Welcome Friends, you are welcome to learnvern. I am Anshu Sachan.
In the last session we saw what the fundamental accounting assumptions are. Today we will be learning about the process of books of account. Where does it start from? We already know what the transaction is. We also know what a financial transaction is. Now, how would we record it, and where should we record it? Okay.
We need to record the transaction in the accounting ledger. Now, what is the ledger? Ledger is an account. All these accounts or ledgers together make a books of account. So, if we talk about ledger, then what is a ledger? It contains a record of transaction, which means, the transactions are recorded in the ledger and then they are bifurcated into separate income, expense, assets and liabilities. As I have told you, all the accounts can be divided into 4 distinct parts. The first one is Asset, another one is income, one is liabilities and other is expense. And based on these things, a ledger is created.
Now, what happens in a ledger. Suppose I made a transaction, there would be a minimum of 2 effects. Let's take an example for it, like the purchase of goods. We have purchased the material. Now, if we have purchased it in credit then the entry would be purchase expense debit to trade creditors. Here, we need to understand. That this trade creditor is related to the materials. Okay. Whenever there is a business, and we purchase a material, then it would be in trade creditors. So, in the same example, if we further divide it, then there is an entry of purchase debit to trade creditors. So, what is a purchase? It is our expense. And what are trade creditors? It is a liability. So there would be a different opening for purchase and a different ledger would open for trade creditors. You can also call it a secondary book. Meaning the starting point of the books of account.
We have decided the journal, we have also decided the account type. As this is a purchase, that means it is an expense, so it is a nominal account. Then the second one is, trade creditors, it would be a real account. If we fit it in the accounting rule, then you would know, expense is always debited, because expense is a nominal account. And what was the rule for the nominal? It was, expense, debit. And the second one is, trade creditors, credit.
What kind of account was a trade creditor here? It was a personal account. Now, what have we learned in the accounting rule? It was, credit the giver. Means the one who is supplying the product, we need to credit him. Okay. So what would be the entry? Purchase account debit to trade creditors. Now, we have seen the account type and also the accounting rule. Now what we will do with this is, we will post this in a particular ledger. But what is this particular ledger? If I say the particular ledger is a purchase account. Now, the purchase account is kind of a complete ledger of the purchase. In which, through the year, whatever purchase that we have made, the entries of it will be made there. The purchase debit and whatever the opposing part, either cash or creditor, will be credited there. Similarly, if the purchase has been returned, it means if I have purchased something and the purchase is not good, so I have returned it. Then that thing will also be reflected in the purchase ledger. Okay.
Furthermore, we will look at this. Look at your screen, you can see a picture. The ledger looks like this. This means that there are two things in this. First side is debit and then there is credit on the other side. If you look at the debit side then, there is a date then there is description, if there it is a general entry then there would be number and amount would be there. This is the part of debit. Similarly, there would be the part of credit right in front of it. It has the same things, date, descriptions and then number and amount. Here, what we need to do first is. If it is a debit then the entry that we will do is. Purchase debit, to trade creditors. So what will be the purchase account, or the purchase ledger. It would be debit. So we will write it on the side of the debit.
First we will write the date of the transaction impact, that is the date in which the transaction happened and in the description there would be the name of the account, you can see here in the ledger, that it is of the cash account. So, if there is a purchase account ledger then we will be writing the date first, then in the description, we will write the name of the opposing trade characters. In the amount, we will write the amount of the transaction that we have done. Suppose if it's 5k, then we will write 5k. Understood. In the similar manner, whenever the purchase account is debited then, the debit side is impacted, but remember that in description. We need to write the name of the opposing party. Suppose, that purchase was made in cash, then the entry would be a purchase account debit to cash in bank. Then here, what would be the name of the party in front? It will be cash in bank. Let me tell you, it is a simple way. In the debit ledger, whichever account is debited, then debit it in the same ledger. But in narration, we need to credit the party in front. Understanding me? You need to write the name of the opposing description.
Let's take another example, suppose wwe have paid the electricity expense, the entry would be of the electricity expense, or Torrent Power Limited, the company that supplies electricity to us, debit to cheque, means cash in the bank. So here the electricity expense would be a different ledger that will be created. In its debit side, the debt would be there, in the narration, the company that is supplying the power would be there. And also the amount would be there. Right. There you can also write the number of the check.
So, during the year, whatever such expenses that you have done, whatever income that you have made, how much ever asset that we have in our business and whatever liabilities are there in your business. An individual ledger would be made for all of them. Similarly, a debit and credit ledger would be made. In which if there is a purchase account, if the account gets debit then debit would be affected and the account that gets credited then the credit would get affected. Then ultimately, at the end of the year. All of the accounts get closed. Okay. This is called the closing of Ledger. Remember, we need to keep the opening and during the year, whichever transactions are there, we need to book them, and then there would be a closing for it. Okay.
Now, let's look at the methods for writing the account. What does method mean? How can you write the accounts? Now, if we say, there are two different methods of writing the account. The first one is, Cash Basis and the second one is Accrual Basis. Now what does the cash basis and accrual basis mean and who all can use these methods. If I talk about India, then there is a company law, that regulates the different companies. So they have said specifically, that whichever private limited companies, or listed companies are there, they cannot use the cash basis method. Okay. they have to compulsorily write their accounts using the accrual basis. Now, what does accrual basis mean?
Accrual basis depends on the insurance, like if there is your expense, then the moment that expense is incurred. Incurred means, it was made, it is a secondary matter as if you have made the payment or not. But that payment has been incurred. Your liability has been created and you need to make the payment of it. Then at that time I will book it. Let's take an example of a purchase.
I have made a purchase of goods for 15k. I have purchased the goods in credit and have not paid the money for the goods. So, if I am following the accrual basis of accounting, as on which methods I have prepared the books of account. Then that is an accrual basis, then the entry will be based on the invoice. The purchase invoice that has been made, my entry would be made on that basis. Purchase account debit to trade creditors. Now, when I will make a payment to the trade creditors after the completion of the 30 days credit period. Then there will be an entry of creditors to cash in bank. Understanding me?
It means the moment, the point at which the expense has been incurred then at that moment you have to book it. So, it is called accrual basis. Same thing happens with income. Suppose I made a sale to someone. Okay. And the payment of that I have asked him to be paid after 15 days. Because that was a daily customer or regular customer of ours. So what we have done is, we have provided him a credit term, to enhance my business. So what would be the entry? For that particular customer, his account would be debited. If you are not maintaining this then, you can also debiot the trade debtors. The entry would be trade debtors debit to sales account credit. Do you understand me? The moment you have raised the sales invoice or you have made a sales invoice, then it would at that time hit the sales account or sales ledger, on it's a debit side, sorry on its credit side. It is a sales ledger, so the entry would be trade debtors debit to sales ledger credit. What will happen in the sales ledger? It will go in the credit side and the name would be of that particular trade debtor.
In the similar fashion, a complete ledger for income, expense, assets and liability, will be made. So, as we say that the books of account are maintained on an accrual basis, then when the expenses are incurred then at that time it would be booked. And income when it is recognized, or the revenue when it is recognized then at that time, it would be booked. We won't be waiting for a time when the payment of the expense is made, or the receipt of the income is received. You would not be waiting for the payment receipt. The movement it is approved, the movement it is incurred, it would be written or recorded in the books of account. This is known as accrual basis. In India, it is compulsory for a company to maintain the books of account, on an accrual basis. Okay. Means, the complete books of account will be recorded on an accrual basis and even in the notes to account, they need to write the accounting policy, as the books of account are made on the accrual basis. This was everything about the accrual basis.
Now, the other one is cash basis. What happens in this is. The moment the payment is made, not when the expense is supposed to happen but when the expense is already done. But you made the payment of it after 30 days, then when the payment is made, then its booking will happen. Not when the expense is incurred, it would not be booked at that time. Getting me? In a similar manner. Receipt, when I will receive the money, in actuality on hand. Then its income would be booked, not when the sales invoice is raised. So, this was the difference between the accrual as it is based on the accrual basis and the cash is based on the receipt and payment basis. Now, who can maintain the accounts on a cash basis. Generally, except for a company, everyone can maintain it in this way, but it would depend on which kinds of transactions that your business has. If your business is small, it's on a smaller level, and you have also started it on a smaller level then you can use the cash basis, because in this method a complete account is maintained in cash and bank. Meaning, here we can assume we do the business on the cash basis, that we do not do a lot of business on a credit basis. Or if your business is as such that your business does not have a lot of credit period, everything happens on a cash basis.
For that, let's suppose a doctor. A doctor would never let you pay the money later. Whenever you go to a doctor, first you need to pay the fees of the case, then only the doctor would provide his service. Right? Same goes with the chartered accountant and the civil engineering. All of these are professionals. All of the professionals maintain their account on a cash basis. Generally whenever you see it in practical life also, you would find very few accounts, that are in the retail business and they work on a cash basis. Because what happens here is that, credit is one of the important parameters, one of the important elements of your retail business. Whereas, on the other hand, as I said, engineers, doctors and chartered accountants. What happens with them is, the receipt is made and then they provide their service. So, they can maintain their account on a cash basis.
Now comes a question, which one is better? Which is the best one? The one that will give you a proper result. If we look at it that way, then the accrual basis is better. Now the next thing, if you properly want to understand the accrual basis then you need to understand the 4 things. These things are; what are your trade debtors, what are other debtors; what are trade creditors; and what are other creditors. Why? As I said in the cash basis, the sales and purchase that we do, the main business activity. Suppose I am a doctor, okay. So,the case fees that I take, is my main income, it will be my sales and my main revenue. It is my main business activity, my main business income. Okay. what would be my expense, it would generally be the equipements, or if I called a third party doctor, or called an expert and paid their fees. So that can be my main expense. Okay.
According to the business activity, there you can record the income and expenses on a cash basis. But when I am talking about other debtors. What is the meaning of other debtors? It is apart from your business activity. Meaning you gave some money in advance to someone. Suppose your office is on rent, and you have paid the rent deposit. Okay? Then yes, you can book that. On which basis? On a cash basis. Okay. You can book the rent as you have already paid for it, and also as you have paid it in advance.
So here, you need to understand, trade debtors, are those debtors from which you have to take money, and that money you need to take related to the accounting activity. Other debtors means, apart from the activity, if you need to receive the money, as if you have paid advance to a staff member. Even when you go get an electricity connection, then at that time also, you need to pay a deposit. So what are all of these things? All of these things would be mentioned in the other debtors. You can maintain that. Similar to this are trade creditors, the business that you have, the suppliers related to that, if you have taken materials on credit from them. Then those will be in trade creditors. But if there is an expense, some money that you have spent and you are yet to repay it. Like, you are yet to pay the maintenance of the computer, AMC of the computer. Or you are yet to pay the electricity expense, it's March but the bill would be there in April. So, you are yet to pay for the expense, All of these would go in the other creditors. So, trade means related to your trade and other means related to other trades. Whenever you will be following the accounting method, whenever you will be following the accounting method. Then keep these two things in your mind. That on a cash basis, only trade debtors and trade creditors, are on payment and receipt basis. It does not happen, as there is an expense. Like other debtors and other creditors, that would be on a paid basis. Okay. As if there is a doctor, and he needs to pay his electricity bill. So, will it be recorded? Yes, it can be recorded at other expense. Okay.
These were our accounting methods and ledgers.
If you have any queries or comments……
In the next topic we will learn about the flowchart of the bookkeeping process. What is its starting point and where does it end?
Until then Thank You.
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