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ES-2 - Lesson 5
ES-2 - Lesson 5
Lesson 5. TYPES OF ACCOUNTS AND RULES FOR DEBIT AND CREDIT
FINANCIAL MANAGEMENT & COST ACCOUNTING
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Module 2. Accounting procedure
Lesson 5
TYPES OF ACCOUNTS AND RULES FOR DEBIT AND CREDIT
5.1 Accounting Mechanics: The Double Entry System
5.1.1 Taccounts (or Ledgers)
5.3 The Accounting Procedure
5.4 Some Basic Terminology used in Accounting
5.1 Accounting Mechanics: The Double Entry System
Today's accounting system is based on the double entry system developed in the 15th Century by Lucas pocioli, a fransican monk. The
double entry system is based on the basic premise that
Total liabilities = Total Assets
Or
(Owner’s capital + outsider's funds) = Total Assets
It states that each and every financial transaction that takes place in a business organization has two aspects (or two effects which are equal
and opposite). For example if furniture is purchased by cash, then furniture account increase but at the same time cash decreases by the
same amount. “A dual entry system of accounting is defined as the system which recognizes and records both the aspects of transactions."
5.1.1 Taccounts (or Ledgers)
A given financial transaction has two aspects and it is bound to affect two concerned accounts. The entries in the given account are made in
a "t" – account. It consists of two sides left side and right side. The left side is called debit side and the right side is called credit side.
Making an entry on the left side of taccount is called debiting the account, and in the same way making an entry on the right side of t
account is called crediting the account.
Table 5.1 A typical 'T' account is shown below
Dr. Cr.
Amt.
Date Particulars J.F. Date Particulars J.F. Amt. (Rs.)
(Rs.)
J.F. – refers to the page number of the journal at which the transaction is recorded
(J.F =Journal Folio)
Up to this point, it is understood that in double entry system, a given transaction affects two accounts. Out of the given two accounts one a/c
is to be debited and the other a/c is to be credited (by the same amount).In order to decide whether the account is to be debited or credited
depends upon which type of account it is.
There are three types of accounts – Personal, Real and Nominal. The rules regarding Dr and Cr these accounts are given below
1. Personal Accounts
The accounts of all those persons organizations / entities from whom the company has either to receive money or has to pay money, are
called personal accounts.
2. Real Accounts
The firm also owns property like land, building, plant and machinery, stock, cash etc. The accounts of various assets or property
acquired by the firm, are classified as Real account.
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3. Nominal Accounts
The accounts of various items which represent either income and gain or expenses and loss of the firm are nominal accounts. For
example accounts of rent, wages, salary, telephone bills are classified as nominal accounts. Similarly dividend received a/c. interest
earned a/c, commission a/c are also nominal accounts.
Table 5.2 Rules for Debit and Credit
Document used to Record (or capture) the details of a given transaction are:
1. Payment Voucher.
A payment voucher records all the details of a particular transaction whenever a payment is made by the company. A payment voucher
is a standard form and contains all details of the payment being made. For example, when an expense is incrcurred, the supplier sends a
bill which is to be paid. The account department prepares a payment voucher for that bill, and then makes a payment.
2. Receipts on Money Receipt
Whenever the company receives cash/cheque etc from any person / organization, then it gives a receipt to the person / organization. This
receipt contains all relevant data of the transaction, such as date, amount, name of person, particulars, etc.
3. Journal Voucher
A journal voucher is used to record all the residual transactions. An internal transaction of the company which does not involve cash
receipt or cash payment is to be recorded in a journal voucher.
5.3 The Accounting Procedure
The objective of accounting is to record cash and Credit transaction of the firm and after proper treatment, preparing the final accounts of
the firm. The steps which are followed in accounting to accomplish goal are –
1. Recording of all business transaction in a primary book called journal.
2. All the entries of the journal must be then posted to appropriate ledgers. It is called ledger – posting.
3. All the ledgers are then balanced and their balances ascertained.
4. Preparation of final accounts – Trading a/c, P and L a/c and Balance sheet from the trial balance.
5.4 Some Basic Terminology used in Accounting
1. Cash Basis of Accounting
It is one of the two main methods of accounting (Cash basis and Accrual basis). In this method the entire accounting is done by
considering cash transactions only – i.e. all the income are recognized as income such as accrued income, income generated but not
received etc are ignored. Another example is – sales is recognized not at the point of sale but at the time when cash is received.
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Similarly all expenses are recognized as an expenses only if actual cash is paid. Therefore accrued expense, prepaid – expense etc do not
have any place in cash basis of accounting.
Used by
This system of accounting is generally used by individuals like doctors, lawyers engineers, brokers, small traders etc.
Advantages
It is simple method. It avoids the difficulties of accounting adjustments at the close date (i.e. at end of accounting year)
Disadvantages
These systems can not accurately reveal the profit / loss during a given accounting period.
2. Mercantile Basis of Accounting (Accrual Basis)
This method is commonly used by business concerns. All incomes are recognized as incomes of the particular year in which they were
generated (irrespective of the fact whether cash was received or not). Similarly all expenses are charged to the period in which they
relate (irrespective of the fact that whether cash has been actually paid or not). for ex. – in accrual basis of accounting – if sales are
made at the last day of accounting period, but the cash is not received, (it is expected to be received after 20 days) then, such a
transaction, the sale is considered to be of the earlier year (irrespective of the fact whether cash has been received or not).
Similarly, if expenses are incurred this year, but the cash is to be paid in next accounting year, then also, it is to be considered as an
expense of this year only (because the particular expense relates to this year only and not to any other year !)
Thus, from the above it can be seen that, the accrual basis of accounting strictly follows the accounting period concept. It has the ability
to accurately reveal, the profit / loss incurred during a given accounting period. This is so because it considers each and every income
pertaining to the particular accounting year (irrespective of the fact whether cash is received or not).This system of accounting requires
the adjustments at the end of accounting period. It produces the final accounting which exhibits a true and fair view of the state of
affairs.
3. Transaction
A business transaction means exchange of benefits (or value) between two persons / (entities). It arises out of exchange of goods /
services. It has dual aspects – Receiving and giving the benefit.
Cash Transaction
A transaction which involves immediate payment (or Receipt) of cash, is called cash transaction.
Credit Transaction
For example when goods worth Rs. 2000 are sold on credit to Mr. Rajesh, then in such a case, Mr. Rajesh does not immediately pay
cash to the firm. Such a transaction (buying or selling) in which the receipt of cash is postponed to a future date is a credit transaction.
A simple accounting entry, involving cash transaction :
Transaction : “Purchased Rs. 500 worth stationery by paying cash”
Rewriting the rules of debit and credit –
Personal a/c Debit the Receiver Credit the giver
Real a/c Debit what comes in Credit what goes out
Nominal a/c Debit all expenses and losses Credit all incomes and gains
In the above transaction, the company receives. Stationery worth Rs. 500 (so stationery increases) but at the same time cash reduces by Rs.
500.
Attempting a very simple accounting entry, by following the rules stated above. We come to know that –
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A dual entry system involves two affected accounts, one account is debited and other is credited by the same account. (But for that which
account should be debited and which should be credited, we have to look at the above given rules).
Similarly, In an accounting entry, if the transaction was on credit (i.e. it did not involve immediate payment of cash, but cash payment was
postponed to a future date).
The transaction becomes:
“Purchased stationery worth Rs. 500, on credit, from “Mahavir Stationery Stores”. one thing is certain from the above, that stationery a/c
(stationery comes in), is a real a/c; and it will be debited.
Stationery a/c Real a/c Comes in Stationery a/c Debited
But, now another account, has to be credited by the same amount i.e. Rs.500. (But which account?). In case of a cash transaction, we
identified that cash a/c was the relevant account, and as cash decreased by Rs.500, the rule followed was :
Cash account (real account) Goes out cash a/c should be credited.
But in case of a credit transaction; one thing is sure that stationery a/c is to be debited but the other account to be credited is that of the
‘’supplier’’.
Credit Transactions are mainly of two types –
1. Credit Purchase
2. Credit Sales
Credit Purchase
In credit purchases, the company has taken the benefit (goods / services etc) but the company owes money to the concerned supplier. And
the accounts persons/entities organizations to which the company owes money are credited. (Moreover these persons are called creditors of
the company)
In our case,
CREDIT PURCHASE
Received by company
Stationery Mahavir Stationery Stores
From the above diagram, it is clear that,
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Credit Sales
It means the sales of goods has been made to the customer but he will make the payment within the credit period..
CREDIT SALES
Company (Seller) Mr. Joseph (Buyer)
In credit sales (by the company) to a buyer Mr. Joseph, Mr. Joseph owes money to the company. Always, the accounts of persons / entities /
organizations, who owe money to the company, i.e. the company has to receive money from them, are debited. They are also called the
Debtor of the company
From the above diagram, it is clear that,
Joseph’s a/c Personal a/c receiver Debit
Sales a/c Real a/c Goes out Credit
Last modified: Wednesday, 15 May 2013, 11:09 AM
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