Accounting Process — Basic Accounting Procedures - Journal Entries
Learning Outcomes
- Understand meaning and significance of Double Entry System.
- Familiarize with the term 'account' and understand the classification of accounts into personal, real and nominal.
- Note the utility of such classification and sub-classifications.
- Understand how debits and credits are determined from transactions and events.
- Observe the points to be taken care of while recording a transaction in the journal.
1.1 Double Entry System
- Double entry system of accounting is more than 500 years old.
- Luca Pacioli — an Italian friar & mathematician published Summa de Arithmetica, Geometria, Proportioni, et Proportionitala ("Everything about Arithmetic, Geometry and proportions") — the first book that described a double entry accounting system.
- Double entry system of book-keeping has emerged in the process of evolution of various accounting techniques. It is the only scientific system of accounting.
- According to it, every transaction has two-fold aspects — debit and credit and both the aspects are to be recorded in the books of accounts.
- Therefore, in every transaction at least two accounts are affected.
KNOWLEDGE NUGGET
- Double Entry System: Every transaction has two-fold aspects — Debit and Credit
- Luca Pacioli: Published first book on double entry system in 1494
- Scientific System: Only scientific system of accounting
1.2 Advantages of Double Entry System
- (i) By the use of this system the accuracy of the accounting work can be established, through the device of the trial balance.
- (ii) The profit earned or loss incurred during a period can be ascertained together with details.
- (iii) The financial position of the entity or the institution concerned can be ascertained at the end of each period, through preparation of the financial statements.
- (iv) The system permits accounts to be kept in as much details as necessary and therefore provides significant information for the purpose of control and reporting.
- (v) Result of one year may be compared with those of previous years and reasons for the change may be ascertained.
ADVANTAGES — SUMMARY
- Accuracy: Through Trial Balance
- Profit/Loss: Ascertained with details
- Financial Position: Through Balance Sheet
- Control: Detailed information for control and reporting
- Comparison: Year-to-year comparison possible
1.3 Account
- A person starts his business with say, ₹10,00,000 as capital with corresponding balance of cash ₹10,00,000.
- Transactions entered into by the entity will alter the cash balance in two ways — one will increase the cash balance and other will reduce it.
- Payment for goods purchased, salaries paid and rent expense paid, etc., will reduce the cash balance whereas sales of goods for cash and collection from customers will increase it.
CASH ACCOUNT (T-FORM)
| Particular | Increase (Receipt) | Particular | Decrease (Payment) |
|---|---|---|---|
| Opening Balance | 10,00,000 | (7) | 1,00,000 |
| (2) | 2,50,000 | (8) | 3,00,000 |
| (3) | 2,00,000 | (9) | 2,00,000 |
| (4) | 5,00,000 | (10) | 5,00,000 |
| (5) | 1,35,000 | (11) | 12,00,000 |
| (6) | 4,00,000 | New or Closing Balance | 1,85,000 |
| Total | 24,85,000 | Total | 24,85,000 |
- The proper form of an account is as follows:
ACCOUNT
| Date | Particulars | Amount | Date | Particulars | Amount |
|---|
1.4 Debit and Credit
- Accountants use the term Debit (Dr.) to denote an entry on the left side of any account and Credit (Cr.) to denote an entry on the right side of any account.
BASIC ACCOUNTING EQUATION
Assets = Liabilities + Capital
Or
Assets = Liabilities + (Contributed Capital + Beginning Retained Earnings + Revenue — Expenses — Dividends)
- Contributed capital = the original capital introduced by the owner.
- Beginning retained earnings = previous earnings not distributed to the shareholders.
- Revenue = generated from the ongoing activities of the business.
- Expenses = cost incurred for the operations of the company.
- Dividends = earnings distributed to the shareholders of the company.
RULES OF DEBIT AND CREDIT
- Increases in assets are recorded on the left-hand side and decreases in them on the right-hand side.
- In the case of liabilities and capital, increases are recorded on the right-hand side and decreases on the left-hand side.
- Expenses are debited and Incomes are credited.
QUICK REFERENCE
| Debit | Credit |
|---|---|
| Increase in Purchases | Increase in Sales |
| Increase in Expenses | Increase in Revenue and Incomes |
| Increase in Assets | Increase in Liabilities and Owners' Capital |
Illustration 1
Following are the transactions entered into by R after he started his business. Show how various accounts will be affected by these transactions:
SOLUTION
| Date | Explanation | Accounts Involved | Nature of Accounts | How affected | Debit (₹ in 000) | Credit (₹ in 000) |
|---|---|---|---|---|---|---|
| April 1 | ₹5,000 cash invested in business | Bank and R's Capital | Asset / Capital | Increased / Increased | 5,000 | 5,000 |
| April 2 | Purchased furniture for ₹1,200 | Furniture and Bank | Asset / Asset | Increased / Decreased | 1,200 | 1,200 |
| April 3 | Paid ₹1,100 to employee for salary | Salary & Bank | Expense / Asset | Increased / Decreased | 1,100 | 1,100 |
| April 4 | Paid Rent ₹1,150 | Rent & Bank | Expense / Asset | Increased / Decreased | 1,150 | 1,150 |
| April 5 | Received interest ₹2,000 | Cash & Interest | Asset / Income | Increased / Increased | 2,000 | 2,000 |
1.5 Transactions
- A transaction is a type of event, which is generally external in nature and can be determined in terms of money.
- In an accounting period, every business has huge number of transactions which are analysed in financial terms and then recorded individually.
- A transaction is a two-way process in which value is transferred from one party to another.
- For recording transaction, it is very important that they are supported by a substantial document like purchase invoices, bills, payslips, cash-memos, passbook etc.
Transactions analysed in terms of money and supported by proper documents are recorded in the books of accounts under double entry system. To analyse the dual aspect of each transaction, two approaches can be followed:
- (1) Accounting Equation Approach
- (2) Traditional Approach
1.6 Accounting Equation Approach
- The relationship of assets with that of liabilities and owners' equity in the equation form is known as 'Accounting Equation'.
- Basic accounting equation: Assets = Liabilities + Capital
- Under double entry system, every business transaction has two-fold effect on the business enterprise where each transaction affects changes in assets, liabilities or capital in such a way that an accounting equation is completed and equated.
- This accounting equation holds good at all points of time and for any number of transactions and events except when there are errors in accounting process.
ACCOUNTING EQUATION
Equity + Liabilities = Assets
Or
Equity + Long-Term Liabilities = Fixed Assets + Current Assets — Current Liabilities
- Equity = Capital + Profits — Losses
- Increase in equity is termed as profit while decrease in equity is termed as loss.
Illustration 2
Develop the accounting equation from following information available at the beginning of accounting period:
SOLUTION
All figures in solution are in '000
- Opening: Equity ₹51,000 + Liabilities ₹17,200 = Assets ₹68,200
- Closing: Equity ₹51,420 + Liabilities ₹17,300 = Assets ₹68,720
- Profit = ₹51,420 — ₹51,000 = ₹420
Illustration 3
Mr. Dravid has provided following details related to his financials. Find out the missing figures:
SOLUTION
- Opening Capital: Closing capital — Profits = ₹35,000 — ₹5,000 = ₹30,000
- Opening Assets (A): Liabilities + Capital = ₹12,000 + ₹30,000 = ₹42,000
- Liabilities at end (C): ₹50,000 — ₹35,000 = ₹15,000
- Assets at end (B): Capital + Liabilities = ₹35,000 + ₹15,000 = ₹50,000
1.7 Traditional Approach
- Under traditional approach of recording transactions, one should first understand the term debit and credit and their rules.
- Transactions in the journal are recorded on the basis of the rules of debit and credit only.
1.7.1 Classification of Accounts
CLASSIFICATION OF ACCOUNTS
- (i) Personal Accounts: Relate to persons, trade receivables or trade payables.
- Natural personal accounts: Human beings like Ram, Rita, etc.
- Artificial (legal) personal accounts: Government, Companies, Clubs, Co-operative societies etc.
- Representative personal accounts: Outstanding liability account, prepaid account, capital account, drawings account.
- (ii) Impersonal Accounts: Accounts which are not personal such as machinery account, cash account, rent account etc.
- Real Accounts: Assets of the firm but not debt — land, building, investment, cash, bank.
- Nominal Accounts: Expenses, losses, gains, revenue — salary account, interest paid account, commission received account.
1.7.2 Golden Rules of Accounting
GOLDEN RULES OF ACCOUNTING
| Types of Account | Account to be Debited | Account to be Credited |
|---|---|---|
| Personal Account | Receiver | Giver |
| Real Account | What comes in | What goes out |
| Nominal Account | Expense and losses | Income and gains |
1.8 Modern Classification of Accounts
| Types of account | Normal balance of account | Account to be debited when there is: | Account to be credited when there is: |
|---|---|---|---|
| Asset account | Debit | Increase | Decrease |
| Liabilities account | Credit | Decrease | Increase |
| Capital account | Credit | Decrease | Increase |
| Revenue account | Credit | Decrease | Increase |
| Expenditure account | Debit | Increase | Decrease |
| Withdraw account | Debit | Increase | Decrease |
1.9 Journal
- Transactions are first entered in this book to show which accounts should be debited and which credited.
- Journal is also called subsidiary book.
- Recording of transactions in journal is termed as journalizing the entries.
- It is the book of original entry in which transactions are entered on a daily basis in a chronological order.
1.9.1 Journalising Process
- All transactions may be first recorded in the journal as and when they occur; the record is chronological.
- There are basically two types of journals:
- 1. General journal
- 2. Specialized journal
FORM OF JOURNAL
| Date | Particulars | Ledger Folio (L.F.) | Amount Dr. | Amount Cr. |
|---|
1.9.2 Points to be taken into account while recording a transaction in the Journal
- 1. Journal entries can be single entry (one debit and one credit) or compound entry (one debit and two or more credits or two or more debits and one credit).
- 2. If journal entries are recorded in several pages then both the amount column of each page should be totalled and carried forward.
JOURNAL ENTRY EXAMPLE
| May 5 | Bank Account | Dr. | ₹14,50,000 |
| To Mohan | ₹14,50,000 | ||
| (Being the amount received from Mohan in payment of the amount due from him) | |||
Illustration 4
Analyse transactions of M/s Sahil & Co. for the month of March, 2022 on the basis of double entry system by adopting Accounting Equation Approach and Traditional Approach.
SOLUTION — ACCOUNTING EQUATION APPROACH
| ASSETS | = | CAPITAL | + | LIABILITIES | |||||
|---|---|---|---|---|---|---|---|---|---|
| CASH | + | BANK | + | FURNITURE | = | CAPITAL | + | LIABILITIES | |
| (a) | - | + | 4,000 | + | - | = | 4,000 | + | - |
| (b) | +200 | - | 200 | + | - | = | - | + | - |
| (c) | - | + | 500 | + | - | = | - | + | 500 |
| (d) | - | - | 300 | + | - | = | -400 | + | 100 |
| (e) | - | - | 500 | + | 500 | = | - | + | - |
| Balance | 200 | + | 3,500 | + | 500 | = | 3,600 | + | 600 |
1.11 Accounting for GST
1.11.1 Introduction to GST
- Goods and Services Tax (GST) is a comprehensive Indirect Tax which has subsumed multiple Indirect Taxes in India such as State Value added Tax (VAT), Excise Duty, Service Tax etc.
- GST is a single tax on the supply of goods and services, right from the manufacturer to consumer.
1.11.2 Salient features of GST
- GST is levied on supply i.e., manufacture or sale of goods and provision of services.
- Under GST, tax is levied only the value added at each stage of the supply chain.
- GST is a destination-based consumption tax — levied at the place where goods or services are consumed.
- There is no tax on tax or cascading of taxes under GST system.
- Under GST, there is a harmonization of laws, procedures and rates of tax across the country.
1.11.3 Types of Taxes under GST
- CGST (Central Goods and Service Tax): Levied and collected by the Centre on "Intra-State" supply.
- SGST (State Goods and Services Tax): Levied and collected by State Governments on "Intra-state" supply.
- UTGST (Union Territory Goods and Service Tax): Levied and collected by Union Territories without Legislatures.
- IGST (Integrated Goods and Services Tax): Levied on "inter-state" supply, collected by the Centre.
GST — KEY POINTS
- Intra-State: CGST + SGST (or UTGST)
- Inter-State: IGST
- Input Tax Credit: IGST → IGST first, then CGST/SGST; CGST → CGST then IGST; SGST → SGST then IGST
- CGST cannot be set off against SGST and vice versa.
1.11.4 Input and Output GST
- Input Tax: Tax paid by the recipient on procurement of goods/services.
- Output Tax: GST charged on supply of goods or services made by a supplier.
- Utilization of Input Tax Credit: IGST → IGST first, then CGST/SGST; CGST → CGST then IGST; SGST → SGST then IGST.
DOUBLE ENTRY BOOK-KEEPING WITH GST
Journal entry for Sales:
| Account Receivable/Debtors A/c | Dr. | Gross Amount (including GST) |
| To Sales A/c | Net Amount (excluding GST) | |
| To Output GST | Amount of GST |
Journal entry for Purchase:
| Purchases A/c | Dr. | Net Amount (excluding GST) |
| Input GST A/c | Dr. | Amount of GST |
| To Account Payable/Creditors | Gross Amount (including GST) |
Illustration 8
Journalise the following transactions in the books of Mr. Rohit:
SOLUTION (Selected Entries)
- (i) Purchased goods from Sahil for ₹50,000 plus CGST and SGST @ 9% each:
- Purchases A/c Dr. ₹50,000
- Input CGST A/c Dr. ₹4,500
- Input SGST A/c Dr. ₹4,500
- To Sahil's A/c ₹59,000
- (iii) Goods costing ₹20,000 withdrawn for personal use:
- Drawings A/c Dr. ₹23,600
- To Purchase A/c ₹20,000
- To Input CGST A/c ₹1,800
- To Input SGST A/c ₹1,800
- (vi) Purchased furniture for ₹44,800 including IGST @ 12%:
- Furniture A/c Dr. ₹40,000 (WN: 44,800 × 100/112)
- Input IGST A/c Dr. ₹4,800
- To Bank A/c ₹44,800
Summary
- The accounting process starts with the recording of transactions in the form of journal entries.
- The recording is based on double entry system. This book or register called journal is the book of first or original entry.
- Next step is to post the entries in the ledger which is covered in the next unit.
Test Your Knowledge
True and False
- 1. In accounting equation approach, equity + Long-term liabilities = fixed asset + current assets — current liabilities. True
- 2. In the traditional approach, for an entity a debtor will be receiver after sale of goods. False
- 3. The rule of nominal account states that all expenses & losses are recorded on credit side. False
- 4. Journal proper is also called a subsidiary book. True
- 5. Capital account has a debit balance. False
- 6. Purchase account is a nominal account. True
- 7. All the personal & real account are recorded in P&L A/c. False
- 8. Asset side of balance sheet contains all the personal & nominal accounts. False
- 9. Capital account is a personal account. True
- 10. Journal is also known as the book of original entry. True
Multiple Choice Questions
| 1. The rent paid to landlord is credited to | (a) Landlord's account. (b) Rent account. (c) Cash account |
| 2. In case of a debt becoming bad, the amount should be credited to | (a) Trade receivables account. (b) Bad debts account. (c) Cash account. |
| 3. A Ltd. has a ₹35,000 account receivable from Mohan. On January 22, Mohan makes a partial payment of ₹21,000. The journal entry includes: | (a) A credit to the cash received account. (b) A credit to the Accounts receivable account of ₹21,000. (c) A debit to the cash account of ₹14,000. |
| 4. Which financial statement represents the accounting equation? | (a) Income Statement (b) Statement of Cash flows (c) Balance Sheet |
| 5. Which account is the odd one out? | (a) Office furniture & Equipment. (b) Freehold land and Buildings. (c) Inventory of materials |
| 6. The debts written off as bad, if recovered subsequently are | (a) Credited to Bad Debts Recovered Account (b) Credited to Trade Receivables Account. (c) Debited to Profit and Loss Account. |
| 7. In Double Entry System of Book-keeping every business transaction affects: | (a) Two accounts (b) Two sides of the same account. (c) The same account on two different dates. |
| 8. A sale of goods to Ram for cash should be debited to: | (a) Ram (b) Cash (c) Sales |
High-Yield Interactive Quiz — Basic Accounting Procedures - Journal Entries
Q1. The double entry system of accounting was first described by:
Correct Answer: B. Luca Pacioli, an Italian friar & mathematician, published Summa de Arithmetica in 1494 — the first book that described a double entry accounting system.
Q2. According to the rules of debit and credit, increases in assets are recorded on:
Correct Answer: A. Increases in assets are recorded on the left-hand side (debit side) and decreases in them on the right-hand side (credit side).
Q3. Which type of account is "Capital Account"?
Correct Answer: B. Capital account is the account of the proprietor and therefore it is a personal account.
Q4. The golden rule for Real Account is:
Correct Answer: B. The golden rule for Real Account is "Debit what comes in, Credit what goes out". For Personal Account: "Debit the receiver, Credit the giver". For Nominal Account: "Debit all expenses and losses, Credit all incomes and gains".
Q5. The accounting equation is:
Correct Answer: B. The basic accounting equation is: Assets = Liabilities + Capital (or Equity).
Q6. Which of the following is a nominal account?
Correct Answer: D. Salary Account is a nominal account as it relates to expenses. Furniture, Cash and Bank are real accounts (assets).
Q7. Journal is also known as:
Correct Answer: B. Journal is the book of original entry in which transactions are entered on a daily basis in a chronological order.
Q8. Under GST, the tax levied on inter-state supply is:
Correct Answer: C. IGST (Integrated Goods and Services Tax) is levied on the "inter-state" supply of goods and services and is collected by the Centre.
Q9. Which of the following cannot be set off against SGST?
Correct Answer: B. CGST credit cannot be utilized against SGST. SGST credit can be utilized against SGST liability and IGST, but not against CGST.
Q10. If equity increases, it is termed as:
Correct Answer: B. Increase in equity is termed as profit while decrease in equity is termed as loss.
Q11. Which of the following is a representative personal account?
Correct Answer: C. Outstanding Salary Account is a representative personal account. Ram's Account is a natural personal account. Company Account is an artificial personal account. Bank Account is a real account.
Q12. The process of recording transactions in the journal is called:
Correct Answer: B. Recording of transactions in journal is termed as journalizing the entries.