ACCOUNTING SYSTEM

It is stated that ‘an account is a summary of relevant transactions at one place relating to a
particular head’

All accounts are divided into two sides. The left side of an account is arbitrarily or traditionally
called Debit side and the right side of an account is called the Credit side.
The terms originated from the Latin terms "debere" or "debitum" which means "what is due";
and "credere" or "creditum" which means "something entrusted or loaned". Every transaction
has two aspects and each aspect has an account.

Double Entry Accounting System

Double entry system was introduced to the business world by an Italian merchant named Lucas
Pacioli in 1494 A.D. Though the system of recording business transactions in a systematic
manner has originated in Italy, it was perfected in England and other European countries
during the 18th century only i.e., after the Industrial Revolution. Many countries have adopted
this system today.
Double Entry Accounting System recognizes that every transaction has a dual effect. There are
two sides of every transaction. If one account is debited, any other account must be credited.
Every transaction affects at least two accounts in opposite directions. It may, however be
noted, that the double entry does not mean that a transaction is recorded twice. But it means
that at least two accounts are affected by a transaction one account receiving a benefit and
other account yielding a benefit. It is because of dual aspect principle that the two sides of the
Balance Sheet are always equal and the following accounting equation will always hold good at
any point of time.
Assets = Liabilities + Capital (or Net Worth)
Or
Capital (or Net Worth) = Assets – Liabilities
Whenever a transaction is to be recorded, it has to be recorded in two or more accounts to
balance the equation. If a transaction affects (increases or decreases) one side of equation, it
will also affect (increase or decrease) the other side of equation or increase one account and
decrease another account on the same side of equation. Equation remains balanced whenever
a transaction takes place. E.g. Mr. A commences a business with Rs. 5 Lacs in cash and takes a
loan of Rs 1 Lacs from bank, and this Rs. 6 Lacs are used in buying some assets say plant &
machinery, the equation will be as follows:
Assets = Liabilities + Capital
6 Lakh = 1 Lakh + 5 Lakh

ADVANTAGES OF DOUBLE ENTRY SYSTEM

This system affords the under mentioned advantages:

1. By the use of this system the accuracy of the accounting work can be established,
through the device of the trial balance.
2. The profit earned or loss suffered during a period can be ascertained together with
details.
3. The financial position of the firm or the institution concerned can be ascertained at the
end of each period, through preparation of the balance sheet.
4. The system permits accounts to be kept in as much details as necessary and, therefore
affords significant information for the purposes of control etc.
5. Result of one year may be compared with those of previous years and reasons for the
change may be ascertained.

It is because of these advantages that the system has been used extensively in all countries.
Classification of Accounts
Transactions can be divided into three categories.
• Transactions relating to individuals and firms- Personal Account
• Transactions relating to properties, goods or cash- Real Account
• Transactions relating to expenses or losses and incomes or gains-Nominal Account
Therefore, accounts can also be classified into Personal, Real and Nominal.

I. Personal Accounts: The accounts which relate to persons. Personal accounts include the
following.
a) Natural Persons: Accounts which relate to individuals. For example, Mohan’s A/c,
Shyam’s A/c etc.

b) Artificial persons: Accounts which relate to a group of persons or firms or institutions.

For example, HMT Ltd., Indian Overseas Bank, Life Insurance Corporation of India,
Cosmopolitan club etc.
c) Representative Persons: Accounts which represent a particular person or group of
persons. For example, outstanding salary account, prepaid insurance account, etc.
A business concern may keep business relations with all the above personal accounts, because
of buying goods from them or selling goods to them or borrowing from them or lending to
them. Thus they become either Debtors or Creditors.
The proprietor being an individual, his capital account and his drawings account are also
personal accounts.

II. Real Accounts: Accounts relating to properties and assets which are owned by the business
concern. Real accounts include tangible and intangible accounts. For example, Land, Building,
Goodwill, Purchases, etc.
III. Nominal Accounts: These accounts do not have any existence, form or shape. They relate to
incomes and expenses and gains and losses of a business concern. For example, Salary Account,
Dividend Account, etc.

Classify the following items into Personal, Real and Nominal Accounts.
1. Capital
2. Sales
3. Drawings
4. Outstanding salary
5. Cash
6. Rent
7. Interest paid
8. Indian Bank
9. Discount received
10. Building
11. Bank
12. Chandrasekar
13. Murugan Lending Library
14. Advertisement
15. Purchases

Golden Rules of Accounting

All the above classified accounts have two rules each, one related to Debit and one related to
Credit for recording the transactions which are termed as golden rules of accounting, as
transactions are recorded on the basis of double entry system.

Types of Account Account to be Debited Account to be Credited

Personal Account Receiver Giver
Real Account What comes in What goes out
Nominal Account Expense and losses Income and gains
From the following information, state the nature of account and state which account will be
debited and which will be credited.

1. Started business with a capital of 50,00,000

2. Wages and salaries paid
3. Rent received 2,00,000
4. Purchased goods on credit from Julie
5. Sold goods on credit

5. Sold goods for Rs. 16,000 and received payment in cheque.

Solution:

Transaction ACCOUNTS NATURE DEBIT OR CREDIT Journal Entry

INVOLVED
Started business Bank account Personal Debit (Receiver) Bank A/c Dr.
with capital of
50,00,000 Capital account Personal Credit (giver) To Capital A/c

Wages and salaries Wages/salaries Nominal Debit (expense) Wages/Salaries Dr.

paid
Bank Personal Credit (giver) To Bank A/c

Rent received Bank Personal Debit (Receiver) Bank A/c Dr.

Rent Nominal Credit (income) To Rent A/c

Purchases made on Purchases Nominal Debit (expense) Purchases A/c Dr.
credit
Creditor Personal Credit (giver) To Creditor A/c

Goods sold and Bank Personal Debit (Receiver) Bank A/c Dr.
payment received
in cheque Sales Nominal Credit (gains) To Sales A/c