In this article, you will learn:
Your business undertakes innumerable transactions during an accounting period. These transactions are recorded and then analysed in order to determine their impact on the financial position of the business.
Thus, accounting is a mechanism that involves collecting, recording, classifying, summarizing, presenting and interpreting financial information. Such information pertains to the economic transactions of the business.
Therefore, the accounting process starts with identifying events impacting the financial position of the business and the ones that can be measured in terms of money.
Then, such events are recorded in an organized manner in the original book of entry called the ‘Journal’.
Following this, these events or transactions are classified. Such classification is done in a manner that similar transactions pertaining to a person, thing, expense or any other aspect of business are grouped together under suitable accounts.
Further, golden rules of accounting pertaining to different types of accounts are applied in order to represent transactions in a T format.
These golden principles of accounting act as guidelines while recording transactions in the books of accounts. So, before examining these golden rules of accounting, let’s first get a glimpse of what are the different types of accounts.
Types of Accounts
Accounts are classified into following categories:
As the name suggests, Personal Accounts are the ones that are related with individuals, companies, firms, group of associations etc. Thus, these persons could include natural persons, artificial persons or representative persons.
Real Accounts are the ones that are related with properties, assets or possessions. Furthermore, these properties can be both physically existing as well as non physical in nature. Thus, Real Accounts can be of two types: Tangible Real Accounts and Intangible Real accounts.
Nominal Accounts relate to income, expenses, losses or gains. These include Wages A/c, Salary A/c, Rent A/c etc.
What are Golden Rules of Accounting?
The 3 Golden Rules of Accounting are the very basis that provide guidelines with regards to the manner in which transactions must be recorded in the books of accounts.
As per accounting rules, all business transactions must be recorded in the books of accounts of a business using the Double Entry System of accounting.
Accordingly, Double Entry System of Accounting means every business transaction involves at least two accounts. In other words, every business transaction has an equal and opposite effect in minimum two different accounts. So, for every debit, there is an equal and opposite credit.
What is Debit and Credit in Accounting?
The terms debit and credit are used to record every business transaction in accounting. Accordingly, the debit and credit basically indicate on which side of a particular account a business transaction needs to be recorded.
Thus, every account in a business transaction takes the format of letter T. Hence, these accounts are referred to as T – Accounts. This means that such accounts have a left and a right side that record increase or decrease in the particular item. So, this is done to know where each item stands at the end of the accounting period.
Thus, recording an amount on the left side of the account means debiting the account. Whereas, recording the amount on the right side means crediting the account.
Now, there are two approaches to decide whether the account needs to be debited or credited:
Under Modern Approach, business transactions are divided into five categories. These include transactions relating to:
- Owner – Example personal accounts like capital account
- Other Liabilities – Example personal accounts like suppliers
- Assets – Example real accounts like land, cash, building, inventory etc
- Expenses – Example nominal accounts like salary, wages, rent etc
- Revenues – Example nominal accounts like interest received, goods sold etc.
The following table gives a summary of how different types of accounts are debited or credited under Modern Approach using golden rules of debit and credit.
Under this approach, one needs to identify the account that gets impacted by a transaction as well as the type of account.
Following this, golden rules of accounting are applied to determine whether an account needs to be debited or credited. Thus, the golden rules of accounting are as under:
The following is an example that showcases golden rules of accounting with journal entries for Karan, who is a sole proprietor.
1. Karan started a business with Rs 10,00,000.
Accounts Involved: Cash – Real Account, Karan’ Capital – Personal Account
Effect of Transaction: Cash (asset) increases by Rs 10,00,000 and Capital (liability) increases by Rs 10,00,000.
2. Then, he deposited Rs 9,60,000 in Bank of Baroda.
Accounts Involved: Cash – Real Account, Bank of Baroda – Personal Account
Effect of Transaction: Cash at Bank (asset) increases by Rs 9,60,000 and Cash (asset) decreases by Rs 9,60,000.
3. In addition to this, he purchased Furniture worth Rs 6,00,000 and in return issued a cheque on the same day.
Accounts Involved: Bank – Real Account, Furniture – Real Account
Effect of Transaction: Furniture (asset) increases by Rs 6,00,000 and the Bank (asset) decreases by Rs 6,00,000.
4. Also, Karan Purchased Machinery for Rs 2,00,000 and paid an advance of Rs 30,000 to M/s Singhania
Accounts Involved: Machinery – Real Account, Cash – Real Account, Singhania – Personal Account
Effect of Transaction: Machinery (asset) increases by Rs 2,00,000, Cash (asset) decreases by Rs 30,000 and Creditors (liability) increases by Rs 1,70,000.
5. Then, Karan bought goods from M/s Khanna worth Rs 70,000.
Accounts Involved: Stock – Real Account, M/s Khanna – Personal Account
Effect of Transaction: Goods increase by Rs 70,000 and the Creditors (liability) increases by Rs 70,000.
6. Further, he sold goods worth Rs 50,000 to Bector Enterprises for Rs 60,000.
Accounts Involved: Stock – Real Account, Bector Enterprises – Personal Account, Karan’s Capital – Personal Account
Effect of Transaction: Debtors (asset) increased by Rs 60,000, Goods (asset) decrease by Rs 50,000 and Capital (Profit) increases by Rs 10,000.
|S.No.||Effect of Transaction||Account||Debit or Credit|