Diagnóstico Estratégico de la Formación Técnica en el Perú.

The left hand side of an account is called the debit side; while the right hand side is called the credit side. An entry on the left side of an account is called a debit entry, or merely a debit, an entry on the right side is called a credit entry or credit. The act of recording an entry on the left side of an account is called debiting the account; and recording an entry on the right side of an account is called crediting the account. The difference between the total debits and total credits is the account balance. Double entry system means the recording of both the aspects i.e. debit and credit.

GOLDEN RULES

Personal Accounts: ‘Debit the receiver and credit the giver’ Real Accounts: ‘Debit what comes in, and credit what goes out’ Nominal Accounts: ‘Debit all expenses and losses and credit all incomes and

gains’ Explanation:

Personal Accounts: ‘Debit the receiver and credit the giver’, i.e. debit the account of the person who receives something and credit the account of the person who gives something. For example, if you purchase goods from Ram on credit, the two accounts involved are Goods (Purchase) Account and Ram’s Account. The latter account is a personal account. Since, Ram is the giver in this transaction, his account will be credited. Similarly, if cash is paid to Ram, Ram’s Account will be debited since he is the receiver. Thus, the account of a person is debited with any benefit such person receives and is credited with any benefit such person imparts.

Real Accounts: ‘Debit what comes in, and credit what goes out’, i.e. debit the account of the thing which comes in and credit the account of the thing which goes out. For example, where furniture is purchased for cash, furniture account is debited while cash account is credited.

Nominal Accounts: ‘Debit all expenses and losses and credit all incomes and gains’ i.e. debit the accounts of expenses and losses and credit all incomes and gains. For example, if you pay salary to your clerk, the two accounts involved are salary account and cash account. Salary account is a nominal account. Salary paid is an expense of the business and therefore this account will be debited. Similarly if interest is received, interest account will be credited, since interest is an income item.

Significance of Debit and Credit (a) Debit in Personal Accounts

(i) If the account is new, debit implies that the person whose account is being debited has become debtor of the business.

(ii) If the account is already there and the person whose account is being debited is already a debtor of the business, the new debit implies that the sum due from that person has increased.

(iii) If the account of a person who is a creditor of the business is debited, the debit implies that the amount due to that person has decreased by the amount of debit. It is also conceivable that the creditor may become a debtor after the debit entry; it will happen when the amount of the debit exceeds the amount for which the person was a creditor immediately before the debit.

(b) Credit in Personal Accounts

(i) If the account is new, credit implies that the person whose account is being credited has become creditor of the business.

(ii) If the account of a creditor of the business is credited, it will mean that the amount which is due to that person has increased by the amount of the fresh credit. Credit in the account of a debtor of the business signifies that the amount for which the debtor was liable to the business has

diminished by the amount of the credit entry. It is also possible that a debtor may become a creditor after the credit.

(c) Debit in Real Accounts: A debit in real account means that either the value of the asset whose account is being debited has increased or the business has acquired more of that asset.

(d) Credit in Real Accounts: A credit in the real account implies that either the value of the asset whose account is being credited has decreased or the business has disposed of a part or the whole of the asset for the amount of the credit.

(e) Debit in Nominal Accounts: A debit in nominal account signifies that there has been an expense or loss of the amount of the debit or some income or profit has diminished by the amount of the debit. (f) Credit in Nominal Accounts: A credit in a nominal account implies that there has been an income or

a profit of the amount of credit or some expense or loss has diminished by the amount of the credit. IMPORTANT NOTE: ANALYSING TRANSACTIONS FOR RECORDING

If the three fundamental rules described above are kept in mind, it would be possible to record all the transactions correctly. Follow these simple steps to record all the transactions:

– Identify the two accounts involved in the transaction.

– Find out the type of account for both the accounts involved in the transaction. – Apply the rules of debit and credit.

For example, payment of salary is a transaction. It involves Salary Account and the Cash Account. Salary Account is a nominal account whereas the Cash Account is a real account. Salary is an Expense. Rule of Nominal Accounts says “Debit all expenses and losses”. So, Salary Account will be debited. Whereas rule of real accounts says credit what goes out. Here cash is going out. So, Cash Account will be credited

Illustration 1: From the following transactions, identify the nature of accounts involved and state which account will be debited and which account will be credited?

S. No. TRANSACTION ACCOUNTS

INVOLVED

TYPE OF ACCOUNT

DEBIT/ CREDIT

1. Mr. Anil started business with ` 60,000. Cash Account Capital Account Real Personal Debit (Incomings) Credit (Giver)

2. Purchased goods for cash ` 25,000. Purchases A/c Cash Account Real Real Debit (Incomings) Credit (Outgoings)

3. Sold goods for cash`20,000. Cash Account Sales A/c

Real Real

Debit (Incomings) Credit (Outgoings)

4. Purchased goods from Mr. Bansal for cash`10,000. Purchases A/c Cash Account Real Real Debit (Incomings) Credit (Outgoings)

5. Sold goods to Mr. Charles`8,000 on credit. Charles Sales A/c Personal Real Debit (Receiver) Credit (Outgoings)

6. Purchased furniture for ` 6,000 Furniture A/c

Cash Account Real Real

Debit (Incomings) Credit (Outgoings)

7. Paid rent`1,500 Rent Account Cash Account

Nominal Real

Debit (Expenses) Credit (Outgoings)

8. Paid wages Wages A/c

Cash Account

Nominal Real

Debit (Expenses) Credit (Outgoings)

9. Purchased goods from Ajit on credit Purchases A/c Ajit Real Personal Debit (Incomings) Credit (giver)

10. Dividend received Cash Account Dividend A/c Real Real Debit (incomings) Credit (Income)

11. Machinery sold Cash Account

Machinery A/c

Real Real

Debit (incomings) Credit (Outgoings)

12. Outstanding for salaries

Salaries A/c Outstanding Salaries A/c Nominal Personal A/c Debit (Expenses) Debit (Creditors)

ACCOUNTING EQUATION

All business transactions are recorded as having a dual aspect. At any point of time, a firm will possess things which may either be sold or converted into cash or which may be later used for a fairly long time. All these things are called assets. Building, land, machinery, furniture, stock, debtors, bills receivable, cash at bank, cash in hand etc. are a few examples of assets. The proprietor of the business brings capital into the business out of which the business (a separate entity) purchases assets for its use. Thus, the amount of the assets of a business is equal to the amount of capital contributed by the proprietor of the business. Thus, Capital = Assets.

In case the capital contributed by the proprietor is insufficient, the business takes borrowing from other parties or outsiders. These parties may give loan or allow credit facilities at the time of purchase of goods. The money which is owed to outsiders and which has to be paid, sooner or latter are called liabilities. For example: Loans, Bank Overdraft, Creditors, Bills Payable, and Outstanding Expenses etc. On the one hand, the loan given by the outside parties increases the assets of the business, on the other hand, claims of creditors and lender of money on the assets of the business increase.

Hence, the sum of resources (assets) = obligations (capital + liabilities) Therefore, Capital + Liabilities = Assets; or

Capital = Assets — Liabilities.

This equation is known as accounting equation. This equation is based on the concept that for every debit, there is an equivalent credit. The entire system of double entry book-keeping is based on this concept.

Example: Suppose A starts a business with a capital of ` 50,000, immediately the firm will have ` 50,000 as cash as asset and at the same time the firm will owe to the owner`50,000 which is taken as the proprietor’s capital. Thus,

Capital (`50,000) = Assets`50,000 (Cash).

If the firm purchases furniture worth`10,000 out of the money provided by A, the situation will be: Capital (`50,000) = Cash (`40,000) + Furniture (`10,000).

Subsequently, if the business borrows`15,000 from a bank, the position will be as follows:

Capital (`50,000) + Bank loan (`15,000) = Cash (`55,000) + Furniture (`10,000).