CHAPTER 7: DOUBLE ENTRY SYSTEM (RULES OF DEBIT AND CREDIT)

LEARNING OUTCOMES:

INTRODUCTION
RULES OF DEBIT AND CREDIT

MODERN APPROACH:
ASSET 
EXPENSE
LIABILITY
CAPITAL 
REVENUE

TRADITIONAL APPROACH:
PERSONAL
IMPERSONAL


INTRODUCTION

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Transactions are recorded in the books of accounts on the basis of double entry system.
This system is based on the principle of Dual aspect which states that every transaction has two aspects:
A debit and a credit of equal amount that is every debit must have a corresponding credit of equal amount in one or more accounts and vice versa.

Account is a summarised record of related transactions at one place under a particular head.
A separate account is maintained to record transactions relating to each person, asset liability, revenue, expense etc.

*All accounts are divided into two sides Debit and Credit.

Rules of Debit and Credit
From the point of view of recording transactions in an account, there are two approaches regarding such rules:
1. Modern approach ( or Accounting Equation approach or American system)

2. Traditional approach (British approach or English system)


Modern approach under this approach:

All the accounts are classified into five 'NATURE' :

Assets, Expense, Liabilities, Capital Revenue

1.Assets Account:
These accounts relate to various assets and properties of the business like
land and building ,furniture ,plant and machinery, stock, debtors, bills receivables, cash, bank, prepaid expenses, accrued incomes etc.

Rule : Debit- Increase in the amount of an Asset

Credit - Decrease in the amount of the Asset.
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2. Expenses Account:
These are the accounts of expenses and losses
like purchases, rent paid, discount allowed, wages, bad debts, salaries, carriage, repairs, loss on sale of fixed assets etc
.
Rule: Debit- Increase in the amount of expense or loss

Credit- Decrease in the amount of expense or loss

3.Liabilities Account:
These accounts relate to persons and parties to whom sums are payable by the business like that of lenders, creditors for goods, bills payable, outstanding expenses, bank loan, unearned income, bank overdraft etc.

Rule: Credit- Increase in the amount of the liability

Debit- Decrease in the amount of the liability

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4. Capital Account:
These accounts relate to the accounts of the proprietor or partners who have invested in the business. For example, capital account of owner, Capital accounts of partners and Drawings account.

Rule: Credit-Increase in the amount of the Capital

Debit- Decrease in the amount of the Capital

5.Revenue Accounts:
These are the accounts of revenue /incomes/profits like sales, interest received, discount received, bad debts recovered, commission received, miscellaneous receipts, rent received etc.

Rule: Credit- Increase in the amount of the revenue or income

Debit- Decrease in the amount of the revenue or income

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II.Traditional approach:

under this approach all the accounts are classified into the following two 'NATURE':
Personal accounts and Impersonal accounts.

Personal accounts :
Accounts which relate to an individual, firm, company or an institution are called personal accounts. For example account of Shyam or Shyam's account, account of M/s Kamal traders, bank account, capital account, drawings account,etc.

Rule: Debit The Receiver (account of the person who receives something from the business is debited)

Credit- The Giver (account of the person who gives something to the business is credited)

Classification of personal accounts:


Personal accounts can be classified into following three categories:

1. Natural personal accounts:
These are the account which relate to human beings. Such accounts are in the name of individuals. For example, Amit's account, Shyam's account, Mohits account etc. Capital and drawings of the proprietor also comes under this account.

2. Artificial personal accounts:
These are the accounts which relate to accounts of corporate firms or institutions which are regarded as persons in business dealings.
They are known as artificial personal accounts because they do not have physical existence like human beings for example account of Titan industries, account of M/s Kamal traders, account of St. Columba's School, account of LIC of India etc.

3. Representative personal accounts:
These are the accounts which represent a certain person or a group of persons. For example, if a firm has not paid salary to an employee then an outstanding salary account will be opened in the books which will represent the amount of salary payable to such employee.
Other examples of representative personal accounts are prepaid insurance account, accrued commission account, unearned interest account, etc.

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Impersonal accounts:

All those accounts which are not personal accounts are termed as impersonal accounts. For example , machinery account, rent account ,interest received account,etc.

Impersonal accounts can be further subdivided into two 'NATURE' of accounts:

1. Real Accounts:

Accounts relating to properties and assets owned by the business firm (excluding debtors) are known as Real Accounts. They include both tangible and intangible assets.
It should be noted that assets may be tangible or intangible but their value should be measured in terms of money.

Examples of Real Accounts:

Tangible assets : land and building, plant and machinery, furniture and fixtures, stock, cash in hand,etc. Intangible Assets: Goodwill, patents, trademarks, technical know-how, etc

Rule: Debit- what comes in (when any property comes into the business)

Credit- what goes out (when any property goes outside the business)

2.Nominal Accounts:
Accounts relating to expenses, losses, gains, revenue, etc are known as nominal accounts.
For example salary account ,rent account, purchase account, sales account, interest received account, discount allowed, bad debts,etc.
The net result of all the Nominal Accounts is Profit or Loss, which is transferred to the Capital Account.

Rule: Debit- All expenses and losses

Credit- All incomes and gains