Source Document and Rules of Debit and Credit

Business transactions involve the exchange of economic consideration between parties and have two-fold effects recorded in two or more accounts. These transactions are evidenced by documents such as Cash Memos, Invoices, Sales Bills, Pay-in-slips, Cheques, Salary Slips, etc. A document that provides evidence of a transaction and on the basis of which entries are made in subsidiary books is called a Source Document or Voucher. These are also known as supporting documents.

Classification of Vouchers

Vouchers are classified into:

• Source / Supporting Vouchers: Documents evidencing transactions.
• Accounting Vouchers: Documents prepared by accountants to record debit and credit details before making entries in books of accounts.

Common Source Documents

• Cash Memo: Prepared by the seller when goods are sold for cash. It contains date, item details, quantity, rate, total amount, and terms of sale. Serves as evidence for both seller and purchaser.
• Invoice / Bill: Prepared when goods are sold on credit. Contains party details, date, items sold, quantity, rate, total amount, and terms of sale.
• Receipt Voucher: Prepared to record receipt of cash or cheque. Usually in duplicate; original given to payer, duplicate retained for records.
• Pay-in-Slip: Used for depositing cash or cheque into the bank, provided by the bank.
• Cheque: A negotiable instrument payable on demand, drawn on a bank to pay a specified amount.
• Debit Note: Prepared when a party’s account is to be debited, e.g., when goods are overvalued or returned.
• Credit Note: Prepared when a party’s account is to be credited, e.g., when goods are undervalued or returned.

Accounting Vouchers

Based on supporting vouchers, accountants prepare accounting vouchers before recording entries. Types include:

• Cash Voucher: Prepared for cash receipts or payments. Debit cash voucher for payments, credit cash voucher for receipts.
• Non-cash / Transfer Voucher: Prepared for non-cash transactions like credit sales, purchases, or rectifications. Simple transactions have one debit and one credit (Transaction Voucher). Complex transactions have multiple debits and credits (Complex / Journal Voucher).

Accounting Equation

The accounting equation expresses the relationship between assets, liabilities, and owner’s equity:

A = L + C

Where:

• A = Assets
• L = Liabilities
• C = Capital

This equation signifies that the assets of a business are always equal to the total of its liabilities and capital. Under the double entry system, every transaction affects this equation, maintaining its balance. It is also known as the Balance Sheet Equation.

Rules of Debit and Credit

To record transactions, it is essential to determine which accounts to debit and credit. Two approaches exist:

Traditional Approach

Accounts are classified as:

• Personal Accounts: Related to persons (customers, suppliers, proprietors). Subtypes include:

1. Natural Personal Accounts: Human beings.
2. Artificial (Legal) Personal Accounts: Business entities like companies, societies.
3. Representative Personal Accounts: Represent groups of persons, e.g., outstanding salary.

• Impersonal Accounts: Not personal, further divided into:

1. Real Accounts: Assets like building, cash, goodwill.
2. Nominal Accounts: Expenses, losses, incomes, gains like rent, dividend.

Golden Rules of Accounting (Traditional Method)

• Personal Account: Debit the receiver, credit the giver.
• Real Account: Debit what comes in, credit what goes out.
• Nominal Account: Debit all expenses and losses, credit all incomes and gains.

Modern Approach

Accounts are classified into five categories:

• Assets: Owned resources with debit balances (e.g., machinery, cash, debtors).
• Liabilities: Amounts owed to outsiders with credit balances (e.g., creditors, bank loans).
• Capital: Owner’s investment with credit balances.
• Revenue: Incomes and gains with credit balances (e.g., sales, dividends).
• Expenses: Business costs and losses with debit balances (e.g., salary, commission).

Fundamental Rules for Recording Changes

• Assets / Expenses (Losses): Increase is debited, decrease is credited.
• Liabilities / Capital / Revenues (Gains): Increase is credited, decrease is debited.

Key Terms

• Complex Voucher / Journal Voucher: Voucher for transactions with multiple debits and credits.
• Vouchers: Supporting (external/internal) and accounting vouchers (cash/non-cash).
• Cash Vouchers: Debit vouchers, pay-in-slip, credit vouchers.
• Non-cash Vouchers: Invoice, debit note, credit note.

Journal

The Journal is the book of original entry where business transactions are first recorded in chronological order. The process of recording is called journalising, and each entry is a journal entry.

Types of Journal Entries

• Simple Journal Entry: One debit and one credit of the same amount.
• Compound Journal Entry: One debit and two or more credits or vice versa.

Functions of Journal

• Analyzes transactions to determine debit and credit effects.
• Records transactions with brief narration starting with 'Being...' or 'For...'.
• Maintains chronological record for future reference.

Advantages of Journal

• Provides timely information as transactions are recorded in order.
• Narrations help understand the nature of transactions.
• Minimizes errors by recording both debit and credit aspects.
• Forms the basis for ledger posting.

Opening Entry

Opening entry records the opening balances of accounts transferred from the previous year. Assets appearing on the previous year’s balance sheet are debited, and liabilities are credited in the opening entry.