1. Introduction to Accounting Process
Accounting involves a systematic process of identifying, analyzing, recording, classifying, and summarizing business transactions, and then communicating their effects to interested users. This chapter focuses on the initial steps: identifying transactions, preparing source documents, recording in the journal (book of original entry), and posting to the ledger.
2. Business Transactions and Source Documents
- Definition: A business transaction is an exchange of economic consideration between parties, characterized by a “Give and Take” aspect. These transactions have a two-fold effect and are recorded in at least two accounts.
- Evidence: Business transactions are typically supported by appropriate documents, known as Source Documents or Vouchers. Examples include Cash Memos, Invoices, Sales Bills, Pay-in-slips, Cheques, and Salary Slips.
- Purpose of Vouchers: Vouchers serve as evidence for transactions. Even for petty expenses without external documentation, internal vouchers can be prepared and approved. All vouchers are arranged chronologically, serially numbered, and kept in a separate file, forming the basis for all book of account recordings.
3. Preparation of Accounting Vouchers
- Classification: Accounting vouchers can be categorized into cash vouchers, debit vouchers, credit vouchers, and journal vouchers.
- Format: There is no universally fixed format for accounting vouchers, but a specimen of a simple transaction voucher is commonly used.
- Preservation: Vouchers must be preserved until the accounts audit and tax assessments for the relevant period are complete.
- Types of Vouchers:
- Transaction Voucher: Prepared for a simple transaction involving one debit and one credit.
- Compound Voucher: Records transactions entailing multiple debits/credits and one credit/debit. These can be Debit Vouchers or Credit Vouchers.
- Complex Voucher/Journal Voucher: Prepared for transactions with multiple debits and multiple credits.
- Essential Elements of an Accounting Voucher:
- Printed on good quality paper.
- Firm’s name printed at the top.
- Date of transaction (not recording date).
- Serial voucher number.
- Name of the account to be debited or credited.
- Debit and credit amounts in figures.
- Account-wise description of the transaction.
- Name and signature of the preparer.
- Name and signature of the authorized person.
4. Accounting Equation
- Principle: The accounting equation fundamentally states that the assets of a business are always equal to the sum of its liabilities and capital (owner’s equity).
- Formula: A=L+C
- Where, A = Assets
- L = Liabilities
- C = Capital
- Derivatives: The equation can be rearranged to find missing figures:
- A−L=C
- A−C=L
- Balance Sheet Equation: It is also known as the Balance Sheet Equation because it reflects the fundamental relationship between components of the balance sheet. The resources owned by a business (assets) must equal the claims against those resources by proprietors (capital) and outsiders (liabilities).
- Effect of Transactions: Every business transaction impacts the accounting equation, but the equation always remains balanced. Profits increase capital, while losses decrease it.
5. Using Debit and Credit
- Double-Entry System: In double-entry accounting, every transaction affects at least two accounts, and the total amount debited must always equal the total amount credited.
- Debit (Dr.) and Credit (Cr.): These terms indicate whether transactions are recorded on the left-hand side (Debit) or right-hand side (Credit) of an account.
- T-Account: The simplest form of an account is a “T-account,” which has a left (debit) side and a right (credit) side for recording increases and decreases.
6. Rules of Debit and Credit
Accounts are categorized into five types for transaction recording:
- Assets
- Liabilities
- Capital
- Expenses/Losses
- Revenues/Gains
The fundamental rules for recording changes in these accounts are:
- For Assets and Expenses/Losses:
- Increase in Asset: Debited
- Decrease in Asset: Credited
- Increase in Expenses/Losses: Debited
- Decrease in Expenses/Losses: Credited
- For Liabilities, Capital, and Revenues/Gains:
- Increase in Liabilities: Credited
- Decrease in Liabilities: Debited
- Increase in Capital: Credited
- Decrease in Capital: Debited
- Increase in Revenue/Gain: Credited
- Decrease in Revenue/Gain: Debited
7. Books of Original Entry (Journal)
- Definition: Books of original entry are where transactions are first recorded in chronological order.
- Journal: The journal is a primary book of original entry. The process of recording entries in the journal is called journalizing.
8. The Ledger
- Definition: The ledger is the principal book of the accounting system. It is a collection of all accounts (debited or credited in the journal or special journals) where transactions related to a specific account are maintained.
- Utility: The ledger is crucial for ascertaining the net result of all transactions for a particular account on a given date. It allows management to quickly determine amounts due from customers or payable to suppliers, which is difficult to find from chronologically ordered journal entries alone.
- Posting: The process of transferring entries from books of original entry (like the journal) to the ledger accounts is called posting.
- Format: Each account in the ledger is typically opened on a separate page or card, often with an index and code number for easy identification and location.
- Title of the Account: Name of the item, suffixed with ‘Account’.
- Dr./Cr.: ‘Dr.’ for Debit (left side) and ‘Cr.’ for Credit (right side).
- Date: Year, Month, and Date of transactions in chronological order.
- Particulars: Name of the item with reference to the original book of entry.
- Journal Folio (J.F.): Records the page number of the original book of entry from which the transaction was posted.
- Amount: Records the numerical amount corresponding to the original entry.
