Chapter 5 Accounting Process

Chapter Index

S. No.

Reference

No.

Particulars

Slide

From-To

1 Learning Objectives 3

2 Topic 1 Accounting Process 4-9

3 Topic 2 Debit and Credit Rules 10-12

4 Topic 3 Journal 13-16

5 Topic 4 Ledger 17-23

6 Topic 5 Subsidiary Books 24-30

Learning Objectives

Discuss and explain the process of accounting

Examine various stages in the accounting process

Describe the traditional approach for recording transactions

Explain the meaning of transaction analysis

Discuss the rules of debit and credit

Explain the meaning and format of a journal

Discuss the process of journalising

Discuss the process of ledger balancing

Examine the relation between a journal and a ledger

Describe various types of subsidiary books of accounts

Accounting Process

The accounting process starts when any financial transaction is made by an

organisation.

You can say that the main objective of this process is recording financial

transactions systematically and accurately in the journal and process them to

prepare financial statements.

The accounting process results in various financial statements, such as

balance sheet, profit and loss account and other statements.

The process of financial accounting involves a number of steps.

Process of

Accounting

Stages in Accounting Process

The process of accounting starts with the identification of financial transactions.

Next, it records transactions in the books of accounts.

Then, the process classifies and summarises the information and prepares a trial

balance and financial statements.

Preparation of Trial Balance and Financial Statements

Posting to the Ledger

Recording Entries in the Books of Original Entry

Preparation of Vouchers

Identification of Financial Transactions

The steps involved in the accounting process are

Traditional And Modern Approach For Recording Transactions

According to the traditional approach, various accounts are classified as

Ca

teg

ori

es o

f A

cco

un

ts

Personal Account

Natural Personal Accounts

Artificial Personal Accounts

Representative Personal Accounts

Real Account Tangible Real Accounts

Intangible Real Accounts

Nominal Account

According to the modern approach, all the accounts are classified under various heads

which are as follows:

Types of Accounts

Assets Liabilities Capital Account

Revenue Account

Expenses Account

Transaction Analysis

Every business organisation involves a large number of transactions on a daily basis,

for example, issue of shares, purchase of raw material, rent paid, wages paid, salary

paid, sale of finished goods, etc.

All these transactions lead to changes in three basic elements, which are assets,

liabilities and share capital.

Transaction analysis provides a clear view of the owner’s original investment by

applying an accounting equation.

An accounting equation shows a relationship between assets (valuable resources

owned by the organisation), liabilities (present obligations of the organisation) and

share capital (the owners’ equity required to operate a business).

This relationship can be expressed by a mathematical equation which is as follows:

Assets = Liabilities + Capital

This mathematical equation must be balanced to match the assets and liabilities side of

a balance sheet.

Debit and Credit Rules

Debit and credit are the most fundamental concepts of accounting, which represent two

sides of each transaction recorded in the books of accounts. As explained earlier, every

transaction has receiving and giving aspects.

The aspect of receiving (increase in assets) is known as the debit aspect and the aspect

of giving (decrease in assets) is known as the credit aspect.

The debit and credit aspects of a transaction form the basis of the double entry

bookkeeping system and are two opposite actions.

(Any Account Title)

Left side Right side

Debit Credit

Pattern of Recording the Debit and Credit in an Account are

Three Golden Rules of Accounting is shown in the Table

Accounts Debit Credit

Personal The receiver The giver

Real What comes in What goes out

Nominal All expenses and losses All incomes and gains

Increases (+) in assets are debits and decreases (–) in assets are credits.

Increases (+) in liabilities are credits and decreases (–) in liabilities are debits.

Increases (+) in capital are credits and decreases (–) in capital are debits.

Increases (+) in expenses/losses are debits and decreases (–) in expenses/ losses are credits.

According to the modern approach, the rules of debit and credit that are used to record

increases and decreases in balances of accounts are as follows:

Increases (+) in incomes/gains are credits and decreases (–) in incomes/gains are debits.

Journal

A journal refers to a primary book of accounts in which all transactions of a business

are recorded.

A journal can also be defined as a chronological record of business transactions.

The format of a journal is shown in Table

The process of recording a transaction in a journal is known as journalising.

Date Particulars L.F. Debit

Amount (Rs.)

Credit

Amount (Rs.)

Name of the debited account Dr. To

Name of the credited account

(Narration)

Format of Journal

Process of Journalising

We have mentioned that a journal entry is the basic record of

business transactions.

It becomes easy to journalise business transactions when you

understand the rules of debit and credit.

When you journalise a transaction, one account receives the

benefits and another account gives the benefits.

The steps are performed to enter a transaction in the journal are:

2. Ascertaining the nature of the account which is affected.

1. Ascertaining that the accounts are affected by the transaction.

3. Ascertaining the account to be debited and the account to be credited by

applying the rules of debit and credit.

4. Ascertaining the amount by which the accounts are to be debited and

credited.

5. Recording the date and month of the transaction in the date column and the

year at the top.

7. Recording the name of the account to be credited in the ―Particulars‖

column. The name of the account to be credited should be written in the

next line preceded by the word ―To‖. The word ―To‖ is written towards the

right after leaving a few spaces. Write the amount to be credited in the

―Credit Amount‖ column.

6. Recording the name of the account to be debited in the ―Particulars‖

column. Along with the name of the account, the abbreviation ―Dr.‖ should

also be written in the same line against the name of the account. Write the

amount to be debited in the ―Debit Amount‖ column.

8. Recording a brief description of the transaction starting from the next line in

the ―Particulars‖ column. This brief description of the transaction is termed

as narration.

9. Drawing a line across the ―Particulars‖ column to separate one journal entry

from the other.

Ledger

A ledger refers to a book or register in which financial transactions are permanently

recorded after being summarised and classified.

You need to arrange a ledger account under particular headings.

Ledgers help in preparing a trial balance, after which the final statement is prepared.

A ledger is also known as the principal book. Although a journal provides a complete

listing of the daily transactions of a business; it does not provide information about a

specific account in one place.

Each side is further divided into four columns.

The left side of the ledger is called the debit side, whereas the right side of the

ledger is called the credit side.

In a ledger, each account is divided into two sides—the debit side and the credit

side.

Format of a Ledger Account

Date Particulars J.F. Amount (Rs.) Date Particulars J.F. Amount (Rs.)

Dr. Name of Account Cr.

Parting transaction of a Journal to a Ledger

A ledger is often referred to as T-account due to its resemblance to the letter T.

The left side of the ledger is debit, whereas the right side is credit.

Transactions are posted to a ledger periodically, such as on a weekly or monthly

basis, according to convenience.

4. Similarly, posting the credited transaction of the journal entry on the debit

side of the account, which is debited in the journal entry.

5. Beginning the debit side with ―To‖ and the credit side with ―By‖.

2. Entering the date of a transaction in the ―Date‖ column.

3. Posting the debited transaction of the journal entry on the credit side of the

account. This is credited in the journal entry.

6. Entering the page number of the journal from where the transaction is

transferred to the ledger in the ―J.F.‖ column.

1. Creating the ledger accounts. These accounts are based on the accounts

recorded in the corresponding journal.

Perform the following steps to post transactions of a journal to a ledger:

Ledger Balancing

For example, if the credit side is greater than the debit side, the difference of

both sides is recorded in the debit side.

On the other hand, if the debit side is greater than the credit side, the difference

is recorded in the credit side.

Ledger balancing means totalling the amount of both sides (that is, the credit

side and the debit side) of the account and writing the difference to the side

whose total is less.

Following steps need to be performed to balance an account:

1. Calculate the amount of both the debit and credit sides of the account

separately.

2. Calculate the difference between both sides. If there is no difference, it

means that the balance is nil. If the total of the debit side is greater than the

total of the credit side, the difference is written on the credit side; and if the

total of the credit side is greater than the total of the debit side, the difference

is written on the debit side.

3. Type the balance as ―To Balance c/d‖, if the difference is on the debit side.

The word ―c/d‖ means carried down to the next period. Similarly, type

the balance as ―To Balance b/d‖ if the difference is on the credit side. The

word ―b/d‖ means brought down from an earlier period. A period refers

to any duration, such as a month or three months (quarterly), according to

convenience.

4. Calculate the credit and debit totals at their respective sides of the

account.

Relation between Journal and Ledger

The relation between a journal and a ledger can be described by

the following points:

Both the journal and the ledger are the books used for recording

transactions in a double entry accounting system.

A journal is prepared in chronological order, whereas the ledger is

prepared as an analytical record.

Recording activity starts with the passing of entries in the journal. The

ledger is the secondary book prepared from the journal.

In case of legal disputes related to financial transactions, the journal holds

more value than the ledger.

Subsidiary Books

In a real-life scenario, a large number of business transactions take place in an

organisation. Therefore, it becomes difficult to record all transactions in one prime book.

To overcome this difficulty, a separate book is maintained for similar types of transactions,

such as one book for receipts and payments of cash and another book for sales of goods

and their purchases.

Subsidiary books are prepared on the basis of the book of original entry.

As transactions are directly recorded in such subsidiary books, there would not be any

requirement of the journal entry or making entries in the book of original entry.

Cash Book

A cash book includes records of all the receipts and payments made by cash and

cheques.

The cash book, which is used to record cash as well as bank transactions,

is also known as cash book with bank column.

The cash book has two sides, namely the left side that records all cash receipts,

and the right side that records all cash payments.

The special feature of the cash book is that it functions as a journal and

a ledger with regard to the cash and bank transactions, respectively.

Format of a Cash Book

The format of the cash book is shown in the figure

Purchase Book

Purchase book involves the records of the credit purchases of

goods.

The cash purchases of goods or the credit purchases of assets are

not recorded in this book.

The format of the purchase book is shown in Figure

Sales Book

Sales book involves records of all credit sales of goods.

Sales book does not record the cash sales of goods or credit sales of assets. It

is also known as sales journal.

The format of the sales book is shown in Figure

Purchase Returns Book

The purchase returns book includes the records of

the return of goods and materials

sent back to suppliers. It is also called the return

outward book.

The format of the purchase returns book is shown in Figure

The sales returns book includes the records of the returns of the credit sales

received back from customers. It is also known as the return inwards book.

The format of the sales return book is shown in Figure

Sales Returns Book

In the next chapter, you will learn about:

The concept of a trial balance

The primary objectives of preparing a trial balance

How to prepare a trial balance

Various limitations of a trial balance

Ways of rectifying errors of a trial balance

The preparation of final accounts of sole proprietorship firms

The journal entries for year-end adjustments

Till now, you have learned about:

The process of accounting

Various stages in the accounting process

The traditional approach for recording transactions

The meaning of transaction analysis

The rules of debit and credit

The meaning and format of a journal

The process of journalizing

The process of ledger balancing

The relation between a journal and a ledger

Various types of subsidiary books of accounts