Golden Rules for Journal Entry
There are two ways either learn and understand golden rules properly or shortcut. i am going to tell you both.
Golden rules- there are three golden rules and you need to keep them in mind while doing a/c because every transaction depends on these rules.
- Debit the Receiver and Credit the Giver
This principle is used in the case of personal accounts. When a person gives something to the organization, it becomes an inflow and therefore the person must be credit in the books of accounts. The converse of this is also true, which is why the receiver needs to be debited.
for eg- Goods worth 1000 bucks sold to Mr. Smith from Mr. John. In this transaction, Mr. Smith is the receiver of goods, he is called receiver and his account is to be debited in the books of business. Mr. John is the giver of goods, he is called giver and his account is to be credited in the books of business.
2. Debit What Comes in and Credit What Goes out
This principle is applied in case of real accounts. Real accounts involve machinery, land and building etc. They have a debit balance by default. Thus when you debit what comes in, you are adding to the existing account balance. This is exactly what needs to be done. Similarly when you credit what goes out, you are reducing the account balance when a tangible asset goes out of the organization.
for eg-Goods sold on cash for 1500 bucks. In this transaction cash, an assets for business comes into the business on sales of goods, and therefore cash account is to be debited in the books of business. On the other side, goods, an assets of business goes out of the business on sale and therefore goods account(or sales a/c) is to be credited in the books of business.
3. Debit all Expenses or Loss and Credit all Income Gains or Profit
This rule is applied when the account in question is a nominal account. The capital of the company is a liability. Therefore it has a default credit balance. When you credit all incomes and gains, you increase the capital and by debiting expenses and losses, you decrease the capital. This is exactly what needs to be done for the system to stay in balance.
for eg- Paid 50 bucks as a commission to our agent, here commission which is paid to an agent is business expense and it is to be debited in the books of business. (2) Received 100 bucks as interest on our fixed deposit, here interest which is received is business income and therefore it is to be credited in the books of business.
to make you understand i am going to provide a simple eg.
for eg- sold goods worth rs 5000
here cash is increasing( cash is consider asset for business) debit cash a/c whereas goods are decreasing(goods are also consider as assets) so credit goods a/c( or better to say sales a/c). your j.e will be-
cash a/c dr 5000
to sales a/c 5000
First of all
1. when assets increase then they are debited and when they decrease they are credited.
2. when liabilities increase they are credited and when they decrease they are debited.
Thereafter come the golden rules of journal entries.
Three rules of journal entries...
1. Assets - like cash, goods, furniture etc. then "debit what comes in and credit what goes out of business" e.g. if u purchase furniture for cash then furniture comes in and cash goes out so the entry is like
Furniture A/c Dr.
To cash A/c
2. Persons - like names, banks, companies (artificial persons) etc. then "debit the receiver and credit the giver" e.g. if u hv purchased goods from xyz on credit then
Purchase a/c dr. (goods are represented by purchase a/c,
sales a/c and when they come in then
purchase a/c will be debited)
To xyz (credit the giver)
if u sale furniture to abc for credit then
Abc dr. (debit the receiver)
To Furniture a/c (credit what goes out)
3. Profits, losses, incomes and expenses - these hv an impact on the capital a/c which is related to liabilities side so expenses and losses are debited whereas profits and incomes are credited e.g. payment of electricity bill of ur shop..
Electricity a/c dr. (expenses are debited)
To cash a/c (credit what goes out)
if u hv earned interest on investments as income and got it in cash...
cash a/c dr. (debit what comes in)
To interest a/c (credit the incomes)
Journal entry is said To be books of original entry. Its very easy to create since you need basic knowledge of golden rules.
- Debit the receivers, credit the giver.
- Debit what comes in , credit what goes out
- Debit all expenses and losses ,credit all incomes and gains .
Example
The format for journal entry is
Account to be debited. Dr.
To account to be credited.
Bookkeeping – Definition, Importance, Types & Methods
5 What is bookkeeping and why is it important?
Bookkeeping is the process of recording your company’s financial transactions into organized accounts on a daily basis. It can also refer to the different recording techniques businesses can use. Bookkeeping is an essential part of your accounting process for a few reasons. When you keep transaction records updated, you can generate accurate financial reports that help measure business performance. Detailed records will also be handy in the event of a tax audit.
This guide will walk you through the different methods of bookkeeping, how entries are recorded, and the major financial statements involved.
Methods of bookkeeping
Before you begin bookkeeping, your business must decide what method you are going to follow. When choosing, consider the volume of daily transactions your business has and the amount of revenue you earn. If you are a small business, a complex bookkeeping method designed for enterprises may cause unnecessary complications. Conversely, less robust methods of bookkeeping will not suffice for large corporations.
With this in mind, let’s break these methods down so you can find the right one for your business.
Single-entry bookkeeping
Single-entry bookkeeping is a straightforward method where one entry is made for each transaction in your books. These transactions are usually maintained in a cash book to track incoming revenue and outgoing expenses. You do not need formal accounting training for the single-entry system. The single-entry method will suit small private companies and sole proprietorships that do not buy or sell on credit, own little to no physical assets, and hold small amounts of inventory.
Double-entry bookkeeping
Double-entry bookkeeping is more robust. It follows the principle that every transaction affects at least two accounts, and they are recorded as debits and credits. For example, if you make a sale for $10, your cash account will be debited for $10 and your sales account will be credited by the same amount. In the double-entry system, the total credits must always equal the total debits. When this happens, your books are “balanced.”
Using the double-entry method for bookkeeping makes more sense if your business is large, public, or buys and sells on credit. Enterprises often choose the double-entry system because it leaves less room for error. In a way, it ‘double-checks’ your books because each transaction is recorded as two matching but offsetting accounts.
Cash-based or accrual-based
The next step is choosing between a cash or accrual basis for your bookkeeping. This decision will depend on when your business recognizes its revenue and expenses.
In cash-based, you recognize revenue when you receive cash into your business. Expenses are recognized when they are paid for. In other words, any time cash enters or exits your accounts, they are recognized in the books. This means that purchases or sales made on credit will not go into your books until the cash exchanges.
In the accrual method, revenue is recognized when it is earned. Similarly, expenses are recorded when they are incurred, usually along with corresponding revenues. The actual cash does not have to enter or exit for the transaction to be recorded. You can mark your sales and purchases made on credit right away.
Both a cash and accrual basis can work with single- or double-entry bookkeeping. In general however, the single-entry method is the foundation for cash-based bookkeeping. Transactions are recorded as single entries which are either cash coming in or going out. The accrual basis works better with the double-entry system.
How to record entries in bookkeeping
Generating financial statements like balance sheets, income statements, and cash flow statements helps you understand where your business stands and gauge its performance. For these reports to portray your business accurately, you must have properly documented records of your transactions. Keeping these records as current as possible is also helpful when reconciling your accounts.
Recording transactions begins with source documents like purchase and sales orders, bills, invoices, and cash register tapes. Once you gather these documents, you can record the transactions using journals, ledgers, and the trial balance. If you are a very small company, you may only need a cash register. The information can then be consolidated and turned into financial statements.
Cash registers
A cash register is an electronic machine that is used to calculate and register transactions. Usually, cash registers are used to record cash flow in stores. The cashier collects the cash for a sale and returns a balance amount to the customer. Both the collected cash and balance returned are recorded in the register as single-entry cash accounts. Cash registers also store transaction receipts, so you can easily record them in your sales journal.
Cash registers are commonly found in businesses of all sizes. However, they aren’t usually the primary method of recording transactions because they use the single-entry, cash-based system of bookkeeping. This makes them convenient for very small businesses but too simplistic for enterprises.
The journal
The journal is called the book of original entry. It is the place where a business chronologically records its transactions for the first time. A journal can be either physical (in the form of a book or diary), or digital (stored as spreadsheets, or data in accounting software). It specifies the date of each transaction, the accounts credited or debited, and the amount involved. While the journal is not usually checked for balance at the end of the fiscal year, each journal entry affects the ledger. As we’ll learn, it is imperative that the ledger is balanced, so keeping an accurate journal is a good habit to keep. This form is useful for double-entry bookkeeping.
The ledger
A ledger is a book or a compilation of accounts. It is also called the book of second entry. After you enter transactions in a journal, they are classified into separate accounts and then transferred into the ledger. These records are transcribed by accounts in the order: assets, liabilities, equity, income, and expenses. Like the journal, the ledger can also be physical or electronic spreadsheets.
A ledger contains a chart of accounts, which is a list of all the names and number of accounts in the ledger. The chart usually occurs in the same order of accounts as the transcribed records.
Unlike the journal, ledgers are investigated by auditors, so they must always be balanced at the end of the fiscal year. If the total debits are more than the total credits, it’s called a debit balance. If the total credits outweigh the total debits, there is a credit balance. The ledger is important in double-entry bookkeeping where each transaction changes at least two sub-ledger accounts.
Trial balance
The trial balance is produced from the compiled and summarized ledger entries. The trial balance is like a test to see if your books are balanced. It lists the accounts exactly in the following order: assets, liabilities, equity, income, and expenses with the ending account balance.
An accountant usually generates the trial balance to see where your business stands and how well your books are balanced. This can then be cross-checked against ledgers and journals. Imbalances between debits and credits are easy to spot on the trial balance. It is not always error-free, though. Any miscalculated or wrongly-transcribed journal entry in the ledger can cause an incorrect trial balance. It is best to look out for errors early, and correct them on the ledger instead of waiting for the trial balance at the end of the fiscal year.
Financial statements
The next, and probably the most important, step in bookkeeping is to generate financial statements. These statements are prepared by consolidating information from the entries you have recorded on a day-to-day basis. They provide insight into your company’s performance over time, revealing the areas you need to improve on. The three major financial reports that every business must know and understand are the cash flow statement, balance sheet, and income statement.
The cash flow statement
The cash flow statement is exactly what its name suggests. It is a financial report that tracks incoming and outgoing cash in your business. It allows you (and investors) to understand how well your company handles debt and expenses. By summarizing this data, you can see if you are making enough cash to run a sustainable, profitable business.
The balance sheet
The balance sheet reports a business’ assets, liabilities, and shareholder’s equity at a given point in time. In simple words, it tells you what your business owns, owes, and the amount invested by shareholders. However, the balance sheet is only a snapshot of a business’ financial position for a particular date. It must be compared with balance sheets of other periods as well. The balance sheet allows you to understand the liquidity and financial structure of your business through analytics like current ratio, asset turnover ratio, inventory turnover ratio, and debt-to-equity ratio.
The income statement
The income statement, also called the profit and loss statement, focuses on the revenue gained and expenses incurred by a business over time. There are two parts in a typical income statement. The upper half lists operating income while the lower half lists expenditures. The statement tracks these over a period, such as the last quarter of the fiscal year. It shows how the net revenue of your business is converted into net earnings which result in either profit or loss. The income statement does not focus on receipts or cash details.
Bank reconciliation
Bank reconciliation is the process of finding congruence between the transactions in your bank account and the transactions in your bookkeeping records. Reconciling your bank accounts is an imperative step in bookkeeping because, after everything else is logged, it is the last step to finding discrepancies in your books. Bank reconciliation helps you ensure that there is nothing amiss when it comes to your money.
Why is it mandatory?
Bank reconciliation is a must because it:
- Provides the exact financial situation of your company
- Tracks cash flow accurately
- Helps detect fraud or bank errors
Stay on top of your bookkeeping
Proper bookkeeping drives your company to success. It is a foundational accounting process, and developing strategies to improve core areas of your business would be nearly impossible without it. Yet as important as bookkeeping is, implementing the wrong system for your company can cause challenges. Some companies can still use manual methods with physical diaries and paper journals. However, as technology gets more and more advanced, even smaller companies could get benefits from going digital. This is where a cloud bookkeeping solution like Zoho Books comes in.
Zoho Books helps you keep accurate records of your business finances. It provides quicker and easier solutions for cash management, accounts payable/receivable, bank reconciliation, and generating financial statements. Further, its built-in automation takes care of mundane accounting tasks and helps you focus more on your business. Try our bookkeeping software for free and see how it can help your business maintain perfect bookkeeping records.
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