Recording of Transactions - I

Written and reviewed by Devendra Dubey, Mathematics & Commerce faculty at UniDrill (M.Sc. Mathematics, Osmania University · 10 years teaching). Based on NCERT Accountancy Class XI (Financial Accounting Part I), Chapter 3.

Anita's first week: eight events, one clear record

Anita starts a trading firm. In seven days she brings in capital, buys a machine, buys goods on credit, pays salary and advance rent, makes a cash sale and takes some money home. At the end of the week she must say how much cash she has, what she owes Ritu and whether the firm is better off. A pile of bills cannot say that. A journal and a ledger can.

The route every transaction takes is the subject of this chapter. The path in one line: voucher → effect on the accounting equation → debit and credit rule → journal → ledger → balance.

Vouchers: the proof behind the entry

A business transaction is an exchange that has a give and a take, so it is recorded in at least two accounts. Before recording, the firm prepares a voucher, a document that proves the transaction. Cash memos, invoices, pay-in slips, cheques and salary slips are source documents. For small items with no bill, the firm prepares and approves a voucher internally. A good voucher carries the firm's name, the date of the transaction (not the date of writing it up), a serial number, the accounts to be debited and credited, the amount, a description and the signatures of the preparer and an authorised person.

Vouchers differ by how many accounts are debited and credited.

The accounting equation

Everything the business owns (assets) was paid for by someone: the owner (capital) or outsiders (liabilities). So the two sides always match:

$$\text{Assets} = \text{Liabilities} + \text{Capital}$$

It can be rearranged as $\text{Capital} = \text{Assets} - \text{Liabilities}$ and $\text{Liabilities} = \text{Assets} - \text{Capital}$. Because it relates the items on a balance sheet, it is also called the balance sheet equation. Profits raise capital and losses reduce it. Every transaction changes at least two items, and the equation still balances afterwards.

Debit, credit and the five heads of accounts

A T-account is a simple account drawn like the letter T. The left side is debit (Dr.) and the right side is credit (Cr.). To debit is only to enter on the left; to credit is only to enter on the right. Whether a debit increases or decreases an account depends on which head it belongs to.

Learn it as two groups. Assets and expenses grow on the debit side. Liabilities, capital and revenues grow on the credit side. Every transaction has an equal debit and credit, which is double entry in action.

Beyond the textbook. For the exam: a debit increases an asset or an expense and decreases a liability. In reality: debit simply means the left side of an account. It is not good or bad, and it does not mean "money out". A debit to Cash means cash came in, while a debit to Creditors means a debt was paid off. Why it matters: if you ask "does this account increase or decrease?" before choosing a side, you will never mix up the rules.

Pause and predict: A customer, Ravi, pays ₹10,000 of the money he owed you. Cash is debited. Which account is credited, and why?

Check your answer: Ravi's account. Ravi is a debtor, an asset, and his debt has shrunk. An asset decreases on the credit side.

The journal: where entries are born

The journal is the book of original entry. Transactions are written here first, in date order, and the act is called journalising. Each entry has five columns.

An entry with one debit and one credit is a simple entry. One with more than one debit or more than one credit is a compound entry. Two practical rules save marks. First, there is no Goods account: goods are split across Purchases, Sales, Purchases Return, Sales Return and Stock, so goods bought are debited to Purchases. Second, Purchases is only for goods in which the firm deals. Machinery or furniture bought for use is debited to its own asset account.

The ledger: the book of accounts

The ledger is the principal book, a collection of all the accounts. From a ledger account you can read the balance on any day, which is very difficult from the journal. Moving entries from the journal to the ledger is posting.

At the end of a period each account is balanced: add both sides, enter the difference on the shorter side as Balance c/d, and bring it down on the opposite side as Balance b/d at the start of the next period.

Ledger accounts are also grouped by how long they last. Permanent accounts (assets, liabilities, capital) are balanced and carried forward into the next year. Temporary accounts (revenues and expenses) are closed at the year end by transfer to the Trading and Profit and Loss Account. Drawings behave like a temporary account: its balance is transferred to Capital at the year end.

Beyond the textbook. For the exam: you journalise each entry by hand and post it to the ledger. In reality: accounting software still asks for a voucher for every event, but it prepares the journal view and the ledger accounts automatically from that single entry. Why it matters: the logic you learn here is exactly what the software follows, so a wrong debit or credit at the first step spreads to every report.

Worked examples

Worked example: eight events and the equation. Anita's firm has these events in order. Track assets, liabilities and capital after each one.

Check the last row: $2{,}00{,}000 + 4{,}90{,}000 = 6{,}90{,}000$. The assets are cash ₹4,68,000, goods ₹1,20,000, machinery ₹90,000 and prepaid rent ₹12,000, which add to ₹6,90,000. Notice event 6: profit of ₹20,000 raises capital. Events 4, 7 and 8 reduce capital because costs and drawings use up the owner's stake.

Common wrong step. Treating the salary payment in event 4 as lowering only cash. Assets would fall by ₹15,000, but liabilities and capital would stay put, and the equation would break. An expense always lowers capital too.

Worked example: journalising the same events. Which side of each account does the rule send it to?

The journal records the cash sale at its selling price of ₹1,00,000. The cost of the goods sold is worked out at year end from purchases and closing stock, so there is no separate entry for it at the time of sale.

Common wrong entry. Debiting Capital A/c instead of Drawings A/c for the cash taken home. The two step method keeps the owner's withdrawals visible; Drawings is closed against Capital only at the year end.

Worked example: posting and balancing. Post the entries to three ledger accounts and balance them.

Cash starts the next period with a debit balance (Balance b/d) of ₹4,68,000, machinery with ₹90,000 debit, and Ritu with a credit balance of ₹2,00,000, which Anita owes. The cash balance matches the equation table above.

Common wrong entry. Writing the account's own name in Particulars (for example "To Cash A/c" inside the Cash account) or putting Balance c/d on the wrong side. Particulars always names the other account, and Balance c/d goes on the side that is smaller so that both totals match.

Worked example: a compound entry with two discounts. Anita sells goods of list price ₹50,000 to Anil at 10% trade discount. Anil pays within the credit period and gets 2% cash discount. Record both events.

Common wrong entry. Cash Dr ₹49,000, Discount Dr ₹1,000, To Sales ₹50,000. This takes the cash discount on the list price and ignores the trade discount, so sales, cash and discount are all wrong.

Worked example: selling an old asset. Anita sells two old pieces of furniture, each with a book value of ₹10,000, one for ₹12,000 and the other for ₹7,500.

Common wrong entry. Crediting Sales A/c with ₹12,000. Sales is for goods in which the firm deals. The furniture would stay on the books at ₹10,000 and the sales figure would be inflated.

Worked example: a debit voucher and a complex voucher. On Jul 5 Anita pays salary ₹15,000, rent ₹10,000 and electricity ₹3,000 together in cash. On Jul 9 she buys goods for ₹60,000 and furniture for ₹20,000 from Mehta Traders, paying ₹30,000 in cash and the balance on credit.

Common wrong entry. Debiting Purchases with the entire ₹80,000. The furniture is not goods for resale, so it must be debited to the Furniture account.

Pause and predict: Anita pays ₹12,000 on 25 March for the rent of April. Should she debit Rent or Prepaid Rent?

Check your answer: Prepaid Rent. The benefit has not been used yet, so it is an asset until April. If she debited Rent, this year's expenses would be overstated.

Exam traps

Formula and format sheet

60-second revision

Where this chapter connects

The ideas here are tested again as soon as the books grow. Recording of Transactions II splits the journal into the cash book, purchases book, sales book and returns books. Trial Balance and Rectification of Errors takes the ledger balances you find here and checks that debits equal credits. The reasoning behind the equation is in Theory Base of Accounting.