Lesson-3 Journalizing Transactions-I Learning Objectives To understand the recording of transactions To know what are the advantages of journal

nal To learn about the classification of accounts and its rules

Introduction Accounting is the art of recording, classifying and summarizing the financial transactions and interpreting the results thereof. Thus, the accounting cycle involves the following four major phases: 1. 2. 3. 4. Recording of transactions-- This is done in a book called journal. Classifying the transactions-- This is done in a book called ledger. Summarizing the transactions-- This includes preparation of trial balance, profit and loss account and balance sheet of the business. Interpreting the results-- This involves computation of various accounting ratios etc. to know about the liquidity, solvency and profitability of the business.

Journal A journal records all daily transactions of a business in the order of their occurrence. A journal may, therefore, be defined as a book containing a chronological record of transactions. It is a book in which transactions are recorded first of all under the double entry system. Thus, journal is a book of the original records. A journal does not replace but precedes the ledger. The process of recording transactions on the basis of rules of double entry system in a journal is termed as journalizing. The record of a business transaction in journal is called journal entry. The performa of a journal is as follows: Date (1) Particulars (2) L.F. (3) Debit (Rs.) (4) Credit (Rs.) (5)

Advantages of Journal The recording of business transactions in journal book on the basis of double entry system has following advantages:

1.

Complete Information about the Business

The journal gives complete information about business transactions in a chronological order. Accounts to be debited and credited are recorded at once in one place. 2. Explanation of the Transaction

An entry in the journal book includes a brief explanation of the transaction called narration. 3. Minimum Errors

Double entry system used for recording is clearly visible in journal as both debit and credit aspects are recorded at one place. It also makes posting into ledger accounts easier. This ultimately reduces possibility of errors. Rules of Debit and Credit All transactions in the journal are recorded on the basis of rules of debit and credit. For this purpose, transactions have been classified into three categories: i. ii. iii. Transactions relating to persons Transactions relating to properties and assets Transactions relating to incomes and expenses

On the basis of above rules, it is necessary to keep the accounts in respect of the following: i. ii. iii. Each person with whom it deals (customer, suppliers) Each property or asset which it owns (building, machinery etc.) Each item of income and expense (commission, rent, salary etc.)

Classification of Accounts Accounts can be classified into personal, real and nominal accounts. Personal Accounts Personal accounts include the accounts of persons with whom the business deals. These accounts can be further classified into three categories: a. Natural Personal Account Natural personal account means persons who are creations of God. For example, Vijays a/c, Shubhams a/c etc. b. Artificial Person Account

Artificial person account includes accounts of corporate bodies or institutions which are recognized as persons in business dealings. For example, government, club, limited company, cooperative society etc. c. Representative Personal Account Representative personal account is the account which represents a person or a group of persons. For example, when the rent is due to landlord, an outstanding rent account represents the account of a landlord to whom the rent is payable. Real Accounts Real accounts may be of the following types: a. Tangible Real Account Tangible real accounts are those which relate to such things that can be touched, felt and measured. For example, cash a/c, building a/c, furniture a/c etc. b. Intangible Real Account These accounts represent such things which cannot be touched but, however, can be measured in terms of money. For example, patent a/c, goodwill a/c etc. Nominal Accounts Nominal accounts are opened in the books of accounts to simply explain the nature of the transactions. They do not really exist. For example, salary paid to employee, rent paid to landlord etc. Nominal accounts mainly include accounts of expense, losses, income and gains. Rules of Accounting Type of Account Personal Account Real Account Nominal Account Rules for Accounting Debit the receiver, credit the giver Debit what comes in, credit what goes out Debit all expenses (losses), credit all incomes (gains)

Examples of Journal Entries 1. A commences business with capital of Rs. 1,00,000 on 1.1.2001. In this case, two accounts are involved, i.e. As a/c who is the proprietor and cash a/c. As a/c is of personal nature and cash a/c is a tangible asset. Applying the above rules, A is the giver of cash. Therefore, As capital a/c should be credited and cash is coming in the business. Cash being the real account, the account will be debited. The journal entry should be passed as follows: Date 1.1.2001 Cash a/c Particulars Dr. L.F. Debit (Rs.) 1,00,000 Credit (Rs.)

To Capital a/c (Being commencement of business)

1,00,000

The words in the bracket are called narration which describe the nature of transaction. 2. A pays rent of Rs. 5,000 of premises to landlord L on 01.01.2001. Date Particulars L.F. Debit (Rs.) 5,000 Credit (Rs.) 5,000

1.1.2001 Real a/c Dr. To Cash a/c (Being rent paid for January 2001)

In this case, real account is nominal account and being an expense for the business it is debited as per the above-mentioned rule. Since the rent is paid by way of cash, the cash balance will go down and hence the cash account is credited. 3. Goods purchased worth Rs. 20,000 on credit from S on 01.01.2001. Date Particulars L.F. Debit (Rs.) 20,000 Credit (Rs.) 20,000

1.1.2001 Goods A/c Dr. To S A/c (Being purchase of goods on credit)

Goods account is real account, being an asset. Since goods are coming in, goods account is debited. Account of S, who is the supplier and giver of goods, is credited, being personal account. Example Show the classification of the following accounts according to the traditional approach: a. b. c. d. e. f. g. h. i. j. k. l. m. n. Building account Purchases account Sales account Bank deposits account Rent account Rent outstanding account Cash account Adjusted purchases account Closing stock account Investments account Debtors account Sales tax payable account Discount allowed account Bad debts account

o. p. q. r. s. t. u. v. w. x. y. z.

Capital account Drawings account Provision for depreciation account Interest receivable account Rent received in advance account Prepaid salary account Provision for bad and doubtful debts account Bad debts recovered account Depreciation account. Personal income tax account Stock reserve account Provision for discount on creditors account

Also classify the above-mentioned accounts according to accounting equation approach. Solution Nature of Account S. No. (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m) (n) (o) (p) (q) (r) (s) (t) (u) (v) (w) (x) Title of Account Building Purchases Sales Bank Deposits Rent Rent Outstanding Cash Adjusted Purchases Closing Stock Investments Debtors Sales Tax Payable Discount Allowed Bad Debts Capital Drawings Provision for Depreciation Interest Receivable Rent Received in Advance Prepaid Salary Provision for Bad and Doubtful debts Bad Debts Recovered Depreciation Personal Income Tax Traditional Approach Real Real Nominal (Revenue) Personal Nominal (Expense) Personal Real Nominal (Expense) Real Real Personal Personal Nominal (Expense) Nominal (Expense) Personal Personal Valuation (Real) Personal Personal Personal Valuation (Personal) Nominal (Gain) Nominal (Expense) Personal (Drawing) Accounting Equation Approach Asset Asset Temporary Capital (Revenue) Asset Temporary Capital (Expense) Liability Asset Temporary Capital (Expense) Asset Asset Asset Liability Temporary Capital (Expense) Temporary Capital (Expense) Capital Temporary Capital (Drawings) Asset Asset Liability Valuation (Asset) Valuation (Asset) Temporary Capital (Gain) Temporary Capital (Expense) Temporary Capital (Drawings)

(y) (z)

Stock Reserve Provision for Discount on Creditors

Valuation (Real) Valuation (Personal)

Valuation (Asset) Valuation (Liability)

Summary 1. Primary book is the book of accounts where transactions and events are recorded in the first instance. 2. Primary books are called journals. 3. There are eight types of primary books. 4. It is necessary to follow a ground rule to record entries in journals. 5. A cash book is journal as well as ledger. 6. A journal proper is a book of residual entries. Questions 1. Give an example of business transaction affecting only the following: Assets Liabilities Capital

2. Differentiate between the following: Temporary capital accounts and nominal accounts Trade discount and cash discount

3. Do you agree with the following statements: a. b. c. d. e. f. g. h. i. Sales day book is a part of ledger. Opening stock account is a nominal account. Purchase day book records all credit purchases of goods. Drawings account is a temporary capital account. A transaction can increase an asset and decrease a liability. Discount account records trade discount. Patent rights made for prompt payment is called trade discount. The allowance made for prompt payment is called trade discount. Capital + Long Term Liabilities = Fixed Assets + Current Assets + Cash Current Liabilities.

4. What are the rules of debit and credit for the following: Assets Liabilities Capital Revenue Expenses

Valuation accounts