BASIC CONCEPTS OF

ACCOUNTING
Structure
Objectives
Introduction
Accounting-An Overview

1.0
1.1
1.2

1.2.1
1.2.2
1.2.3
1.2.4
1.2.5
1.2.6
1.2.7

1.3

Objectives of Accounting
Definition and Scope of Accounting
Book-keeping, Accounting and Accountancy
Parties Interested in Accounting Information
Branches of Accounting
Advantages of Accounting
Limitations of Accounting

Basic Accounting Concepts

1.3.1 Concepts to be Observed at the Recording Stage
1.3.2 Concepts to be Observed at the Reporting Stage

Systems of Book-Keeping

1.4

1.4.1 Double Entry System

1.4.2 Single Entry System

1.5

What is an Account?
Classification of Accounts
Rules of Debit and Credit
Accounting Process
Let Us Sum Up
Key Words
Some Useful Books
Answers to Check Your Progress
Terminal Questions
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1.6
1.7
1.8
1.9
1.10
1.1 1
1.12
1.13

1.0 OBJECTIVES
After studying this unit you should be able to :
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appreciate the need for accounting

define accounting and outline its scope
distinguish between book-keeping, accounting'and accountancy
identify the parties interested in accounting information
describe the advantages and limitations of accounting
explain the accounting concepts tp be observed at the recording stage
explain the systems of book-keeping
classify aCC0un~d
analyse the transactions and identify the accounts to be debited and
credited
identify the stages' involved in accounting

1.1 INTRODUCTION
In business numerous transactions take place every day. It is humanly impossible to
remember all of them. Hence the need to record them. The recording of business
transactions .is the main function served by Accounting. With the help of accounting records
the businessman is able to ascertain the profit or loss and the financial position of his
Business at the end of a given period and communicate such information to all iilterested
parties. In this unit we intend to have an overview of Accounting and discuss its nature, .
scope and importance. We shall dso discuss the basic concepts which are to be observed at
the recording stage and explain tlie principle of double entry i.e,, the rules of debit and .
credit.

Accounting Fundamentals

8.2 ACCOLTNTIMG-AN

OVERVIEW

You know there is a limit to human memory. You cannot remember everything you do or
each transaction you make. If you are given Rs. 5,000 and asked to buy a number of items
you will find it difficult to remember the detail of various items you purchased. Hence, it
becomes necessary for you to write them on a piece of paper or a note book. It is still more'
difficult in case of business which usually involves a large nbmber of transactions. In
business you have to buy and sell more frequently. You make payments and receive
payments every now and then. It becomes almost impossible to remember all these
transactions.'~~,
unless'you'record them properly you cannot obtain any financial
information you need. For example, you cannot easily ascertain the amounts to be received
from various customers to whom the goods were sold on credit. You will not know the
detail of how much you owe to your suppliers. You may also find it difficult to work out the
profit earned or loss incurred during a particular period. It is, therefore, necessarj to
maintain a proper record of all the transactions which take place from time to time. The
recording of business transactions in a systematic manner is the n~ainfunction served by
accounting. Whichever the form of business organisation-a sole proprietorship, a
partnership, a company, or a co-operative society-it has to maintain proper accounts. he
accounting information is useful both for the management and the outside agencies like tax
authorities, banks, creditors etc. The management needs it for purposes of planning,
controlling and decision making. The banks and creditors require it for assessing the credit
worthiness of the business and the tax authorities use it for determinirig the amwnt of
income tax, sales tax, etc. In fact, accounting is necessary not only for business
organisations but also for non-business organisations like schools, colleges, hospitals, clubs
etc.

1.2.1 Objectives of Accounting

The objectives of accounting can be stated as follows :
1 'To maintain systematic records: Accounting is used to maintain systematic record of
all financial transactions like purchast and sale of goods, cash receipts and cash
payments, etc. It is also used for recording various assets and liabilities of the business,

To ascertain net prufit or net loss of the business: A businessnian would be

interested in periodically findirig the net result of his business operations i.e., whether
the business has earned profit or incurred some loss. A proper record of al1,income intf
expenses helps in preparing a Pi-ofit and Loss Account and ascertain the net result of
business operations during a particular period.

To ascertain the financial positio~lof the business: The businessman is also

interested in ascertaining the financial position of his business at the end of a particular
~ to
period i.e., how much it owns and how much it owes to others. He would a l s like
know what happened to his capital, whether it has increased or decreased or remained
. constant. A systematic record of assets and liabilities facilitates the preparation of a '
position statement called Balance Sheet which provides the necessary information.

To provide accounting information to interested parties: Apart from owners there

are various parties who are interested in the dccounting inforniation. These are:
bankers, creditors, tax authorities, prospective investors etc. ~hey'needsuch
information to assess the profitability and the financial soundness of the business. The
accounting information is communicated to them in the form of an annual report.

1.2.2 Definition and Scope.of Accounting

The subject of 'Accounting' has been defined in different ways by different authorities. So,
it is very difficult to define the subject through a single definition. However, the following
definitions would give a general understanding of the subject.
According to the American,Accounting Association "Accounting is the process of
identifying, measuring and communicating econqnic information to permit informed
judgements and decisions by users of the information". This definition stresses three aspects
viz., identifying, measuring, and communicating econoinic information.
In the words of the Committee on Terminology, appointed by the American Institute of
Certified Public Accountants, "Accounting is the art of recording, classifying and
summarising in a significant manner and in terms of money, transactions and events which

I
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are, in part at least, of a financial character and intelpreting the results thereof'. This is a
popular definition of accounting and it outlines fully the nature and scope of acconnting
activity.
You know a business is generally started with the proprietor's funds known as capital. The
proprietor may also borrow some funds from hanks end other agencies. These fundb are
utilised to acquir!: the assets needed for the business and also to carry out'various business
activities. In the process a number of transactions take place. The accountant.has to identify
the transactions to be recorded, measure them in terms of money, and record them in
appropriate books of account. Then he has to classify them under separate heads of account,
prepare a summary in the forrrl of Profit and Loss Account and Balance Sheet, and analyse,
interpret and communicate the results to the interested parties. This is the sum and substance
of accounting. The scope of accounting can, therefore, be outlined as follows :
1

Accounting is concenled with the transactions and events which are of a financial
character. Such transactio~ishave to be identified by the accountant. He can do so with
the help of various bills and receipts.

Having identified the transactions, they should be measured orpxpressed in terms of

money, if not expressed already. ~ v e transaction
r ~
is recorded in books only in terms of
money and not in terms of physical quantities.

The transactions which are identified and measured are to be recorded in a book called
'Journal' or in one of its sub-divisions.

The recorded transactions have to be classified with a view to group transactions of

similar nature at one place. This work is done in a separate book called 'Ledger'. In the
ledger, a separate account is opened for each item so that all transactions relating to it
can be brought at one place. For example, salaries paid at different times are brought
under 'Salaries Account'.

The transactions which are recorded and classified will resdt in a mass of financial
data. It is, therefore, necessary to summarise such data periodically (at least once a year)
in a significant mid meaningful fonn. This is done in the form of a Profit and Loss
Account which reveals profit or loss, and a Balance Sheet which indicates the financial
position of the business.

The summarised results have to be analysed and interpreted with the help of statistical
tools like ratios, averages, etc., and examined critically. Later on, this data will be
communicated in the form of reports to the interested parties.

Look at Figure 1.1 and note the activities involved in accounting which starts with
identifying the transactions to be recorded and ends with communicating the results to
,owners, management and the other interested
who use them for decision making.
Figure 1.1: Accuunti~lgActivities

Is m accounting
entry required

Tr~nsactions

Measure them

classify them

owner
management

Make
Decisions

Basic Concept9 of
h~co~rririe~

Accounting Fundnmentals

1.2.3 Book-keeping, Accounting and Accountancy

According to G.A. Lee, the accounting system has following two stages :
i)

the making of routine records, in prescribed form and according to set rules, of all
events which affect the financial state of the organisation; and

ii) the summarisation from time to time of the information contained in the records, its
presentation in a significant form to interested parties, and its interpretation as an aid t q
decision making by these parties.
Stage (i) is called Book-keeping and stage (ii) is called Accounting.
Book-keeping is thus a narrow term concerned mainly with the maintenance of the books of
account and covers the first four activities listed in the scope of accounting viz., identifying
the riansactions and events to be recorded, measuring them in terms of money, recording
them in the books of prime entry, and posting them into ledger. Accounting, on the other
hand, is concerned with summarising the recorded data, interpreting the financial results and
communicating them to all interested parties. In other words, accounting starts where bookkeeping ends. But in practice, the accountants also direct and review the work of bookkeepers and therefore the term accounting is generally used in a broader sense covering all
the accounting activities, Thus, Book-keeping is regarded as a part of Accounting.
The term 'Accountancy' refers to a systematised knowledge of accounting and is regarded
as an academic subject like economics, statistics, chemistry, etc. It explains 'why to do' and
'how to do' of various'aspects of accounting. In other words, while Accounting refers to the
actual process of preparing and presenting the accounts, Accountancy tells us why and how
to prepare the books of account and how to summarise the accounting information and
communicate it to the interested parties. Thus, Accountancy is a science (a body of

systematised knowledge) whereas Accpunting is the art of putting such knowledge into
practice.
In general usage, however, Accountancy and Accounting are used as synonyms (meaning
the same thing). But, of late, the term accounting is becoming more and more popular.

1.2.4 Parties Interested in Accounting Information

You have learnt that many people are interested in examining the financial information
provided in the form of a Profit and Loss Account and a Balance Sheet. This helps them
a) to study the present position of business,
b) to compare its present performance with that of its past years, and
c) to compare its performance with that of similar enterprises.
Now let us see who such parties are and how accounting information is useful to them.

Owners: Owners contribute capital and assume the risk of business. Naturally, they are
interested in knowing the amount of profit earned by the business and so also its financial
position. If, however, the management of the business is entrusted to paid managers, the
owners also use the accounting information to evaluate the performance of the managers.

Managers: Accounting information is of immense use to managers. It helps them to plan,

control and evaluate all business activities. They also need such information for making
various deci'sions.
Lenders: Initially the funds are provided by the owners. But, when the business requires
more funds, they are usually provided by banks and other lenders of money. Before lending ;
money they would like to know about the solvency (capacity to repay debts) of the
enterprise so as to satisfy themselves that their money will be safe and the repayments will
be made on time.

Creditors: Those who supply goods and services on credit are called creditors. Like
lenders, they too want to know about credit worthiness of the enterprise. This helps them to
determine the limits up to which credit can be granted.

Prospect;?.: Investors: A person who wants to become a partner in a firm or a person who
wants to become a shareholder of a company, would like to know how safe and rewarding
the proposed investment would be.
Tax Authorities: Tax authorities of the Government arejnterested in the financial .
statements so as to assess the tax .liability
- of the enterprise.

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Era~ployees:The e~nployeesof the enterprise are also interested in knowing the state of
iffairs of the organisation in which they are working, so as to know how safe their is-+~terests
are in that organisation.

1.2.5 Branches of Aecouasting

Accounting as we know it today has evolved over many centuries in response to the
changing economic, social and political conditions. The econonlic development and
technological improvements have resulted in an increase in the scale of operations and the
advent of the company form of business organisation. This has made the nlalragcment
function more and more complex and increased the impoi~anceof accourlting hformatio~i.
This gave rise to special branches of accounting. These are briefly explained below.

Financial accounting: The pulpose of this branch of accounting is to keep a record of all
financial transactions so that
a) the profit earned or loss incurred by the business during an accounting period can be
worked out,
b) the financial position of the business.as at the end of the accounting period can be
ascertained, and

c) the financial information required by the inaliagement and other interested parties can
be provided.
Financial Accounting is mainly confined to the preparation of financial statements and their
communication to the interested parties.

Cost Accounting: The purpose of cost accounting is to urtllyse tlie expenditure so as to

ascertaii.;the cost of varioi~sproducts manufactured by the finn ant! fix the prices. It also
necessary costing information to management
helps in controllir~gthe costs and providi~~g
for decision ~iraking.
Management Accounting: The purpose of management accounting is to assist tlie
management in tnking rational policy decisions and to evaluate the impact of its decisio~ls
and actions. Examples of such decisions arc: pricing decisions, make or buy decisions,
etc. This branch of accourlting is primarily concerned with
capital e~~enditure'decisions,
providing the necessary accounting information about funds, costs, profits, etc., to the
management which may hklp them in such decisions and also in planning and cor~trollir~g
business operations.

Replaces memory: Since all the financial events are recorded in the books, there is no
need to rely on memory. The books of account will serve as historial records. Any
information required at any time call be easily had from these records.

Provides control over assets: Accouiiting provides infomlation regclrdirig cash in hand.
cash at bank, the stock of goods, the amounts receivable.from various parties and the
amounts invested in various other assets. Information about such matters help the
owners and the management to make use of the assets in thc best possiblk way.

Facilitates the preparation of financial statements: With the help of information

contained in the accounting records the 1)rofit and Loss account arid the Balance Sheet
can be easily prepared. These firimcinl statements enable the businessman to know the
net result of business operations during the accounting pe~iodand the financial position
of the business as at the end of t l ~ eaccounting period.

Meets the information requirements: Various i~iterestedparties such as owners,

lenders, creditors, etc., get the necessary information at frequent intervals which help
them in their decision making.

Facilitates a eonlparnfive study: With the help of accounting information one can
compare the present perfonnance of the enterprise with that of its past and with that of
similar organisations. This enables the managelllent to draw useful conclusio~lsabout
the business and lnake efforts to improve the performance.

Assists the management in many other ways: The accounting illformation provided
to the mallagement helps them in taking rational decisions and in platlning and
controlling all business activities.

Accounti~~g
Fundnmentals

Difticult to conceal fraud o r thefk: It is difficult to conceal fraud, theft, etc. because of
the periodic balancing of books of account. Further, in big organisations the book- ,
keeping work is divided among many persons which minirnises the chances for
committing fraud.

Tax matters: The Ciovemment levies various taxes such as customs duty, excise duty,
sales tax, and income tax. Properly maintained accounting records will help in the
settlement of all tax matters with the tax authorities.

Ascertaining value of business: In the event of sale of a business firm, the accounting
records will help in ascertaining the correct value of business.

10 Acts as reliable evidence: Systematic record of business transactions is generally

treated by courts as good evidence in case of disputes.

1.2.7 Limitations of Accounting

The accounting information is used by various parties who form judgement about the
profitability and the financial soundness of a business on the basis of such information. It is,
therefore, necessary to know about the limitatio~~s
of accounting. These are as fullows:
1

They do not record transactions and events which are not of a financial character. Hence,
they do not reveal a complete picture because facts like quality of human resources,
licences possessed, Iocational advantage, business contacts, etc. do not find any place in
books of account.

2 The data is historical in nature. The accountants adopt historical cost as the basis in
valuing and reporting all assets and liabilities. They do not reflect current values. It is
quite possible that items like land and buildings may have much more value than what is
stated in the balance sheet.

3 Facts recorded in financial statements are greatly influenced by accounting conventions

and personal judgements. Hence, they do not reveal the true picture. In many cases,
estimates may be used to deternine the value of various items. For example, debtors are
estimated in terms of collectibility, inventories are based on marketability, and fixed
assets are based on useful working life. All these estimates are materially affected by
personal judgements.
4 Data provided in the financial statements is insufficient for proper analysis and decision
!naking. It only provides information about the overall profitability of the business. No
infoimation is given about the cost and profitability of different activities.
1
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Check Your Progress A

1

What is Accounting?

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List the activities involved in Accounting.

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Name the parties interested in accounting information.

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State whether each of the following statements is True or False.

i) Accounting is conce~nedonly with the recording of transactions.
ii) Accounting records only those transactions which are of a
financial character.
63
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iii) Book-keeping and Accpunting are synonymous terms.
iv) Cost Accounting helps in ascertaining and controlling costs.
Management Accounting provides necessary information to
management which helps them in planning, controlling
and decision making.
vi) The main objective of financial accounting is to ascertain the
profit or loss and the financial position of the business.

Basic Concepts of
Accounting

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1.3 BASIC ACCOUNTING CONCEPTS

Accounting is a system evolved to achieve a set of objectives as outlined earlier (refer to
1.2.1). In order to achieve these objectives we maintain systematic record of all business
transactions and prepare annual reports for the interested parties. Any activity that you
perform is facilitated if you have a set of rules to guide you. When you are driving your
vehicle you keep to the left. You are in fact following a traffic rule. If drivers do not follow
this rule, there will be a chaos on the road. The same thing is true of accounting which has
evolved over a period of several centuries. During this period, certain rules and conventions
have been adopted which serve as guidelines in identifying the events and transactions to be
accounted for, measuring them, recording them in books of account, summarising them, and
reporting them to the interested parties. These rules and conventions are termed as
'Generally Accepted Accounting Principles'. To explain these principles, the writers have
used a variety of terms such as concepts, postulates, conventions, underlying principles,
basic assumptions, etc. The same kule may be described by one author as a concept, by
another as a postulate and still by another as a convention. This often confuses the learners.
Hence, it is better to call all rules and conventions which guide accounting activity and
s ' are the fundamental ideas or basic
practice as 'Basic kccounting ~ o n c ' e ~ tThese
assumptions underlying tile theory and practice of financial accounting and are the broad
working rules for all accounting activities developed and accepted by the accounting
profession. This brings about uniformity in the practice of accounting.
These concepts can be classified into two broad groups as follows :
i) concepts to be observed at the recording stage i.e., while recording the transactions, and
ii) concepts to be observed at the reporting stage i.e., at the time of preparing the final
accounts.
It must however be remembered that some of them are overlapping and even contradictory.

1.3.1 Concepts to be observed at the recording stage

The concepts which guide us in identifying, measuring and recording the transactions are :
1

Business Entity Concept

Money Measurement Concept

Objcctive Evidence Concept

4
5

Historical Record Concept

Cost Concept

Dual Aspect Concept

Let us take them one by one and learn the accounting implications of each concept.
,L

Business Entity Concept: Business entity means a unit of organised business ar?irity. In
that sense, a provision store, a cloth dealer, an industrial establishment, an electricity supply
undertaking, a bank, a school, a hospital, etc. are all business entities.
From the accounting point of view every business enterprise is an entity separate and
distinct from its pro~rietor(s)/owner(s).The accounting system gives information only about
the business and not its owner@). In other words, we record those transactions in the books

Accounting Fuuadudle~itals

of account which relate only to the business. The o\vncr's personal affairs (his expenditure
on housing, food, clothing, etc.) will not appear in the books of accounr of his business.
However, when pcrsonal expenditure of tlie owner is met from business funds it shall also
he recorded in the business books. It will be recorded as drawings by the proprietor and not
as business expenditure.
Another implication of business entity concept is that the owner of a business is to be
treated as a creditor who also has a claim over the assets of the business. As such, the
amotint invested by him (capital) is regarded as a liability for the business.
The business entity concept is applicable to all fosms of business organisations. This
distinction can be easily maintained in the case of a limited company because the company
has a legal entity of its own. But such distinction becomes difficult in case of a sole
proprietorship or partnership, because in the eyes of the law the partner or the sole
proprietor are not considered separate entities. 'They itse persorlally liable for all business
transactions. Eut for accounting purposes, they are to be treated :is separate entities. This
enables lhem to ascertain the profit or loss of business more conveniently and accurately.

Money Meask~rcnlentConcept: Usually, business deals in a variety of items having

different pl~ysicalunits such as kilograms, quintals, tons, metres, likes, etc. If the sales and
purchases of different items are recorded is tenns of their physical units, adding them
together will pose problotns. But, if these are recordsd in a connnon denomination, their
total becomes homogeneous and ~neaningful.Therefore, we need u common unit of
measurement. Money does this firnction. It is adopted as the common measuring unit for the
purpose of accounting. A11 recording, therefore, is done in terms of the standard cusrency of
the country where business is set up. For example, in India it is done in terms,of Rupees, in
USA it is clone in tenns of US DoIlars, artd so on.
Another implication of rnoney measurement concept is that only those transactioris and
events are to be recorded in the books of account which can be expressed in terms of money
such as purchases, sales, payment of salaries, goods lost in accident, etc. Other happenings
(non-monetaryj like death of an efficient manages or the appointment of an accountant,
howsoever important they may be, are not recorded in the books of account. This is because
their effect is not measurable or cluantifial~lein terms of money.
.'

This approach has its own drawbacks. The value of money changes over a period of time.
The value of rupee today is much less than what it was in 1961. Such a change is nowhere
reflected in accounts. That is why the accou~~ting
data does not reflect the true and fair view
of the affairs of the bushzss.
~ e n c enow-a-days,
,
it is co~lsidereddesirable to provide additional data showing the effect
of changes in the price level on the reported income and the assets and. liabilities of the
business.

Objective Evidence Concept: The t e k objeclivity refers to being free from bias or free
from subjectivity. Accounting measurements are to be unbiased and verifiable
independently. For this purpose, all accounting transactions should be evidenced and
supported by documents such as itlvoices, receipts, cash memos, etc. These supporting
documents (vouchers) form the basis for making entries in [he books of account and for
their verification by auditors afterwards. AS for the items like depreciation and the provision
for doubtful debts where no documentary evidence is available, the policy statements made
by management are treated as the ilecessary evidence.
Historical Record Concept: You know that after identifying the transactions and
measuring them in terms of tnoney we record them in the books of account. According to
the histotical record concept, we r e c ~ r donly those transactions which have actually taken
place and not those which lnoy take place (future transactions). It is because accounting
rgcord presupposes that the transactions are to be identified and objectively evidenced. This
is possible only in the case of past (actually happened) transactions. The future transactions
can hardly be identified and measured accurately. You also know that all transactions are to
be recorded in chronological (datewise) order. This leads to the preparation of a historical
record of all transactions. It also implies that we simply record the facts and nothing else.
As you will study later, we also make provision for soine expected losses such as doubtful
debts. This may be contrary to what is stated in historical record concept. But tl~isis done
only at the time of ascertaining the profit a r loss of the business. It is not a routitre item.
This is done in accordance with another concept called Co~iservatismConcept about which
you will study later.

Cost Concept: Business activity, in essence, is an exchange of money. The price paid (or
agreed to be paid in case of a credit tl-ansaction)at the time of purchase is called cost.
According to the cost concept, all assets are recorded in books at their original purchase
price. This cost also for~nsan appropriate basis for all subsequent accounting for the assets.
For example, if the business buys a machine for Rs. 80,000 it would be recorded in books at
IPS.80,000. In case its market value increases to Rs. 1,00,000 later on (or decreases to Rs.
50,000) it will continue to be shown at Rs. 80,000 and not at its market value.
This does not mean, however, that the asset will always be shown at cost. You know that
with passage of time the value of an asset decreases. Hence, it may systematically be
reduced from year to year by charging depreciation and the asset be shown in the balance
sheet at the depreciated value. The depreciation is usually charged as a fixed percentage of
cost. It bears no relationship with changes in its market value. In other words, the value at
whicl~tile assets are shown in the balance sheet has no relevance to its market value. This,
110 doubt, makes it difficult to assess the true financial position of the business and is
therefore regarded as an irtiportarlt li~llitationof the cost concept. But this approach is
preferred because, firstly it is difficult and time consuming to ascertain the market values,
and secondly there will be too much of subjectivity in assessing tlie current values.
However, this limitation has been overcome with the help of inflation accounting.

Dual Aspect Concept: This is a basic concept of accounting. According to this cor~cept
every business transaction has a two-fold effect. In commercial context it is a famous dictum
that "every receiver is also a giver and every giver is also a receiver". For example, if you
purchase a machine for Rs. 8,000, you receive machine on the one hand and give Rs. 8,000
on the other. Thus, this transaction has a two-fold effect i.e., (i) increase in one asset and (ii)
decrease in another asset. Similarly, if you buy goods worth Rs. 500 on credit, it will
increase an asset (stock of goods) on the one hand and increase a liability (creditors) on the
other. Thus, every business transaction involves two aspects: (i) the.receiving aspect, and (ii)
the giving aspect, In case of the first example you find that the receiving aspect is machinery
and the giving aspect is cash. In the second example the receiving aspect is goods and the
giving aspect is the creditor. If complete record of transactions is to be made, it would be
necessary to record both the aspects in books of account. This principle is the cose of double
enuy book-keeping and if this is strictly followed, it is called 'Double Entry System of
Book-keeping' about which you will learn in detail later.
Let us understand another accounting implication of the dual aspect concept. To start with,
the i~litialfunds (capital) required by the business :ire contributed by the owner. If necessary,
additional funds are provided by the outsiders (creditors). As per the du:11 aspect concept all
these receipts creaLe corresponding obligations for their repayment. In other words, a
contribution to the business, either in cash or kind, not only increases its resources (assets),
but also its obligations (liabilities/equities) correspondingly. Thus, at an;. riven point of
time, the total assets and the total liabilities must be equal.
This equality is called 'balance sheet equation' or 'accounting equation'. It is stated as
under :
Liabilities (Equities) = Assets
or
Capital + Outside Liabilities = Assets
The term 'assets' denotes the resources (property) owned by the business while the term
'equities' denotes t l ~ eclaims of various parties against the business assets. Equities are of
two types: (i) owners' equity, and (ii) outsiders' equity. Owners' equity called capital is the
claim of the owners against the assets of the business. Outsiders' equ'ity called liabilities is
the claim of outside parties like creditors, bank, etc. against the assets of &e business. Thus,
all assets of the business are claimed either by the owners or by the outsiders, Iience, the
total assets of a business will always be equal to its liabilities.
When various business transactions take place, they effect the assets nnd liabilities in such a
'way that this equality is always maintained. Let us take a few transactions and see how this
equality is maintained.
1

Mr. Gyan Chand started business with Rs. 50,000 cash: The cash received by the
business is its asset. According to the business entity concept, business and the owner
are two separate entities. Hence, the capital contributed by Mr. Gyan Chand is a liability
to the business. Thus :

Accounting Fundamentals

Capital
= Assets
Rs. 50,000 = Rs. 50,000 (cash)
2 He purchased goods on credit from Chakravarty for Rs. 5,000: This increases an
asset (stock of goods) on the one hand and a liability (creditors) on the other. Now the
equation will be :
Capital + Liabilities = Assets
Rs. 50,000 + Rs. 5,000 = Rs. 5,000 + Rs. 50,000
Capital
Creditors Stock
Cash
3 He purchased furniture worth Rs. 10,000 and paid cash: This increases one asset
(furniture) and decreases another asset (cash). Now the equation will be :
Capital t Liabilities = Assets
Rs. 50,000 + Rs. 5,000 = Rs. 10,000 + Rs. 5,000 + Rs. 40.000
Capital
Creditors Furniture
Stock
Cash
This equation can be presented in the form of a Balance Sheet (a statement of assets and
liabilities) as follows :
Gyan Chand's Balance Sheet
Capital nnd Liabilities
Capital
Creditors
(Mr. Chakrnvarty)

Stock of goods

5,000

40,000

Note that the totals on both sides of the Balance Sheet are equal. This equality remains valid
ii~espectiveof the number of transactions and the items affected thereby. It is so because of
their dual effect on the assets and liabilities of the business.

1.3.2 Concepts to be observed at the reporting stage

The following concepts have to be kept in mind while preparing the final accounts.
1

Going Concern Concept

2
3
4
5
6
7

Accounting Period Concept

Matching Concept
Conservatism Concept
Consistency Concept
Full disclosure Concept
Materiality Concept

You will learn abour these concepts in Unit 6.

Check Your Progress B

Wliat do you understand.by business entity concept?

Fill in the blanks.

i)

Basic accounting concepts are broad .................for the accounting activity.

ii) According to the business entity concept the owner's capital in business is to be

treated as a ................... for the business.

iii) Every business pansaction has a dual effect on assets and
business.
iv) An asset is recorded in books of account at ........................

.................of the

14

V)

The system of recording transactions based on dual aspect concept is called .........

3'

Mr. Radhey La1 has a shoe factory. A few transactions and events are given below.
State which of these will be recorded in the books of his business.
i)

Basic Concepts of
Accounting

Purchased a machine for the factory.

ii) A pair of shoes taken home for his'son.

iii) Appointed Ganesh as an assistant accountant.
iv) Borrowed Rs. 8,000 from Saraf for the business.
V)

He paid salary to his domestic servant.

vi) The production manager went on medical leave.

vii) He paid wages for the month of May to factory workers.
viii) Appointed Ballu Shoe & Co. as dealers for the town.
4

Show the dual effect of the following transactions on assets and liabilities of the
business.
i)

Purchased goods for cash for Rs. 8,000.

ii) Purchased a delivery van on credit for Rs. 40,000.

iii) Paid Rs. 5,000 to a creditor.
iv) The proprietor took Rs. 2,000 from the business for personal expenses.
5

Find out the missing amounts on the basis of the accounting equation.
i)

Capital Rs. 40,000 + Liabilities Rs. 15,000 = Assets Rs. ..........

. . . . . . ..

. = Assets Rs. 80,000

ii) Capital Rs. 65,000 + Liabilities Rs.
iii) Capital Rs ........,.+Liabilities Rs. 30;000 = Assets Rs. 90,000.

1.4
SYSTEMS OF BOOK-KEEPING
Book-keeping as explained earlier is the art of recording business transactions in a
systematic manner. Broadly, there are two systems of book-keeping: (i) Double Entry
System, and (ii) Single Entry System.

1.4.1 Double Entry System

Under the dual aspect concept you learnt that every business transaction has two aspects: (i)
the receiving aspect, and (ii) the giving aspect. For example, when you purchase goods for
e s Thus, a transaction affects two items (also called
cash, goods come in arid ~ a s b ' ~ oout.
accounts) at the same time. When you record the transactions in the books of account of a
business, it would be better if you record the effects relating to both the items. In the above
example the items affected are goods and cash, stock of goods increases and cash decreases.
So, we should record the increase in stock of goods and also the decrease in cash. This
involves two entries, one in Goods Account and the other in Cash Account. This method of
recording business transactions is called 'Double Entry System'. It recognises and records
both the aspects of every transactions. According to this system the account which involves
receiving aspect is debited and the account which involves giving aspect is credited. Thus,
for every debit there will be an equivalent credit. For this purpose certain rules have been
framed. These are discussed in detail later in this unit.
The advantages of Double Entry System are as follows :
1

It provides complete and reliable record of all business transactions because it records
both the aspects.

It supplies full information about the incomes, expenses, assets and liabilities of the
business. This helps the management in taking appropriate decisions.

The arithmetical accuracy of the books of account cawbe easily verified by preparing a
trial balance.

The financial result of business organisations he., prafit ~r loss, can be correctly
ascertained.

The financial position of the business can alsd be ascertained at any point of time.

Accour~tingFundamentals

1.4.2 Single Entry System

Single Entry System does not mean that only one aspect of a transaction is recorded. It
$imply refers to incomplele records or the defective double enlry system. Under this system
neither all the transactions are recorded nor all the account books are maintained. In certain
cases the two aspects of a transaction are duly recorded while in others only one aspect is
recorded. Sotne transactions are simply ignored, they are not recorded at all. The Single
Entry Syslem is thus a mixt~ueof double entry, single entry and no entry. The accounts
maintained under this system are incomplete and unsystematic and, therefore, not reliable.
The main defect in this system is that the arithmetical accuracy of the books of account
cannot be checked, because a trial balance cannot be prepared. It also becomes difficult to
ascertain the correct amount of profit or Ioss. This sysleln is nornlally followed by small
business fin&. You will learn more about it in Unit 15.

1.5 WHAT IS AN ACCOUNT ?

You have learnt'that every business transaction has dual effect and that under Double Entry
Systerrl ent~iesare made in both the accuunls affected. You also.learn1 that the account
which involves receiving aspect is debited and the account which involves giving aspect is
credited. In order to understand the rules of debit and credit you rnust know more about the
term 'account'. An account is a summarised redord of all transactions relating Lo a particular
person, a thing, or an item of income or expense. It is vertically divided into two halves and
resembles the shape of the English alphabet 'T' as under :

Name of the account

Dr.

--

Cr.

The left hand side is called the 'debit side'. It is indicated by 'Dr.' (abbreviation for debit)
on the left hand top corner of the account. The right hand side, known as the 'credit side', is
indicnted by 'Cr.' (abbreviation for credit) on the right hand top comer of the account. The
name of the account is written at the top in the centre. The ward 'Ac-count' or its
abbreviadon 'Ah' is added to the nanie of the account. For example, if the account is
related to machinery, it is written as 'Machinery Accounl'.

1.6 CLASSIFICATION OF ACCOUNTS

-----

-----

All business transactions are broadly classified into three categories: (i)those relating to
persons, (ii) those relating to property (assets), and (iii) those relating to incomes and
expenses. Thus, three classes of accounts are maintained for recording all business
transactions. They are: (i) Personal Accounts (ii) Real Accounts, and (iii) Nominal
Accounts. Real and Nominal Accounts taken together are called Impersonal Accounts.
Personal Accounts: Accounts which show transactions with persons are called 'Personal
Accounts'. A separate account is kept in the name of each person for recording the benefit!
recehed from, or given to, the person in the courseof dealings with him. Examples are:
Krishna's Account, Gopal's Account, Loan from Ratmlal's Account, etc.
Personal accounts also include accounts in the names of fums, companies or institutions
such as Hiralal & Sons' Account, Nagarjuna Finance Limited Account, The Andhra Bank
Account, etc.

'The accounts which represent expenses payable, expenses paid in i~tlvance,incomes

receivable, and incomes received in advance are also personal accounts, though impersonal
in name. For example, the salaries due to employees, which have not been paid before
closing of the books of account for the year, aie recorded in 'Salari,es Outstanding Account'.
It is regarded as a personal account because it represents h e employees to whom salaries are
payable by the business. Such a personal account is,called 'Representative Personal
Account'. Other examples of representative prsonal accounts are: Interest Outstanding
Account, Prepaid Insurance Account, Rent Received in Advance Account, etc. Capital
Account and Drawings ~ c c o u nare
t also treated as personal accounts as they show dealings
with the owner of the business.
Real Accounts: Accounts relating to properties or assets are known as 'Real Accounts'.
Every business needs assets such as machinery, furniture, etc. for running its activities. A
.. separate account is maintained for each asset owned by the business. All transactions
, relating to a particular asset are recorded in the concerned asset account. Cash Account,
Fumiture Account, Machinery Account, Building Account, etc., are some examples of real
' accounts. They are known as real accounts because they represent things of value owned by
the business.

-.

Nominal Accounts: Accounts relating to expenses, losses, incomes Ad gains are known as
'Nominal Accounts'. A separate account is maintained for each item of expense, loss;
income or gain. Wages Account, Salaries Account, Commission Received Account, and
Interest Received Account are some examples of nominal accounts.
Classification of accounts is presented in Figure 1.2
Figure 1.2: Clne~lficatlonof Accounts

Accounts

I
" Personal

'I

Accounts

Impersonal Accounts

'I .
I

Real Accounts
Gopal
Loan from Retenlal
Salaries Outstanding
..hsurance Repaid

Furniture
Buildings
Machinery
Vehicles

I
Nominal Accounta
Salariea
Wages
Intenet
Rent
Commiesion

1 1'7 RULES OF DEBIT AND CREDIT

/ You have learnt that every transaction affects two accounts and according to Double Entty

System, entries have to be made in both the accounts. Before recording a transaction,
I therefore, it is necessary to find out which of the two accounts is to be debited and which is
, to be credited. The general rule, as stated earlier, is to debit the account which involves a
receiving aspect and credit the account which involves a giving aspect. But, for

I convenience, three different rules have been laid down for the three classes of accounts.
1 These are as follows:
I

For Personal Accounts: The account of the person receiving benefit (receiver) of the
transaction (from the business) is debited and the account of the person givirig the
" '* benefit (giver) of the transaction (to the business) is credited. Thus, the rule L 'debit
,, the r m i v e r and crcdlt the 'giver9.
'

jZ

1';3

'
I
'

,
'

For Real Accounts: When an asset is coming into the business, the accdunt of that .
asset is debited. When an asset is going out of the business, the account of that m e t is,
cndited. Thus, the rule is 'debit what mmea i o and ered&swhat p e a a t 9 .
For Nominal Accounts: When ar~expense is incurred or loss suffered, the account
representing the expense or the loss is debited because the budness receives the benefit
thereof. When any income is earned or gain made, the account representing the income
or the gain is credited. This is h a u s e the business gives some benefit. Thus, the rule is
'debit all expenaes and lossee and credit all incomes and galns9,
..

Basic Concepts o f .
Accounting

kcc~ontiegFutidrmen6rrls'

We shall now see the appjisaii~~of

tbaserules, i&ing a few transactions.

Example 11 : Paid casi~to Wamesh B Co. Rs. 5,008.

la this case the two accoullts affected are Rarnesh & Cur'sAccount arid Cash Account.
Ramesh & CO.;~Account is a personal account and Cash Account is a real account. Rameshr
$b Co. has received the benefit (cad Rs. 5,006) from the brtsiness and, therefofe, it has td be
debited as per the first pzrt of the rule for personal accounts 'debit the receiver'. As cash has
gone out, Cash Account will be credited acc~rdingto the second part of the rule for red
accounts 'credit what goes out'.

Example 2: Received sash from Ajay Rs. 1,000.

In this case Cash Account and Ajay's Account are the two accounts affected. Cash Account
is a red account anld Ajay's account is a p r s o r i ~account.
l
As cash has come in, Cash
Account will have to be debited according to the first part of the rule for real accounts 'debit
what comes in'. .4jay has given the bendit (cash Rs. 5,000) to the busiriess and, therefore,
his account will liave to be credited as per the second part of the rule for personal accounts
'credit the giver'.

,'

Example 3: h i d rent Rs.1,000.

In this case, the accounts affected are Rent Account aid Cash Account. Rent Account is a
norninal'account and Cash Account is a red account. As per the first part of the rule for
nominal accoatnis 'debit expenses and losses', Rent Account will have to he debited as it is
an expense to tllc business. As cash haa gone out, Cash Account will have to be creditcd
according to the secotid part of the rule for real accounts 'credit what goes out'.

Example 4: Received Rs. 450 as cumn~issisn,

In this case, Cash Account and Commission Account arc the two accounts affected, Cash
Account is a real account and Comrt~issionA c G o ~i s~a ~nominal
I~
account. As cash has come
in, Cash Account will liave to be debited according ro the k s t part of the rule for real
accounts 'debit what cotnes iri'. As pet second pa,d of the rule for non~inalaccounts, 'credit
incomes and gains', Commission Accouitt will be credited as it is an illcome to the business.

You have seen that the diree n~lesof debit and credit as explained above, make it
convenient for you to analyse the transactions and identify the accounts to be debited and-.-.. credited.
!
-.-. I.:

-C
1 State whether each bf eke statements is Rae or False.
i)

ii)
iii)
ivj

v)
vi)

:i

An Account is a s~lrnminrisedrecord of 211 transactions relating to a

particular person'or an item.
Right hmd side of an account is called &bit side.
Account which represents an iten1 of asset is cdled representative
personnl account.
,
Accounts relating to assets held in the name of the firm aee called
nornilid accounts.
Capital Account is a persona1 acccunt. '
Goodwill Account is a personal accou~it.

...........
..........

...........*r
..........
..........
.........

2 Names of some accounts are given blow. Classify them into Persow#$,Real or Nominal.

I Cl~saof Account

Name of Account
i)
ii)

......................................................................
.......................................................................

Bank A/c

Interest A/c
iii) Interest outstanding A/c
iv) Patents A/c
-v) Loan from Gopaldas A/c
vi) Lmse Tools .4/c
, vij) comdission Received in A
vili) Prepaid Saldes AJc
ix) Shtibilery andprinting A/c
rj Elecwcity Charges A/;. "'

.......................................................................

....:..........................................

18

,'.

'

&

d,

'

'

............... ...............................................
.
LA
.,

'".3

Basic Concepts of
Accounting

Fmm the following transactions determine the accounts affected, classify them m d state
whether they are to be debited or credited; ---

. . .
L

Rs.

.,

ii)
j

Purchased typewriter for cash

Purchased furniture from R & Co. on cre'dit

iii)
iv)

Interest received

x)

Sold goods for cafh

Paid wages
v) Received cash from A
vi) Additional capital introduced into the business
vii) Paid cash to B
viii) Paid carriage
ix) Purchased goods from F & Co. on credit
h.

, .

. .

---

,-

he accounting process consists of the following four stages/l

i)

Recording the Transactions

..I

ii) Classifying the Transactions

iii) Summarising the Transactions
iS) ~nterpredn~
the Results
Let us now briefly discuss these stages.
?'

~ e c o r d i nthe
~ Transactions: The accounting process begins with recording of all
transactions in the book of original entry. This book is called 'Journal'. All transactions are
recorded in the Journal in a chronological order (datewise) withsthehelp of various vouchers
such as cash memos, cash receipts, invoices, etc.

ClaSsifying the Transactions: The second stage consists of grouping the transactions of
similar nature and posting them to the conccmed accounts in another book called 'Ledger'.
For example, all trhsactions related to cash me posted to Cash Account and the transactions
related to different persons are entered separately in the account of each person. The
objective of classifying the transactions in this manner is to ascertain the combined effect of
all transactions of a given period in respect of each account, For this purpose, all accollnts
are balanced periodically.

Summarising the Transactions: The next step is to prepare a year-end summary known as
.'Final Accounts'. But before preparing the final accounts, we prepare a statclient called
Trial Balance in order to check the arithmetic4 accuracy of the books of account. If the Trial
Balance tallies, itmeans that the transactions have been currently recorded and posted into
ledger. Then, with the help of the Trial Balance and some other relevant information we
prepare the final accounts. The objectives of preparing the final accounts are (i) to know the
net result of business activities, and (ii) to ascertain the financial position of the business.
The final account consists of an income statemeqt called 'Trading and Profit land Loss
Account' and a position statement called 'Balance Sheet'. The Trading and Profit and Loss
Account gives us the information about the am&t of profit made or the loss incurred
during the year and the Balwce Sheet shows the position of assets and liabilities of the
business as at the end of the year. .
'Interpreting the Results: The last stage consists of analysing and interpreting the results
'
dhown by the fin9 accounts. This involvea computation of various accounting ratios to
1

assess the liquidity, solvency, and profitability of the business. quch analysis is meant for
interested parties like management, investors,bankers, creditors, etc. The balances on '
various accouhts appearing in the Balance Sheet will .thentie trimsfeked to the new books of
for the next year .
account for the next year, Thereafter the p.mcess of recording transactions
.
star& again. '
;.
s

L9

Arcwnllng Fundamenbls'

1.9 LET US SUM UP

In business a number of transactions take place every day. It is not possible to remember all
of them. Hence the need to record them. The recording of business transactions in a
$ystematic manner is the main function served by accounting. It enables us to ascertain the
profit and loss and the financial positions of the business. It also provides the necessary
financial information to all interested parties.
~ i c o u n t i is
n ~the process of identifying, measuring, recording, classifying and summarising 1
'
the transactions, and analysing, interpreting and communicating the results thereof. The
accounting system has two stages: (i) Book-keeping, and (ii) Accounting. Book-keeping is
mainly concerned with the maintenance of books of account, while accounting is concerned
with summarising the recorded data, interpreting the financial results and communicating
them to all interested parties. Changes in economic environment and increasing complexity
of management have given rise to the specialised branches of accounting such as financial
accounting, cost accounting and management accounting,

'

The accountants, over a perbd of time, have developed certain guidelines for all accounting
,work. These nre called basic concepts of accounting. Certain concepts are to be observed at
Ihe time of recording the transactions, while others are relevant at the summarising and
=porting stages. The concepts to be observed at the recording stage art: business entity,
money measurement, objective evidence, historical record, cost and the dual aspect
concepts.
According to Dual Aspect concept every business transaction involves two asp,ects (if the
receiving aspect, and liiJ the giving aspect. Undef 'Double.Entry System' both the aspects
must be recorded in books of accoutit. As per rules the receiving aspect igrecorded on the
debit side of account affected by transaction and giving aspect on the credit side of the
,
account affected, For convenience, accounts have been classified into personal, real and I
nominal aqcounts and separate rules have been framed for debiting and crediting different
classes of accounts. These are called Rules of Debit and Credit.
The accounting process is divided into four stages: (i) recording the transactions in the
books of original entry, (ii) classifying the transactions, (iii) sum~narisingthe transactions,
and (iv) Interpreting the results.

1.10 KEY WORDS

Account! A summarised statement of transactions relating to a particular person, thing
expense or income,
Accounting Period: A period of twelve months for which the accounts are usually kept.
ASset: Arlything having an economic value, a ptoperty.
.
fdellnce Sheet: A statement of assets and liabilities as at the end of an accounting period.
Books of Account: Books in the form of bound registers or loose sheets wherein
transactibns ire recorded.
Business: Any activity carried on with profit motive.
Bualnas Unit: A unit fotmed for the purpose of carrying on some kind of business activity.
Capltel: Owner's investment and equity in the business.
t]oUtipmig: An association of persons registered under the Companies Act.
Credit: It represents the giving aspect of a transaction. ,
Creditor: A
to whom the business owcs.
bebit: It represents the receiving aspect of a transaction.
Debtor! A peraon owing to the,business,
Expmdlture:Spending of money or incurring a liability for some benefit, service or asset
received by the business.
Expense: An expenditure incurred for some benefit or service.
Equity: A claim or right over the business. It includes both the owners' and creditits' ,
claims.
Financial Position: Position of assets and liabilities of a business at a given point of time.

Financial Statement: Summary of accounting informatioh'such as Profit and Loss Account

and Balance Sheet prepared at the end of an accounting period. These are also called Final
Accounts.
Income: Amount earned through business operations.
Liability: Amount owed by the business to outsiders.
Nominal Accounts: Accounts relating to incomes and expenses.
Partnership Firm: A business unit owned by two or more persons who have agreed to
share the profits of the business carried on by all or any of them acting for all.
Personal Accounts: Accounts relating to persons, firms and institutions.
Profit: Excess of income over expenses during a given period.
Profit and Loss Account: An account showing profit or loss of the business during an
accounting period.
Real Accounts: Accounts relating to the properties of business.
Sole Proprietorsliip: A business unit owned by one person.
Transaction: Transfer of money or money's worth between the two business units.

1.11 SOME USEFUL BOOKS

1

Harold Bierman Jr. and Allan R. Drebin, 1978: Firzancial Accounting, An Introduction,
W.B. Saunders Company, Philadelphion, London. (Chapters 1-3)

Maheshwari, S.N., 1986. Introduction to Accounting, Vikas Publishing House: New

Delhi. (Chapters 1, 2)

Patil, V,A. and J.S. Korlahalli, 1986. Principles and Practice ofAccounting, R. Chand
& Co., New Delhi. (Chapters 1-3)

Gupta, R.L. and M. Radhaswarny, 1986. Advanced Accountancy,Sultan Chand & Sons:
New Delhi. (Chapter l , 2 )

1.12 ANSWERS TO CHECK YOUR PROGRESS

A. 4
B. 2
3
4

i) False 'ii) True iii) False iv) True v) True vi) True
i) Working rules ii) liability iii) liabilities iv) cost v) Double Entry System
i, ii, iv, and vii will be recorded in books of his business.
i) Stock of goods increases, cash decreases
ii) An asset increases, creditors increase
iii) Creditors decrease, cash decreases
v) Capital decreases, cash decreases
5 i) Rs.55,000
ii) Rs. 15,000
iii) Rs, 60,000
C. 1 i) True
ii) False
iii) False iv) False v) True vi) False
2 i) Personal ii) Nominal iii) Personal iv) Real v) Personal vi) Real
vii) Personal viii) Personal ix) Nominal. x) Nominal

11

Transaction

Account to be
deblted

Nature of
account

Account to be
credited
,

Nature of
account

i)
ii)
iii)
iv)
V)
vi)
vii)
viii)
ix)
X)

Typewriter AJc
Furniture Glc
Cash A/c
Wages A/c
Cash A/c
Cash A/c
B's A/c
Carriage AJc
Goods A/c
Cash AJc

Real
Real
Real
Nominal
Real
Real
Personal
Nominal
Real
ReaI

Cash A/c
R & Co. A/c
Interest A/c
Cash AJc
A's Nc
Capital A/c

Real
Personal
Nominal
Real
Personal
Personal
Real
Real
Personal
R&I-

.
I

Cash Alc
Cash A/c
F & Co. A/c
Goods A/c

BWIC~ o n c a &ofi

Accounting

Define Accounting and explain its scope.

What are the objectives of Accounting? Name the different parties interested in
accounting information ahd state why they want it.

Write notes on:

a) Advantages of Accounting
b) Branches of Accounting

c) Accounting Process
Types of Accounts

Briefly explain the accounting concepts which guide the accountant at the recording
stage.
I

What do you understand by Dual Aspect Concept? Explain its accounting implications.

Note: These questions will help you to understand the unit better. Try to write
answers for them. But do not submit your answers to the University. These are
for your practice only.
---

---

--

THE ACCOUNTING PROCESS

2.0
-2.1
2.2

Objecti.ves
Introduction
Journal
2.2.1 Tm!lsactions ReIating to Goads
2.2.2 Receipts and Payments by Ctiequcs
2.2.3 'Transactions with the Pmprietor
2.2.4 'Transactions Relating to Cash Discoudt
2.2.5 Compound Journal Entry
2.2.6 'kanswctions Relating to Bad Debts

2.3

Ledger

2.3.1 Posting into Ledger

2.3.2 Balancing kdger Accounts
2.3.3 Significance of Balances

2.4
2.5
2.6
2.7
2.8
2.9
2.10

Trtnl Balance
.
Qpenidg Entry
Let Us Sum Up
Key Words
Some Useful Books
Answers to Check Your Progress
Terminal Questions/Exercises

2.0 OBJECTIVES
' After studying this unit you should be able to:
8
Q

+.

'

explain what a journal is

describe how different, types of transactions will he recorded in the journal
post journal entries in the concerned ledger accounts
balance a ledger account and explain the significance of balances in different types of
accounts
prepare a trial balance to test the arithmetical accuracy of recording in the books of
account
explain what an opening entry is and how it is posted into ledger

In Unit 1 you learnt that the accounting process involves four stages: (i) recording the
transactions, (ii) classifying~hetransactions, (iii) summarising the transactions, and (iv)
interpreting the results. Thus, you are aware that all transactions are recorded first in the
books of original entry viz,, Journal, and then posted into the concerned accounts in the
ledger. You have also learnt the basic accounting concepts to be observed at the recording
.stage and the rules of debit and credit. With the help of these rules we shall discuss in this
unit how various transactions are recorded in the Journal and how they will be posted into
the concerned ledger accounts. We shall also explain how to balance different accounts a d
prepare a Trial Balance in order to test the arithmetical accuracy of the books of account.

2.2 JOURNAL

.Journal is a daily record of business transactions. It is also called a 'Day Book' and is used
for recording all day today transactibns in the order in which they occur. It is a book of
prime entry (also called baok of original entry) because all transactions are reeorded first in
this book. h e process of recording a pansaction in the journal is called 'Journalising' and
; the entries made in this book are called ' J o i a l Emries'. The p r o f m a of Journal is given
i
I in Figure 2.).
1.