Journal, Ledger and Trial Balance | ISC Class 11 Accounts Notes

This note covers the accounting equation and its uses, the double entry system and classification of accounts, the rules of journalising under the traditional and modern approaches, the format, advantages, simple and compound entries and opening entry of a journal, a brief theoretical introduction to GST, the meaning, format and mechanics of posting of a ledger, the closing and balancing of ledger accounts with adjusting and closing journal entries, the sub-division of the journal into cash book (simple and triple column with cash, bank and discount columns, including contra entries and end-of-period cash balance and overdraft adjustments), petty cash book, sales and purchases day books (simple and columnar), returns day books and journal proper, the mechanics of posting from special subsidiary books, and the meaning, objectives, advantages, limitations and preparation of a trial balance by the balance method.

What is the accounting equation and why is it useful?

The accounting equation states that the assets of a business are always equal to the total of its liabilities and capital (owner's equity).

It is written as A = L + C, where A = Assets, L = Liabilities and C = Capital. Because it shows the same relationship as the balance sheet, it is also called the balance sheet equation.

The equation can be rearranged to find a missing figure: C = A − L (capital equals assets minus liabilities) or L = A − C (liabilities equal assets minus capital).

At any point of time, the resources of a business (assets) must equal the claims on those resources. The claim of the proprietor is capital, and the claim of outsiders is liabilities.

Every transaction has a two-fold ("give and take") effect, so the equation always remains balanced after each transaction is recorded.

Definition: Accounting equation. A statement of equality between the resources of a business (assets) and the claims against those resources (liabilities and capital), expressed as Assets = Liabilities + Capital.

Worked example 1. Rohit started business with cash ₹5,00,000 (capital). He then opened a bank account with ₹4,80,000, bought furniture for ₹60,000 by cheque, bought plant and machinery for ₹1,25,000 paying ₹10,000 cash and owing the balance to M/s Ramjee Lal, bought goods on credit from M/s Sumit Traders for ₹55,000, and sold goods costing ₹25,000 to Rajani Enterprises for ₹35,000.

Answer: After these transactions the assets are Cash ₹10,000, Bank ₹4,20,000, Debtors (Rajani Enterprises) ₹35,000, Stock ₹30,000, Furniture ₹60,000 and Plant and Machinery ₹1,25,000, totalling ₹6,80,000.

Liabilities (creditors: Ramjee Lal ₹1,15,000 + Sumit Traders ₹55,000) total ₹1,70,000, and Capital, after adding the profit of ₹10,000 on the sale, is ₹5,10,000. ₹6,80,000 = ₹1,70,000 + ₹5,10,000, so the equation balances.

What is the double entry system and how are accounts classified?

Under the double entry system, every transaction affects and is recorded in at least two accounts, so that the total amount debited always equals the total amount credited. All accounts are divided into five categories: Asset, Liability, Capital, Expenses/Losses and Revenues/Gains.

Accounts may also be classified under the traditional approach into Personal accounts (accounts of persons and firms), Real accounts (accounts of assets and properties) and Nominal accounts (accounts of expenses, losses, incomes and gains), or under the modern approach into the five categories above (Asset, Liability, Capital, Revenue, Expense).

Both approaches lead to the same debit and credit entries for a given transaction; they differ only in the terminology used to justify the rule.

Definition: Double entry system. A system of recording transactions in which every transaction is recorded with equal debits and equal credits in at least two accounts.

What are the rules of journalising under the two approaches?

Two fundamental rules govern the recording of changes under the modern approach:

1. Increase in asset is debited, and decrease in asset is credited.
2. Increase in expenses/losses is debited, and decrease in expenses/losses is credited.
3. Increase in liabilities is credited, and decrease in liabilities is debited.
4. Increase in capital is credited, and decrease in capital is debited.
5. Increase in revenue/gain is credited, and decrease in revenue/gain is debited.

Under the traditional approach, each account type has its own rule: for Personal accounts, debit the receiver and credit the giver; for Real accounts, debit what comes in and credit what goes out; for Nominal accounts, debit all expenses and losses and credit all incomes and gains.

What is a journal, and what are the advantages of using a journal?

The journal is the basic book of original entry in which transactions are recorded in chronological order, as and when they take place, before being posted to the ledger.

Its format has five columns: Date, Particulars, Ledger Folio (L.F.), Debit Amount and Credit Amount.

In the Particulars column, the account to be debited is written first with "Dr." against it, and the account to be credited is written on the next line prefixed with "To".

A brief explanation called the narration is written below the account titles, and a line is drawn to mark the end of the entry.

Advantages of a journal

Recording transactions first in the journal, rather than directly in the ledger accounts, gives a complete and chronological record of each transaction in one place, links the debits and credits of every transaction together through the narration, allows the ledger folio to be filled in only at the time of posting, and lets amount columns be totalled and carried forward (c/f) from page to page so that no transaction is lost or overlooked.

Definition: Narration. A brief description of a transaction written below the debit and credit lines of a journal entry, in brackets, explaining what the entry represents.

What are simple and compound journal entries, and what is an opening journal entry?

When only two accounts are involved to record a transaction, it is called a simple journal entry. For example, goods purchased on credit for ₹30,000 from M/s Govind Traders involves only the Purchases account (debited) and the Govind Traders account (credited).

When more than one account is debited or credited for a single transaction, it is called a compound journal entry.

For example, office furniture purchased from Modern Furniture's for ₹25,000, of which ₹5,000 is paid by cash immediately and ₹20,000 remains payable, is recorded by debiting Office Furniture A/c ₹25,000 and crediting Cash A/c ₹5,000 and Modern Furniture A/c ₹20,000.

An opening journal entry is the entry passed at the start of a new accounting period to bring into the books the assets, liabilities and capital balances carried forward from the previous period's balance sheet, debiting each asset account and crediting each liability and the capital account.

Worked example 2. Office furniture is purchased from Modern Furniture's on 4 July for ₹25,000; ₹5,000 is paid by cash immediately and the balance of ₹20,000 is still payable.

Answer: Office Furniture A/c Dr. ₹25,000; To Cash A/c ₹5,000; To Modern Furniture A/c ₹20,000 (purchase of office furniture from Modern Furniture's). This is a compound entry because three accounts are involved.

What is GST, and how does it appear in brief in the accounting records?

GST (Goods and Services Tax) is a tax levied on the supply of goods and services, charged throughout India.

For a sale within the same state it is split into Central GST (CGST) and State GST (SGST), each charged at an equal rate; for a sale between two different states, a single Integrated GST (IGST) is charged instead.

GST came into force on 1 July 2017 and replaced many earlier indirect taxes, such as central excise duty, service tax and state value added tax, with one tax.

It is collected at each stage of the supply chain, but a registered business can set off the GST it paid on its purchases (input tax credit) against the GST it collects on its sales (output tax), so the tax is finally borne by the consumer. In the books, GST collected and GST paid are kept in separate accounts; journal entries with GST are a separate, more detailed study.

What is a ledger, and how is posting from the journal done?

The ledger is the principal book of the accounting system; it is a collection of all the accounts, debited or credited, in the journal.

The net result of all transactions relating to a particular account on a given date, such as the amount due from a customer, can be ascertained only from the ledger, because the journal records transactions in chronological order rather than by account.

Its format has, on each side (debit and credit), the columns Date, Particulars, Journal Folio (J.F.) and Amount, with the account's name written at the top as its title.

Posting is the process of transferring entries from the journal to the ledger accounts. It follows a set procedure:

1. Locate, in the ledger, the account to be debited as entered in the journal.
2. Enter the date of the transaction in the date column on the debit side.
3. In the Particulars column, write the name of the account through which it has been debited in the journal (and the corresponding credit account on the credit side of that other account).
4. Enter the page number of the journal in the folio column, and in the journal write the page number of the ledger on which that account appears.
5. Enter the relevant amount in the amount column on the debit side (and similarly for the credit side of the account to be credited).

Draw a T-shaped account with the title at the top and "Dr." on the left and "Cr." on the right; each side has columns for Date, Particulars, J.F. and Amount, with the two sides later totalled and balanced.

How are ledger accounts closed and balanced?

Ledger accounts fall into two groups. Accounts whose balances are carried down (c/d) and brought down (b/d) into the next period are the asset, liability and capital accounts; these balances appear in the balance sheet.

Expenses and revenues are closed at the end of the accounting period by transferring their balances to the Trading and Profit and Loss Account rather than carrying them forward.

In practice, expenses and revenues directly connected with buying and selling goods (such as purchases, sales, carriage inwards and returns) are transferred to the Trading Account, while indirect expenses and gains (such as rent, salaries, discount and commission) are transferred to the Profit and Loss Account.

Any further adjusting entries (for outstanding expenses, prepaid expenses, depreciation and similar items) and closing entries (transferring balances of nominal accounts) are passed in the journal proper before the final balancing of the ledger.

What are adjusting and closing journal entries?

An adjusting entry is passed at the end of the period to bring an unrecorded item into the books or to correct the amount already recorded, so that the expenses and revenues of the period are stated correctly. A closing entry is then passed to transfer the balance of each temporary account to the Trading Account or the Profit and Loss Account, leaving that account with a nil balance.

An expense that has been incurred but not yet paid is recorded by debiting the expense account and crediting an outstanding expense account, which is a liability. An expense paid in advance is recorded by debiting a prepaid expense account, which is an asset, and crediting the expense account. Depreciation for the period is recorded by debiting the Depreciation account and crediting the asset account.

At the close of the period, each direct expense and revenue account is closed by transferring its balance to the Trading Account, and each indirect expense and gain account is closed by transferring its balance to the Profit and Loss Account. The asset, liability and capital accounts are not closed; they are balanced and carried down.

Worked example 3. A trader's books at 31 March show: salary paid during the year ₹60,000, of which ₹5,000 relates to the next year; rent of ₹18,000 for the year is still unpaid; and depreciation of ₹12,000 is to be charged on machinery. Pass the adjusting entries and close the expense accounts.

Answer: Prepaid Salary A/c Dr. ₹5,000; To Salary A/c ₹5,000. Rent A/c Dr. ₹18,000; To Outstanding Rent A/c ₹18,000. Depreciation A/c Dr. ₹12,000; To Machinery A/c ₹12,000.

Salary charged for the year = 60,000 − 5,000 = ₹55,000. The closing entries are: Profit and Loss A/c Dr. ₹85,000; To Salary A/c ₹55,000; To Rent A/c ₹18,000; To Depreciation A/c ₹12,000. The three expense accounts now show nil balances, and Prepaid Salary ₹5,000 and Outstanding Rent ₹18,000 are carried to the balance sheet.

Definition: Posting. The process of transferring debit and credit entries recorded in the journal to the respective accounts in the ledger.

What is a cash book, and how are the simple and triple column cash books prepared?

The cash book records all cash receipts and payments, starting with the cash or bank balance at the beginning of the period.

It serves the purpose of both a journal and a ledger (cash) account, so when a cash book is maintained, cash transactions are not recorded separately in the journal, and no separate cash account is needed in the ledger.

A simple cash book (also called a single column cash book) has only one amount column on each side, recording cash receipts on the debit side and cash payments on the credit side; its balance is carried down (c/d) at the end of the period and brought down (b/d) at the start of the next.

A triple column cash book adds a Bank column and a Discount column on each side, so that cash, bank and discount received or allowed can all be recorded in one book.

When a transaction affects both the cash column and the bank column of the same cash book (for example, cash deposited into the bank, or cash withdrawn from the bank), it is called a contra entry and is marked "C" in the L.F. column on both sides instead of being posted elsewhere.

A cheque received may sometimes not be deposited into the bank on the same day it is received; it is then recorded as a cash receipt on the day received and only shown as a bank receipt (contra entry) on the day it is actually deposited.

How are the discount columns of the triple column cash book posted?

The discount columns are memorandum columns. They are not balanced like the cash and bank columns; they are only totalled at the end of the period.

The total of the Discount (Dr.) column on the receipts side is discount allowed to customers. It is an expense, so it is posted to the debit of the Discount Allowed A/c: Discount Allowed A/c Dr.; To Sundry Debtors A/c.

The total of the Discount (Cr.) column on the payments side is discount received from suppliers. It is a gain, so it is posted to the credit of the Discount Received A/c: Sundry Creditors A/c Dr.; To Discount Received A/c.

Discount allowed is shown on the debit side of the Profit and Loss Account, and discount received on its credit side.

Worked example 7. In a month a trader received ₹9,800 from a debtor whose account was ₹10,000, allowing discount of ₹200, and paid ₹4,900 to a creditor whose account was ₹5,000, receiving discount of ₹100. The Discount (Dr.) column totals ₹200 and the Discount (Cr.) column totals ₹100.

Answer: For discount allowed: Discount Allowed A/c Dr. ₹200; To Sundry Debtors A/c ₹200. For discount received: Sundry Creditors A/c Dr. ₹100; To Discount Received A/c ₹100.

The Discount Allowed A/c shows a debit balance of ₹200, an expense charged to the Profit and Loss Account; the Discount Received A/c shows a credit balance of ₹100, a gain credited to the Profit and Loss Account. Neither discount column is balanced in the cash book.

How is a definite cash balance or an overdraft arranged at the end of the period?

A firm may wish to keep a definite minimum cash balance in hand at the end of the month, or it may have an overdraft facility with its bank that it wishes to use. The cash book is then adjusted at the end of the period so that the closing balance shows exactly that figure.

If the cash balance in hand is more than the definite balance to be kept, the excess is deposited into the bank, and the entry is a contra entry debiting the Bank column and crediting the Cash column. If the cash in hand is less than the definite balance, cash is withdrawn from the bank, and the entry debits the Cash column and credits the Bank column.

Where the cash in hand is below the definite balance and the bank balance is too small to make up the shortfall, the firm uses its overdraft facility: it withdraws the shortfall from the bank, so the Bank column ends with a credit (overdraft) balance, and the Cash column is debited with the amount withdrawn. The two columns are then balanced, the cash balance being carried down on the credit side and the overdraft balance on the debit side of the Bank column.

Worked example 4. Roopa Traders had cash in hand of ₹30,000 on 1 November. During the month it received ₹12,000 from Gurmeet, sold goods for cash ₹28,000 and ₹18,200, and paid insurance ₹6,000, bought furniture for ₹13,800, bought goods for cash ₹17,400, bought stationery ₹1,100, paid Rukmani ₹12,500 in full settlement, paid rent ₹2,500 and salary ₹3,500, and deposited ₹8,000 into the bank.

Answer: Total receipts = 30,000 + 12,000 + 28,000 + 18,200 = ₹88,200. Total payments = 6,000 + 13,800 + 17,400 + 1,100 + 12,500 + 2,500 + 3,500 + 8,000 = ₹64,800.

Closing balance carried down = 88,200 − 64,800 = ₹23,400, which is brought down as the opening balance on 1 December.

Worked example 5. A trader keeps a definite cash balance of ₹5,000 in hand at the end of each month and has an overdraft facility with the bank. (a) At the end of October the cash book shows cash in hand of ₹12,000 and a bank balance of ₹40,000. (b) At the end of November it shows cash in hand of ₹1,500 and a bank balance of ₹2,000. Show the adjustments.

Answer: (a) Cash in hand is ₹7,000 more than the definite balance, so ₹7,000 is deposited into the bank: Bank A/c Dr. ₹7,000; To Cash A/c ₹7,000 (contra entry, marked C). Cash in hand becomes ₹5,000 and the bank balance ₹47,000.

(b) Cash in hand is ₹3,500 short of the definite balance (₹5,000 − ₹1,500), so ₹3,500 is withdrawn from the bank: Cash A/c Dr. ₹3,500; To Bank A/c ₹3,500 (contra entry). Cash in hand becomes ₹5,000, and the bank balance becomes ₹2,000 − ₹3,500, an overdraft of ₹1,500. The overdraft is carried down on the debit side of the Bank column and brought down on the credit side.

A bar chart with the dates of November on the horizontal axis and the running cash balance in rupees on the vertical axis; the bars rise after receipts (from Gurmeet, cash sales) and fall after payments (insurance, furniture, purchases, rent, salary, bank deposit), ending at the closing balance of ₹23,400.

What is a petty cash book, and how do the analytical and imprest systems work?

A petty cash book is a separate subsidiary book used to record small, recurring cash payments, such as postage, stationery, cartage and refreshments, which would otherwise clutter the main cash book. It is usually kept by a separate official called the petty cashier.

Under the imprest system, the petty cashier is given a fixed sum of money (the "imprest amount") at the start of a period.

As payments are made, the fund reduces; at the end of the period (or when the fund runs low), the cashier is reimbursed with exactly the amount spent, so that the fund is restored to the original fixed amount for the next period.

An analytical petty cash book has, in addition to the total amount column, separate analysis columns for each common type of expense (for example, postage, stationery, carriage, sundries), so that the total of each column can be posted to the relevant ledger account in a single figure rather than posting every small payment separately.

Definition: Imprest system. A method of running a petty cash fund in which the cashier starts each period with a fixed sum and is reimbursed, at the end of the period, with exactly the amount spent, restoring the fund to its original fixed level.

What are the sales, purchases and returns day books, and the journal proper?

Because many business transactions are repetitive, the journal is sub-divided into special books, also called day books or subsidiary books, each recording transactions of one similar kind.

The purchases (day) book and sales (day) book record only credit purchases and credit sales of goods.

In a simple format, each has the columns Date, Particulars, Invoice Number, L.F., Details and Amount; a columnar format additionally separates Net Invoice, Goods and Carriage so that carriage charges included in an invoice can be shown apart from the value of the goods themselves.

How is the columnar sales or purchases day book written up?

In the columnar day book the Details column shows the full invoice figure, and this is then split between the Goods column (the net invoice value of the goods) and the Carriage column (carriage charged on the invoice). The Net Invoice column carries the total of the invoice.

At the end of the period the Goods column total is posted to the Purchases A/c (debit) or the Sales A/c (credit), the Carriage column total is posted to Carriage Inward A/c (debit) or Carriage Outward A/c (debit), and the Net Invoice total is posted to the personal accounts of the suppliers or customers.

Draw a book with the heading "Purchases Day Book" and the columns Date, Particulars, Invoice No., L.F., Details, Net Invoice, Goods and Carriage; enter one invoice of ₹20,000 for goods plus ₹500 carriage, showing Details ₹20,500, Net Invoice ₹20,500, Goods ₹20,000 and Carriage ₹500, and total each column at the foot.

Worked example 8. A trader buys goods on credit from Meena Traders for ₹20,000, the supplier charging carriage of ₹500 on the invoice, and from Ritu goods of ₹12,000 with carriage of ₹300.

Answer: In the columnar purchases day book the two invoices are entered as Details ₹20,500 and ₹12,000 plus ₹300, with Net Invoice ₹20,500 and ₹12,300, Goods ₹20,000 and ₹12,000, and Carriage ₹500 and ₹300.

The column totals are Net Invoice ₹32,800, Goods ₹32,000 and Carriage ₹800. Posting: Purchases A/c Dr. ₹32,000; Carriage Inward A/c Dr. ₹800; To Meena Traders A/c ₹20,500; To Ritu A/c ₹12,300.

The purchases return (return outwards) book and sales return (return inwards) book record goods returned to suppliers and goods returned by customers respectively, using the columns Date, Particulars, Credit/Debit Note Number, L.F., Details and Amount.

Transactions that cannot be recorded in any of these special journals are recorded in a residual book called the journal proper.

Entries such as the opening entry, adjusting entries, closing entries and entries to rectify errors are typically passed through the journal proper.

How is posting done from the special subsidiary books?

Posting from each special subsidiary book follows the same mechanics as posting from the ordinary journal, with one difference: the day books are posted in totals rather than entry by entry.

Each individual entry in a day book is posted to the personal account of the customer or supplier named in it, on the side on which that person's account stands in the book.

The periodic total of the Goods or Amount column is posted only once, at the end of the period, to the impersonal account: the total of the sales day book to the credit of the Sales A/c, the total of the purchases day book to the debit of the Purchases A/c, the total of the sales return book to the debit of the Sales Return A/c and the total of the purchases return book to the credit of the Purchases Return A/c.

The folio columns are cross-referenced in both books, and the total of the personal accounts posted must equal the total posted to the impersonal account, so that the two sides of the ledger remain equal.

Worked example 9. A trader's sales day book for the month shows credit sales to Mohit Bros ₹10,000 and to Rupak Traders ₹11,000, a total of ₹21,000.

Answer: Each entry is posted to the personal account: Mohit Bros A/c Dr. ₹10,000 and Rupak Traders A/c Dr. ₹11,000. The total is posted once: Sales A/c Cr. ₹21,000.

The debit total of the personal accounts, 10,000 + 11,000 = ₹21,000, equals the credit to the Sales A/c, so the ledger stays in balance.

What is a trial balance, and what are its objectives, advantages and limitations?

A trial balance is a statement that lists the debit and credit balances of all the ledger accounts on a particular date, to check that the books have been correctly maintained on the double entry principle.

Its chief objective is to verify the arithmetical accuracy of the ledger: since every debit has a corresponding credit, the total of the debit column must equal the total of the credit column.

What are the objectives of a trial balance?

1. To check the arithmetical accuracy of the ledger, by showing that the total of the debit balances equals the total of the credit balances.
2. To provide a summary of all the ledger balances on a particular date, arranged in one statement.
3. To serve as the basis for preparing the Trading Account, the Profit and Loss Account and the Balance Sheet.
4. To help in locating errors, because a difference between the two totals points to an error in the books.

Advantages of a trial balance

A trial balance helps locate certain types of clerical errors before the final accounts are prepared, provides a convenient, one-page summary of all ledger balances, and forms the basis from which the Trading Account, Profit and Loss Account and Balance Sheet are prepared.

Limitations of a trial balance

An agreement of the trial balance is not conclusive proof that the books are entirely free of errors.

It will not reveal errors of complete omission of a transaction (where neither account was recorded), errors of principle (where a correct amount is posted to the wrong class of account), or compensating errors (where two or more errors cancel each other out in total), because the debit and credit totals can still agree even though such errors exist.

Definition: Trial balance. A statement showing the debit and credit balances of all ledger accounts on a given date, prepared mainly to check the arithmetical accuracy of the double entry records.

How is a trial balance prepared by the balance method?

Under the balance method, only the closing balance of each ledger account (and not its full debit and credit totals) is listed in the trial balance: accounts with a debit balance (normally assets and expenses) are shown in the debit column, and accounts with a credit balance (normally liabilities, capital and revenues) are shown in the credit column.

If the ledger has been correctly maintained, the two column totals will be equal: Total debit balances = Total credit balances.

Worked example 6. Prepare a trial balance by the balance method from Rohit's final ledger balances: Cash ₹10,000, Bank ₹4,20,000, Debtors (Rajani Enterprises) ₹35,000, Stock ₹30,000, Furniture ₹60,000, Plant and Machinery ₹1,25,000, Creditors ₹1,70,000, Capital ₹5,10,000.

Answer: The debit balances are Cash ₹10,000, Bank ₹4,20,000, Debtors ₹35,000, Stock ₹30,000, Furniture ₹60,000 and Plant and Machinery ₹1,25,000. Adding these: 10,000 + 4,20,000 + 35,000 + 30,000 + 60,000 + 1,25,000 = ₹6,80,000.

The credit balances are Creditors ₹1,70,000 and Capital ₹5,10,000. Adding these: 1,70,000 + 5,10,000 = ₹6,80,000. Since both column totals come to ₹6,80,000, the trial balance agrees.

A bar chart with two bars, "Total debit balances" and "Total credit balances", on the horizontal axis and the rupee amount on the vertical axis; both bars reach the same height of ₹6,80,000, illustrating that the two sides of a correctly prepared trial balance must agree.

Going beyond the syllabus

These ideas extend the unit and are not needed for the questions on it.

How are GST transactions recorded and set off?

Where GST is charged on a transaction, Indian businesses record the tax through separate Input and Output CGST, SGST and IGST accounts and periodically set off the output tax collected on sales against the input tax already paid on purchases, paying only the net balance in cash.

For example, if a Delhi-based trader such as Anudeep buys goods from another Delhi supplier, Kanta, the invoice carries both CGST and SGST at equal rates, each account being debited separately as Input CGST and Input SGST; if the same trader instead buys from a supplier in Rajasthan, only a single IGST account is debited, because the supply crosses state lines.

When Anudeep later sells goods within Delhi to a customer such as Sidhu, the corresponding Output CGST and Output SGST accounts are credited at the time of sale, while a sale to a customer in Punjab or Uttar Pradesh would instead credit the Output IGST account.

At the end of the tax period, the Output accounts are set off against the matching Input accounts, and only the remaining net balance is paid in cash through what is called the Electronic Cash Ledger.

Working through such entries with actual rates and amounts, once the input and output accounts have been set off against each other, is a more advanced application of the same double entry principles studied in the chapter.

Glossary

• Source document — a document, such as a cash memo, invoice or cheque, that provides evidence of a business transaction.
• Accounting equation — the statement that Assets = Liabilities + Capital at all times.
• Double entry system — recording every transaction with equal debits and equal credits in at least two accounts.
• Journal — the book of original entry in which transactions are first recorded in chronological order.
• Narration — a brief explanation of a journal entry, written below the debited and credited accounts.
• Simple entry — a journal entry involving only one account debited and one account credited.
• Compound entry — a journal entry involving more than one account debited or credited.
• Opening entry — the journal entry that brings forward assets, liabilities and capital from the previous period's balance sheet.
• Ledger — the principal book containing all accounts to which journal entries are posted.
• Posting — transferring a journal entry's debit and credit amounts to the relevant ledger accounts.
• Contra entry — an entry in a triple column cash book affecting both the cash and bank columns, marked "C".
• Imprest system — a petty cash method in which the fund is reimbursed to a fixed level each period.
• Journal proper — the book used for transactions that cannot be entered in any other special journal.
• Trial balance — a statement of the debit and credit balances of all ledger accounts, used to check arithmetical accuracy.
• GST — Goods and Services Tax charged in India, split into CGST and SGST for sales within a state, or charged as IGST between states.

Common errors and misconceptions

• Misconception: An agreeing trial balance proves there are no errors in the books. Correct: It only proves that debit and credit totals match; errors of omission, principle and compensating errors can still exist.
• Misconception: Debit always means an increase and credit always means a decrease. Correct: Debit increases assets and expenses but decreases liabilities, capital and revenues; credit does the opposite.
• Misconception: When goods are bought, the "Goods" account is debited. Correct: Purchases, sales, purchases returns, sales returns and stock are each recorded in their own separate account.
• Misconception: A simple entry and a compound entry differ in the amount involved. Correct: They differ in the number of accounts involved, not the amount; a compound entry has more than two accounts.
• Misconception: All ledger accounts are carried forward to the next period. Correct: Only asset, liability and capital accounts are balanced and carried down; expense and revenue accounts are closed to the Trading or Profit and Loss Account.
• Misconception: A contra entry needs to be posted to a ledger account like any other entry. Correct: A contra entry is recorded on both sides of the same triple column cash book and is marked "C" instead of being posted elsewhere.
• Misconception: The ledger folio (L.F.) column is filled in when the journal entry is first made. Correct: It is filled in only at the time of posting to the ledger, not at the time of making the journal entry.
• Misconception: The discount columns of the triple column cash book are balanced like the cash and bank columns. Correct: They are only totalled; the total of the Discount (Dr.) column is posted to Discount Allowed A/c and the total of the Discount (Cr.) column to Discount Received A/c.

Exam-style questions with model answers

Q1. Choose the correct option. When goods are purchased on credit from a supplier, the account to be debited is: (a) the supplier's account (b) the Purchases account (c) the Cash account (d) the Sales account. [1 mark]

1. (b) the Purchases account. Purchases is an expense of the business, and an increase in an expense is debited, while the supplier's account is credited as the giver.

Q2. State the meaning of a contra entry. [2 marks]

1. A contra entry is an entry that affects both the cash column and the bank column of the same triple column cash book.
2. It is marked "C" in the L.F. column on both sides and is not posted to any separate ledger account.

Q3. Distinguish between an adjusting entry and a closing entry, giving one example of each. [3 marks]

1. An adjusting entry is passed at the end of the period to record an item that is unrecorded or wrongly recorded, so that the expenses and revenues of the period are correct.
2. For example, rent of ₹18,000 for the year still unpaid is recorded as Rent A/c Dr. ₹18,000; To Outstanding Rent A/c ₹18,000.
3. A closing entry transfers the balance of a temporary account to the Trading Account or the Profit and Loss Account, for example Profit and Loss A/c Dr. ₹18,000; To Rent A/c ₹18,000, which leaves the Rent account with a nil balance.

Q4. Explain the mechanics of posting a journal entry to the ledger, in the order the steps are carried out. [4 marks]

1. Locate, in the ledger, the account that is to be debited as shown in the journal entry.
2. Enter the date of the transaction on the debit side of that account.
3. In the Particulars column, write the name of the account with which it has been debited, that is, the account on the credit side of the same entry.
4. Enter the journal's page number in the ledger's folio column, and the ledger's page number in the journal's folio column, to cross-reference the two books.
5. Enter the amount on the debit side, and then repeat the same steps for the account to be credited, entering the amount on its credit side.

Q5. A trader keeps a definite cash balance of ₹4,000 in hand at the end of each month and has an overdraft facility. Show the adjustments when the cash book shows (a) cash in hand ₹9,000 and bank balance ₹25,000; (b) cash in hand ₹1,000 and bank balance ₹2,000. [4 marks]

1. (a) Cash in hand exceeds the definite balance by ₹9,000 − ₹4,000 = ₹5,000, so the excess is deposited: Bank A/c Dr. ₹5,000; To Cash A/c ₹5,000 (contra entry).
2. Cash in hand becomes ₹4,000 and the bank balance ₹25,000 + ₹5,000 = ₹30,000.
3. (b) Cash in hand is ₹3,000 short of the definite balance, so ₹3,000 is withdrawn: Cash A/c Dr. ₹3,000; To Bank A/c ₹3,000 (contra entry).
4. Cash in hand becomes ₹4,000, and the bank balance becomes ₹2,000 − ₹3,000, an overdraft (credit balance) of ₹1,000, carried down on the debit side of the Bank column.

Q6. From the following ledger balances of a trader, prepare a trial balance by the balance method: Cash ₹8,000; Bank ₹1,20,000; Debtors ₹25,000; Stock ₹40,000; Creditors ₹35,000; Capital ₹1,58,000. [5 marks]

1. Accounts with debit balances (assets) are listed in the debit column: Cash ₹8,000, Bank ₹1,20,000, Debtors ₹25,000 and Stock ₹40,000.
2. Accounts with credit balances are listed in the credit column: Creditors ₹35,000 and Capital ₹1,58,000.
3. Total of the debit column = 8,000 + 1,20,000 + 25,000 + 40,000 = ₹1,93,000.
4. Total of the credit column = 35,000 + 1,58,000 = ₹1,93,000.
5. Since both totals are equal at ₹1,93,000, the trial balance agrees, confirming the arithmetical accuracy of the ledger.

Q7. Assertion: A trial balance that agrees is proof that the books contain no errors. Reason: Errors of complete omission and errors of principle do not disturb the equality of the debit and credit totals. Which option is correct? (a) Both Assertion and Reason are true and Reason explains Assertion (b) Both are true but Reason does not explain Assertion (c) Assertion is true and Reason is false (d) Assertion is false and Reason is true. [1 mark]

1. (d) Assertion is false and Reason is true. An agreeing trial balance only proves arithmetical accuracy, and errors of complete omission, errors of principle and compensating errors can still remain in the books.

Q8. Evaluate the usefulness of the trial balance as a check on the books of account, and explain why its agreement does not guarantee that the books are free of all errors. [6 marks]

1. The main objective of a trial balance is to check the arithmetical accuracy of the ledger by comparing the total of all debit balances with the total of all credit balances.
2. It also serves as a convenient summary of all ledger account balances on a particular date.
3. It forms the starting point for preparing the Trading Account, Profit and Loss Account and Balance Sheet.
4. However, its agreement does not prove the complete absence of errors, because some errors leave the trial balance unaffected.
5. These include errors of complete omission (a transaction left out of both accounts), errors of principle (an amount posted to the wrong class of account) and compensating errors (two or more errors that cancel out in total).
6. All of these can occur while the debit and credit totals still agree, so the trial balance is a useful but limited check on the accuracy of the books.

Key takeaways

• The accounting equation, Assets = Liabilities + Capital, must balance after every transaction because each transaction has a two-fold effect.
• Under the double entry system every transaction is recorded with equal debits and equal credits in at least two accounts.
• The modern approach classifies accounts as Asset, Liability, Capital, Revenue and Expense; the traditional approach classifies them as Personal, Real and Nominal.
• Increases in assets and expenses are debited; increases in liabilities, capital and revenues are credited, and decreases are the reverse.
• A journal entry may be simple (two accounts) or compound (more than two accounts), and each carries a narration.
• Posting transfers journal entries to ledger accounts; the folio columns of the two books are cross-referenced to each other.
• Asset, liability and capital accounts are balanced and carried down; expense and revenue accounts are closed to the Trading or Profit and Loss Account.
• Adjusting entries record unrecorded items such as outstanding and prepaid expenses and depreciation, while closing entries transfer temporary account balances to the Trading or Profit and Loss Account.
• The journal is sub-divided into the cash book, petty cash book, purchases and sales day books, returns day books and journal proper for efficient recording.
• A trial balance lists ledger balances to check arithmetical accuracy, but it cannot detect errors of omission, principle or compensating errors.

Test yourself

What does the accounting equation state?

It states that the assets of a business are always equal to the total of its liabilities and capital, written as Assets = Liabilities + Capital.

Name the two accounts affected when goods are purchased on credit.

The Purchases account is debited, and the account of the supplier (creditor) from whom the goods were bought is credited.

Why is the L.F. column of the journal left blank when the entry is first made?

Because the ledger folio can only be filled in once the entry has actually been posted to the ledger account, which happens after the journal entry is recorded.

What is the imprest amount in a petty cash book?

It is the fixed sum of money given to the petty cashier at the start of a period, which is restored to that same level each time the cashier is reimbursed.

Which account is credited when a contra entry records cash deposited into the bank?

No ledger account is credited separately; the amount is simply shown on the credit side of the cash column and the debit side of the bank column within the same cash book, marked "C".

What happens to a revenue account at the end of the accounting period?

Being a temporary account, it is closed by transferring its balance to the Trading Account or the Profit and Loss Account, rather than being carried forward.

Give one limitation of the trial balance.

It does not reveal errors of principle, where an amount has been posted to the wrong type of account even though the debit and credit amounts agree.

How is an expense paid in advance recorded at the end of the period?

The prepaid portion is recorded by debiting a prepaid expense account, which is an asset, and crediting the expense account, so that only the expense of the period is charged.