RULES OF DEBIT AND CREDIT
DEBIT is another name for the Left-hand side of all types of accounts.
CREDIT is another name for the Right-hand side of all types of accounts.
Whether you make a T account or follow the standard format of Ledger Account the Debit amounts will be written on the left side and Credit amounts will be written on the right side.
As the normal balance of an account is usually:
DEBIT for Asset Accounts
CREDIT for Liability Accounts
CREDIT for Equity Accounts
CREDIT for Revenue / Sale Accounts
DEBIT for Expense / Cost Accounts
Therefore,
A Debit Entry in Asset Account signifies INCREASE
A Debit Entry in Liability Account signifies DECREASE
A Debit Entry in Equity Account signifies DECREASE
A Debit Entry in Revenue Account signifies DECREASE
A Debit Entry in Expense Account signifies INCREASE
And accordingly,
A Credit Entry in Asset Account signifies DECREASE
A Credit Entry in Liability Account signifies INCREASE
A Credit Entry in Equity Account signifies INCREASE
A Credit Entry in Revenue Account signifies INCREASE
A Credit Entry in Expense Account signifies DECREASE
In other words, we may also say, that in case a business transaction has an effect of increase in an asset account, then the amount should be placed to its Debit side (Left-hand side). Accordingly, follow the above mentioned rules for other types of accounts.
For any business transaction, minimum two accounts are affected, so you must Debit one account and Credit one account.
The above rules for Debit and Credit can also be understood in another way.
For all REAL Accounts
Debit what Comes-in
Credit what Goes-out
For all PERSONAL Accounts
Debit the Benefit Receiver
Credit the Benefit Giver
For all NOMINAL Accounts
Debit all Expenses / Cost / Losses Accounts
Credit all Revenue / Sale / Income Accounts
Monday, February 8, 2010
DOUBLE-ENTRY ACCOUNTING
DOUBLE-ENTRY ACCOUNTING
Keeping in mind the basic accounting equation, we may say that each business transaction has two way effect (double effect) on the financial position of the business. In other words, a business transaction is recorded as a Debit entry in one account and a Credit entry in another account. So recording of the double effect of a transaction is called Double-entry Accounting.
Although the double entry system of accounting was prevalent even before the fifteenth century AD, it was described by an Italian mathematician in his book published in 1494 AD. The systems and procedures described in this book have since been further developed.
The basic accounting equation has been based upon this Double-entry system of Accounting.
Any business transaction will record the Debit as
Increase in Asset Account
Decrease in Liability Account
Decrease in Owner’s Equity Account
Increase in Expense Account
Decrease in Revenue Account
And the same transaction will record the Credit as
Decrease in another Asset Account
Increase in a Liability Account
Increase in Owner’s Equity Account
Decrease in an Expense Account
Increase in a Revenue Account
Keeping in mind the basic accounting equation, we may say that each business transaction has two way effect (double effect) on the financial position of the business. In other words, a business transaction is recorded as a Debit entry in one account and a Credit entry in another account. So recording of the double effect of a transaction is called Double-entry Accounting.
Although the double entry system of accounting was prevalent even before the fifteenth century AD, it was described by an Italian mathematician in his book published in 1494 AD. The systems and procedures described in this book have since been further developed.
The basic accounting equation has been based upon this Double-entry system of Accounting.
Any business transaction will record the Debit as
Increase in Asset Account
Decrease in Liability Account
Decrease in Owner’s Equity Account
Increase in Expense Account
Decrease in Revenue Account
And the same transaction will record the Credit as
Decrease in another Asset Account
Increase in a Liability Account
Increase in Owner’s Equity Account
Decrease in an Expense Account
Increase in a Revenue Account
TYPES OF ACCOUNTS
CLASSIFICATION OF ACCOUNTS
One classification of accounts is done on the basis of Financial Statements.
Accordingly, there may be the following types of accounts.
1) BALANCE SHEET ACCOUNTS which include:
Assets Accounts
Current Assets Accounts
Non-current Assets Accounts
Liabilities Accounts
Current Liabilities Accounts
Non-current Liabilities Accounts
Owners’ Equity Accounts
Share Capital Accounts
Retained Earnings Account
2) PROFIT AND LOSS ACCOUNTS which include:
Revenue / Sale / Income Accounts
Expenses / Cost Accounts
Another classification of accounts is done on the basis of the nature of account.
1) REAL ACCOUNTS
All properties owned by the business are Real Accounts, like Fixed Assets of Buildings, Furniture, and Currents Assets of Stocks.
2) PERSONAL ACCOUNTS
All accounts related to Debtors (Receivable from parties) and Creditors (Payable to parties) and Drawings account of Owners are examples to Personal Accounts.
Therefore, all Balance Sheet Accounts are either Real Accounts or Personal Accounts. At the year end the balances in these accounts are carried forward to the next year.
3) NOMINAL ACCOUNTS or TEMPORARY ACCOUNTS
All Profit and Loss Accounts are temporary accounts and are called Nominal Accounts. On the one hand, these may be Revenue Accounts like Sales of Goods, Income from Services, Rent Income, Interest Income, and on the other hand, these may be Cost and Expense Accounts like Cost of Goods Sold, Salary Expense, Rent Expense, etc.
All these accounts are closed at the year end and the Net Result of all these accounts is transferred to Balance Sheet in the Owner’s Equity.
One classification of accounts is done on the basis of Financial Statements.
Accordingly, there may be the following types of accounts.
1) BALANCE SHEET ACCOUNTS which include:
Assets Accounts
Current Assets Accounts
Non-current Assets Accounts
Liabilities Accounts
Current Liabilities Accounts
Non-current Liabilities Accounts
Owners’ Equity Accounts
Share Capital Accounts
Retained Earnings Account
2) PROFIT AND LOSS ACCOUNTS which include:
Revenue / Sale / Income Accounts
Expenses / Cost Accounts
Another classification of accounts is done on the basis of the nature of account.
1) REAL ACCOUNTS
All properties owned by the business are Real Accounts, like Fixed Assets of Buildings, Furniture, and Currents Assets of Stocks.
2) PERSONAL ACCOUNTS
All accounts related to Debtors (Receivable from parties) and Creditors (Payable to parties) and Drawings account of Owners are examples to Personal Accounts.
Therefore, all Balance Sheet Accounts are either Real Accounts or Personal Accounts. At the year end the balances in these accounts are carried forward to the next year.
3) NOMINAL ACCOUNTS or TEMPORARY ACCOUNTS
All Profit and Loss Accounts are temporary accounts and are called Nominal Accounts. On the one hand, these may be Revenue Accounts like Sales of Goods, Income from Services, Rent Income, Interest Income, and on the other hand, these may be Cost and Expense Accounts like Cost of Goods Sold, Salary Expense, Rent Expense, etc.
All these accounts are closed at the year end and the Net Result of all these accounts is transferred to Balance Sheet in the Owner’s Equity.
Wednesday, February 3, 2010
ACCOUNTING CYCLE
ACCOUNTING CYCLE
The sequence of activities that is performed for the accounting of a business transaction after it has occurred is commonly known as Accounting Cycle and the following processes are carried out for its completion.
To better understand the Accounting Cycle, it should be considered with reference to an accounting period, normally a month or a year.
Identify the transaction:
Identify the event as a transaction and generate the source document.
Analyze the transaction:
Determine the transaction amount, the Accounts affected and their Debits and Credits.
Journal Entries:
Record the transaction in a Journal, as a Debit and a Credit.
Posting to Ledger:
Transfer of Journal entries to appropriate accounts in the Ledger with cross reference.
Trial Balance:
Preparation of Trial Balance (Summary of Ledger Accounts) to verify the sum of Debits equals the sum of Credits.
Adjusting Entries:
Make adjusting entries for Accrued and Deferred items, record them in Journal and Post them to Accounts in the Ledger.
Adjusted Trial Balance:
Prepare another Trial Balance after recording the Adjusting entries.
Financial Statements:
Prepare all the Financial Statements.
Closing Entries:
Transfer the balances of Revenue and Expense Accounts to Owner’s Equity.
After-Closing Trial Balance:
A final trial balance is prepared after the Closing Entries.
(This will include only Balance Sheet Accounts)
The sequence of activities that is performed for the accounting of a business transaction after it has occurred is commonly known as Accounting Cycle and the following processes are carried out for its completion.
To better understand the Accounting Cycle, it should be considered with reference to an accounting period, normally a month or a year.
Identify the transaction:
Identify the event as a transaction and generate the source document.
Analyze the transaction:
Determine the transaction amount, the Accounts affected and their Debits and Credits.
Journal Entries:
Record the transaction in a Journal, as a Debit and a Credit.
Posting to Ledger:
Transfer of Journal entries to appropriate accounts in the Ledger with cross reference.
Trial Balance:
Preparation of Trial Balance (Summary of Ledger Accounts) to verify the sum of Debits equals the sum of Credits.
Adjusting Entries:
Make adjusting entries for Accrued and Deferred items, record them in Journal and Post them to Accounts in the Ledger.
Adjusted Trial Balance:
Prepare another Trial Balance after recording the Adjusting entries.
Financial Statements:
Prepare all the Financial Statements.
Closing Entries:
Transfer the balances of Revenue and Expense Accounts to Owner’s Equity.
After-Closing Trial Balance:
A final trial balance is prepared after the Closing Entries.
(This will include only Balance Sheet Accounts)
FUNDAMENTAL ACCOUNTING EQUATION
FUNDAMENTAL ACCOUNTING EQUATION
The properties owned by a business are called ASSETS.
The rights to these properties are called EQUITIES.
Accounting deals with property and rights to property.
For every business enterprise, the sum of rights to the properties is equal to the sum of the properties owned by it.
This relationship can be expressed in form of an Accounting Equation.
ASSETS = EQUITIES
Or in simple words, if the business enterprise is not borrowing from outside sources and it is doing all its business in cash (no credit), then there will be no Liabilities and the above equation will stand true.
However, generally the business has to be carried out on credit basis and also sometimes the business enterprise may have to borrow funds from other sources. In that case the rights to properties (Equities) are divided into two principal types, which are The Rights of Creditors (Liabilities) and The Rights of Owners (Owner’s Equity).
So more logical Accounting Equation, which recognizes both types of Equities can be stated as follows.
ASSETS = LIABILITIES + OWNER’S EQUITY
Consequently, we may also express this equation as follows.
ASSETS – LIABILITIES = OWNER’S EQUITY
Here it is also notable that every business transaction can be stated in terms of its effect on the three basic elements of the accounting equation – Assets, Liabilities and Owner’s Equity.
Assets are resources (things that are owned by business).
Liabilities are obligations of the business (amounts that are owed by business).
Owner’s Equity is the amount left over after deduction of Liabilities from Assets
The properties owned by a business are called ASSETS.
The rights to these properties are called EQUITIES.
Accounting deals with property and rights to property.
For every business enterprise, the sum of rights to the properties is equal to the sum of the properties owned by it.
This relationship can be expressed in form of an Accounting Equation.
ASSETS = EQUITIES
Or in simple words, if the business enterprise is not borrowing from outside sources and it is doing all its business in cash (no credit), then there will be no Liabilities and the above equation will stand true.
However, generally the business has to be carried out on credit basis and also sometimes the business enterprise may have to borrow funds from other sources. In that case the rights to properties (Equities) are divided into two principal types, which are The Rights of Creditors (Liabilities) and The Rights of Owners (Owner’s Equity).
So more logical Accounting Equation, which recognizes both types of Equities can be stated as follows.
ASSETS = LIABILITIES + OWNER’S EQUITY
Consequently, we may also express this equation as follows.
ASSETS – LIABILITIES = OWNER’S EQUITY
Here it is also notable that every business transaction can be stated in terms of its effect on the three basic elements of the accounting equation – Assets, Liabilities and Owner’s Equity.
Assets are resources (things that are owned by business).
Liabilities are obligations of the business (amounts that are owed by business).
Owner’s Equity is the amount left over after deduction of Liabilities from Assets
Tuesday, February 2, 2010
FORMS OF BUSINESS ORGANIZATION
FORMS OF BUSINESS ORGANIZATION
Accounting always applies to an Economic Organization or Economic Unit, whether Profit-making or Non-profit-making. Economic Units have business transactions that must be recorded, classified, summarized and interpreted. The accounting principles, as applicable to Economic Units for profit-making necessitate understanding of the forms of Business Enterprises which may be broadly of the following three types.
(These are differentiated on the basis of Ownership)
Sole Proprietorship
A business owned by one person is called Sole Proprietorship.
Partnership
An un-incorporated business owned by two or more persons, voluntarily acting as partners (co-owners) is called Partnership.
Limited Company / Corporation
A Company is a Legal Entity formed under the laws of the country (Companies Act or Companies Ordinance).
In other words, a Corporation is the only type of business organization recognized under the law as an entity separate from its owners.
The ownership in the Company is divided into shares owned by its shareholders and the owners of the Company are not personally liable for the debts of the business.
A company may be Private Limited Company or a Public Limited Company.
TYPES OF BUSINESS ORGANIZATION
The above stated forms of business organizations may carry out any of the following types of business.
TRADING (NON-INDUSTRIAL)
(Buying and Selling, Imports and Exports) (Products remaining the same)
(This also includes Retail and Wholesale Business)
MANUFACTURING (INDUSTRIAL)
(Industries) (Input products and Output products being different)
(This may also include Construction)
SERVICES
(Lawyers, Doctors, Consultants, Engineers)
(Professional and Business Services) (Provide services not goods)
Other examples are Leisure and Hospitality, Information, Financial Activities, Government, Education and Health Services, Transport, Warehousing, and Utilities, etc.
There may be combinations of the above as well.
Accounting always applies to an Economic Organization or Economic Unit, whether Profit-making or Non-profit-making. Economic Units have business transactions that must be recorded, classified, summarized and interpreted. The accounting principles, as applicable to Economic Units for profit-making necessitate understanding of the forms of Business Enterprises which may be broadly of the following three types.
(These are differentiated on the basis of Ownership)
Sole Proprietorship
A business owned by one person is called Sole Proprietorship.
Partnership
An un-incorporated business owned by two or more persons, voluntarily acting as partners (co-owners) is called Partnership.
Limited Company / Corporation
A Company is a Legal Entity formed under the laws of the country (Companies Act or Companies Ordinance).
In other words, a Corporation is the only type of business organization recognized under the law as an entity separate from its owners.
The ownership in the Company is divided into shares owned by its shareholders and the owners of the Company are not personally liable for the debts of the business.
A company may be Private Limited Company or a Public Limited Company.
TYPES OF BUSINESS ORGANIZATION
The above stated forms of business organizations may carry out any of the following types of business.
TRADING (NON-INDUSTRIAL)
(Buying and Selling, Imports and Exports) (Products remaining the same)
(This also includes Retail and Wholesale Business)
MANUFACTURING (INDUSTRIAL)
(Industries) (Input products and Output products being different)
(This may also include Construction)
SERVICES
(Lawyers, Doctors, Consultants, Engineers)
(Professional and Business Services) (Provide services not goods)
Other examples are Leisure and Hospitality, Information, Financial Activities, Government, Education and Health Services, Transport, Warehousing, and Utilities, etc.
There may be combinations of the above as well.
WHAT IS ACCOUNTING
WHAT IS ACCOUNTING
Accounting is often characterized as “the language of business”.
Accounting is normally defined on the basis of functions that it performs.
DEFINITION OF ACCOUNTING
“Accounting has been described as the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof.”
The above definition clearly indicates that Accounting provides the guidelines as to how the following processes will be performed.
RECORDING means putting the transactions and events to writing.
CLASSIFYING involves sorting all the transactions in an orderly and systematic manner.
SUMMARIZING means bringing the accounting data together in a form that further enhances their usefulness. This means preparation of periodical reports.
INTERPRETING includes analysis of the results of operations. This may be in the form of percentage analysis or ratios.
Accounting is often characterized as “the language of business”.
Accounting is normally defined on the basis of functions that it performs.
DEFINITION OF ACCOUNTING
“Accounting has been described as the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof.”
The above definition clearly indicates that Accounting provides the guidelines as to how the following processes will be performed.
RECORDING means putting the transactions and events to writing.
CLASSIFYING involves sorting all the transactions in an orderly and systematic manner.
SUMMARIZING means bringing the accounting data together in a form that further enhances their usefulness. This means preparation of periodical reports.
INTERPRETING includes analysis of the results of operations. This may be in the form of percentage analysis or ratios.
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