Chapter 2 — Recording of Business Transactions

Accounting does not begin with the journal. It begins with a piece of paper that proves a transaction took place. Every entry in the books must rest on such written evidence, because the objectivity concept requires that an auditor should be able to verify each entry. These pieces of paper are called source documents, and the internal record prepared from them for the accounts department is called a voucher.

Common source documents

• Cash memo: issued by the seller when goods are sold for cash. The buyer keeps it as evidence of a cash purchase; the seller's copy is evidence of a cash sale.
• Invoice or bill: prepared by the seller when goods are sold on credit. It shows the name of the buyer, the description, quantity, rate and amount of goods, trade discount if any, tax and the total due. The seller's copy supports the sales book; the buyer's copy supports the purchases book.
• Receipt: issued when cash is received from a customer or any other person. The counterfoil remains with the issuer as evidence.
• Debit note: sent by a buyer to a seller when goods are returned or when the buyer has been overcharged, informing the seller that his account has been debited.
• Credit note: sent by a seller to a buyer when goods are received back, informing the buyer that his account has been credited.
• Pay-in-slip: the form filled in when cash or cheques are deposited into the bank; the counterfoil is evidence of the deposit.
• Cheque and its counterfoil: evidence of payment made through the bank.
• Bank statement or pass book: evidence of bank charges, interest and other bank transactions.

Vouchers

A voucher is a document prepared within the business, on the basis of the source document, that authorises the recording of a transaction. It is signed by the person preparing it and by the person authorising it. Vouchers are of two main kinds. Cash vouchers record cash receipts (debit vouchers for payments and credit vouchers for receipts) and are supported by receipts, cash memos or bills. Non-cash or transfer vouchers record transactions in which no cash moves, such as credit sales, credit purchases, depreciation and returns. A voucher normally shows the voucher number, date, the accounts to be debited and credited, the amount in figures and words, a narration and the signatures. Vouchers are filed serially so that any entry can be traced back to its evidence.

The flow is therefore: transaction happens, source document is obtained or issued, voucher is prepared and approved, entry is made in the journal or subsidiary book, and posting is made to the ledger. Without the first two steps, the entry has no foundation and cannot be verified.

The word journal comes from the French jour, meaning day. The journal is the book in which transactions are first recorded, day by day, in the order in which they occur. It is therefore called the book of original entry or the book of prime entry. Each record in it is called a journal entry, and the act of recording is called journalising.

The journal has five columns:

• Date: the year is written at the top, and the month and day against each entry.
• Particulars: the name of the account to be debited is written first, close to the left margin, followed by the abbreviation Dr. On the next line, a little to the right, the word To is written, followed by the name of the account to be credited. Below this, in brackets, a short explanation of the transaction called the narration is given, beginning with the word Being. A thin line is drawn across the particulars column after each entry.
• L.F. (Ledger Folio): the page number of the ledger to which each account is posted. It is filled in at the time of posting, not at the time of journalising, and it serves as a cross-reference and as proof that posting has been done.
• Debit amount: the amount debited, written against the account debited.
• Credit amount: the amount credited, written against the account credited.

Features of the journal

• It records transactions in chronological order, so it gives a date-wise history of the business.
• It records both aspects of every transaction together, in one place, so the double entry is complete in the journal itself.
• It carries a narration, so the reason for each entry is known.
• It is the basis for posting to the ledger.

Advantages of the journal

• It reduces the chance of omission, because every transaction is first written here.
• It shows the debit and credit of each transaction side by side, so errors of posting can be traced.
• The narration explains the transaction for future reference.
• It is accepted as evidence in courts.
• The totals of the debit and credit columns help to check arithmetical accuracy.

In a large business a single journal becomes too bulky, and so the journal is divided into several subsidiary books, which are the subject of the next chapters. Even then, entries that do not fit any subsidiary book are made in a residual journal called the journal proper.

Journalising is a matter of asking the same four questions about every transaction. With practice the questions become automatic, but a beginner should ask them aloud.

Step 1: Which two accounts are affected? Read the transaction and name the two accounts. In Paid wages Rs 2,000, the accounts are wages account and cash account. In Sold goods to Ramesh on credit, the accounts are Ramesh's account and sales account. If cash is mentioned, cash account is one of the two; if a cheque is mentioned, bank account is one; if a person's name is given without the word cash, it is a credit transaction and that person's account is one.

Step 2: What type is each account? Classify each as personal, real or nominal. Wages is nominal; cash is real; Ramesh is personal; sales is nominal.

Step 3: Apply the golden rule to each account. Wages is an expense, so debit wages. Cash goes out, so credit cash. Ramesh receives goods, so debit Ramesh. Sales is an income, so credit sales.

Step 4: Write the entry in the journal with the date, the debited account first with Dr, then To and the credited account, the amounts in their columns, and a narration.

Worked set of common transactions

Points that trip students up

• Goods bought are always Purchases A/c, never Goods A/c or Stock A/c. Goods sold are always Sales A/c. Purchases of assets such as furniture or machinery go to the asset account, not to purchases.
• When a transaction names a person and does not say cash or cheque, it is a credit transaction. Sold goods to Ravi means Ravi's account is debited. Sold goods to Ravi for cash means cash account is debited and Ravi's name is not used at all.
• Paid by cheque means bank account is credited; received a cheque and deposited it means bank account is debited.
• Expenses paid on behalf of the owner (life insurance premium, income tax, household expenses) are drawings, not business expenses.

Two kinds of journal entry need special attention because they differ from the ordinary one-debit one-credit pattern.

Compound journal entry

Sometimes a single transaction, or several transactions on the same date of the same nature, affect more than two accounts. Instead of writing separate entries, one entry with more than one debit or more than one credit, or both, may be passed. This is a compound entry. The total of the debits must still equal the total of the credits.

Suppose on 5 April the business paid Rs 3,000 rent, Rs 6,000 salaries and Rs 1,000 electricity, all in cash. The compound entry is:

Another common case is receiving payment from a debtor with discount. Ravi owed Rs 10,000 and paid Rs 9,700 in full settlement. Cash A/c Dr 9,700; Discount Allowed A/c Dr 300; To Ravi's A/c 10,000. Here two accounts are debited and one is credited, and both sides total Rs 10,000.

Opening entry

When a business that has been running for some time starts a new accounting year, the balances of assets, liabilities and capital at the end of the previous year must be brought into the new books. This is done through the opening entry, which is the first entry of the year in the journal. All assets are debited (because they come in, real accounts, or represent debtors who received value, personal accounts), all liabilities are credited (creditors who gave value), and capital is credited with the difference. If capital is not given, it is found from the accounting equation: Capital = Assets − Liabilities.

Example: On 1 April 2026 Suresh had cash Rs 15,000, bank Rs 40,000, stock Rs 50,000, debtors Rs 25,000, furniture Rs 20,000, creditors Rs 30,000 and a bank loan Rs 20,000. Capital = (15,000 + 40,000 + 50,000 + 25,000 + 20,000) − (30,000 + 20,000) = 1,50,000 − 50,000 = Rs 1,00,000.

The opening entry is always a compound entry. When posted, it creates the opening balances in the ledger accounts; the balance of each asset account appears on its debit side as To Balance b/d and each liability on its credit side as By Balance b/d. If a business is entirely new and starts only with cash, the opening entry is simply Cash A/c Dr, To Capital A/c.

Discount is a reduction in the amount that a buyer has to pay. Two kinds appear in the journal, and they are treated very differently.

Trade discount is a deduction from the list or catalogue price allowed by a manufacturer or wholesaler to a retailer, usually to enable the retailer to sell at the list price and still earn a margin, or as an incentive for buying in large quantities. It is deducted on the face of the invoice, and the net amount only is recorded. Trade discount never appears in any account in the books of either the buyer or the seller. The reason is that neither party ever expected to pay or receive the list price; the real price of the goods is the net price.

Example: Sold goods to Kavita, list price Rs 20,000, at a trade discount of 10 per cent. The invoice shows Rs 20,000 less Rs 2,000, net Rs 18,000. The entry is Kavita's A/c Dr 18,000; To Sales A/c 18,000. The Rs 2,000 is not mentioned anywhere except in the narration.

Cash discount is a reduction allowed by a creditor to a debtor for paying the amount due promptly, before the due date. It arises after the sale, at the time of payment, and it is recorded in the books because a real amount of money is given up. The seller who allows the discount records it as discount allowed, a loss (nominal account, debited). The buyer who receives it records it as discount received, a gain (nominal account, credited).

Example: Kavita pays Rs 17,640 in full settlement of Rs 18,000, receiving a cash discount of 2 per cent, Rs 360. In the seller's books: Cash A/c Dr 17,640; Discount Allowed A/c Dr 360; To Kavita's A/c 18,000. In Kavita's books: Seller's A/c Dr 18,000; To Cash A/c 17,640; To Discount Received A/c 360.

When both discounts appear in the same transaction, trade discount is deducted first from the list price and then cash discount is calculated on the net amount, not on the list price.

A related term is full settlement. When a debtor pays an amount smaller than the balance due and the creditor accepts it in full settlement, the difference is treated as cash discount and the debtor's account is closed. The phrase in full settlement in a question is a signal that discount is involved.

A number of transactions involve goods leaving the business for reasons other than sale. Because goods are recorded at cost in the purchases account, all these entries credit purchases account, not sales account, so that the cost of goods used for other purposes is removed from the cost of goods sold.

Goods withdrawn by the proprietor for personal use. The owner takes goods home. This is drawings in kind. Drawings A/c Dr; To Purchases A/c. The amount is the cost of the goods.

Goods given as charity or donation. Charity A/c Dr; To Purchases A/c. Charity is an expense, a nominal account.

Goods distributed as free samples for advertisement. Advertisement A/c Dr (or Free Samples A/c Dr); To Purchases A/c.

Goods lost by fire, theft or accident. Loss by Fire A/c Dr (or Loss by Theft A/c Dr); To Purchases A/c. If the goods were insured and the insurance company admits the claim, the admitted part is transferred to the insurance company: Insurance Company A/c Dr (with the claim admitted); Loss by Fire A/c Dr (with the balance); To Purchases A/c (with the total cost). When the claim is received: Bank A/c Dr; To Insurance Company A/c.

Goods used in the business for making an asset. If a furniture dealer uses his own stock of furniture in the office, Furniture A/c Dr; To Purchases A/c.

Cash and other special items

• Bad debts: when a debtor cannot pay, the amount is written off as a loss. Bad Debts A/c Dr; To Debtor's A/c. If part is received, Cash A/c Dr (amount received); Bad Debts A/c Dr (amount not received); To Debtor's A/c (total). An insolvent debtor who pays a dividend of 40 paise in the rupee on Rs 5,000 gives Rs 2,000 cash and Rs 3,000 bad debts.
• Bad debts recovered: when an amount written off earlier is later received, the debtor's account is not touched; Cash A/c Dr; To Bad Debts Recovered A/c (an income).
• Depreciation: the fall in the value of a fixed asset through use. Depreciation A/c Dr; To Asset A/c.
• Interest on capital: Interest on Capital A/c Dr; To Capital A/c. Interest on drawings: Drawings A/c Dr (or Capital A/c Dr); To Interest on Drawings A/c.
• Outstanding expenses: Expense A/c Dr; To Outstanding Expense A/c. Prepaid expenses: Prepaid Expense A/c Dr; To Expense A/c.
• Accrued income: Accrued Income A/c Dr; To Income A/c. Income received in advance: Income A/c Dr; To Income Received in Advance A/c.
• Cash deposited into bank: Bank A/c Dr; To Cash A/c. Cash withdrawn from bank: Cash A/c Dr; To Bank A/c. Both are called contra transactions because they affect only cash and bank.
• Cheque received and deposited the same day: Bank A/c Dr; To Customer's A/c. Cheque dishonoured: Customer's A/c Dr; To Bank A/c.
• Sale of an old asset: Cash A/c Dr; To Asset A/c, with loss on sale debited or profit on sale credited for any difference from book value.

The common thread is to ask what really happened: goods left at cost, an asset lost value, an expense belongs to a period. The entry follows from the answer.

The following transactions of Lakshmi Traders for April 2026 bring together everything covered so far. Work through each entry and confirm the reasoning.

• Apr 1: Started business with cash Rs 2,00,000.
• Apr 2: Deposited into bank Rs 1,20,000.
• Apr 3: Purchased goods from Vijay Rs 40,000.
• Apr 5: Sold goods for cash Rs 25,000.
• Apr 7: Sold goods to Nirmala Rs 30,000.
• Apr 9: Returned goods to Vijay Rs 2,000.
• Apr 12: Nirmala returned goods Rs 1,500.
• Apr 15: Paid Vijay by cheque Rs 37,000 in full settlement.
• Apr 18: Received cash from Nirmala Rs 28,000 in full settlement.
• Apr 20: Purchased furniture for cash Rs 15,000.
• Apr 25: Paid rent Rs 5,000 and salaries Rs 10,000 in cash.
• Apr 28: Withdrew cash for personal use Rs 3,000.
• Apr 30: Goods costing Rs 1,000 given as charity.

Notice how the balances due were worked out before the settlement entries. Vijay was owed Rs 40,000 less the Rs 2,000 return, so Rs 38,000; paying Rs 37,000 in full settlement gives a discount received of Rs 1,000. Nirmala owed Rs 30,000 less Rs 1,500 returned, so Rs 28,500; receiving Rs 28,000 gives discount allowed of Rs 500. In an examination, always compute the amount due after returns before applying full settlement. The total of the debit column, Rs 4,88,500, equals the total of the credit column, as it must.

The journal records transactions in date order, so entries relating to the same account are scattered across many pages. To know how much Nirmala owes, or how much has been spent on rent this year, one would have to search the whole journal. The ledger solves this. It is the book in which all transactions relating to one account are collected together on one page or set of pages. Because the ledger is where entries finally come to rest, it is called the book of final entry or the principal book of accounts. Every account in the business, whether personal, real or nominal, has its own place in the ledger.

Format of a ledger account

A ledger account looks like the letter T, and so it is often called a T-account. The name of the account is written at the top in the centre. The left side is the debit side, marked Dr, and the right side is the credit side, marked Cr. Each side has four columns.

• Date: the date of the transaction as in the journal.
• Particulars: the name of the other account involved in the transaction. On the debit side it is preceded by To, on the credit side by By.
• J.F. (Journal Folio): the page number of the journal from which the entry has been posted.
• Amount: the amount of the transaction.

Importance and utility of the ledger

• It gives complete information about each account at one place: how much a customer owes, how much has been spent on each expense, the value of each asset.
• It is the source of the trial balance, which tests the arithmetical accuracy of the books.
• It is the source of the final accounts: nominal accounts go to the trading and profit and loss account, and real and personal accounts go to the balance sheet.
• It helps management to control expenses and to follow up debtors.
• It provides the balances needed for the opening entry of the next year.

Types of ledger. A small business keeps a single ledger. A large business divides it into a debtors ledger (or sales ledger) for customers' accounts, a creditors ledger (or purchases ledger) for suppliers' accounts, and a general ledger for all real and nominal accounts and the summary accounts. The ledger may be a bound book, loose leaves in a binder, or, today, a file in an accounting program; the principle is the same.

The journal and the ledger are the two principal books of the double entry system. They are not rivals; each does what the other cannot. The journal answers the question what happened on this date, and the ledger answers the question what is the position of this account. Examiners regularly ask for the distinction, and the points are best remembered in a table.

A frequent question is whether the ledger can be maintained without the journal. In theory a transaction could be posted straight to two ledger accounts, and some very small businesses do this. But the risk of omission and of posting to a wrong account is high, there is no narration to explain the entry, and there is no date-wise record. So the journal, or its subsidiary books, is always kept, and the ledger is written from it. The order is fixed: journal first, ledger second.

Another point to understand is the relationship between the two words folio. When an entry is posted, the page number of the ledger is written in the L.F. column of the journal, and the page number of the journal is written in the J.F. column of the ledger. These cross-references let anyone trace an entry from the ledger back to the journal and from the journal back to the voucher. They also show at a glance which journal entries have not yet been posted.

Posting is the process of transferring the debit and credit aspects of a journal entry to the respective accounts in the ledger. Every journal entry produces two postings, one on the debit side of the account debited and one on the credit side of the account credited. The rules are mechanical, and following them exactly prevents the most common errors.

Rules of posting

• Open a separate account in the ledger for every account name that appears in the journal. Do not open one account for all customers or all expenses; each person, each asset and each expense has its own account.
• For the account debited in the journal, make an entry on the debit side of that account. In the particulars column write the word To followed by the name of the account that was credited in the journal entry.
• For the account credited in the journal, make an entry on the credit side of that account. In the particulars column write the word By followed by the name of the account that was debited in the journal entry.
• Write the date of the journal entry in the date column and the amount in the amount column.
• Write the journal page number in the J.F. column of the ledger and the ledger page number in the L.F. column of the journal.
• The words To and By have no meaning in themselves; they are only a convention marking the debit and credit sides.

Posting a compound entry. Each account in a compound entry is posted separately. In the entry Cash A/c Dr 28,000, Discount Allowed A/c Dr 500, To Nirmala's A/c 28,500, cash account is debited To Nirmala 28,000, discount allowed account is debited To Nirmala 500, and Nirmala's account is credited twice: By Cash 28,000 and By Discount Allowed 500. The credit side of Nirmala's account does not show a single entry of 28,500 By Sundries; each account is named so that the entry can be traced.

Posting the opening entry. Assets are posted on the debit side of their accounts as To Balance b/d and liabilities and capital on the credit side as By Balance b/d. The letters b/d stand for brought down.

Worked posting. Take the entry of Apr 3: Purchases A/c Dr 40,000; To Vijay's A/c 40,000.

Then the entry of Apr 9: Vijay's A/c Dr 2,000; To Purchase Returns A/c 2,000. Vijay's account gets To Purchase Returns 2,000 on the debit side; purchase returns account gets By Vijay 2,000 on the credit side. And Apr 15: Vijay's account gets To Bank 37,000 and To Discount Received 1,000 on the debit side; bank account gets By Vijay 37,000 on the credit side; discount received account gets By Vijay 1,000 on the credit side. Vijay's account now shows 40,000 on the credit side and 2,000 + 37,000 + 1,000 = 40,000 on the debit side; it is settled.

Posting should be done regularly, daily or weekly, so that the ledger is always up to date and the L.F. column shows which entries remain. Errors in posting, such as posting to the wrong side, the wrong account or the wrong amount, are the subject of the chapter on rectification of errors.

After posting, each ledger account has a number of entries on one or both sides. To know the net position of the account, it is balanced. Balancing means finding the difference between the total of the debit side and the total of the credit side and writing that difference on the smaller side so that both sides become equal. The difference is called the balance of the account.

Steps in balancing

• Total both sides of the account in pencil or in the margin.
• Find the difference between the two totals.
• Write the difference on the side with the smaller total, in the particulars column as To Balance c/d if it is on the debit side or By Balance c/d if it is on the credit side. The letters c/d mean carried down. Use the last date of the period.
• Now both sides are equal. Write the equal total on both sides on the same line and draw double lines under it.
• Bring the balance down to the opposite side below the totals as the opening figure of the next period: To Balance b/d on the debit side or By Balance b/d on the credit side, dated the first day of the next period. The letters b/d mean brought down.

Meaning of the balance

• If the debit total is larger, the account has a debit balance. The balance c/d is written on the credit side and is brought down on the debit side. Asset accounts, expense accounts, debtors' accounts and drawings have debit balances.
• If the credit total is larger, the account has a credit balance. The balance c/d is written on the debit side and brought down on the credit side. Liability accounts, capital, income accounts and creditors' accounts have credit balances.
• If both sides are equal, the account has nil balance; it is simply closed by totalling both sides. A supplier's account that has been fully paid shows nil balance.

Which accounts are balanced. Personal accounts and real accounts are balanced, because their balances show what is owed to or by persons and what assets exist; these balances go to the balance sheet. Nominal accounts are not balanced in the usual way; at the end of the year they are closed by transferring their totals to the trading account or the profit and loss account, and they begin the new year with nothing. During the year, for the purpose of the trial balance, the totals of nominal accounts are used as their balances.

Worked example: Cash Account of Lakshmi Traders for April

The debit side totals Rs 2,53,000 and the credit side Rs 1,53,000, so the balance of Rs 1,00,000 is a debit balance: cash in hand at the end of April. Cash account, being cash, can never have a credit balance; if it does, an error has been made. A bank account, on the other hand, can have a credit balance, which means an overdraft.

To see the whole process end to end, take a short set of transactions of Ramesh for May 2026, journalise them, post them and balance the accounts.

• May 1: Commenced business with cash Rs 50,000.
• May 3: Purchased goods for cash Rs 20,000.
• May 6: Sold goods to Sunil Rs 15,000.
• May 10: Purchased goods from Anil Rs 12,000.
• May 15: Received cash from Sunil Rs 15,000.
• May 20: Paid Anil Rs 12,000.
• May 25: Paid wages Rs 2,000.
• May 31: Sold goods for cash Rs 10,000.

Journal entries (in brief): May 1 Cash Dr 50,000 To Capital; May 3 Purchases Dr 20,000 To Cash; May 6 Sunil Dr 15,000 To Sales; May 10 Purchases Dr 12,000 To Anil; May 15 Cash Dr 15,000 To Sunil; May 20 Anil Dr 12,000 To Cash; May 25 Wages Dr 2,000 To Cash; May 31 Cash Dr 10,000 To Sales.

Ledger accounts

Reading the result. Cash in hand at the end of May is Rs 41,000 (debit balance). Capital is Rs 50,000 (credit balance). Purchases for the month total Rs 32,000 and sales Rs 25,000; these are nominal accounts, and their balances will go to the trading account. Sunil and Anil have nil balances, since one paid and the other was paid. The debit balances (41,000 + 32,000 + 2,000 = 75,000) equal the credit balances (50,000 + 25,000 = 75,000), which is the trial balance agreeing, the topic of a later chapter. Whenever the posting has been done correctly, this equality holds.

Most marks lost in journal and ledger questions come from a handful of recurring mistakes. Knowing them in advance is the best protection.

Errors in journalising

• Using the wrong account name for goods. Goods bought for resale are Purchases; goods sold are Sales; goods returned to a supplier are Purchase Returns (or Returns Outward); goods returned by a customer are Sales Returns (or Returns Inward). Never write Goods A/c.
• Confusing cash and credit. If the transaction says cash or cheque, use cash or bank account and do not use the person's name. If it names a person and says nothing about cash, it is credit and the person's account is used.
• Treating an asset purchase as goods. Furniture bought by a stationery shop is an asset; furniture bought by a furniture shop is goods. Ask what the business deals in.
• Mixing up trade and cash discount. Trade discount is deducted before recording and never appears; cash discount is recorded as discount allowed or received.
• Wrong side for discount. Discount allowed is a loss and is debited; discount received is a gain and is credited.
• Forgetting to compute the balance before full settlement. Deduct returns from the invoice before working out the discount.
• Personal expenses of the owner treated as business expenses. Income tax, life insurance premium and household purchases are drawings.
• Missing narration. Every journal entry needs a narration in brackets.
• Crediting sales for goods withdrawn, given as charity or lost. These are credited to purchases, at cost.

Errors in posting and balancing

• Posting to the wrong side: the account debited in the journal must receive the entry on its debit side.
• Writing the same account name in the particulars column. On the debit side of cash account, write To Sales, not To Cash.
• Opening a single account called Sundry Debtors when separate customers are named; each customer gets an account.
• Forgetting to bring the balance down; balance c/d must always be followed by balance b/d on the opposite side.
• Balancing nominal accounts as if they were assets; at year end they are transferred, not carried down.
• Leaving the folio columns blank, which loses the cross-reference marks in the exam and makes checking impossible in practice.

Precautions

• Read each transaction twice and underline the two accounts before writing.
• Keep a running mental total of the debit and credit columns; a difference means an entry is missing or wrong.
• Post in the same order as the journal so that nothing is skipped, ticking each journal line as it is posted.
• After balancing, list the balances and check that debit balances equal credit balances; if they do not, recheck the arithmetic before looking for a posting error.

A student who avoids these errors will find that the journal and ledger, once feared, become the easiest and most reliable marks in the paper.