Notes - Accounting Process : Journal to Trial Balance

19. Accounting Process: Journal to Trial Balance

 

19.1 Meaning of Accounting Process

 

The accounting process consists of a series of activities or operations aimed to provide financial information to a business entity. The accounting process covers those activities that are involved so that financial information are accumulated and presented in reports that would be useful to interested parties.

 

The various activities involved in the accounting process have been mentioned below

1. Source Documents
2. Books of Original Entry
3. Ledger Accounts
4. Trial Balance
5. Final Accounts

 

19.1.1 Source Documents

 

• Source documents are written documents which contain details of the transactions and are prepared at the time, a transaction is entered into. They are also referred to as supporting documents.
• Source documents are of prime importance, as they are the evidences of business transactions which provide information about the nature of the transaction, parties involved, date and the amount involved in it. Examples-bills of purchases, invoices for sales, debit and credit notes etc.

 

Vouchers

Vouchers are documents evidencing a business transaction. A voucher details the accounts that are debited and credited. It is prepared on the basis of source documents such as cash memo, invoice or bill, receipt, pay-in-slip, cheque, debit and credit notes etc.

 

Types of Vouchers

Basically, vouchers may be classified into two categories as follows

1. Supporting Vouchers These are the documents which come into existence when a transaction is entered into. These are also known as source vouchers or source documents.
2. Accounting Vouchers Accounting vouchers are the secondary vouchers. These vouchers are a written document prepared on the basis of supporting vouchers for accounting and recording purposes, prepared by an accountant and countersigned by an authorised person. The accounting vouchers are prepared for cash as well, as non-cash transactions.

 

Accounting vouchers may be classified into cash vouchers and non-cash vouchers

1. Cash Vouchers These are prepared for cash transactions only, i.e., cash receipts and cash payments. It includes receipt and payment through cheques.

      Cash vouchers can further be classified as debit vouchers and credit vouchers

(i) Debit Vouchers These are prepared to record the transactions involving cash payments.

(ii) Credit Vouchers These are prepared to record the transactions involving cash receipts i.e. when cash is received.

2. Non-Cash Vouchers or Transfer Vouchers

The vouchers which are prepared for transactions not involving cash i.e. non-cash transactions are known as non-cash vouchers or transfer vouchers.

 

19.1.2 Book of Original Entry

 

A book of original entry is a book of record in which transactions are recorded as they occur on daily basis and in chronological order, before they are posted to the relevant accounts in the ledger. These books are also known as books of prime entry as transactions are first recorded in them before they are posted to the accounts in the ledger. Journal book and subsidiary books are books of original entry.

 

 

 

Journal Book

The word ‘journal’ has been derived from the French word ‘Jour’ meaning daily records. Journal is a book in which transactions are recorded in chronological order, i.e. date-wise, in the order in which they occur. The process of recording a transaction in a journal is called journalising. An entry made in the journal is called a journal entry.

 

Entries can be classified into the following categories

(i)   Simple Journal Entry If a transaction involves only two accounts in which one account is debited and another account is credited, is called as simple journal entry.

(ii) Compound Journal Entry It is an entry which involves multiple accounts. A transaction which involves more than two accounts to be debited or credited is called as compound entry.

(iii) Contra Entries The entries which involve cash account and bank account and in which, if cash account is debited then bank account is credited or vice-versa, are called contra entries. To record such entries in the cash book, we generally write (c) in the ledger folio column.

 

Format of Journal

The format of journal is given below

 

JOURNAL

 

Date	Particulars	LF	Amt (Dr)	Amt(Cr)

 

Rules of Journalising

The rules of journalising can be studied under two approaches.

 

1. Traditional Approach

Under this system, accounts are classified as follows

(i) Personal Accounts

The accounts which relate to the name of the persons.

 

Such persons can be natural or artificial. Personal accounts are broadly classified into three categories

(a)  Natural Personal Accounts Accounts created in the name of human beings are natural personal accounts e.g. Ram account, debtors account, creditors account, capital account, drawings account.

(b)  Artificial Personal Accounts Artificial persons are those which are not living human beings but they may have existence in the eyes of law e.g. Reliance Ltd, Shyam provisions stores, X and Co, bank account.

(c)  Representative Personal Accounts Accounts which represents certain group of people to whom or from whom amount is payable or receivable respectively, outstanding expense account, prepaid expense, accrued income, income received in advance.

 

(ii) Impersonal Accounts

(a) Real Accounts Accounts created for tangible or intangible assets of the firm. These are broadly classified as “Tangible Real Accounts” Tangible real accounts are those accounts which relate to such things which can be touched, felt, measured etc. e.g. Land account, stock account etc.

      Intangible Real Accounts The accounts which cannot be seen and touched. Such accounts represent legal rights e.g. goodwill account, patents account, brand/trademarks account, copyrights/mastheads account, licences/franchise account etc.

(b)  Nominal (Revenue or Expense) Accounts All accounts which are simply opened as per the nature of the transactions. They do not really exist. These are of two types

1. Expenses and Losses

Expenses Rent paid account, salaries account.

Losses Loss on sale of assets account, loss due to decrease in the value of assets or increase in the value of liabilities.                

2. Incomes and Gains

Incomes Interest received account, discount received account.

Gains Profit on sale of assets account, profit due to increase in the value of assets or decrease in the value of liabilities.

 

Rules for Debit and Credit According to Traditional Classification

(i.e. Personal, Real and Nominal)

 

Personal Accounts	Debit the receiver	Credit the giver
Real Accounts	Debit what comes in	Credit what goes out
Nominal Accounts	Debit all expenses and losses	Credit all incomes and gains

 

2. Modern Approach or Accounting Equation Based Approach

According to the modern approach, accounts are classified as follows

(i)   Assets Accounts The accounts of assets and properties are termed as assets accounts, e.g. building, plant and machinery, land, patents, inventory etc.

 

(ii) Liabilities Accounts The accounts of lenders, creditors for goods and expenses are termed as liabilities accounts, e.g. lender account, creditors for goods account etc.

 

(iii) Capital Accounts The accounts of the partners or the proprietors, who have invested money in the business are termed as capital accounts.

 

(iv) Revenue/Gains Accounts These are the accounts of income and gains that the business has earned by selling its goods and services, e.g. sales, interest received etc.

 

(v) Expenses/Losses Accounts The accounts which show the amount spent or lost in carrying on the business operations are termed as expenses/losses accounts, e.g. purchases, wages paid etc.

 

Rules for Debit and Credit According to Modern Approach

Or

Accounting Equation Based Approach

(A summarised view)

 

Type of Accounts	Rule for Debit	Rule for Credit
Assets Accounts	Debit the increase	Credit the decrease
Liabilities Accounts	Debit the decrease	Credit the increase
Capital Accounts	Debit the decrease	Credit the increase
Revenue Accounts	Debit the decrease	Credit the increase
Expenses Accounts	Debit the increase	Credit the decrease

 

Subsidiary Books

The books which are prepared for specific and repetitive transactions are called special books or day books or special journals or subsidiary books. Such books may be classified into two categories

(i) Cash book

(ii) Special purpose subsidiary books

 

Cash Book

It is a special journal which is used for recording all cash receipts and cash payments. Cash book is a book of prime entry/original entry in which all cash and bank transactions are recorded in a chronological order. It has two sides, i.e. debit and credit. Debit side records all receipts of cash (including cheques). Credit side records all payments of cash (including cheques).

 

1. Single Column Cash Book or Simple Cash Book

The single column cash book records all transactions of the business in a chronological order, i.e. it is a complete record of cash receipts and cash payments.

 

Single Column Cash Book

 

Date	Particulars	L.F	Amt (`)	Date	Particulars	L.F	Amt (`)

                              

         \[\downarrow \]                                                                                     \[\downarrow \]

 

 

2. Two Column or Double Column Cash Book

(Cash Book with Discount Column)

Two column cash book is a cash book which has two columns on each side of the cash book. One for cash and another for bank. All the cash receipts, deposits into bank are recorded on debit side and all cash payments, withdrawals from bank and discount received are recorded on credit side.

 

Two Column Cash Book

 

Date	Particulars	L.F	Cash	Bank	Date	Particulars	L.F	Bank

                              

         \[\downarrow \]                                                                                         \[\downarrow \]

     Receipts                                                                          Payments

 

Other Subsidiary Books

 

1. Purchase Book or Purchase Journal

Purchase journal records all credit purchases of goods (i.e. goods in which the enterprise deals in). Cash purchases and purchases of goods other than goods in which the firm deals, are not recorded in purchase journal or book. The source documents for recording entries in the books are invoices or bills received by the firm from the suppliers of the goods with the amounts net of trade discount/quantity discount.

Purchase book is also known as invoice book/bought book.

 

Format of a Purchases Book

 

Purchases Book

 

Date	Particulars/Name of the Supplier/Account to be Credited	Invoice No	L.F	Details	Total Amt

 

2. Sales Book or Sales Journal

Sales book records all credit sales of merchandise (i.e. the goods in which the firm deals in). It does not record the cash sales of merchandise or any other asset other than the merchandise. The source documents for recording entries in the sales journal are sales invoice or bill issued by the firm to the customers with the net of trade discount/quantity discount. It is also known as day book.

 

Format of a Sales Book

 

Sales Book

 

Date	Particulars/Name of the Customer/Account to be Debited	Invoice No	L.F	Details	Total Amt

 

3. Purchase Return or Return Outwards Book

In this book, purchase return of goods are recorded. It does not record the returns of goods purchased on cash basis nor the returns of purchases other than the goods in which the firm deals in. The entries are usually made in the purchases return book on the basis of debit notes issued to the suppliers and credit notes received from the suppliers.

 

Format of a Purchases Return Book

 

Purchase Return Book

 

Date	Particulars/Name of the Customer/Account to be Credited	Credited Note No	L.F	Details	Total Amt

 

4. Sales Return or Return Inwards Book

This journal is used to record return of goods by customers that had been sold on credit. It does not record the return of goods sold on cash basis nor the return of any asset other than the goods in which the firm deals in. The source documents for recording entries in the sales return journal are the credit notes issued to the customers or debit notes issued by the customers.                                                                                        

 

Format of a Sales Return Book

 

Sales Return Book

 

Date	Particulars/Name of the Customer/Account to be Credited	Credited Note No	L.F	Details	Total Amt

 

19.1.3 Ledger

 

A ledger is the principal book of accounting system which contains all the accounts (assets, liabilities, revenue, expenses). All the transactions recorded in the books of original entry are transferred to ledger. Ledger is called the principal book/book of final entry as trial balance is prepared from it and thereafter financial statements are prepared. It is the ultimate destination of all the transactions. The book which contains a classified and permanent record of all the business transactions is called a ledger.

 

Format of Ledger

 

   Dr                                         Name of Account                                              Cr

Date

Particulars

J.F

Date

Particulars

J.F

Amt

 

Posting the Entries

The process of transferring the entries from the books of original entry to the ledger is referred to as posting. Posting is the grouping of all the transactions, in respect to a particular account at one place which facilitates meaningful conclusion.

Thus, when the transactions relating to a particular account have been recorded, it shows the final or closing balance. Such closing balances help us to prepare trial balance.

 

Balancing of Accounts

Balancing of an account is the process of ascertaining the difference between the total of debits and total of credits appearing in an account. In other words, balancing of an account suggests totaling both the sides of an account, finding the difference in total of the two sides and writing the difference on the side whose total is less. The difference of amount will be recorded as ‘Balance c/d’. It may be a debit balance or a credit balance or a nil balance.

Balancing of an account is necessary to ascertain the net effect of all the transactions posted to that account during a given period.      

Generally, personal and real accounts are balanced and nominal accounts are closed by transferring the balance to trading or profit and loss account.

 

19.1.4 Trial Balance

 

Trial balance is a statement not an account which is generally prepared at the end of an accounting year on the basis of closing balances taken out of the ledger and cash book.                               

This statement ensures the arithmetical accuracy of all of the transactions duly posted on the debit and credit sides of all accounts.

 

Specimen of Trial Balance

 

Trial Balance as on…

 

Name of Accounts	LF	Debit Balance (`)	Credit Balance (`)
Total

 

Objectives of Preparing Trial Balance            

The objectives of preparing the trial balance are described below

(i) Helps in ascertaining the arithmetical accuracy of ledger accounts.

(ii) It acts as a summary of various ledger accounts.

(iii) It helps in preparing final accounts.

(iv) If helps in locating errors.

 

Limitations of Trial Balance

The following are the main limitations of a. trial balance

(i) It is not a conclusive proof of accuracy.

(ii) It does not give complete information about ledger.

(iii) It is not a substitute of final accounts.

 

Methods of Preparing Trial Balance

There are mainly two methods to prepare trial balance              

(i)   Total Amount Method As per this method, total of each side of each account is recorded in the trial balance even if an account has nil balance. It is also called as gross trial balance.

(ii)  Balance Method It is the most common method. Under this method, accounts having debit or credit balance in the ledger and cash book are recorded and any account having no balance is not recorded anywhere in the trial balance.