Chapter 3: Recording of Transactions - I

Introduction

• This chapter introduces the process of recording business transactions in the books
of accounts using the double-entry system.

• It covers the identification of transactions, preparation of source documents, and

recording entries in the Journal and Ledger.

• The objective is to maintain a systematic record of financial transactions to prepare

financial statements.

1. Business Transactions

• Definition: A business transaction is an economic event that affects the financial

position of a business and can be measured in monetary terms.

• Types of Transactions:

o Cash Transactions: Involve immediate payment or receipt of cash (e.g.,

cash sales, cash purchases).

o Credit Transactions: Payment or receipt is deferred to a future date (e.g.,

goods sold on credit).

o Non-Cash Transactions: Involve no immediate cash flow (e.g., depreciation,

provision for bad debts).

• Characteristics:

o Measurable in monetary terms.

o Affects the accounting equation (Assets = Liabilities + Capital).

o Supported by source documents.

2. Source Documents

• Definition: Source documents are original records that provide evidence of a

business transaction.

• Examples:
 o Cash Memo: Issued for cash sales or purchases.

o Invoice/Bill: Evidence of credit sales or purchases.

o Receipt: Proof of cash received.

o Pay-in-Slip: Record of cash deposited in the bank.

o Cheque: Proof of payment made through the bank.

o Debit Note: Issued when goods are returned to the supplier or for additional
charges.

o Credit Note: Issued when goods are returned by customers or for discounts
allowed.

• Importance:

o Provides objective evidence for transactions.

o Supports the recording of entries in the books of accounts.

o Helps in auditing and verification.

3. Accounting Equation

• The accounting equation is the foundation of the double-entry system: [

\text{Assets} = \text{Liabilities} + \text{Capital} ]

• Every transaction affects at least two accounts, ensuring the equation remains
balanced.

• Examples:

o Owner invests ₹1,00,000 in the business:

▪ Increases Cash (Asset) by ₹1,00,000.

▪ Increases Capital by ₹1,00,000.

o Purchases machinery for ₹50,000 on credit:

▪ Increases Machinery (Asset) by ₹50,000.

▪ Increases Creditors (Liability) by ₹50,000.

4. Double-Entry System

• Definition: A system of recording transactions where every transaction affects at

least two accounts—one debited and one credited—with equal amounts.

• Basis: Dual Aspect Concept (every transaction has two aspects).

• Advantages:

o Ensures accuracy through the Trial Balance.

o Facilitates preparation of financial statements.

o Helps detect errors and frauds.

• Rules of Debit and Credit:

o Based on the type of account: Personal, Real, or Nominal.

5. Types of Accounts and Rules of Debit and Credit

Accounts are classified into three types, each with specific debit and credit rules:

Type of
Examples Debit Rule Credit Rule
Account

Personal Individuals, firms, banks (e.g., Ram,

Debit the Receiver Credit the Giver
Accounts ABC Ltd., Bank A/c)

Real Tangible/intangible assets (e.g., Debit what Comes Credit what Goes
Accounts Cash, Machinery, Furniture) In Out

Credit all
Nominal Expenses, losses, incomes, gains Debit all Expenses
Incomes and
Accounts (e.g., Salaries, Rent, Sales) and Losses
Gains

• Examples:

o Paid salaries ₹10,000:

▪ Debit Salaries A/c (Nominal—expense).

▪ Credit Cash A/c (Real—cash goes out).

o Received cash from Ram ₹5,000:

 ▪ Debit Cash A/c (Real—cash comes in).

▪ Credit Ram A/c (Personal—giver).

6. Books of Original Entry

• Definition: Books of original entry are where transactions are first recorded in a
systematic manner.

• Primary Book: Journal (also called the book of prime entry).

• Purpose: To record transactions chronologically with details of accounts affected,

amounts, and narration.

7. Journal

• Definition: The Journal is a book where transactions are recorded in chronological

order using the double-entry system.

• Format of a Journal Entry:

Date Particulars L.F. Debit (₹) Credit (₹)

Account to be Debited Dr.

YYYY-MM-DD To Account to be Credited Amount Amount
(Narration)

• Components:

o Date: Date of the transaction.

o Particulars: Accounts affected (Debit and Credit).

o L.F. (Ledger Folio): Page number of the ledger where the entry is posted.

o Debit Amount: Amount debited to an account.

o Credit Amount: Amount credited to an account.

o Narration: Brief explanation of the transaction.

• Steps to Journalize a Transaction:

1. Identify the transaction and its two aspects (debit and credit).
2. Classify the accounts involved (Personal, Real, or Nominal).

3. Apply the relevant debit and credit rules.

4. Record the entry in the Journal with date, particulars, amounts, and narration.

• Example:

o Transaction: Started business with cash ₹1,00,000 on April 1, 2024.

o Journal Entry:

Date Particulars L.F. Debit (₹) Credit (₹)

Cash A/c Dr.

2024-04-01 To Capital A/c 1,00,000 1,00,000
(Being business started with cash)

8. Ledger

• Definition: A Ledger is a book that contains all accounts and summarizes

transactions recorded in the Journal.

• Purpose:

o Classifies transactions under specific accounts.

o Shows the net effect of transactions on each account.

o Facilitates preparation of the Trial Balance and financial statements.

• Format of a Ledger Account:

Dr. Account Name Cr.

Date Particulars Amount (₹) Date

YYYY-MM-DD To (Source of Debit) Amount YYYY-MM-DD

• Components:

o Dr. Side: Records all debit entries.

o Cr. Side: Records all credit entries.

o Date: Date of the transaction.

 o Particulars: Source of the entry (e.g., “To Cash A/c” or “By Sales A/c”).

o Amount: Value of the transaction.

• Posting:

o Transferring Journal entries to the respective accounts in the Ledger is called

posting.

o For each Journal entry:

▪ Debit account is posted on the debit side of that account in the

Ledger.

▪ Credit account is posted on the credit side of that account in the

Ledger.

• Example:

o From the Journal entry above (Cash ₹1,00,000 invested):

▪ Cash A/c:

▪ Debit: ₹1,00,000 (To Capital A/c).

▪ Capital A/c:

▪ Credit: ₹1,00,000 (By Cash A/c).

9. Balancing of Accounts

• Definition: Balancing is the process of calculating the difference between the total
debits and total credits of an account to determine its closing balance.

• Steps:

1. Total the debit and credit sides of the account.

2. Find the difference between the two totals.

3. If Debit > Credit:

▪ Enter the difference on the credit side as “By Balance c/d” (carried
down).

▪ The balance is a Debit Balance.

 4. If Credit > Debit:

▪ Enter the difference on the debit side as “To Balance c/d”.

▪ The balance is a Credit Balance.

5. Bring the balance down to the opposite side as “To Balance b/d” (brought
down) for the next period.

• Example:

o Cash A/c has:

▪ Debit: ₹1,00,000 (Capital), ₹20,000 (Sales).

▪ Credit: ₹30,000 (Purchases).

o Total Debit = ₹1,20,000; Total Credit = ₹30,000.

o Difference = ₹90,000 (Debit Balance).

o Entry: “By Balance c/d ₹90,000” on the credit side.

o Next period: “To Balance b/d ₹90,000” on the debit side.

10. Compound Journal Entry

• Definition: A single Journal entry that records multiple transactions or a transaction

affecting more than two accounts.

• Example:

o Purchased goods for ₹20,000 and paid carriage ₹1,000 in cash:

▪ Journal Entry:

Date Particulars L.F. Debit (₹) Credit (₹)

Purchases A/c Dr.

Carriage A/c Dr. 20,000
2024-04-02 21,000
To Cash A/c 1,000
(Being goods purchased and carriage paid in cash)

11. Key Terms

 • Transaction: An economic event affecting the financial position.

• Source Document: Evidence of a transaction (e.g., invoice, receipt).

• Journal: Book of original entry for recording transactions.

• Ledger: Book that summarizes transactions by account.

• Posting: Transferring Journal entries to the Ledger.

• Debit: Left side of an account (receiver, comes in, expenses/losses).

• Credit: Right side of an account (giver, goes out, incomes/gains).

• Balancing: Calculating the net balance of an account.

12. Advantages of Journal and Ledger

• Journal:

o Provides a chronological record of transactions.

o Reduces errors through detailed narration.

o Serves as a basis for posting to the Ledger.

• Ledger:

o Summarizes transactions by account.

o Facilitates preparation of Trial Balance and financial statements.

o Shows the financial position of each account.

13. Limitations

• Journal:

o Time-consuming for large businesses with many transactions.

o Not suitable for direct preparation of financial statements.

• Ledger:

o Does not provide a chronological view of transactions.

o Errors in Journal entries carry over to the Ledger.

14. Summary

• Chapter 3 focuses on the recording of transactions using the double-entry system.

• Transactions are first recorded in the Journal (book of original entry) with debit and
credit entries.

• Journal entries are posted to the Ledger, which classifies transactions by account.

• The accounting equation and rules of debit and credit ensure accuracy.

• Source documents provide evidence for transactions.

• Balancing accounts determines the closing balance for financial reporting.

15. Practice Questions

Objective Type Questions

1. What is a business transaction?

o a) Any event in the business

o b) An economic event measurable in monetary terms

o c) A non-financial event

o d) An internal event only

o Answer: b) An economic event measurable in monetary terms

2. Which of the following is a source document?

o a) Journal

o b) Ledger

o c) Invoice

o d) Trial Balance

o Answer: c) Invoice

3. The rule for a Personal Account is:

o a) Debit what comes in, Credit what goes out

 o b) Debit the receiver, Credit the giver

o c) Debit expenses, Credit incomes

o d) None of the above

o Answer: b) Debit the receiver, Credit the giver

4. A Journal entry affecting more than two accounts is called:

o a) Simple Entry

o b) Compound Entry

o c) Closing Entry

o d) Opening Entry

o Answer: b) Compound Entry

5. The process of transferring Journal entries to the Ledger is called:

o a) Journalizing

o b) Posting

o c) Balancing

o d) Summarizing

o Answer: b) Posting

Short Answer Questions

6. Explain the double-entry system with an example.

7. Differentiate between a Journal and a Ledger.

8. What are source documents? Give three examples.

9. State the rules of debit and credit for Real and Nominal Accounts.

10. What is meant by balancing an account? Explain the steps.

Long Answer Questions

11. Journalize the following transactions in the books of Mohan:

o April 1, 2024: Started business with cash ₹2,00,000.

o April 2, 2024: Purchased goods for cash ₹50,000.

 o April 3, 2024: Sold goods on credit to Suresh ₹30,000.

o April 4, 2024: Paid rent ₹5,000 in cash.

o April 5, 2024: Received cash from Suresh ₹20,000.

12. From the above transactions (Q11), post the entries to the respective Ledger
accounts and balance them.

13. Explain the accounting equation with three examples of transactions and their
impact on Assets, Liabilities, and Capital.

14. What is a compound Journal entry? Illustrate with an example.

15. Discuss the advantages and limitations of the Journal and Ledger in the accounting
process.

16. Answers to Practice Questions (Short and Long)

Short Answer Questions

6. Double-Entry System:

o A system where every transaction affects two accounts—one debited and

one credited—with equal amounts.

o Example: Paid ₹10,000 for rent:

▪ Debit Rent A/c (Nominal—expense).

▪ Credit Cash A/c (Real—cash goes out).

7. Difference Between Journal and Ledger:

o Journal: Records transactions chronologically; book of original entry;

contains detailed narration.

o Ledger: Summarizes transactions by account; book of final entry; used for

preparing financial statements.

8. Source Documents:

o Original records evidencing a transaction.

o Examples: Invoice, Cash Memo, Receipt.

9. Rules of Debit and Credit:

 o Real Accounts: Debit what comes in, Credit what goes out.

o Nominal Accounts: Debit expenses and losses, Credit incomes and gains.

10. Balancing an Account:

o Calculating the difference between debit and credit sides to find the closing
balance.

o Steps:

1. Total debit and credit sides.

2. Find the difference.

3. Enter the difference as “Balance c/d” on the smaller side.

4. Bring the balance down as “Balance b/d” for the next period.

Long Answer Questions (Sample Answer)

11. Journal Entries:

Date Particulars L.F. Debit (₹) Credit (₹)

Cash A/c Dr.

2024-04-01 To Capital A/c 2,00,000 2,00,000
(Being business started with cash)

Purchases A/c Dr.

2024-04-02 To Cash A/c 50,000 50,000
(Being goods purchased for cash)

Suresh A/c Dr.

2024-04-03 To Sales A/c 30,000 30,000
(Being goods sold on credit)

Rent A/c Dr.

2024-04-04 To Cash A/c 5,000 5,000
(Being rent paid in cash)

Cash A/c Dr.

2024-04-05 To Suresh A/c 20,000 20,000
(Being cash received from Suresh)

12. Ledger Accounts (Sample for Cash A/c and Suresh A/c):
Cash A/c

| Dr. | | | Cr. | |-----|-------|---------|-----|-------|---------| | Date | Particulars | Amount (₹) | Date |

Particulars | Amount (₹) | | 2024-04-01 | To Capital A/c | 2,00,000 | 2024-04-02 | By
Purchases A/c | 50,000 | | 2024-04-05 | To Suresh A/c | 20,000 | 2024-04-04 | By Rent A/c |
5,000 | | | | | 2024-04-05 | By Balance c/d | 1,65,000 | | | Total | 2,20,000 | | Total | 2,20,000 | |
2024-04-06 | To Balance b/d | 1,65,000 | | | |

Suresh A/c

| Dr. | | | Cr. | |-----|-------|---------|-----|-------|---------| | Date | Particulars | Amount (₹) | Date |

Particulars | Amount (₹) | | 2024-04-03 | To Sales A/c | 30,000 | 2024-04-05 | By Cash A/c |
20,000 | | | | | 2024-04-05 | By Balance c/d | 10,000 | | | Total | 30,000 | | Total | 30,000 | |
2024-04-06 | To Balance b/d | 10,000 | | | |

(Other accounts like Capital A/c, Purchases A/c, Sales A/c, and Rent A/c can be prepared
similarly.)