Dual Aspect of Transactions

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Rules of Debit and Credit >>

Financial Statement Analysis-FIN621

Lesson-2

ACCOUNT AND ACCOUNTING CYCLE/PROCESS

Account

An accounting system keeps separate record of each item like assets, liabilities, etc. For example, a

separate record is kept for cash that shows increase and decrease in it.

This record that summarizes movement in an individual item is called an Account.

Each element/sub-element of the balance sheet is named as "Account", having three parts

viz title, left side (Debit or Dr) and a right side (Credit or Cr). Technically, these are also called `Ledger

Accounts'. The same is true of Income Statement, which would be discussed later.

The Ledger Accounts are also called T-account, because these are in the shape of the alphabet `T' as

shown below:-

Title

Account Payable:An amount owed to a supplier for good or services purchased on credit; payment is

due within a short time period, usually 30 days or less.

Notes Payable: A liability expressed by a written promise to make a future payment at a specific time,

OR are obligations (short term debt) evidenced by a promissory note? The proceeds of the note are used

to purchase current assets (inventory & receivables).

Dual Aspect of Transactions

For every debit there is an equal credit. This is also called the dual aspect of the transaction i.e. every

transaction has two aspects, debit and credit and they are always equal. This means that every

transaction should have two-sided effect. For example Mr. A starts his business and he initially invests

Rupees 100,000/- in cash for his business. Out of this cash following items are purchased in cash;

A building for Rupees 50,000/-;

Furniture for Rupees 10,000/-; and

A vehicle for Rupees 15,000/-

This means that he has spent a total of Rupees 75,000/- and has left with Rupees 25,000 cash. We will

apply the Dual Aspect Concept on these events from the viewpoint of business.

When Mr. A invested Rupees 100,000/-, the cash account benefited from him. The event will be

recorded in the books of business as,

Debit

Cash

Rs.100, 000

Credit

Mr. A

Rs.100, 000

Analyse the transaction. The account that received the benefit, in this case is the cash account,

and the account that provided the benefit is that of Mr. A.

Building purchased The building account benefited from cash account

Debit

Building

Rs.50, 000

Credit

Cash

Rs.50, 000

Financial Statement Analysis-FIN621

Furniture purchased The furniture account benefited from cash account

Debit

Furniture

Rs.10, 000

Credit

Cash

Rs.10, 000

Vehicle purchased The vehicle account benefited from cash account

Debit

Vehicle

Rs.15, 000

Credit

Cash

Rs.15, 000

Basic Principle of Double Entry

We can devise the basic principle of double entry book-keeping from our discussion to this point "Every

Debit has a Credit" which means that "All Debits are always equal to All Credits".

Assets

Assets are the properties and possessions of the business.

Properties and possessions can be of two types:

o Tangible Assets that have physical existence ( are further divided into Fixed Assets and

Current Assets)

o Intangible Assets that have no physical existence

Examples of both are as follows:

o Tangible Assets Furniture, Vehicle etc.

o Intangible Assets Right to receive money, Good will etc.

Accounting Equation

From the above example, if the debits and credits are added up, the situation will be as follows:

Debits

Cash

Rs.100, 000/-

Building

50,000/-

Furniture

10,000/-

Vehicle

15,000/-

Credits

Mr. A

Rs.100, 000/-

Cash

75,000/-

The total Equation becomes:

DEBITS

CREDITS

Cash + Building + Furniture + Vehicle

Cash + Mr. A

100000 + 50000 + 10000

+ 15000

75000 + 75000

Cash on Left Hand Side is Rupees 100,000/- and on Right Hand Side it is Rs.75, 000/-. If it is gathered

on the Left Hand Side it will give a positive figure of Rupees 25,000/- (which you will notice is our

balance of cash in hand). Now the equation becomes:

Financial Statement Analysis-FIN621

DEBITS

CREDITS

Cash + Building

+ Furniture+ Vehicle

Mr. A

25,000+ 50,000 + 10,000 + 15,000

100,000

Keeping the entity concept in mind we can see that the business owns the building, furniture, vehicle

and cash and will obtain benefit from these things in future. Any thing that provides benefit to the

business in future is called `Asset'. Similarly the business had obtained the money from Mr. A and this

money will have to be returned in form of either cash or benefits. Any thing for which the business has

to repay in any form is called `Liability'. So cash, building, furniture and vehicle are the assets of the

business and the amount received from Mr. A for which the business will have to provide a return or

benefit is the liability of the business. Therefore, our equation becomes:

Assets

Liabilities

The liabilities of the business can be classified into two major classes i.e. the amounts payable to

`outsiders' and those payable to the `owners'. The liability of the business towards its owners is called

`Capital' and amount payable to outsiders is called liability. Therefore, our accounting equation finally

becomes:

Assets

Capital

Liabilities

Business or Commercial Accounts are based upon Double entry accounting involving Debit and

credit entries. Rule for Dr. & Cr entries to record changes in balance sheet Accounts or Accounting

Equation is: increase in assets are debited (since Assets are on left side of Accounting Equation) and

increase in liabilities and Owner's Equity are credited because these are on the right side of Accounting

Equation. Correspondingly, decrease in Assets is credited and decrease in liabilities and Owners Equity

are debited.

Dr+ ↑ Assets = Liabilities + Owner's equity

Cr↓_

Cr ↑ + ↓ _ Dr ↑+Cr ↓_ Dr.

Rule for Income Statement items is that Revenues are credited and expenses are

debited. The basis of this rule is that income statement shows the effect of Revenues & Expenses on

owner's equity. Difference of Revenues and Expenses causes difference in owner's equity. Since

Revenues increase owner's equity, these are credited. Correspondingly, since expenses ultimately

reduce owner's equity, these are debited.

It would thus be seen that normal balances in Assets Accounts would be debit and those in

Liability and Owner's Equity Accounts would be credit. Orderly arrangement of Accounts is to be

maintained. Numbering of Accounts is also done to facilitate proper record-keeping and cross-

references. When the business is large, a Chart of Accounts is maintained which lists the various

Accounts giving details of their titles and numbers.

Compound Entry. A journal entry that has more than one debit or credit entry.

General Journal

Date

Account Title and explanation

Dr.

Cr.

Cash

180,000

Khizr, Capital

180,000

July, 2006 (1)

(Owner invested cash in business)

July, 2006 (5)

Building

36,000

Cash

15,000

Financial Statement Analysis-FIN621

Accounts payable

21,000

(Purchase building partly for cash and

Partly on credit)

"LP" is reference account No: of the particular ledger accounts. For example cash account has been

assigned number 1 in ledger and capital account is given number 50.

C) Posting in ledger which mean transferring debits and credits from journal to ledger account. This is

also called ledgerising or classification

Date

Explanation

Ref

Dr.

Cr.

Jul 1

180,000

Khizr

Capital

Account No:50

Jul 1

180,000

"Ref" is reference to the page of journal i.e. page 1. This shows that there is cross-reference between

journal and ledger through "LP" and "ref" columns in journal and ledger respectively.

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