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CHAPTER 5

DOUBLE ENTRY SYSTEM OF ACCOUNTING, JOURNAL & RULES OF JOURNALIZING

Double entry system of accounting is more than 500 years old. Luca Pacioli wrote the first book of 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 aspects are to be recorded in the books of accounts. Therefore, in every transaction at least two accounts are affected.

For example, on purchase of furniture either the cash balance will be reduced or a liability to the supplier will arise and new asset furniture is acquired.

ACCOUNT

(Imagine your bank account for easier understanding)

An account refers to assets, liabilities, income, expenses, and equity, as represented by individual ledger pages, to which changes in value are chronologically recorded with debit and credit entries.

Diagram: ‘T’ Account (ledger account)

                    ‘T’ Account (ledger account)

     Assets and expenses on             Incomes, liabilities and
     The left-hand side                Capital on the right-hand side
              DEBIT                              CREDIT

•Basic accounting equation: Assets = Liabilities + Capital + Profit (Income-Expenses)

Assets + Expenses = Liabilities + Capital+ Income

Basic Rules

1. For every transaction there will be a debit and credit entry. (Recall Dual Aspect Concept)

2. These debits and credits will be equal and opposite. i.e., For every debit there will be an equal and corresponding Credit

3. E.g. in Cash account all cash receipts are recorded on debit side and cash outflows on credit side.

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Debit & Credit

Debit & Credit are the two sides of an account. Left hand side is called debit & Right-hand side is called credit. So, when we say, debit an account, we mean that the amount is to be entered in the debit side i.e., Left hand side of that account & vice versa. This helps in ascertaining the ultimate position of each item at the end of an accounting period.

• debiting an account → make an entry on the left-hand side of an account

• crediting an account → make an entry on the right-hand side of an account

TRANSACTIONS

Transactions are recorded in books of accounts. A transaction is a two-way process in which value is transferred from one party to another. In it either a party receives a value in terms of goods etc. and passes the value in terms of money or vice versa. For recording transactions, it is very important that they are supported by a substantial document like purchasing invoices, bills, pay-slips, cash-memos, pass book etc.

ACCOUNTING

Accounting of transactions can be done by analysing the transaction under two approaches:

1. Traditional Approach.

2. Modern Approach (Also called Accounting equation Approach)

Traditional Approach

Under traditional approach, Accounts are classified in three groups

1. Personal Accounts

2. Real Accounts

3. Nominal Accounts

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Types of Accounts

                         Types of Accounts
                                ↓
          ┌─────────────────────┼─────────────────────┐
          ↓                     ↓                     ↓
     Real Account        Personal Account       Nominal Account
          ↓                     ↓                     ↓
       All Assets             All Parties        All Items of P&L
 (Tangible and Intangible) (Debtors and Creditors) (Income and Expenses)
          ↓                     ↓                     ↓
        Rules                  Rules                 Rules
          ↓                     ↓                     ↓
   Debit what comes in    Debit the receiver   Debit all expenses and losses
   Credit what goes out   Credit the giver     Credit All incomes & gains

Personal Accounts

Accounts which are related with accounts of individuals, firms, companies are known as personal accounts. The personal accounts may further be classified into three categories:

Natural Personal Accounts: Accounts of individuals relating to natural persons like Ram, Rahim

Artificial (Legal) Personal Accounts: Accounts of companies, institutions such as Reliance Industries Ltd; clubs are artificial personal accounts.

Representative Personal Accounts: The accounts which represent some person such as salary outstanding account, prepaid insurance account, accrued interest account are considered as representative personal accounts.

Real Accounts

Real accounts are the accounts related to assets/properties. These may be classified into tangible real account and intangible real account.

The accounts relating to tangible assets such as building, plant, machinery, cash, furniture etc. are classified as tangible real accounts.

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Intangible real accounts are the accounts related to intangible assets such as goodwill, trademarks, copyrights, franchisees, Patents etc.

Nominal Accounts

The accounts relating to income, expenses, losses and gains are classified as nominal accounts. For example, Salary Account, Rent Account, Interest Account, Sales Account, Bad Debts Accounts.

Three Golden rules under Traditional Approach

RULES FOR DEBIT AND CREDIT

Modern Approach (Also called Accounting equation Approach)

Under Modern approach, All accounts are divided into five categories for the purposes of recording the transactions:

(a) Asset

(b) Liability

(c) Capital

(d) Expenses/Losses, and

(e) Revenues/Gains.

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Two rules under Modern Approach

1. FOR ASSETS & EXPENSES

2. FOR CAPITAL, LIABILITY & REVENUES

Two fundamental rules are followed to record the changes in these accounts:

(1) For recording changes in Assets/Expenses (Losses):

(i) “Increase in asset is debited, and decrease in asset is credited.”

(ii) “Increase in expenses/losses is debited, and decrease in expenses/ losses is credited.”

(2) For recording changes in Liabilities and Capital/Revenues (Gains):

(i) “Increase in liabilities is credited and decrease in liabilities is debited.”

(ii) “Increase in capital is credited and decrease in capital is debited.”

(iii) “Increase in revenue/gain is credited and decrease in revenue/gain is debited.”

Table

JOURNAL

The word journal comes from the French word “Jour” meaning “day”.

Journal is a primary book for recording the day to day transactions in a chronological order i.e. the order in which they occur.

The journal is a form of diary for business transactions.

This is called the book of first/Original entry since every transaction is recorded firstly in the journal. Afterwards, transactions from this book are posted to the respective accounts called Ledger Accounts.

Journal Entry

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Journal entry means recording the business transactions in the journal. For each transaction, a separate entry is recorded. Before recording, the transaction is analysed to determine which account is to be debited and which account is to be credited.

The Performa of journal is shown as follows:

JOURNALIZING

It is the process of recording journal entries in the Journal.

It is a systematic act of entering the transaction in a day book in order of their occurrence i.e., date-wise or event-wise.

How to do Journal Entry

After analysing the business transactions, the following steps in journalizing are followed:

1. Find out what accounts are involved in business transaction.

2. Ascertain what is the nature of accounts involved?

3. Ascertain the golden rule of debit and credit is applicable for each of the accounts involved.

4. Find out what account is to be debited which is to be credited.

Steps of Journal Entry

Record the date of transaction in the “Date Column”.

Write the name of the account to be debited very near to the left hand side in the ‘Particulars Column’ along with the word ‘Dr’ on the same line against the name of the account in the ‘Particulars Column’ and the amount to be debited in the ‘Debit Amount column’ against the name of the account.

Record the name of the account to be credited in the next line preceded by the word ‘To’ at a few spaces towards right in the ‘Particulars Column’ and the amount to be credited in the ‘Credit Amount Column’ in front of the name of the account.

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Record narration (i.e. a brief explanation of the transaction) within brackets in the following line in ‘Particulars Column’.

A thin line is drawn all through the particulars column to separate one Journal entry from the other and it shows that the entry of a transaction has been completed.

Now, Let’s take an example & try to do Journal entry using both approaches.

Example:-

From the following information , state the nature of account and state which account will be debited and which will be credited.

1. Started business with a capital of ₹ 50,00,000.

2. Wages and salaries paid ₹ 50,000

3. Rent received ₹ 2,00,000

4. Purchased goods on credit ₹ 9,00,000

5. Sold goods for ₹ 8,16,000 and received payment in cheque.

Traditional Approach

Modern Approach

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Illustration

Show the classification of the following Accounts under traditional and accounting equation approach:

(a) Building; (b) Purchases; (c) Sales; (d) Bank Fixed Deposit; (e) Rent; (f) Rent Outstanding; (g) Cash; (h) Adjusted Purchases; (i) Closing Inventory; (j) Investments; (k) Trade receivables; (l) Sales Tax Payable, (m) Discount Allowed; (n) Bad Debts; (o) Capital; (p) Drawings; (q) Interest Receivable account; (r) Rent received in advance account; (s) Prepaid salary account; (t) Bad debts recovered account; (u) Depreciation account, (v) Personal income-tax account.

SOLUTION

Nature of Account

YouTube Link for Lecture 1: https://youtu.be/ZoaZWG8VPFA

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YouTube Link for Lecture 2: https://youtu.be/y0dGf9mRb_o

YouTube Link for Lecture 3: https://youtu.be/ilaQPPzOXcA

Channel Name: Lateef’s Commerce Academy

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Important visual elements included in this specific notes

I have also included the content of the visual elements rather than leaving them out:

Page 18: ‘T’ Account (ledger account) diagram showing Assets and expenses → DEBIT on the left and Incomes, liabilities and Capital → CREDIT on the right.

Page 19: Arrow diagrams showing:

• debiting an account → left-hand side

• crediting an account → right-hand side

Page 20: “Types of Accounts” diagram showing:

• Real Account → All Assets → Tangible and Intangible → Debit what comes in / Credit what goes out

• Personal Account → All Parties → Debtors and Creditors → Debit the receiver / Credit the giver

• Nominal Account → All Items of P&L → Income and Expenses → Debit all expenses and losses / Credit All incomes & gains

Pages 21–22: Debit/Credit tables reproduced above.

Pages 23–26: Journal format, traditional approach table, modern approach table, and classification solution table reproduced above.