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7&8

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tupakula
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LECTURE 7 and 8 GENERAL ACCOUNTING

PRINCIPLES
DOUBLE ENTRY SYSTEM
Double entry system of accounting is more than 500 years old. “Luca Pacioli” an Italian friar
& mathematician published Summa de Arithmetica, Geometria, Proportioni, et
Proportionalita (“Everything about Arithemetic Geometryhi and proportions”). The first book
that described a double entry accounting system. Double entry system of book-keeping has
emerged in the process of evolution of various accounting techniques. It is the only scientific
system of accounting. According to it, every transaction has two-fold aspects–debit and credit
and both the aspects are to be recorded in the books of accounts. Therefore, in every
transaction at least two accounts are effected.

For example, on purchase of furniture either the cash balance will be reduced or a liability to
the supplier will arise. and new asset furniture is acquired . This has been made clear already,
the Double Entry System records both the aspects. It may be defined as the system which
recognises and records both the aspects of transactions. This system has proved to be
systematic and has been found of great use for recording the financial affairs for all
institutions requiring use of money.

ACCOUNTING APPROACHES
1) ACCOUNTING EQUATION APPROACH
The relationship of assets with that of liabilities and owners’ equity in the equation
form is known as ‘Accounting Equation’. Basic accounting equation comes into
picture when sum total of capital and liabilities equalises assets, where assets are
what the business owns and capital and liabilities are what the business owes. Under
double entry system, every business transaction has two-fold effect on the business
enterprise where each transaction affects changes in assets, liabilities or capital in
such a way that an accounting equation is completed and equated. This accounting
equation holds good at all points of time and for any number of transactions and
events except when there are errors in accounting process.
Let us suppose that an individual started business by contributing 50,00,000 and
taking loan of 10,00,000 from a bank to be repayable, after 5 years. He purchased
furniture costing 10,00,000, and merchandise worth 50,00,000. For purchasing the
merchandise he paid 40,00,000 to the suppliers and agreed to pay balance after 3
months. Assume that all these transactions and events occurred at to, base point of
time

The contribution by the owner is termed as capital; the borrowings are termed as
loans or liabilities. Whenever the loan is repayable in the short-run, say within one
year, it is called short-term loan or liability. On the other hand, if the loan is
repayable within say 4 or 5 years or more, it would be termed as long term loan or
liability.

Some other short-term liabilities relating to credit purchase of merchandise are


popularly called as trade payables, and for other purchases and services received on
credit as expense payables. These short-term liabilities are also termed as current
liabilities.
On the other hand, money raised has been invested in two types of assets–fixed
assets and current assets. Furniture is a fixed asset, if it lasts long, say more than
one year, and has utility to the business, while inventory and cash balance will not
remain fixed for long as soon as the business starts to roll-these are current assets.
Often the owner’s claim or fund in the business is called equity. Owner’s claim
implies capital invested plus any profit earned minus any loss sustained.
Now at to we have an equation:

Equity + Liabilities = Assets


2) TRADITIONAL APPROACH
Under traditional approach of recording transactions one should first understand
the term debit and credit and their rules.

Transactions in the journal are recorded on the basis of the rules of debit and credit
only. For the purpose of recording, these transactions are classified in three groups:
(i) Personal transactions.
(ii) Transactions related to assets and properties.
(iii) Transactions related to expenses, losses, income and gains.

CLASSIFICATION OF ACCOUNTS
A) PERSONAL

Personal Accounts: Personal accounts relate to persons, trade receivables or


trade payables. Example would be the account of Ram & Co., a credit
customer or the account of Jhaveri & Co., a supplier of goods. The capital
account is the account of the proprietor and, therefore, it is also personal but
adjustment on account of profits and losses are made in it. This account is
further classified into three categories:

(a) Natural personal accounts: It relates to transactions of human beings like


Ram, Rita, etc.
(b) Artificial (legal) personal accounts: For business purpose, business
entities are treated to have separate entity. They are recognized as persons in
the eye of law for dealing with other persons.
For example: Government, Companies (private or limited), Clubs, Co-
operative societies etc.
(c) Representative personal accounts: These are not in the name of any
person or organization but are represented as personal accounts.

For example: outstanding liability account or prepaid account, capital


account, drawings account.
B) IMPERSONAL ACCOUNT

Impersonal Accounts: Accounts which are not personal such as machinery


account, cash account, rent account etc. These can be further sub-divided
as follows:
(a)Real Accounts: Accounts which relate to assets of the firm but not debt.

For example, accounts regarding land, building, investment, fixed


deposits etc., are real accounts. Cash in hand and Cash at the bank /FD
in bank accounts are also real (However as discussed in the class it can
also be clubbed under Personal account)

(b) Nominal Accounts: Accounts which relate to expenses, losses, gains,


revenue, etc. like salary account, interest paid account, commission
received account. The net result of all the nominal accounts is reflected as
profit or loss which is transferred to the capital account. Nominal accounts
are, therefore, temporary.

GOLDEN RULE OF ACCOUNTING (TRADITIONAL METHOD)


a) Personal account – Debit the receiver Credit the giver
b) Real – Debit what comes in Credit what goes out
c) Nominal – Debit all expenses and Credit all income

3) MODERN APPROACH
Real, nominal and personal accounts is the traditional classification of accounts.
Now, let us see the modern and more acceptable classification of accounts:-

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