Unit 3 - Recording of Transactions
Unit 3 - Recording of Transactions
Unit 3 - Recording of Transactions
3.1 Introduction
In the previous unit, you learnt the basic accounting concepts and
conventions. A concept refers to assumptions or conditions. Accounting
conventions are customs or traditions and accounting principles refers to a
law the method or a rule of conduct. Management of the firm has certain
privileges to choose the accounting methods based on the situation which
eventually is termed as accounting policy. Accounting standards acts as a
guideline and provides uniform techniques of accounting. International
Financial Reporting Standards (IFRS) are standards, interpretations and
framework for the preparation and presentation of financial statements.
In this unit, you will be acquainted with the key aspects of accounting like
accounting equation, double entry system, journal and rules of debit and
credit entries. You will also learn about the classification of accounts under
traditional and modern methods. The preparation of ledger is based upon
this unit.
Objectives:
After studying this unit, you should be able to:
• explain the meaning of assets, liabilities and equity.
• describe the accounting equation and effects of financial transaction on
accounting equation
• state the classification of accounts under modern approach
• explain double entry system and the rules of debit and credit entries
3.2 Meaning of Assets, Liabilities and Capital
A number of basic terms are used in accounting. So, it is necessary to know
the meanings of those basic terms. The important accounting terms used for
accounting equation are:
Assets:
According to Finney and Miller, "Assets are future economic benefits, the
rights which are owned or controlled by an organization or individuals".
To qualify as an asset the following factors must be present:
1) The asset must provide probable future economic benefit that enables it
to provide future net cash flows
2) The entity is able to receive the benefit and restrict other entities’ access
to that benefit.
3) The event that provides the entity with the right to the benefit has
occurred.
4) The asset must be capable of being measured reliably.
The International Accounting Standards Board (IASB) framework states that
reliable measurement means that the number must be free from material
error and bias and can be depended upon by users to represent faithfully.
Assets include:
a) Physical or real properties or things called tangible assets like lands,
building, plant and machinery, motor vehicles, furniture, stock of goods,
cash, etc., owned by a business.
b) Rights in certain things or certain rights having money value called
intangible assets, such as goodwill, patent rights, trademarks and
copyrights possessed by a business.
c) Debts or amounts due to a business from others, such as sundry
debtors, bills receivable, accrued incomes, etc.
Assets are classified based on the purpose for which an asset is held in the
hands of the user. Assets may be fixed, current, liquid or fictitious.
1) Fixed assets are those which are held for use in the production or
supply of goods and services and not for resale in the normal course of
business. Eg. Land, Plant and Machinery are fixed assets. The
exception to it is, for a land developer, land is considered as current
ownership interest. Equity arises from the ownership relation and is the
basis for distribution of earnings to the owners. Distribution of firm’s assets
to owners is voluntary. Equity is increased by owner’s investment as well as
profits earned and are reduced by distribution of profits in the form of
dividends.
For example, if on a given date the total assets of a business are Rs.60,000
and the total liabilities of the business are Rs.20,000, the excess of the total
assets over the total liabilities of the business, viz., (60,000 - 20,000)
Rs. 40,000 will be the owner's equity.
Liabilities 20,000 Assets 60,000
Owner’s Equity 40,000
Total 60,000 Total 60,000
4. The resources (i.e., the assets) are acquired through the finances or
funds provided by two sources, viz., owners (i.e., owners' capital) and
________ (i.e., liabilities).
5. Resources = _________________.
6. Fill the columns marked(?) with suitable numbers using accounting
equation.
Activity 1:
Assume you have opened a mobile shop with an investment of
Rs. 3 lakhs. You sell mobile phones and currencies of Airtel,
Vodaphone and BSNL. Create 5 transactions and give the accounting
equations for them.
In modern approach, accounts are classified into 5 types namely asset a/c,
liability a/c, capital a/c, income a/c and expenses a/c. We have adopted
modern approach to accounting in explaining the concept and in solving the
problems. Let us now learn the classification of accounts under modern
approach.
Table 3.1: Classification of Accounts under Modern Approach
Types of
Meaning Examples
Accounts
Asset Deals with tangible and Land a/c, Building a/c, Plant &
account intangible real assets. Machinery a/c, Cash a/c, Good will
a/c, Trademark a/c, Patents a/c,
Investments a/c.
Liabilities Deals with the financial Long term loans, Debentures, Bank
account obligations of the firm on loans, Trade creditors, Outstanding
outsiders. expenses.
Capital Deals with accounts of the Capital a/c, Drawings a/c.
account owners of the company
Revenue Deals with amount charged Sales a/c, Royalty received a/c,
account for goods sold or service interest received a/c, dividend
rendered, and other received a/c.
incomes.
Expenses Deals with expenses Purchases a/c, Discount allowed
account incurred in the process of a/c, Interest paid a/c, Loss by
earning revenue fire a/c.
Illustration 2:
List of examples of accounts and the category of accounts :
1. Capital (money brought in to the business) – capital a/c
2. Land – asset a/c
3. Patents (intangible asset) – asset a/c
4. Creditors (who owe to the firm) – liability a/c
5. Drawings (money withdrawn by the proprietor) – capital a/c
6. Cash (cash balance with the firm) – asset a/c
7. Sales (revenue earned by selling goods/services) – Revenue a/c
8. Purchases – (goods purchased for manufacturing/reselling) –
Expenses a/c
9. Machinery – asset a/c
10. Discount allowed – expenses a/c
3.5 Double Entry System and Rules of Debit and Credit Entries
Accounting starts with recording and ends in presenting financial information
in a manner, which facilitates 'informed judgements and decisions by users’.
The recording of transactions and events follows a definite rule. Each
transaction and/or event has two aspects or sides – debit and credit.
The T Account
The T account has three parts:
1) A title that details the name of the asset, liability or equity account
2) The left side of the account is known as debit side
3) The right side of the account is known as credit side
Similarly if the total credits exceed the total debits, the account has a credit
balance.
Standard Form of Account
In practice, accountants prepare accounts in standard format which shows
the balance after each transactions and is therefore more useful than the
‘T‘ form.
Let us explain you with an example. Mr. A started a consultancy business
with a capital of Rs. 50,000 on 1st of Jan 2010. On 3rd furniture worth
Rs. 6,000 was purchased for the business. On 10th Jan it received
Rs.10,000 for service rendered. Rent of Rs.8,000 was paid for the premises
on 29th Jan.
Table 3.4: Standard Form of Account
Cash a/c
Types of
Meaning Examples
Accounts
Asset Deals with tangible and Land a/c, Building a/c, Plant &
account intangible real assets. Machinery a/c, Cash a/c, Good will a/c,
Trademark a/c, Patents a/c,
Investments a/c
Liabilities Deals with the financial Long term loans, Debentures, Bank
account obligations of the firm loans, Trade creditors, Outstanding
on outsiders. expenses.
Capital Deals with accounts of Capital a/c, Drawings a/c
account the owners of the
company
Revenue Deals with amount Sales a/c, Royalty received a/c, interest
account charged for goods sold received a/c, dividend received a/c
or service rendered,
and other incomes.
Ledger Dr Cr
Date Particulars Voucher No.
Folio (Rs.) (Rs.)
Voucher Ledger Dr Cr
Date Particulars
No. Folio (Rs.) (Rs.)
Jan 1 Cash a/c Dr 50,000
2010 To Capital a/c 50,000
(Capital contributed by
Mathew)
Voucher Ledger Dr Cr
Date Particulars
No. Folio (Rs.) (Rs.)
Jan 3 Furniture a/c Dr 6,000
2010 To Cash a/c 6,000
(Purchased furniture in
cash)
Voucher Ledger Dr Cr
Date Particulars
No. Folio (Rs.) (Rs.)
Jan 8 Goods a/c Dr 10,000
2010 To Cash a/c 4,000
To Mohan a/c 6,000
(Purchased goods
partly paid in cash)
4. On 10th Jan 2010, sold goods for cash worth Rs. 20,000/-
This transaction has resulted in an increase in asset (cash receipt) and an
increase in income (sales)
Voucher Ledger Dr Cr
Date Particulars
No. Folio (Rs.) (Rs.)
Jan 10 Cash a/c Dr 20,000
2010 To Sales a/c 20,000
(Sold goods for cash)
Voucher Ledger Dr Cr
Date Particulars
No. Folio (Rs.) (Rs.)
Jan 12 Stationery a/c Dr 3,000
2010 To Cash a/c 3,000
(stationery purchased )
6. On 19th Jan, 2010, Received Rs. 9500/- from Mahesh a client in full
settlement of Rs.10,000.
The Journal entry is as follows :
Voucher Ledger Dr Cr
Date Particulars
No. Folio (Rs.) (Rs.)
Jan 10 Cash a/c Dr 9,500
2010 Discount a/c Dr 500
To Mahesh a/c 10,000
(cash received from
Mahesh in full
settlement of his dues )
Journal:
Dr Cr
Date Particulars L.F. Amount Amount
(Rs) (Rs)
Jan.1 Cash A/c ………… Dr. 80,000
To Capital A/c 80,000
(Being Business commenced with cash of
Rs.80, 000)
Jan.10 Purchase A/c ………… Dr. 50,000
To Cash A/c 30,000
To Creditors A/c 20,000
(Being goods purchased on cash &
credit)
Jan.12 Wages A/c ………… Dr. 500
To Cash A/c 500
(Being wages paid)
Jan.15 Cash A/c ……………… Dr. 20,000
Debtors A/c ………………… Dr. 25,000
To Sales A/c 45,000
(Being goods sold on cash and credit)
Jan.16 Creditors A/c…………. Dr. 8,000
To Cash A/c 8,000
(Being amount paid to suppliers of goods)
Jan.20 Cash A/c………… Dr. 15,000
15,000
To Debtors A/c
(Being cash received from debtors)
Journal Entries
Dr Cr
Date Particulars L.F. Amount Amount
(Rs.) (Rs.)
2004 Cash A/c ………… Dr. 25,000
Jan.1 To Capital A/c 25,000
(Being Business commenced with cash
of Rs.25, 000)
Jan.2 Purchases A/c ……………… Dr. 15,000
To Cash A/c 15,000
(Being the amount of cash purchases)
Jan.3 Freight A/c …...………… Dr. 500
To Cash A/c 500
(Being the payment for freight)
Jan.7 Raj Kumar’s A/c ……… Dr. 5,000
5,000
To Sales A/c
(Being sale of goods on credit to Mr.
Raj Kumar)
3.6 Summary
Let us recapitulate the important concepts discussed in this unit –
➢ Assets are future economic benefits, the rights which are owned or
controlled by an organization or individuals
➢ Liabilities are probable future sacrifices of economic benefits arising
from present obligations of a particular entity to transfer assets or
provide services to other entities in the future as a result of past
transactions or events.
➢ Capital or Owner’s Equity is the residual interest in the assets that
remains after deducting its liabilities.
➢ Accounting equation may be stated as a statement of equality between
the resources (i.e., assets) and the sources of finance (i.e., owners'
capital and liabilities).
➢ The accounts maintained by a business concern for these three classes
of transactions may be divided into two broad classes, viz. (1) Personal
Accounts and (2) Impersonal Accounts.
➢ The impersonal accounts may be sub-divided into two classes, viz,
(1) Real, Asset or Property Accounts and (2) Nominal or Fictitious
Accounts.
➢ The T’ account has three parts -A title that details the name of the asset,
liability or equity account - The left side of the account is known as debit
side The right side of the account is known as credit side
➢ Standard Format: In practice, accountants prepare accounts in standard
format which shows the balance after each transactions and is therefore
more useful than the ‘T‘ form.
3.7 Glossary
Asset: Assets are future economic benefits, the rights which are owned or
controlled by an organization or individuals.
Liability: Liabilities are probable future sacrifices of economic benefits
arising from present obligations of a particular entity to transfer assets or
3.9 Answers
Self Assessment Questions
1. Tangible assets, intangible assets, debts
2. Capital
3. (a ) 1,10,000
4. Creditors
5. Source of Finance
6. (1) Equity 50000; Total 50000
(2) Assets 55000; Equity 50000
(3) Assets 60000; Total 60000
(4) Equity 60000; Total 1,00,000
7. (a) 40,000 (b) 2,00,000 (c) 1,64,000 (d) 1,40,000
8. Classify the following accounts
a) Insurance premium paid a/c – expenses a/c
b) Prepaid rent a/c – asset a/c
13. Debit
Terminal Questions
1. In accounting, assets mean resources, things or rights of value owned
by a business undertaking. For more details, refer section 3.2.
2. The accounting equation may be stated as a statement of equality
between the resources (i.e., assets) and the sources of finance
(i.e., owners' capital and liabilities). For more details, refer section 3.3.
3. The classification of accounts under modern approach – asset a/c,
liability a/c, capital a/c, revenue a/c and expenses a/c. For more details
refer section 3.4.
4. Accounting starts with recording and ends in presenting financial
information in a manner, which facilitates 'informed judgments and
decisions by users’. For more details refer section 3.5.
5. Each transaction should be recorded in such a way that it affects two
sides – debit and credit – equally. At the end of the accounting period
both the debit side and credit side are totaled. For more details refer
section 3.5.
References:
• Ashok Banerjee (2009) Financial Accounting, 3rd Edition, Excel Book.
• R. Narayanaswamy (2008) Financial Accounting, A Managerial
perspective, 3rd Edition, Prentice Hall of India.
• P. C. Tulsian (2009) Financial Accounting, Fifth impression, Pearson
Education
• Barry .J. Epstein, Eva K. Jermakowicz (2009-10) IFRS, Wiley India.
• R. L. Gupta, Radhaswamy (2010). Financial Accounting, S. Chand and
Company
• Maheshwari S. N. and S. K. Maheshwari (2009), Advanced Accountancy,
Vikas Publishing House.
• M. C. Shukla (2010). Advanced Accountancy. S. Chand and Company.