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Journal & Ledger

Financial Accounting - purpose, use & roleAccounting is the language of business. And it is a science as well as an art. It is science since accountsare prepared with certain basic principles and laws. Accounting is an art because it prescribes the processthrough which the objectives are fulfilled.

Accounting involves Recording of events & transactions which are of financial character. Classifying similar financial transactions together. Summarizing Analysis & Interpretation. Analysis refers methodical classification of data. Interpretation means

drawing conclusion from data. Communicate the results to relevant stakeholders.

The major users of accounting are Creditors Shareholders Government Investors Lenders Management

The financial data serves the interests of different persons concerned in different manner, as theirobjectives are different.

Different branches of accounting are Financial Accounting - Original form of accounting, mainly limited to the preparation of financial

statements based on historical data. Cost Accounting - Concerned with the estimation of costs in advance and their subsequent

detailed analysis for the purpose of control. Management Accounting - Deals with planning, decision making, forecasting, budgeting, control

over costs and strategy formation.

Major objectives / advantages of accounting are To keep systematic records. To ascertain the results of operation, that is profit or loss. To ascertain the financial position of the business. To provide control and protect business assets. To provide information to the tax authorities. To facilitate rational decision making.


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Major limitations are Profit shown in financial accounting is not fully exact. Financial accounting does not tell the whole story. Accounting statements may be drawn up differently. All assets are not shown up on financial statements (example human assets) Manipulation Impact of inflation.

There are two systems for recording transactions. Single entry system - It is not a scientific system and final accounts cannot be easily prepared on

the basis of this system. Small businesses and organisations that do not require ascertainment of profit, follow this system.

Double entry system -

GAAPAccounting principles can be defined as those rules of action or conduct which are adopted by theaccountants, universally, while recording the transactions. The major characteristics of accounting

principles are. Objectivity - accounting info should not be influenced by personal bias or judgment. Reliability - info should be truthful, accurate & complete and capable of being verified. Feasibility - Understandability - Application - should have a practical utility or application.

Accounting concepts ( 8) are necessary assumptions or conditions which form the basis of accounting. Separate Entity Concept - Business is considered as a separate entity, distinct from the person

who own it. Boutique + Daughters Money Measurement Concept - Accounting records only those transactions that can be expressed

in terms of money. Qualities like workforce skill, morale, market leadership, brand recognition,


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quality of management etc cannot be quantified in monetary terms and so not accounted for in books of accounts.

Dual Aspect Concept - Every business transaction have an dual aspect. This concept helps toestablish the arithmetical accuracy of the accounts and enable detection of errors.

Going Concern Concept - It rather presumes that the enterprise will continue in operation long

enough that the cost of the fixed assets would be charged over the usual lives of the assets.Moreover, the concept applies to the business, as a whole. Even if a branch or division of the

business were closed, ability of the business to continue would not be affected. Cost Concept - Fixed assets like lands need to be shown at original price at which they acquired.

Applicable only to fixed assets. This is related to going concern concept. Accounting Period Concept - Matching Concept - Cost should match with revenue. Realization Concept - Profit is recognized as when realized.

Accounting conventions are the customs and traditions , which guide us in preparing accounting

statements. Conservatism - Whenever there are two equally acceptable methods, the one, which is more

conservative, will be accepted. Principally applicable to current assets. (closing inv valuation) Consistency - Accounting Practices are unchanged, year after year. If the accounting practices

are changed, the fact is to be mentioned and its impact is to be quantified. (closing inv valuation) Materiality - This convention emphasises that all material facts should be recorded in accounting.

Accountant should attach importance to material details and ignore insignificant details. Whilesending a statement of account to the debtor, the exact amount receivable from the concerneddebtor is to be shown. However, when the summary of debtors is presented to the topmanagement, the individual debtors are rounded to the nearest thousand.

Full Disclosure - The Convention of Disclosure means that all material facts must be disclosed inthe financial statements.

Double Entry AccountingWhat is Double Entry?There are two aspects in every business transaction. They are receiving aspect and the other givingaspect. Under this system, every transaction is recorded twice, one on the debit side i.e. the receivingaspect and the other credit side i.e. giving aspect.

Let us illustrate. When a businessman buys goods, he receives goods on one side and on the other side,money is given towards the value of goods. When he hires the services of employees, services arereceived on one side, while payment is made for the services rendered.

The features of double entry can be summarized as under: It records two aspects of every transaction. One aspect is debited and the other aspect is credited. Total of debits are equal to total of credits.


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Accounting EquationAccounting equation is the statement of equality . Here, the resources are equal to the sources. The owneror proprietor and outsiders provide the sources for acquiring resources. The resources are known asAssets. As owners and outsiders have provided the funds to the business and business is independent

from these persons, due to business entity concept , these persons have a claim against the assets of the business. These claims are known as Equities . Equities are of two types. They are owners equity andoutsiders equity. Owners equity (or capital) is the claim of owners against the assets of the business.Outsiders equity (or liabilities) is the claim of the outsiders such as creditors, loan providers and debentureholders against the assets of the company.

Resources (Assets) = Sources of Finance (Capital + Liabilities)

We can say Assets = Capital(Total claims)

Assets = Owners claim + Outsiders claim Assets = Equity + Liabilities

The above is known as the accounting equation or balance sheet equation.

Debit & Credit Rules

AdvantagesAdvantages of double entry are

Possible to have a complete record of all transactions. Arithmetical accuracy can be easily ascertained by preparing a statement called Trial Balance. Provides accurate information on what business owns and what it owes. Can compare the results of business with those of previous years. Possible to prepare trading and profit & loss account at the end of the accounting period. Financial position can be ascertained by preparing balance sheet. Any mistakes or error can be easily found and rectified.


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Misappropriations of funds can be reduced.

This system recognises the fundamental fact that a business transaction is a double-sided affair. DoubleEntry Bookkeeping ensures arithmetical accuracy alone, does not guarantee financial correctness.

Accounting CycleAn accounting cycle is a complete sequence of transactions, beginning with the journal, later recording in aledger, arriving at the balance in the ledger, moving to prepare trial balance and finally preparation offinancial statements Trading and Profit and Loss Account (Income Statement) and Balance Sheet(Position Statement).

1. Identification of transactions.2. Preparation of business documents.3. Recording of transactions in journal.

4. Posting to ledger. (classification)1. All similar transactions are grouped & posted in one book called ledger.

5. Preparation of unadjusted trial balance. (summarizing )6. Passing of adjusting entries.7. Preparation of adjusted trial balance.8. Preparation of statements.


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JournalWhat is Journal?Journal is a book in which transactions are recorded in the order in which they occur. Journal is a book ofdaily record.

Journal is called the book of original entry or prime entry, because all business transactions are firstrecorded in the journal.

An entry made in the journal is called a Journal Entry. In every business, accountant enters the businesstransactions date-wise in a chronological order on the debit and credit side, along with the narrationaccording to the principles of double entry. The process of recording transactions in the journal is calledJournalising .

The totals of debit and credit columns are to be made on every page to confirm the correctness of thearithmetical accuracy as the principle is for every debit, there has to be a corresponding credit. If thetotal of debit and credit do not agree, it is an indication that the amounts have not been entered, correctly,in the journal.

Narration - Brief explanation given to remember the nature & particulars of the transaction.

Journalizing StepsFollowing steps should be followed for journalizing a transaction

1. Find out the accounts affected.2. Identify the account type - personal or real or nominal3. Apply the rules of debit & credit

Subsidiary JournalsThe journal is called the book of original entry because the transactions are first recorded in it. In businessconcerns, there will be innumerable transactions everyday. If these transactions have to be passed throughthe journal, more time & labor are required. With the object of saving time & energy, new methods have

been developed. The method of using special journals or subsidiary journals is one of them.


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Under this method, instead of recording all transactions in one journal each kind of transaction is recordedin separate journals. A special journal, therefore, is a journal in which only one kind of transaction isrecorded.

Transactions can be normally grouped under Buying transactions Selling transactions Cash transactions Miscellaneous transactions.

Special journals are designed on the basis of above grouping.1. Cash book - all kinds of cash receipts & payments are recorded here.2. Purchase book - all credit purchases of goods.3. Sales book - all credit sales of goods.4. Purchase return book - records of goods to the supplier.

5. Sales return book - recording the return of goods by our customers.6. Bills receivables book - recording all bills duly accepted by debtors.7. Bills payables book - recording all bills accepted by us.8. Journal proper - for transactions which can't be entered in any one of the special journals.

Compounded Journal EntryIn certain cases, a single debit is to be equalized by two or more credit entries or more debit entries are to

be equalized by one credit entry. This type of entry is called compound journal entry.

Drawing Account

The proprietor may for personal purpose withdraw money from business. He may also take goods fromthe business for personal use. These transactions are recorded in a separate account called DrawingAccount.

When proprietor withdraw money from business for personal use Debit Drawing a/c Credit Cash or Bank a/c

Like wise when goods are withdrawn for personal use Debit Drawing a/c Credit Purchase a/c

If the withdrawals are very frequent, instead Purchase a/c, credit Sales a/c.

At the end of financial cycle, Drawing a/c should be closed by transferring to Capital a/c. Debit Capital a/c Credit Drawing a/c


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DiscountsCash DiscountTo make prompt payment, cash discount is normally allowed. At times, some reduction in the form ofdiscount is allowed to receive the full and final settlement. To the person who allows the discount, it isexpenditure. Discount is an income to the person getting it.

Discount given to customer is an expense. Discount received from supplier is an income. Discount a/c

Trade Discount When seller gives a deduction on the list price, it is known as trade discount. Normally, trade

discount is given to encourage higher quantum of purchases. Never appear in books of account.

ReturnsPurchase Returns

Under the following circumstances a buyer may return goods to the seller. A part of the goods that he purchased is defective. It is damaged in transit. It is not according to the sample or order. Received excess quantity. It is of inferior quality.

The seller will allow necessary credit to account of the buyer if he accepts the return of goods. Forconvenience, a separate book is kept for recording such returns of goods. Entries are made in purchasereturn books under following circumstances.

1. When the entire part or part of a purchase is actually returned to the supplier.

2. When the purchaser claims any allowance and supplier agrees to the claim.

It is an income / gain. Debit Supplier a/c & Credit Purchase Returns a/cDebit Note - when goods are returned to the seller, a statement is also sent along with them. This is toinform the supplier about the debit given to his account.

Sales Returns Normally whenever goods once sold are returned by the customer, it is recorded in the sales return bookor returns inward book.

Expense / Loss Debit Sales Returns a/c & Credit Debtor's a/c Credit Note - After passing an entry, debtors should be informed of the credit given to their

accounts.

Opening EntryAt the beginning of every account period, a business may open new books of accounts. The journal entrymade to open the new books of account with the previous balances in the account is known as openingentry. This is recorded by debiting asset accounts and crediting liability & capital accounts. If the amount


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of capital is not known, it can be ascertained by applying the formula capital = assets - liabilities.

LedgerWhat is Ledger?Classification of recorded transactions are done in Ledger. Ledger is a book with various accounts (Real,Personal and Nominal Accounts), each account on a separate page, that gives the details of the differenttransactions and its summary.

Final information related to the financial position emerges only from the accounts. As the ledger containsall accounts, the ledger is also called as Principal Book.

Proforma of Ledger

Journal Vs Ledger

Basis Journal Ledger

Nature of Book Original entry Second entry

Record Date wise, chronological order Account wise

Importance for legal evidence Greater weight Lesser weight

Classification of Data Based on transactions Based on accounts

Process Journalizing Posting

Narration Needed for every transaction Not needed for every posting

Folio Folio of ledger is written Folio of journal is written

Final Accounts Final accounts cant be prepared Final accounts can be prepared.

Accuracy Accuracy cant be tested easily Can be tested from trial balance.

Advantages of Ledger Knowledge of accounts : Information about each account is known immediately, which is not

possible from the journal. Knowledge of income and expenditure : Separate accounts are opened for each head of income


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and expenditure. So, information is available about the expense and income, account-wise. Test of accuracy: A trial balance is prepared, taking the summary of all accounts opened in the

ledger and arithmetical accuracy is tested. Knowledge of assets and liabilities: As separate account is opened for each asset as well as

liability, position of each asset and liability is immediately known. Evidence in business disputes : The ledger proves sufficient evidence in a court for business

disputes.

Types of Ledgers Personal (Accounts of debtors & creditors are kept in this ledger)

Purchase Ledger - accounts of creditors only. Sales Ledger - accounts of debtors only.

Impersonal - All real & nominal are entered here. Also called General Ledger Private -To ensure secrecy of the accounts, capital & drawing account of proprietor is entered

here.

Rules of Posting Opening of separate accounts

Each transaction affects minimum two accounts. Separate account is to be opened in theledger. Such account may be real, nominal and personal account. No account is to beopened, twice. All transactions relating to that account, debit as well as credit, are to be

posted in the concerned account, so that net position of the account is known. Posting journal entry to concerned side

If an account is debited in the journal, posting will be made on the debit side of theaccount in the ledger. Similarly, if an account is credited in the journal, that account would

be credited in the ledger. Use of the word 'To' and 'By'

While writing the debit side, commence with words To and write the name of theaccount, which is credited in the journal. Write the words By on the credit side beforewriting the name of the account that is debited in the journal. In other words, the name ofthe other account is to be written.

Balance in account Side (Debit or credit) that is heavy is to be totaled, first. The same total is to be put on the

total column of the other side in the account. Net position is arrived. If debit total is higherthan the credit side, net position would be debit and vice versa.

Balancing an AccountWhen posting is complete in each account, balancing is to be done. To do balancing, first total the heavierside of the account and put the same total on the other side and arrive at the balance. Such balance iscalled balance c/d . The difference of the total of two sides of an account is called Balance, which can bedebit or credit balance.

Balance in the account has to be brought down. Such balance is called balance b/d . The balance that is


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brought down appears in the trial balance. If the brought down balance is debit, the amount appears underthe debit column in the trial balance. Similarly, if the balance brought down is credit, the balance appearsunder the credit column in the trial balance. Both debits and credits should be equal in the trial balance. If

both debit and credit are equal, it is an indication that there is arithmetical accuracy.

Balance b/d is the closing balance of the account for the year concerned. The same amount would become the opening balance for the next year.

Questions Closing Entries (3) Business Entity Concept (3) Money Measurement Concept (3) Define the term financial accounting (3) What do you mean by Journal (3) Double entry bookkeeping (3) Accrual concept (3) Ledger & its format (3) Double entry accounting system (10) Distinguish between account concept and accounting convention (10)

** Cash Book **Cash Book is a journal as well as a Ledger. Cash and bank transactions are directly entered into the cash

book. So, cash book serves the purpose of a journal, book of original entry. The function of a ledger is toshow the balance of an account. From cash book, cash and bank balance, at the end of any day, is known,serving the purpose of a ledger too. Cash Book has a unique position, serving the purposes of a journal aswell as a ledger.** Contra Entries** Petty Cash Book ** Imprest System

Accrual ConceptBusiness transactions are recorded when they occur and not when the related payments are received ormade. This concept is called accrual basis of accounting and it is fundamental to the usefulness of

financial accounting information.

An airline sells its tickets days or even weeks before the flight is made, but it does not record the payments as revenue because the flight, the event on which the revenue is based has not occurred yet.

A business records its utility bills as soon as it receives them and not when they are paid, because theservice has already been used. The company ignored the date when the payment will be made.


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Accounting standards strictly require accounting on accrual basis. However, there is an alternative calledcash basis of accounting. Under the cash basis events are recorded based on their underlying cash inflowsor outflows. Cash basis is normally used while preparing financial statements for tax purposes, etc.

Realization concept in accounting, also known as revenue recognition principle, refers to the application of

accruals concept towards the recognition of revenue (income). Under this principle, revenue is recognized by the seller when it is earned irrespective of whether cash from the transaction has been received or not.

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