Unit 3 Recording of Transactions - I

Q1. What do you mean by Accounting Equations?

Ans: An Accounting Equation is based on the dual concept of accounting, according to
which, every transaction has two aspects namely- Debit and Credit. It means that every
transaction in accounting effect both Debit (Dr) and Credit (Cr) side equally.
Total assets of the business firm are financed through the funds raised from either the
outsiders (which consists generally Creditors and Lenders) or the Owners(which is called
Capital).
According to Business entity concept, Business is separate legal entity from its owner thus
the amount invested by the owner in the business is liability of the business is called Capital.
Accounting equation thus referred to a equation in which total assets is always equal to total
Liabilities (i.e. Capital + Liabilities)

Assets = Capital + Liabilities

Q2. What are the Rules of Debit & Credit?

Ans: Every business transaction affects two or more accounts. An account is summarized
record of transaction at one place relating to a particular head. An account is divided into two
parts i.e. debit and credit. Debit refers to the left side of an account and Credit refers to the
right side of an account.

Approaches for the rules of Debit & Credit

1. Traditional Approach,Under this approach, all ledger accounts are mainly classified into
two categories-
(I) Personal Accounts- It includes all those accounts which are related to any person i.e.
Individuals, firms, companies, Banks etc. This can further classified into three categories-

1.Natural Persons: All the accounts of human beings/ Persons are included such as Ram
A/C, Shyam A/c etc.
2.Artificial Persons: This includes all such accounts which are treated as persons in the eyes
of law & have separate legal entity such as Reliance Ltd., XYZ Ltd.
3.Representative Persons: This includes all such accounts which represents some persons
such as Capital (Represent Owner), Outstanding Salary (Represent Employee).

(II) Impersonal Accounts- It includes all those accounts which are not related to any person.
This can be classified as-

1.Real Accounts: Under this all accounts related to assets are included (except Debtors).
These can be Tangible i.e. Machinery, Furniture, Building, Cash etc. and Intangible i.e.
Goodwill, Trade Mark, Patents, copy Rights etc.
2.Nominal Accounts: This includes all the accounts related to Expenses/Losses &
Incomes/Gains e.g. Salary, Rent, Commission received etc. They are used to record the
transaction in the books of accounts.
Q3. Explain the rules of Debit and Credit.
Ans: Rules of Debit/Credit under Traditional Approach
Classifications of Accounts Rules of Dr./Cr.
Personal Accounts (All Personal Accounts) Debit the receiver. Credit the giver
Real Account Debit what comes in. Credit what goes out.
Nominal Accounts Debit all Losses/Expenses. Credit all
Income/Gains.

Rules of Debit/Credit under Modern Approach.

i) Increase (+) in assets are debits; decreases(-) are credits.
ii) Increase (+) in expenses(+) are debits; decreases(-) are credits.
iii) Increase (+) in liabilities are credits; decreases(-) are debits.
iv) Increase (+) in revenues are credits; decreases(-) are debits.
v) Increase (+) in owner's capital are credits; decreases(-) are debits.

Q4. Define the following.

Ans: 1)Source Documents
A written document which provides evidence of the transactions is called the Source
Document. Source document is the first evidence of a transaction which takes place such as
Cash Memo, Bill or Invoice, Receipt, Pay-in-slip, cheques, Debit-Note & Credit -Note.

(a) Invoice (Bill):An invoice is prepared by Seller at the time of sale of goods on credit. It
contains details such as the goods sold, the party to whom goods are sold, sales amount, date
etc.
(b) Cash Memo: It is prepared by the Seller at the time of Sale of goods on Cash. It contains
details such as goods sold, quantity, amount received, date etc.
(c) Pay-in-Slip:It is used to deposit cash or cheque into bank. It has a counterfoil which is
returned to the depositor with the Signature of the authorized person.
(d) Receipt: It is used when a customer give cash to the Business firm. It is an
acknowledgment of payment or cash received by firm.
(e) Cheque:A cheque is a order in writing, drawn upon a specified banker and payable on
demand.
(f) Debit Note: It is prepared when a buyer returned goods to seller or when purchased return
transaction is entered in the books of accounts. It is prepared by the buyer of the goods.
(g) Credit Note: It is prepared when a seller received goods from buyer or when Sales return
transaction is entered in the books of accounts. It is prepared by the Seller of the goods.

2) VOUCHER

A voucher is a document evidencing a business transaction. Recording in books of accounts

is done on the basis of voucher. It is an accounting evidence of a business transaction.

Classification of Accounting Vouchers

Vouchers Further Classification Purpose
Cash Vouchers Debit Voucher To show cash payment
Credit Voucher To show cash receipt
Non Cash Vouchers Transfer Voucher To show transaction not
involving cash
CASH VOUCHERS:Cash voucher is prepared to record all the transactions which involve
cash either in the form of receipt or payment. Thus, cash voucher is further classified into
Debit Voucher & Credit Voucher.
Debit Voucher: Debit voucher is prepared for all cash payment made by the business firm
such as Payment of Rent. Payment of salary, payment for purchase of goods etc.
Format of Debit Voucher

Credit Voucher: Credit voucher is prepared for cash received by the business firm Such as
Sale of goods for Cash, Payment received from any of Debtors, Income received etc.

Transfer Voucher/Non-Cash Voucher: This type of vouchers are prepared in those

transactions which do not involve Cash. Such as Credit Sales, Credit Purchases, Bad Debts,
Depreciation charged etc.

3) LEDGER
Meaning: After recording the business transactions in the Journal or special purpose
Subsidiary Books, the next step is to transfer the entries to the respective accounts in the
Ledger. Ledger is a book where all the transactions related to a particular account are
collected at one place.

Definition: The Ledger is the main or Principal book of accounts in which all the business
transactions would ultimately find their place under various accounts in a duly classified
form.
From journal each transaction is posted to at least two concerned accounts - debit side of one
account and credit side of another account. Remember that, if there are two accounts involved
in a journal entry, it will be posted to two accounts in the ledger and if the journal entry
consists of three accounts (compound entry) it will be posted to three different accounts in the
ledger. The process of transferring information from journal to ledger accounts is known as
posting. The goal of all transactions is ledger. Ledger is known as the destination of entries in
journal but it must be remembered that transactions cannot be recorded directly in the ledger -
they must be routed through journal. This concept is illustrated below:

Transaction

Journal

Ledger

4) Closing and Balancing of Account

Normally after every month or whenever a businessman is interested in knowing the position
of various A/cs, the accounts are balanced. Various steps for this purposes are:
 1. Debit and Credit sides of each A/c are totalled.
2. The difference between the two sides is inserted on the side which is shorter so as to
make their totals equal.
3. The words 'Balance c/d' i.e., the balance carried down and written against the amount
of difference.
4. In the next period, the balance is brought down on the other side by writing the words
'Balance b/d'.
5. If the Debit side exceeds the Credit Sides the difference is a Debit Balance whereas.
6. If the Credit side exceeds the Debit side the difference is a Credit Balance.

Important points-

1. Debit Balance of a Personal A/c means the person is a Debtor of the firm whereas
Credit Balance of a Personal A/c indicates that the person is a Creditor of the firm.
2. Real A/cs (which include Cash and all other Assets A/cs) will usually show Debit
Balances.
3. Nominal A/cs (A/cs of Income and Expenses) are transferred to Trading and Profit
and Loss A/c of the firm at the end of the Accounting Period.
4. Debit Balance of any A/c means an Asset or an Expense whereas Credit Balance
means a liability, Capital or revenue.