ACCOUNTING PROCEDURES – RULES OF DEBIT & CREDIT

• Account is a record of transaction under a particular head. It records not only the amount of transactions but also their effect and direction.

• An account is divided into two parts , i.e. ,debit and credit. It is usually in a “T” form

• DEBIT & CREDIT

• Debit refers to the left side of an account and credit refers to the right side of an account.
• Dr describes receiving or incoming aspect
• Cr describes giving or outgoing  aspect.
• DR- asset side
• Cr- Liability side

• Accounts can be classified in two ways:

• Traditional Approach (English Approach)
•  Modern Approach (Accounting Equation Approach or American Approach)

CLASSIFICATION OF ACCOUNTS-

INTRODUCTION-

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.

Transactions can be divided into three categories.

 · Transactions relating to individuals and firms

 · Transactions relating to properties, goods or cash

 · Transactions relating to expenses or losses and incomes or gains. Therefore, accounts can also be classified into Personal, Real and Nominal. The classification may be illustrated as follows:

I. Personal Accounts:

The accounts which relate to persons. Personal accounts include the following.

(i) Natural Persons:

Accounts which relate to individuals. For example, Mohan’s A/c, Shyam’s A/c etc.

(ii) 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.

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. Impersonal Accounts:

 All those accounts which are not personal accounts. This is further divided into two types viz. Real and Nominal accounts.

(i) 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.

 (ii) 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.

   Rules of Debit & credit

We shall now see the application of these rules, taking a few transactions.

Example 1: Paid cash to Ramesh & Co. Rs. 5,000.

In this case, the two accounts affected are Ramesh & Co.’s Account and Cash Account. Ramesh & Co.’s Account is a personal account and Cash Account is a real account. Ramesh & Co. has received the benefit (cash Rs. 5,000) from the business and, therefore, it has to be debited as per the first part of the rule for personal accounts ‘debit the receiver’. As cash has gone out, Cash Account will be credited according to the second part of the rule for real accounts ‘credit what goes out’.

 Example 2: Received cash from Ajay Rs. 1,000.

 In this case, Cash Account and Ajay’s Account are the two accounts affected. Cash Account is a real account and Ajay’s account is a personal account. As cash has come in, Cash Account will have to be debited according to the first part of the rule for real accounts ‘debit what comes in’. Ajay has given the benefit (cash Rs. 1,000) to the business and, therefore, his account will have to be credited as per the second part of the rule for personal accounts ‘credit the giver’.

 Example 3: Paid rent Rs. 1,000.

In this case, the accounts affected are Rent Account and Cash Account. Rent Account is a nominal account and Cash Account is a real account. As per the first part of the rule for nominal accounts, ‘debit expenses and losses’, Rent Account will have to be debited as it is an expense to the business. As cash has gone out, Cash Account will have to be credited according to the second part of the rule for real accounts ‘credit what goes out’.

Example 4: Received Rs 400 as commission.

 In this case, Cash Account and Commission Account are the two accounts affected. Cash Account is a real account and Commission Account is a nominal account. As cash has come in, Cash Account will have to be debited according to the first part of the rule for real accounts ‘debit what comes in’. As per second part of the rule for nominal accounts, ‘credit incomes and gains’, Commission Account will be credited as it is an income to the business.

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MODERN APPROACH

• ASSETS ACCOUNTS
• LIABILITY ACCOUNTS
• CAPITAL ACCOUNTS
• REVENUE ACCOUNTS
• EXPENSE ACCOUNTS

ASSETS ACCOUNTS

Assets accounts are those accounts which relate to the economic resources of an enterprise such as Land & Building, Plant & Machinery, Furniture, Patents, Inventory, Bank and Cash, etc.

Rule of Debit and Credit –

Debit the increases

 credit the decreases

LIABILITY ACCOUNTS

Liability accounts are accounts of lenders, creditors for goods, outstanding expenses, etc

Rule of Debit and Credit-

Debit the decreases

Credit the increases

CAPITAL ACCOUNTS –

These are the accounts of proprietorship/ partners who have invested amount in the business. It includes both Capital and Drawings Account.

RULE OF DEBIT AND CREDIT-

Debit the increases

Credit the increases

REVENUE ACCOUNTS –

These are accounts of income and gains. Example are :

Sales, Discount received, Interest received, commission received, bad debts recovered, etc

RULE OF DEBIT AND CREDIT

Debit the decreases

Credit the increases

Expense Accounts

These are the accounts of expense or losses incurred in carrying the business. Example are : Purchases, wages, depreciation, discount allowed and rent, etc.

RULE OF DEBIT AND CREDIT

Debit the increases

Credit the decreases

What is Journal ?

• Journal is a book of accounts in which all day to day business transactions are recorded in a chronological order i.e. in the order of their occurrence. Transactions when recorded in a Journal are known as entries.
• It is the book in which transactions are recorded for the first time. Journal is also known as ‘Book of Original Record’ or ‘Book of Primary Entry’.
• Business transactions of financial nature are classified into various categories of accounts such as assets, liabilities, capital, revenue and expenses.
• Every transaction can be recorded in journal. This process of recording transactions in the journal is’ known as ‘Journalising’.

FORMAT OF JOURNAL ENTRIES

Journal entries are written as per a format stated below:

ENTRY FOR PURCHASE OF GOODS

• CASH PURCHASE
• CREDIT PURCHASE

Journal is of two types

Simple Journal entry

• A simple journal entry contains only one debit and one credit.

Compound journal entry

• If an entry contains more than one debit or credit or both, that entry is known as a compound journal entry.
• If an entry contains more than one debit or credit or both, that entry is known as a compound journal entry. Actually, a compound journal entry is a combination of two or more simple journal entries.

Thus, a compound journal entry can be made in the following three ways:

1. By debiting one account and crediting more than one account.
2. By debiting more than one account and crediting one account.
3. By debiting more than one account and also crediting more than one account

1. Bad debt

When a debtor fails to pay the full amount due to him, the unpaid amount is known as bad debt.

Dinesh was declared involvement & a payment of Rs. 60 paisa, in a rupee loan given to Dinesh 10,000.

Bad debt =[10,000×60/100] = ????. 6,000

2. Discount Allowed and Received

• To encourage a customer to pay the amount due before due date, discount is allowed. This is called cash discount.
• Trade discount is allowed by the wholesaler to retailer on List Price and is not recorded in the books of accounts.
• Bought goods for cash of L.P. Rs. 50,000 at 20% T.D. and 5% cash discount

Outstanding Expenses

Depreciation

Interest on capital