Accounting Guidelines for Identification of Transactions
If an event changes the financial position of a person, family or organisation, and if such change is measurable in terms of money, it is called Transaction. For example, a person spents Rs. 50 for seeing a movie (cinema). For this, there has been a change in his financial position. So, it is his transaction. An event is said to be a transaction-
(i) if the event is measurable in terms of money. For example, bought goods from Ram Rs. 500. It is a transaction, because it is measurable in terms of money unit.
(ii) if the event changes the financial position. For example, goods costing Rs. 1,000 were lost by fire. For this, property worth Rs. 1,000 has been lost. So, it changes the financial position. Hence it is a transaction. Such type of financial change is known as quantitative change. It does not mean that all changes of financial position are quantitative, it also may be qualitative. Due to qualitative change, there is no change in the amount of Assets and Liabilities, only the material change takes place. Suppose, bought furniture worth Rs. 2,000. There is a decrease of Rs. 2,000 in cash and an increase of furniture worth Rs. 2,000. So, the quantity of total property remains the same but there has been a qualitative change in our financial position.
(iii) if there are two parties involved with the event. Suppose, goods purchased by Ram from Rahim. It is a transaction because here two parties-Ram and Rahim are involved with the event.
• Exception: In many times if there are not two parties, transaction may take place. Suppose, goods costing Rs. 1,000 were destroyed by accident. In this case, there are not two parties. In spite of that it is a transaction because for this event there has been a change in the financial position and the quantities of change are also measurable.
(iv) if for such event, property or service is transferred. As, Amal purchased furniture worth Rs. 500 from Bimal. This is a transaction because transfer of property takes place here. Again, suppose, wages paid to workers. It is also a transaction because here cash goes out in exchange of service.
Example 01 [Identification of Transaction] State with reasons, which of the following events should be regarded as business transaction of Mr. Paritosh Roy:
(i) Started business with Rs. 50,000. (ii) Took a loan of Rs. 10,000 for the business.
(iii) Took a loan of Rs. 5,000 from Mr. Premangshu for his daughter's marriage. (iv) Amlan requests for a loan of Rs. 7,500.
(v) Received a price-list from M/s Agarwal.
(vi) Appointed Mr. Ajit as a manager of the business on a salary of Rs. 1,500 p.m
. (vii) Placed an order with M/s Agarwal for supply of goods worth Rs. 30,000.
Solution ⇒
(i) As a result of this transaction, cash of Rs. 50,000 comes into the business. So, it changes the financial position of the business of Mr. Paritosh. Hence, it is a business transaction.
(ii) As a result of this transaction, cash of Rs. 10,000 comes into the business. So, it changes the financial position of the business of Mr. Paritosh. Hence,
it is a business transaction.
(iii) This transaction is just a personal transaction of the Proprietor. It does not change the financial position of the business. So, it is not a business transaction.
(iv) It is not a transaction, because it does not change the financial position of the business. (v) It is not a transaction, because it does not change the financial position of the business.
(vi) The appointment of a manager does not change the financial position of the business. So, it is not a transaction.
(vii) Placing of an order for the supply of goods is not a transaction, because it does not change the financial position of the business.
Classification of Transaction
Cash transaction: A transaction which involves immediate cash/cheque receipt or payment is called a Cash Transaction. For example, goods sold to X for cash 5,000. In a cash transaction, the name of the party to whom goods are sold or from whom goods are purchased, is not recorded. This is because, it serves no purpose.
Credit transaction: An external transaction not involving immediate cash receipt or payment is called a Credit Transaction. For example, Purchase of goods on credit from Y. In a credit transaction, delivery of goods and receipt/payment of money takes place on two different dates.
In a credit transaction, the name of the party is recorded to ascertain how much is owed to or from him.
External transaction: A transaction which involves the business entity and a second party is called an External Transaction. For example, goods sold to Ram for 2,000 on credit.
Internal transaction: A transcation which does not involve a second party is called Internal Transaction. For example, depreciation charged on machinery.
Classification of Accounts Modern Classification of Accounts
ACCOUNT
Assets Account
Liabilities Account
Capital Account
Revenue Account
Expense Account
Withdrawal Account
According to modern approach, accounts are classified into six categories: (1) Assets Account; (2) Liabilities Account; (3) Capital Account; (4) Revenue Account; (5) Expense Account; and (6) Withdrawal Account.
Assets Account: These accounts are accounts of assets and properties such as land, building, plant,
machinery, patents, cash investments, inventory, etc.
Liabilities Account: These accounts are accounts of lenders, creditors for goods, creditors for expenses, etc Capital Account: It is the account of the proprietor / partner who invested money in the business.
.
Revenue Account: These are accounts of incomes and gains. Examples are: sales, discount received, interest received, etc. These accounts accumulate data required for preparation of Trading, Profit and Loss Account.
Expense Account : These are accounts of expenses and losses. Examples are: purchases, wages paid, depreciation, rent, rates and taxes, etc. Like Revenue Account, these accounts accumulate data required for preparation of Trading, Profit and Loss Account.
Withdrawal Account: It is the account related to drawings by the proprietor / partners.
Rules for Debit and Credit
Types of Account |A/C to be |A/C to be
|debited | Credited
1.Assets Account | Increase | Decrease
2. Liabilities
Account |Decrease | Increase
3.Capital |Decrease |Increase
Account
4.Revenue |Decrease |Increase
Account
5.Expense | |Increase |Decrease
Account
6.Withdrawal | Increase ||Decrease
Account
Traditional Classification of Accounts
This is a very old system of classifying accounts. Nowadays, in advanced countries this system of classification of accounts is hardly used. Under this system, accounts are classified into three types.
1. Personal Accounts: These accounts show the transactions with the customers, suppliers, money lenders, the bank and the owner. A business may have many credit transactions with the above persons or organisations. A separate account is to be prepared for each of them. Persons or organisations with whom the business has credit transactions are either debtors or creditors. If they have to give some money to the firm, they are called debtors. Conversely, if the firm is to pay them some money they are known as creditors. The main purpose of preparing personal accounts is to ascertain the balances due to or due from persons or organisations.
2. Real Accounts: These accounts are accounts of assets and properties such as land, building, plant, machinery, patent, cash, investment, inventory, etc. When a machinery is purchased for cash, the two accounts involved are machinery and cash-both are Real Accounts. But if the same machine is purchased from Z & Co. on credit, the two accounts involved will be those of Machinery and Z & Co., the former being a Real Account and the latter being a Personal Account.
3. Nominal Accounts: These are the accounts of incomes, expenses, gains and losses. Examples are: Wages paid, discount allowed or received, purchases, sales, etc. These accounts generally accumulate the data required for the preparation of income statement, i.e., the Trading and Profit and Loss Account.
Illustration 1
Following accounts are being maintained in the books of Sri Pradip Biswas & Co. Classify them under Personal, Real and Nominal headings.
(i) Cash; (ii) Bank; (iii) Commission; (iv) Salaries; (v) Discount; (vi) Bills Receivable; (vii) Sohan Lal; (viii) Banerjee Brothers; (ix) Depreciation; (x) Bad Debt.
Solution
(1) Cash-Real Account; (i) Bank - Personal Account; (iii) Commission - Nominal Account; (iv) Salaries - Nominal Account, (v) Discount-Nominal Account; (vi) Bills Receivable - Real Account; (vii) Sohan Lal - Personal Account; (viii) Banerjee Brothers - Personal Account; (ix) Depreciation - Nominal Account, (x) Bad Debt-Nominal Account.
Illustration 2
The following accounts are maintained in the books of Nintu. Classify these under : Personal, Real and Nominal headings: (i) Interest; (ii) Cash; (iii) Bank; (iv) Mohan Lal; (v) Saraswati Pustak Bhandar; (vi) Vidyapuri; (vii) Motor Vehicles; (viii) Goodwill; (ix) Depreciation; (x) Commission.
Solution
(1) Interest-Nominal Account; (ii) Cash-Real Account; (iii) Bank-Personal Account; (iv) Mohan Lal- Personal Account; (v) Saraswati Pustak Bhandar- Personal Account; (vi) Vidyapuri - Personal Account; (vii) Motor Vehicles - Real Account; (viii) Goodwill - Real Account (ix) Depreciation-Nominal Account; (x) Commission-Nominal Account.
Illustration 3
Classify the following into Real, Nominal, Personal and Valuation Accounts: (i) Plant and Machinery; (ii) Purchases; (iii) Investment; (iv) Bank; ( (v) Tata Iron and Steel Co. Ltd.; (vi) Rent; (vii) Land and Building; (viii) Carriage Outwards; (ix) Capital; (x)Leasehold property; (xi) Trademark; (xii) Returns outwards; (xii) Import duty;
Solution
(1) Plant and Machinery-Real Account; (ii) Purchases - Nominal Account, (ii) Investment - Real Account; (iv) Bank-Personal Account (v) Tata Iron and Steel Co. Ltd- Personal Account, (vi) Rent - Nominal Account; (vii) Land and Building-Real Account; (viii) Carriage Outwards-Nominal Account; (ix) Capital-Personal Account (x) Leasehold Property - Real Account; (xi) Trade Mark-Real Account; (xii) Returns Outwards Nominal Account; (xiii) Import Duty- Nominal Account; It has already been stated that each transaction involves two or more accounts. After ascertaining the accounts involved, our next problem is to
decide which account should be debited and which account should be credited.
Rules for Debit and Credit (Traditional)
Debit and credit are simply additions to or subtraction from an account. In accounting, debit refers to the left hand side of any account and credit refers to the right side. Asset, expenses and losses accounts normally have debit balances; liability, income and capital accounts normally have credit balances.
The term debit is derived from the latin base debere (to owe) which contracts to the form 'Dr.' used in journal entries to refer to debits. Credit comes from the word credere (that which one believes in, including persons, like a creditor), which contracts to the form 'Cr.' used in journal entries for a credit.
1. Personal Accounts: Debit the account of the person who receives something and credit the account of the person who gives something.
2. Real Accounts: Debit the account of the asset/property which comes into the business or addition to an asset, and credit the account which goes out of the business. When furniture is purchased for cash, furniture account is debited (which comes into the business) and cash account is credited (which goes out of the business).
3. Nominal Accounts: Debit the accounts of expenses and losses, and credit the accounts of incomes and gains. When wages are paid, wages account is debited (expenses) and cash account is credited (asset goes out).
4. Valuation Account: Debit the account when the account is to be reduced and credit the account when the account is to be increased.
Rules for Debit and Credit at a Glance
Types of A/C Debited A/C Credited
Account
1. Personal
Account Receiver Giver
2. Real what comes in what goes out
Account
3. Nominal Expenses & Income & Gain
Account Losses
Journal and Ledger
Nowadays, many businesses use computers for maintaining accounting records and data may be stored on floppy disks rather than in journals and ledgers. However, an understanding of accounting concepts is most easily acquired by the study of manual accounting system.
The Journal and its Nature
The first book in which the transactions of a business unit are recorded is called a Journal. Here, business transactions are recorded in chronological order, i.e. in the order in which they occur. Each record in a journal is called an entry. As a journal is the first book in which entries are recorded, a journal is also known as a book of original entry.
A journal entry is an analysis of the effects of a transaction on the accounts, usually accompanied by an explanation (properly called as a narration). Therefore, a journal is a tool for analysing and describing the impact of various transactions upon a business unit. Before a journal entry is passed, it is necessary to decide for each transaction, what are the accounts involved. It is also necessary that the accounts to be debited or credited are identified.
Ruling of a Journal:-
In its usual form,journal is divided by vertical lines into five columns in which to enter ,in respect of each transactions:
a)Date b) particulars c)Ledger Folio
d) Amount (debit) e) Amount (credit)
(a) The date: The year is written at the top of the date column of the next line of the date column, the month and day of the first entry are written. Unless the month or year changes or until a new page is begun, neither the month nor the year is repeated on the page.
(b) Particulars: The particulars column is the column for account titles and description. The name of the account to be debited is entered at the extreme left of the particulars column next to the date column. The symbol "Dr." is written at the right end of the particulars column on the same line of the account debited. The amount of the account debited is entered in the left hand money column. The name of the account to be credited is entered on the next line with a prefix 'To' and is indented to the right of the date column. The amount of the account credited is entered in the right hand money column. A short explanation of the transaction known as narration begins on the line immediately below the account credited. The narration should be adequate to explain the transaction and may include any data needed to identify the transaction. It should be noted that the narration is particularly important for non-routine transactions where their nature is, otherwise, not apparent. The narration always appears within parentheses and is begun with the word "Being"-which means what it is. Finally, a thin line is drawn all through the particulars column to indicate that the entry of a transaction has been completed.
(c) Ledger folio (LF.): The ledger folio column to the right of the particulars columns is not filled in when transactions are recorded in the journal. When the debits and credits are posted in the ledger accounts, the page number of the ledger in which these accounts are appearing are listed in this column.
(d) Amount (Debit): The debit amount is recorded in the amount (Dr.) column opposite the title of the account debited. The unit of measurement, i.e. is recorded at the top of this column on each page and this is not repeated.
(e) Amount (Credit): The credit amount is recorded in the amount (Cr.) column opposite the title of the account credited. Like the amount (Dr.) column, is recorded at the top of this column on each of page.
Subdivision of Journal
The journal is inadequate as the sole book of the original entry when the transactions are numerous. The nature of operations and the volume of transactions in the particular business determine the number and type of journals needed. A medium size business generally maintains the following types of journals:
1. Cash Book-to record cash transactions; 2. Sales Day Book - to record credit sales;
3. Purchases Day Book - to record credit purchases; 4. Sales Return Day Book-to record sales returns;
5. Purchases Return Day Book-to record purchases returns;
6. Bills Receivable Book-to record bills receivable; 7. Bills Payable Book-to record bills payable;
8. Petty Cash Book-to record petty cash payments; and,
9. Journal Proper-to record residuary transactions. It is also used for rectifying errors.
The Ledger
The ledger is the principal book of accounts where similar transactions relating to a particular person or thing are recorded. The journal is used to record the transactions in the chronological order. The owner of a business is not interested to know the effect of individual transaction on the financial statements, what he wants is the accumulated effect of each 'Chart of Accounts'. Chart of accounts is an index to all accounts contained in a double entry system. It allocates to each account a number and arranges accounts in logical subdivisions. For example, if he wants to know the total purchases for an accounting period, he will only see the "Purchase Account".
It is not possible to ascertain from the journal the total amount of purchases made. In the journal, record of purchases made at different dates can also be against cash or credit. Therefore, similar transactions should be sorted out and consolidated at one place to ascertain their net effect. This kind of processing is possible where different accounts are prepared in the ledger. Again, for example, to ascertain the cash position of a business, one is to look at the Cash Account; one can not know cash position with the help of a journal. Likewise, to ascertain net sales for the account period, one is to look at the Sales Account, which incorporates all information with regard to cash sales, credit sales, and the like.
Therefore, an account represents a detailed record of changes that have occured in a particular asset, liability, expense, loss, gain or capital during an accounting period.
The ledger is regarded as a principal book of account for the following reasons :-
: 1. The ledger helps us preparing the trial balance to ensure the arithmatical accuracy of the books of account.
2.The ledger assists us in preparing the Trading, Profit and Loss Account and the Balance Sheet.
3. Amounts due to creditors or due from debtors can be ascertained through ledger. 4. Ledger reduces the possibility of errors, improves the probability of locating errors that do occur.
From the above, it is clear that ledger is the principal book of account but journal entry cannot be avoided for the following reasons:
1. It is a first or primary record in which transactions are analysed before they are posted to ledger.
2. A journal is the record which shows the complete story of a transaction in one entry.
3.It shows all necessary information regarding a transaction. The Ledger Account cannot provide detailed information of a transaction.
4. It provides an explanation of the transaction.
5. 5. It provides a date-wise record of all the transactions.
6. It provides an individual source of quick reference in the future in response to queries.
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