital will increase by Rs.
40,000.

(ii) It is a transaction, because it changes the financial position of Mr. Nikhil's

business. Cash will decrease by Rs. 5,000 and Salaries (expenses) will
increase by Rs. 5,000

(iii) It is a transaction, because it changes the financial position of Mr. Nikhil's

business. Machinery comes in and cash goes out.

(iv) It is not a transaction, because it does not change the financial position of
the business.

(v) It is a transaction, because it changes the financial position of the business.

Bank balance will increase by Rs. 4,000 and cash balance will decrease by
Rs. 4,000.
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(vi) It is also not a transaction, because it does not change the financial position
of Mr. Nikhil.

(vii) It is also not a transaction, because it does not change the financial position
of Mr. Nikhil.

(viii) It is a transaction, because it changes the financial position of Mr. Nikhil's

business.

(ix) It is not a transaction, because it does not change the financial position of
the business of Mr. Nikhil.

ii) Recording the transaction : Journal is the first book of original entry in
which all transactions are recorded event-wise and date-wise and presents a
historical record of all monetary transactions. Journal may further be divided into
sub-journals as well.

iii) Classifying : Accounting is the art of classifying business transactions.

Classification means statement setting out for a period where all the similar
transactions relating to a person, a thing, expense, or any other subject are grouped
together under appropriate heads of accounts.

iv) Summarising : Summarising is the art of making the activities of the

business enterprise as classified in the ledger for the use of management or other
user groups i.e. sundry debtors, sundry creditors etc. Summarisation helps in the
preparation of Profit and Loss Account and Balance sheet for a particular financial
year.

v) Analysis and Interpretation : The financial information or data is recorded

in the books of account must further be analysed and interpreted so to draw
meaningful conclusions. Thus, analysis of accounting information will help the
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management to assess in the performance of business operation and forming future

plans also.

vi) Presentation or reporting of financial information : The end users of

accounting statements must be benefited from analysis and interpretation of data
as some of them are the "share holders" and other one the "stake holders".
Comparison of past and present statements and reports, use of ratios and trend
analysis are the different tools of analysis and interpretation.

From the above discussion one can conclude that accounting is an

art which starts and includes steps right from recording of business transactions
of monetary character to the communicating or reporting the results thereof to
the various interested parties. For this purpose, the transactions are classified
into various accounts, the description of which follows in the next section.

3.2 ACCOUNTING EQUATION

Dual concept states that 'for every debit, there is a credit'. Every
transaction should have two-sided effect to the extent of same amount. This concept
has resulted in accounting equation which states that at any point of time assets
of any entity must be equal (in monetary terms) to the total of owner's equity and
outsider's liabilities. In other words, accounting equation is a statement of equality
between the assets and the sources which finance the assets and is expressed as :
Assets = Sources of Finance

Assets may be tangible e.g. land, building, plant, machinery,

equipment, furniture, investments, cash, bank, stock, debtors etc. or intangible
e.g. patent rights, trade marks, goodwill etc.,

Sources include internal i.e. capital provided by the owner and

external i.e. liabilities. Liabilities are the obligations of the business to others/
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outsiders. The above equation gets expanded.

Assets = Liabilities + Capital

All transactions of a business can be referred to this equation :
Assets = Liabilities + Owner's equity
To further explain the transaction of revenues, expenses, losses and
gains, the equation can be expanded thus :
Assets + Expenses = Liabilities + Revenue + Owner's equity
or Assets = Liabilities + (Revenue – Expenses) + Owner's equity
or Assets = Liabilities + Owner's equity + Owner's equity
(income) which ultimately becomes
Assets = Liabilities + Owner's equity
Let us consider the facts of the following case, step by step, to
understand as to how the equation remains true even in changed circumstances.

Illustration 2

1. Commenced business with cash Rs. 50,000

2. Purchased goods for cash Rs. 20,000 and on credit Rs. 30,000

3. Sold goods for cash Rs. 40,000 costing Rs. 30,000

4. Rent paid Rs. 500

5. Bought furniture Rs. 5,000 on credit

6. Bought refrigerator for personal use Rs. 5,000

Solution :

1. Business receives cash Rs. 50,000 (asset) and it owes Rs. 50,000 to the
proprietor as his capital i.e. equity.
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Assets (=) Liabilities (+) Owner's equity

Cash Rs. 50,000 Nil Capital Rs.

50,000
(2) Purchased goods for cash Rs. 20,000 and on credit Rs. 30,000. Business
has acquired asset namely – goods worth Rs. 50,000 and another asset namely =
cash has decreased by Rs. 20,000 while liability– creditors have been created of
Rs. 30,000.

Assets (=) Liabilities (+) Owner's equity

Cash 30,000 Creditors 30,000 Capital 50,000

Goods 50,000

80,000 30,000 50,000

(3) Sold goods for cash Rs. 40,000 costing Rs. 30,000

This transaction has resulted in decrease of goods by Rs. 30,000 and

increase in cash by Rs. 40,000 thus Increasing equity by Rs. 10,000

Assets (=) Liabilities (+) Owner's equity

Cash 70,000 Creditors 30,000 Capital 60,000

Goods 20,000

90,000 30,000 60,000

(4) Rent paid Rs. 500

This transaction has resulted in an expenditure of Rs. 500 effecting decrease

of cash and equity by Rs. 500 each.

Assets (=) Liabilities (+) Owner's equity

Cash 69,500 Creditors 30,000 Capital 59,500

Goods 20,000

89,500 30,000 59,500

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(5) Bought furniture on credit Rs. 5,000

This transaction results in acquiring an asset namely furniture worth Rs.

5,000 and increasing creditors by Rs. 5,000

Assets (=) Liabilities (+) Owner's equity

Cash 69,500 Creditors 35,000 Capital 59,500

Goods 20,000
Furniture 5,000 59,500
94,500 35,000
(6) Bought refrigerator for personal use Rs. 5,000. This transaction will have
the effect of reducing both cash as well as capital by Rs. 5,000 each.

Assets (=) Liabilities (+) Owner's equity

Cash 64,500 Creditors 35,000 Capital 54,500

Goods 20,000
Furniture 5,000
89,500 35,000 54,500
Account

An account is a summary of the relevant transactions at one place

relating to a particular head. It records not only the amount of transaction but also
their effect and direction.

Classification of Accounts

The classification of accounts is given as follows :

1. Personal Accounts : Accounts which are related to individuals, firms,

companies, co-operative societies, banks, financial institutions are known as
personal accounts. The personal accounts may further be classified into three
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categories :

(i) Natural Personal Accounts : Accounts of individuals (natural persons)

such as Akhils' A/c, Rajesh's A/c, Sohan's A/c are natural personal accounts.

(ii) Artificial Personal Accounts : Accounts of firms, companies, banks,

financial institutions such as Reliance Industries Ltd., Lions Club, M/s Sham &
Sons, Punjab National Bank, National College are artificial personal accounts.

iii) Representative Personal Accounts : The accounts recording transactions

relating to limited expenses and incomes are classified as nominal accounts. But
in certain cases (due to the matching concept of accounting) the amount on a
particular date, is payable to the individuals or recoverable from individuals. Such
amount (i) relates to the particular head of expenditure or income and (ii)
represents persons to whom it is payable or from whom it is recoverable. Such
accounts are classified as representative personal account e.g., Wages outstanding
account, Pre-paid insurance account etc.

2. Real Accounts : Real accounts are the accounts related to assets/properties.

These may be classified into tangible real account and intangible real account.
The accounts relating to tangible assets (which can be touched, purchased and
sold) such as building, plant, machinery, cash, furniture etc. are classified as
tangible real accounts. Intangible real accounts (which do not have physical shape)
are the accounts related to intangible assets such as goodwill, trademarks,
copyrights, patents etc.

3. Nominal Accounts : The accounts relating to income, expenses, losses

and gains are classified as nominal accounts. For example Wages Account, Rent
Account, Interest Account, Salary Account, Bad Debts Accounts, Purchases;
Account etc. fall in the category of nominal accounts.
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3.3 RULES OF DEBIT AND CREDIT

Basically, debit means to enter an amount to the left side of an account

and credit means to enter an amount to the right side of an account. In the
abbreviated form Dr. stands for debit and Cr. stands for credit. Both debit and
credit may represent either increase or decrease depending upon the nature of an
account.
The Rules for Debit and Credit are given below :

Types of Accounts Rules for Debit Rules for Credit

(a) For Personal Accounts Debit the receiver Credit the giver

(b) For Real Accounts Debit what comes in Credit what goes out

(c) For Nominal Accounts Debit all expenses Credit all incomes and
and losses gains

Illustration 3 : How will you classify the following into personal, real and nominal
accounts ?
(i) Investments

(ii) Freehold Premises

(iii) Accrued Interest to Ram

(iv) Haryana Agro Industries Corporation

(v) Janata Mechanical Works

(vi) Salary Account

(vii) Loose Tools Accounts

(viii)Purchases Account

(ix) Corporation Bank Ltd.

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(x) Capital Account

(xi) Brokerage Account

(xii) Toll Tax Account

(xiii) Dividend Received Account

(xiv) Royalty Account

(xv) Sales Account

Solution :

Real Account : (i), (ii), (vii), (viii), (xv)

Nominal Account : (vi), (xi), (xii), (xiii), (xiv)
Personal Account : (iii), (iv), (v), (ix), (x)
3.4 MEANING AND FORMAT OF A JOURNAL

Journal is a historical record of business transactions or events. The word

journal comes from the French word "Jour" meaning "day". It is a book of original
or prime entry written up from the various source documents. Journal is a primary
book for recording the day to day transactions in a chronological order i.e. in the
order in which they occur. The journal is a form of diary for business transactions.
This is also called the book of first entry since every transaction is recorded
firstly in the journal. The format of a journal is shown as follows :

Journal

Date Particulars L.F. Debit Credit

(Rs.) (Rs.)
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(a) Date Column : This column shows the date on which the transaction is
recorded. The year and month is written once, till they change.

(b) Particular Column : Under this column, first the names of the accounts to
be debited, then the names of the accounts to be credited and lastly, the narration
(i.e. a brief explanation of the transaction) are entered.

(c) L.F., i.e. Ledger Folio Column : Under this column, the ledger page number
containing the relevant account is entered at the time of posting.

(d) Debit amount Column : Under this column, the amount to be debited is
entered.

(e) Credit amount Column : Under this column, the amount to be credited is
entered.

3.4.1 Meaning of Journalising

The process of recording a transaction in the journal is called

journalising. The various steps to be followed in journalising business transactions
are given below :

Step 1 Ascertain what accounts are involved in a transaction.

Step 2 Ascertain what is the nature of the accounts involved.

Step 3 Ascertain which rule of debit and credit is applicable for each of the
accounts involved.

Step 4 Ascertain which account is to be debited and which is to be credited.

Step 5 Record the date of transaction in the 'Date column'.

Step 6 Write the name of the account to be debited, very close to the left hand
side i.e. the line demarcating the 'Date column' and the 'Particulars
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column') along with the abbreviation 'Dr.' on the same line against the
name of the account in the 'Particulars column' and the amount to be
debited in the 'Debit Amount column' against the name of the account.

Step 7 Write the name of the account to be credited in the next line preceded by
the word 'To' at a few spaces towards right in the 'Particulars column' and
the amount to be credited in the 'Credit Amount column' against the name
of the account.

Step 8 Write 'Narration' (i.e. a brief description of the transaction) within brackets
in the next line in the 'Particulars column'.

Step 9 Draw a line across the entire 'Particulars column' to separate one Journal
Entry from the other.

Advantages of Journal

1. The transactions are recorded in journal as and when they occur so the
chances of error is minimized.

2. It help in preparation of ledger.

3. Any transfer from one account to another account is made through Journal.

4. The entry recorded in journal are self explanatory as it includes narration

also.

5. It can record any such transaction which cannot be entered in any other
books of account.

6. Every transaction is recorded in chronological order (date wise) so the

chances of manipulations are reduced.

7. Journal shows all information in respect of a transaction at one place.

8. The closing balances of previous year of accounts related to assets and

liabilities can be brought forward to the next year by passing journal entry
in journal.
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Illustration 4 : From the following transactions of Nikhil, find out the nature of
accounts and also state which account should be debited and which should be
credited :

i) Rent paid
ii) Interest received
iii) Purchased furniture for cash
iv) Machinery sold in cash
v) Outstanding salaries
vi) Paid to Surinder
Solution :

Analysis of Transactions

Transaction Accounts Nature of Debit/

Involved Accounts Credit

i) Rent paid Rent Account Nominal Account Debit

Cash Account Real Account Credit

ii) Interest Received Cash Account Real Account Debit

Interest Account Nominal Credit

iii) Purchased furniture for Furniture Account Real Account Debit

cash
Cash Account Real Account Credit

iv) Machinery sold in cash Cash Account Real Account Debit

Machinery Account Real Account Credit

v) Outstanding Salary Salary Account Nominal Account Debit

Outstanding Personal Account Credit
Salary Account
vi) Paid to Surinder Surinder's Account Personal Account De
bit
Cash Account Real Account Credit
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Illustration 5 : Journalise the following transactions :

2005 Rs.

Jan. 1 Mohan started business with cash 80,000

Jan. 6 Purchased goods from Ram on credit 30,000

Jan. 8 Sold goods on cash 6,000

Jan. 15 Bought Furniture from Yash for cash 8,000

Jan. 18 Paid Salary to manager 6,500

Jan. 20 Paid Rent to land lord in cash 1,000

Solution :
Journal
Date Particulars L.F. Debit Credit
2005 Cash Account Dr. 80,000
To Mohan's Capital Account 80,000
(Being business started with cash)
"6 Purchases Account Dr. 30,000
To Ram's Account 30,000
(Being purchase on credit)
"8 Cash Account Dr. 6,000
To Sales Account 6,000
(Being sold goods for cash)
" 15 Furniture Account Dr. 8,000
To Cash Account
(Being bought furniture for cash) 8,000
" 18 Salary Account Dr. 6,500
To Cash Account 6,500
(Being salary paid to manager)
" 20 Rent Account Dr. 1,000
To Cash Account 1,000
(Being rent paid to land lord)
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3.4.2 Compound Journal Entries

When more than two accounts are involved in a transaction and the
transaction is recorded by means of a single journal entry instead of passing several
journal entries, such single journal entry is termed as 'Compound Journal Entry'.

Illustration 6 : Journalise the following :

2005
Nov. 1 Paid to Arun Rs. 5,250 discount allowed by him Rs.50
6 Received from Somesh Rs. 1,900 and from Komesh Rs. 400
8 Goods purchased for cash Rs. 4,000
Furniture purchased for cash Rs. 3,000
Paid cash to Raman Rs. 2,090
Paid Salary in cash Rs. 7,600
Paid Rent in cash Rs. 1,400
Solution :
Journal
Date Particulars L.F. Debit(Rs.) Credit(Rs.)
2005
Nov.1 Arun's Account Dr. 5,300
To Cash Account 5,250
To Discount Received Account 50
(Being the cash paid to Arun and discount received)
Nov.6 Cash Account Dr. 2,300
To Somesh's Account 1,900
To Komesh's Account 400
(Being cash received)
Nov.8 Purchases Account Dr. 4,000
Furniture Dr. 3,000
Account Raman's Dr. 2,090
Account Salary Dr. 7,600
Account Rent Dr. 1,400
Account 18,090
To Cash Account
(Being the cash paid )
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3.4.3 Opening Entry

A journal entry by means of which the balances of various assets,

liabilities and capital appearing in the balance sheet of previous accounting period
are brought forward in the books of the current accounting period, is known as
'Opening Entry'. While passing an opening entry, all assets accounts (individually)
are debited and all liabilities accounts (individually) are credited and the Net worth
(i.e. excess of assets over liabilities) is credited to Proprietor's Capital Account
(in case of a proprietary concern) or Partners' Capital Accounts (in case of a
partnership concern).

Illustration 7 On Ist April 2006, Singh's assets and liabilities stood as follows :

Assets : Cash Rs. 6,000; Bank Rs. 17,000; Stock Rs. 3,000; Bills
Receivable Rs.7,000; Debtors Rs. 3,000; Building Rs.70,000;
Investments Rs. 30,000; Furniture Rs. 4,000

Liabilities : Bills payable Rs. 5000, Creditors Rs. 9000, Ram's Loan Rs. 13000

Pass an opening Journal entry.

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Solution :
Journal
Date Particulars L.F. Debit(Rs.) Credit (Rs.)
2006
April Cash Account Dr. 6,000
1
Bank Account Dr. 17,000
Stock Account Dr. 3,000
Bills Receivable Account Dr. 7,000
Debtors Account Dr. 3,000
Building Account Dr. 70,000
Investment Account Dr. 30,000
Furniture Dr. 4,000
To Bills payable Account 5,000
To Creditor's Account 9,000
To Ram's loan Account 13,000
To Singh's capital 1,13,000
(Being the opening balances of assets and s)
liabilitie
1,40,000 1,40,000

3.4.4 Goods Account

In accounting the meaning of goods is restricted to only those articles
which are purchased by a businessman with an intention to sell it. For example, if
a businessman purchased typewriter, it will be goods for him if he deals in
typewriter but if he deals in other business say clothes then typewriter will be
asset for him and clothes will be goods.

Sub-Division of Goods Accounts

The goods account is not opened in accounting books. In place of

goods account the following accounts are opened in the books of accounts :

Purchases Account : This is opened for goods purchased on cash and credit.

Sales Account : This account is opened for the goods sold on cash and credit.
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Purchase Returns Account or Return Outward Account : This account is

opened for the goods returned to suppliers.

Sales Returns Account or Return Inward Account : This account is opened for
the goods returned by customers.

IMPORTANT CONSIDERATIONS FOR RECORDING THE BUSINESS TRANSACTIONS

1. Trade Discount

Trade discount is usually allowed on the list price of the goods. It may
be allowed by producer to wholesaler and by wholesaler to retailer for purchase of
goods in large quantity. It is not recorded in the books of account and entry is made only
with the net amount paid or received. For example purchased goods of list price Rs.
8,000 at 15% trade discount from X. In this case the following entry will be passed :
Rs. Rs.
Purchases Account Dr. 6,800
To X 6,800
(Being goods purchased at 15%
trade discount less list price)
2. Cash Discount

Cash discount is a concession allowed by seller to buyer to encourage

him to make early cash payment. It is a Nominal Account. The person who allows
discount, treat it as an expense and debits in his books and it is called discount
allowed and the person who receives discount, treat it as an income and it is called
discount received and credited in his books of account as "Discount Received
Account." For example, X owes Rs. 6,000 to Y. He pays Rs. 5,950 in full settlement
against the amount due. In the books of X, the journal entry will be :
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Rs. Rs.
Y Dr. 6,000
To Cash Account 5,950
To Discount Received account 50
(Being Cash paid and discount received)

In the books of Y Rs. Rs.

Cash Account Dr. 5,950
Discount Allowed Account Dr. 50
To X 6,000
(Being cash received and discount allowed)

3. Goods distributed as free samples

Some times business distribute goods as free samples for the purpose
of advertisement. In this case, Advertisement Account is debited and Purchases
Account is credited. For example, goods costing Rs. 8000 were distributed as
free sample. To record this transaction following entry will be passed :

Rs.
Rs.
Advertisement Account Dr. 8,000
To Purchases Account 8,000

4. Interest on capital

Interest paid on capital is an expense. Therefore interest account

should be debited. On the other hand the capital of the business increases. So the
capital account should be credited. The entry will be as follows :
Interest on Capital Account Dr.
To Capital Account
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5. Interest charged on Drawings

If the interest is charged on drawings then it will be an increase in

the income of business, so interest on drawings will be credited. On the other
hand there will be increase in drawings or decrease in Capital. So Drawings
Account will be debited. To record this, following entry will be passed :
Drawing Account/Capital Account Dr.
To Interest on Drawing Account
6. Depreciation charged on Fixed Assets

Depreciation is the gradual, permanent decrease in the value of an

asset due to wear and tear and many other causes. Depreciation is an expense so
the following entry will be passed :
Depreciation Account Dr.
To Asset Account
7. Bad Debts

Sometimes a debtor of business fails to pay the amount due from

him. Reasons may be many e.g. he may become insolvent or he may die. Such
irrecoverable amount is a loss to the business. To record this following entry will
be passed :
Bad Debts Account Dr.
To Debtor's Account
8. Bad Debts Recovered

When any amount becomes irrecoverable from any costumer or

debtor his account is closed in the books. If in future any amount is recovered
from him then his personal account will not be credited because that does not
exist in the books. So the following entry is passed :
Cash Account Dr.
To Bad Debts Recovered Account
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9. Purchase and Sale of investment

When business has some surplus money it may invest this amount is
shares, debentures or other types of securities. When these securities are
purchased, these are recorded at the purchase price paid. At the time of sale of
investment the sale price of an investment is recorded in the books of accounts.
The following entry is passed to record the purchase of investment :
Investment Account Dr.
To Cash Account
In case of sale of these securities the entry will be :
Cash Account Dr.
To Investment Account
10. Loss of Goods by Fire/Accident/theft

A business may suffer loss of goods on account of fire, theft or

accident. It is a business loss and a nominal account. It also reduces the goods at
cost price, and increases the loss/expenses of the business. The entry will be passed
as :
Loss by fire/Accident/theft Account Dr.(for loss)
Insurance Company Account Dr. (for insurance claim
admitted) To Purchases Account

11. Income Tax Paid

Income Tax paid should be debited to Capital Account or Drawings

Account and credited to Cash Account in case of sole proprietorship and
partnership firms. The reason behind this is that income tax is a personal expense
for the sole trader and partners because it is paid on income of proprietor. The
entry will be as follows :
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Capital Account/Drawing Account Dr.

To Cash Account
12. Bank Charges

Bank provide various services to their customers. Bank deducts some

charges by debiting the account of customers. It is an expense for the business.
To record this, Bank charges account is debited and bank account is credited in
the books of customer.

13. Drawings Account

It is a personal account of the proprietor. When the businessman

withdraws cash or goods from the business for his personal/domestic use it is
called as 'drawings'. Drawings reduce the capital as well as goods/cash balance of
the business. The journal entry is :

Drawings Account Dr.

To Cash Account
To Purchases Account
14. Personal expenses of the proprietor

When the private expenses such as life insurance premium, income tax, home
telephone bill, tuition fees of the son of the proprietor etc. are paid out of the cash or
bank account of business it should be debited to the Drawings Account of the
proprietor.

15. Sale of Asset/Property

When the asset of a business is sold, there may occur a profit or loss
on its sale. Its journal entry is :

(i) In case there is a profit on sale of Property/Assets

Cash/Bank Account Dr.
To Asset/Property Account
To Profit on sale of Asset Account
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(ii) In case of a loss on sale of asset

Cash/Bank Account Dr.
Loss on sale of Asset Account Dr.
To Asset Account
16. Amount paid or Received on behalf of customer

(i) When the business entity pays the amount on behalf of old reputed
customers such as carriage in anticipation of recovering the same later on, carriage
account should not be opened because carriage is not the expense of the seller. It
should be debited/charged to customer's Personal account.

(ii) When the business entity receives the amount on behalf of customers
from the third party as mutually settled between the third party and the customer,
the account of the third party/person making the payment should not be opened in
the books of the receiving entity. The journal entry in the books of the entity is :

Cash/Bank Account Dr.

To Customer/Debtor's Account
17. Amount paid on behalf of creditors

When the creditors/supplier instructs the business entity to make

payment on their behalf, the amount so paid should be debited to creditors account
and liability of the business will decrease accordingly.

18. The events affecting business but they do not involve any transfer/exchange
of money for the time being, they would not be recorded in the financial books.

19. Paid wages/installation charges for erection of machinery

Wages and installation charges are the expenses of nominal nature.

But for erection of machinery no separate account should be opened for such
expenses because these expenses are of capital nature and it will be merged/debited
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to the cost of assets i.e. machinery. The journal entry is:

Machinery Account Dr.

To Cash/Bank Account
(Being wages/installation charges paid
for the erection of machinery)
3.5 LEDGER

Journal is a daily record of all business transactions. In the journal

all transactions relating to persons, expenses, assets, liabilities and incomes are
recorded. Journal does not give a complete picture of the fundamental elements
of book keeping i.e. properties, liabilities, proprietorship accounts and expenses
and incomes at a glance and at one place. Business transactions being recurring in
nature, a number of entries are made for a particular type of transactions such as
sales, purchases, receipts and payments of cash, expenses etc., through out the
accounting year. The entries are therefore scattered over in the Journal. In fact,
the whole Journal will have to be gone through to find out the combined effect of
various transactions on a particular account. In case, at any time, a businessman
wants to now :
i) How much he has to pay to the suppliers/creditors of goods ?
ii) How much he has to receive from the customers ?
iii) What is the total amount of purchases and sales made during a particular
period?
iv) How much cash has been spent/incurred on various items of expenses such
as salaries, rent, carriage, stationery etc.
v) What is the amount of profit or loss made during a particular period ?
vi) What is the financial position of the unit on a particular date ?
The above mentioned information cannot be easily gathered from the
journal itself because the details of such information is scattered all over the
 26

journal. It is thus of dire need to get a summarised/grouped record of all the

transactions relating to a particular person, or a thing or an expenditure to take
managerial decisions. The mechanics of collecting, assembling and summarising
all transactions of similar nature at one place can better be served by a book known
as 'ledger' i.e. a classified head of accounts.
Ledger is a principal book of accounts of the enterprise. It is rightly
called as the 'King of Books'. Ledger is a set of accounts. Ledger contains the
various personal, real and nominal accounts in which all business transactions of
the entity are recorded. The main function of the ledger is to classify and
summarise all the items appearing in Journal and other books of original entry
under appropriate head/set of accounts so that at the end of the accounting period,
each account contains the complete information of all transaction relating to it.
A ledger therefore is a collection of accounts and may be defined as a summary
statement of all the transactions relating to a person, asset, expense or income
which have taken place during a given period of time and shows their net effect.

3.5.1 Relationship between Journal and Ledger

Journal and Ledger are the most useful books kept by a business
entity. The points of distinction between the two are given below :
1. The journal is a book of original entry where as the ledger is the main book
of account.
2. In the journal business transactions are recorded as and when they occur
i.e. date-wise. However posting from the journal is done periodically, may
be weekly, fortnightly as per the convenience of the business.
3. The journal does not disclose the complete position of an account. On the
other hand, the ledger indicates the position of each account debit wise or
credit wise, as the case may be. In this way, the net position of each account
is known immediately.
 27

4. The record of transactions in the journal is in the form of journal entries

whereas the record in the ledger is in the form of an account.
Utility of a Ledger

The main utilities of a ledger are summarised as under :

(a) It provides complete information about all accounts in one book.
(b) It enables the ascertainment of the main items of revenues and expenses
(c) It enables the ascertainment of the value of assets and liabilities.
(d) It facilitates the preparation of Final Accounts.
Format of a Ledger Account

A ledger account can be prepared in any one of the following two

forms:
Form 1

Name of the Account ..............

Dr. Cr.
Date Particulars Journal Amount Date Particulars Journal Amount
Folio (Rs.) Folio (Rs.)

Form 2

Name of the Account...............

Date Particulars Journal Debit Credit Dr./Cr. Balance
Folio Amount Amount Rs.
Rs. Rs.
 28

3.5.2 Posting
Posting refers to the process of transferring debit and credit amounts
from the Journal or subsidiary books to the respective heads of accounts in the
ledger. Journal will have at a minimum of one debit and one credit for each
transaction. The ledger will have either a debit or a credit for each account used
in the Journal. Posting may be done daily, weekly fort nightly or monthly according
to the convenience and requirements of the business, but care should be taken to
complete it before the preparation of annual financial statements.
3.5.3 Procedure/Rules of Posting
The following rules should be followed while posting business
transactions to respective accounts in the ledger from the journal :

i) Enter the date and year of the transaction in the date column.

ii) Open separate account in the ledger for each person, asset, revenue, liability,
expense, income and loss appearing in the Journal.

iii) The appropriate/relevant account debited in the Journal will be debited in

the ledger, but the reference should be given of the other account which
has been credited.

iv) Similarly, the account credited in the Journal should be credited in the
ledger, but the reference has to be given of the other account which has
been debited in the Journal.

v) The debit posting should be prefixed by the word 'To' and credit posting
should be prefixed by the word 'By'.

vi) In the Journal Folio (J.F.) column the page number of the book of original
entry (Journal) is entered. This is explained with the following example :

Illustration 8 : Goods sold to Ravi for Rs. 1000 on credit on Ist April 2006.
Record this transaction in the journal and the ledger.
 29

Solution :

The journal entry will be

Date Particulars L.F. Dr. (Rs.) Cr.(Rs.)

2006 Ravi's Account Dr. 1,000
April 1 To Sales Account 1,000
(Being Credit Sales of Goods to Ravi)

The above journal entry will appear in the ledger in two accounts as
follows. On the debit side of Ravi's Account, we will write "To Sales Account" and
on the credit side of Sales Account we will write "By Ravi's Account".

Dr. Ravi's Account Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount

(Rs.) (Rs.)
2006 To Sales Account 1,000
April 1

Dr. Sales's Account Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount
(Rs.) (Rs.)
2006
April1 By Ravi's unt 1,000
Acco
Posting of Compound Journal Entry

When a single entry is passed to record more than one transaction, it

is known as a compound journal entry. However, it will be treated as several
separate entries while posting. The following example will make the point clear:
 30

Illustration 9
Rs.
2006 March 31 Purchased stationary 1,000
Paid salary 7,000
Paid wages 600
Paid rent 1,200
Pass the necessary journal entry and prepare ledger accounts.
Solution :

The Journal entry will be

Date Particulars Dr. (Rs.) Cr.(Rs.)

2006 Stationary Account Dr. 1,000
March 31 Salary Account Dr. 7,000
Wages Account Dr. 600
Rent Account Dr. 1,200
To Cash Account 9,800
(Being cash paid for the above)

Then it will be posted as under :

Dr. Stationary's Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 To Cash Account 1,000

March 31

Dr. Salary's Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 To Cash Account 7,000

March 31
 31

Dr. Rent Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 To Cash Account 1200

March 31

Dr. Wages Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 To Cash Account 600

March 31

Dr. Cash Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006
March 31 By Stationary A/c 1,000
March 31 By Salary A/c 7,000
March 31 By Rent A/c 1,200
March 31 By Wages A/c 600

3.5.4 Balancing of an Account

After transferring the entries from Journal to the ledger, the next
stage is to ascertain the net effect of all the transactions posted to relevant account.
When the posting is completed, most of the accounts may have entries on both
sides of the accounts i.e. debit entries and credits entries. The process of finding
out the difference between the totals of the two sides of a Ledger account is
known as balancing and the difference of the total debits and the total credits of
accounts is known as balance.
 32

If the total of the credit side is bigger than the total of the debit side,
the difference is known as credit balance. In the reverse case, it is called debit
balance.
Steps for Balancing Ledger Account

Ledger accounts may be balanced as and when it is required. The

balances of various accounts are ascertained as under :

1. Make the total of both sides of an account in a worksheet.

2. Write down the higher amount on the side obtained e.g. if the total of the
debit side is 6,000 and the credit side is 5,500, the amount Rs. 6,000 is first
inserted in the total on the debit side.

3. Also write down the same total on the other side of the account i.e. the
total of Rs. 6,000 is written against the total on the credit side also.

4. Find out the difference between the two sides of the account. In this example
debit side is more than credit side; therefore, there is a debit balance of Rs. 500.

5. This debit balance of Rs. 500 is to be shown as "By Balance c/d" in the
account on the credit side.

6. Finally, the amount of the closing balance should be brought down as the
opening balance at the beginning of the next day. Remember that if the opening
balance is not written on the next day, the balancing is incomplete.
Balancing of different accounts

Balancing is done either weekly, monthly, quarterly, biannually or

annually, depending on the requirements of the business concern.

Personal Accounts : Personal accounts are balanced regularly to know the

amounts due to the persons or due from the persons. A debit balance of this account
indicate that the person concerned is a debtor of the business concern and a credit
balance indicates that he is a creditor of the business concern. If a personal account
shows no balance at all, it means that the amount due to him or due from him is
settled in full.
 33

Real Accounts : Real accounts are generally balanced at the end of the accounting
year when final accounts are prepared and always shows debit balances. But, bank
account may show either a debit balance or a credit balance.

Nominal Accounts : In fact, nominal accounts are not balanced, as they are to be
closed by transferring them to the final accounts i.e. Trading and Profit and Loss
Account.

Illustration 10 : Enter the following transactions in the Journal of Ramesh, and

post them to the Ledger.

2006 Rs.
Jan. 1 Assets in hand : Cash Rs. 630; Cash at Bank Rs. 23,100;
Stock of goods; Rs. 26,400; M. & Co., Rs. 6,750.
Liabilities : Marathi & Co. Rs. 3,880; Ram & Sons Rs. 3000.
" 2 Received a cheque from M. & Co. in full settlement 6,650
" 4 Sold goods to Chand & Sons on credit 1,440
Carriage paid 35
Sold goods to G. & Co. for cash 3,120
" 5 Brought goods from Ram & Sons on credit 4,000
Paid Marathi & Co. by cheque in full settlement 3,800
" 6 Bought goods from Chatterjee 6,300
" 13 Returned goods to Chatterjee (not being up to specifications) 300
" 16 Goods used personally by proprietor 50
" 17 Sold goods to M. & Co 5,000
" 20 Cheque received from Chand & Sons 1,440
" 22 Bank advises Chand & Sons cheque returned unpaid
" 24 Cash deposited with bank 2,000
" 27 Cheque sent to Chatterjee (Discount allowed Rs. 150) 5,850
" 31 Paid salaries 600
Paid rent 300
Drew for personal use out of bank 500
 34

Solution :

Journal

Date Particulars L.F. Dr. (Rs.) Cr. (Rs.)

2006
Jan. 1 Cash A/c Dr. 630
Bank A/c Dr. 23,100
Stock of Goods A/c Dr. 26,400
M. & Co. Dr. 6,750
To Marathi & Co. 3,880
To Ram & Sons 3,000
To Ramesh's Capital A/c 50,000
(Being balances of various assets
& liabilities brought forward)
2 Bank A/c Dr. 6,650
Discount Allowed A/c Dr. 100
To M. & Co. 6,750
(Being a cheque received from M.
& Co. & Discount allowed)
4 Chand & Sons A/c Dr. 1,440
To Sales A/c 1,440
(Being goods sold on credit)
4 Carriage Outwards A/c Dr. 35
To Cash A/c 35
(Being the carriage paid)
4 Cash A/c Dr. 3,120
To Sales A/c 3,120
(Being goods sold for cash)
5 Purchases A/c Dr. 4,000
To Ram & Sons 4,000
(Being goods purchased on credit)
 35

5 Marathi & Co. A/c Dr. 3,880

To Bank A/c 3,800
To Discount A/c 80
(Being payment made to Marathi & Co.
in full settlement & discount received)
6 Purchases A/c Dr. 6,300
To Chatterjee 6,300
(Being goods purchased on credit)
13 Chatterjee Dr. 300
To Returns Outwards A/c 300
(Being goods returned to Chatterjee)

16 Drawings A/c Dr. 50

To Purchases A/c 50
(Being goods withdrawn for
personal use)
17 M. & Co. Dr. 5,000
To Sales A/c 5,000
(Being goods sold on credit)
20. Bank A/c Dr. 1,440
To Chand & Sons A/c 1,440
(Being a cheque received from
Chand & Sons)
22 Chand & Sons A/c Dr. 1,440
To Bank A/c 1,440
(Being the cheque of Chand &
Sons dishonoured)
24 Bank A/c Dr. 2,000
To Cash A/c 2,000
(Being cash deposited into bank)
 36

27 Chatterjee A/c Dr. 6,000

To Bank A/c 5,850
To Discount Received A/c 150
(Being payment made to Chatterjee
and discount received)
31 Salaries A/c Dr. 600
To Cash A/c 600
(Being salaries paid)
31 Rent A/c Dr. 300
To Cash A/c 300
(Being rent paid)
31 Drawings A/c Dr. 500
To Bank A/c 500
(Being cash withdrawn from bank
for personal use)

Ledger of Ramesh
Dr. Capital Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 2006
Jan. 31 To Balance c/d 50,000 Jan.1 By Balance b/f 50,000
50,000 50,000
Feb. 1 By Balance b/d 50,000

Dr. Stock of Goods Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.
2006 2006
Jan. 1 To Balance b/f 26,400 Jan.31 By Balance c/d 26,400
26,400 26,400
Feb.1 Balance b/d 26,400
 37

Dr. Cash Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 2006
Jan. 1 To Balance b/f 630 Jan. 4 By Carriage Out-
4 To Sales A/c 3,120 wards A/c 35
24 By Bank A/c 2,000
31 By Salaries 600
31 A/c By Rent 300
31 815
A/c By
3,750 3,750
Balance c/d
Feb.1 To Balance b/d 815

Dr. Bank Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 2006
Jan. 1 To Balance b/f 23,100 Jan. 5 By Marathi & 3,800
Co.
2 To M. & Co. 6,650 22 By Chand & 1,440
Sons
20 To Chand & Sons 1,440 27 By Chatterjee 5,850
24 To Cash A/c 2,000 31 By Drawings 500
31 By Balance c/d 21,600
33,190 33,190
Feb.1 Balance b/d 21,600

Dr. M. & Co.'s Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.
2006 2006
Jan. 1 To Balance b/f 6,750 Jan. 1 By Bank 6,650
17 To Sales A/c 5,000 2 A/c By
Discount 100
Allowed A/c 5,000
11,750 By Balance c/d 11,750
Feb.1 To Balance b/d 5,000
 38

Dr. Marathi & Co.'s Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.
2006 2006
Jan. 5 To Bank A/c 3,800 Jan. 1 By Balance b/f 3,880
5 To Discount
Received A/c 80
3,880 3,880

Dr. Ram & Sons's Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.
2006 2006
Jan. 1 By Balance b/f 3,000
Jan. 31 To Balance c/d 7,000 5 By Purchase A/c 4,000
7,000 7,000
Feb. 1 By Balance b/d 7,000

Dr. Chand & Sons' Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.
2006 2006
Jan.4 To Sales A/c 1,440 Jan. 20 By Bank A/c 1,440
22 To Bank A/c 1,440 31 By balance c/d 1,440
2,880 2,880
Feb. 1 To Balance b/d 1,440

Dr. Chatterjee's Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 2006
Jan. 13 To Returns Jan. 6 By Purchases A/c 6,300
Outwards A/c 300
27 To Bank A/c 5,850
27 To Discount
Received A/c 150
6,300 6,300
 39

Dr. Purchases Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 2006
Jan. 5 To Ram & Sons 4,000 Jan.16 By Drawings A/c 50
6 To Chatterjee 6,300 Jan. 31 By Balance c/d 10,250
10,300 10,300
Feb. 1 To Balance b/d 10,250

Dr. Sales Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006
Jan. 4 By Chand & Sons c 1,440
A/
4 By Cash A/c 3,120
Jan. 31 To Balance c/d 9,560 17 By M. & Co. 5,000
9,560 9,560
Feb.1 By Balance b/d 9,560

Dr. Discount Allowed Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.
2006 2006
Jan. 2 To M. & Co. 100 Jan. 31 By Balance c/d 100
100 100
Feb. 1 To Balance c/d 100

Dr. Carriage Outwards Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 2006
Jan. 4 To Cash A/c 35 Jan. 31 By Balance c/d 35
35 35
Feb. 1 To Balance 35

b/d
 40

Dr. Discount Received Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 2006
Jan. 5 By Marathi & Co. 80
Jan. 31 To Balance c/d 230 27 By Chatterjee A/c 150
230 230
Feb. 1 By Balance b/d 230

Dr. Return Outwards Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 2006
Jan. 31 To balance c/d 300 Jan. 13 By Chatterjee 300
300 300
Feb. 1 By Balance b/d 300

Dr. Drawings Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 2006
Jan. 16 To Purchases A/c 50
31 To Bank A/c 500 Jan. 31 By Balance c/d 550
550 550
Feb. 1 To Balance b/d 550

Dr. Salaries Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 2006
Jan. 3 To Cash A/c 600 Jan. 31 By Balance c/d 600
600 600
Feb. 1 To Balance b/d 600
 41

Dr. Rent Account Cr.

Date Particulars J.F. Rs. Date Particulars J.F. Rs.

2006 2006
Jan. 31 To Cash A/c 300 Jan. 31 By Balance c/d 300
300 300
Feb. 1 To Balance b/d 300

3.6 SUMMARY

Accounting as an information system is the process of identifying, measuring

and communicating the economic information of an organisation to its users who
need the information for making decisions. An accounting process is a complete
sequence with the recording of the transactions and ending with the preparation
of the final accounts. Journal is concerned with the recording of financial
transactions in an orderly manner, soon after their occurrence. The function of
systematic analysis of the recorded data to accumulate the transactions of similar
type at one place is performed by maintaining the ledger in which different
accounts are opened to which transactions are posted.

3.7 KEYWORDS

Accounting equation: Accounting equations is an accounting formula expressing

equivalence of the two expressions of assets and liabilities.

Journal: Journal is a tabular record in which business transactions are recorded

in a chronological order.

Journal entry: The record of the transaction in the journal is called a journal
entry.

Ledger: Ledger is the principal book of accounts where similar transactions

relating to a particular person or thing are recorded.
 42

Posting: It is the process of transferring debit and credit amounts from the
journal or subsidiary books to the respective heads of accounts in the
ledger.

Compound journal entry: A journal entry which includes more than one debit
or more than one credit is called compound journal entry.