Lesson 1, - Types & Ground Rules for Accounting
Introduction of the Host
Mrs.Geetha Dasaraty is a commerce graduate with a Masters in Business
Administration specialising in finance. Her stint with a Coimbatore based company and later with a consulting firm in Chennai has provided her with a decade of experience in project finance and appraisals, accounting and tax laws.
She is a freelance writer and money matters are her forte. She is currently pursuing her final course in Company Secretaryship and is doing a course on Vaishnavism.
She has a passion for literature and Carnatic music. She is also a violinist.
Types & Ground Rules for Accounting.
1. Methods of Accounting
2. Types of Accounts
3. About Debit and Credit
4. Ground Rules of Accounting
5. Glossary of a few Accounting terms.
1. Methods of Accounting
There are two systems for recording transactions.
1. Single Entry System
2. Double Entry System
Single Entry System - This is a simple method of recording transactions and hence is used by small traders. Here, only the cash and personal accounts are maintained, and hence is an incomplete and unscientific method, whose arithmetic accuracy cannot be vouched. This is not a very prevalent method.
Double Entry System - Double Entry system is the modern system of accounting which owes its origin to Pacioli, who lived in Italy in the 15th century.
The Double Entry system is an authentic one, because it recognizes the fact that there are two sides to a transaction. This system is widely prevalent.
2. Types of Accounts
Under Double Entry system, there are two types of accounts.
1. Personal Account
2. Impersonal Accounts
Impersonal Accounts are further subdivided into
a) Real Accounts b) Nominal Accounts.
Personal Accounts - These accounts relate to persons.
These may be -
a) Natural Persons, which means the name of an individual, either customers or suppliers.
b) Artificial persons or legal bodies, which means the accounts of firms, :Limited Companies, Educational Institutions and Banks.
c) Representative Personal Accounts, which are accounts representing outstanding and prepaid expenses and accrued or prepaid incomes.
Real Accounts - These are accounts that relate to the assets of the firm (excluding debtors). These may be tangible real accounts and intangible real accounts.
Assets that have a physical shape and can be felt are tangible real accounts.
Intangible real accounts are assets that cannot be touched like goodwill, copyrights etc.
Nominal Accounts or Revenue/Expenses Accounts:
These accounts relate to the expenses, losses, incomes and gains of the business. Examples are salaries account, rent account, telephone charges a/c, commission received etc.
3. About Debit and Credit:
Under the Double Entry System there are two aspects to every transaction.
The two aspects are:
a) Debit Aspect b) Credit Aspect.
Debit means, `Due for that' which depicts the benefit receiving aspect of a transaction. Credit means, `Due to that' and depicts the' benefit giving aspect' of a transaction.
Debit means -
- That the person has received some benefit for which he has already rendered services.
- In the case of goods or assets, that the stock and value has increased.
- That there is some loss or expense.
- Some benefit has been received in return for some benefit.
- In the case of goods and assets that the stock value or the asset value has decreased.
- In the case of other accounts, the firm has made a profit.
- That the money is owing to the firm.
- That there are assets worth the amount.
- That the firm has incurred loss or expense.
- That the money is owing to the person.
- That the firm has given up so much of assets.
- That there is an income earned.
By practice, the left hand side of an account is
the debit (Dr) side and the right hand side is the credit (Cr) side.
4. Ground Rules for Accounting -
The ground rules for recording entries under Double Entry System are:-
1. Personal Accounts -
Debit the receiver Credit
the giver
2. Real Accounts -
Debit what comes in Credit
what goes out
3. Nominal Accounts -
Debit all expenses and losses Credit all incomes and
gains
While writing the accounts the following rules
are to be followed:
1. Increases in assets have to be recorded on the left hand side (debit
side) and decreases on the right hand side (credit side).
2. Increases in Liabilities are to be recorded on the right hand side
(credit side) and decreases on the left hand side (debit side).
3. Increases in capital are to be recorded on the right hand side (credit
side) and decreases on the left hand side (debit side).
4. Increases in expenses are to be recorded on the left hand side (debit
side) and decreases on the right hand side (credit side).
5. Increases in incomes or gains are to be recorded on the right hand
side (credit side) and decreases on the left hand side (debit side).
6. Glossary of a few Accounting terms.
Assets
Assets are things of value owned by the organisation, which results in
cash or any other benefit in the future.
Capital
Capital means the amount in money terms, which the owner has invested
in the business. It is also known as equity owners or net worth.
Capital = Assets -Liabilities.
Liability
The debts, which are repayable to outsiders, are known as Liabilities.
Claims of persons other than the owners are known as liability.
Revenue
Revenue is the inflow of assets that result in an increase in the capital.
Income from sales, commission, interest, rent income etc.
Expense
Expense is the cost of the things or services used to produce income.
It is any amount spent to produce and sell goods and services that bring
revenue.
Debtor
A debtor is a person who owes money to the firm as a result of credit
sales to him.
Creditor
A creditor is a person to whom the firm owes money as a result of purchase
or any other benefit received.
Purchase
Purchase of goods means the buying of goods with the intention of resale.
It can be cash or credit purchase.
Sale
Sale of goods in the normal course of business is sale of goods. Sales
include cash and credit sales.