British Approach Or Double Entry System

British Approach or Double Entry System:

When one identifies the account that is getting affected by a transaction and type of that account, the next step is to apply the rules to decide whether the accounting treatment is to debit or credit that account.

The Golden rules will guide us whether the account is to be debited or credited.

There is one rule for each basic type of account i.e

1.       Personal Account – Debit the receiver Credit the giver

2.       Real account – Debit what comes into business Credit what goes out of business

3.       Nominal account – Debit all expenses or losses, Credit all incomes or gains

We will see the following example to understand the application of these rules.

1.       Mr.Vikas and Mr.Vaibhavi who are husband and wife started offering consultancy services, by investing cash of Rs.5,00,000 and Rs.2,50,000 respectively.

From the business point of view the two effects of this transaction are: first, the cash of Rs.7,50,000 has come into business and second, there is an obligation of the business towards Mr.Vikas and Mrs.Vaibhavi.

Now, we know that cash is real account, so rule for real account will apply.  Cash has come into the business thereby increasing the asset.  Hence, Cash Account should be debited.

We also know that Vikas’s A/c and Vaibhavi’s A/c are personal accounts, so rule for personal account, so rule for personal account will apply. (As both Vikas and Vaibhavi are givers of cash, their respective accounts will be credited.)

The answer will be

                                Debit Cash                                                          Rs.7,50,000/-

                                Credit Vikas’s Capital                                      Rs.5,00,000/-

                                Credit Vaibhavi’s Capital                               Rs.2,50,000/-

Please note that the total debits and total credits match.  It is the reflection of the dual aspect concept.

2.       They buy office furniture of Rs.25,000/- for cash

Here, the two effects are: First, Furniture (which is an asset) has come into the business and second cash (which is also an asset) that has gone out of business.

Since, both the accounts viz. Furniture and Cash are real accounts, rule for real account will apply. Furniture has come in (asset increase), it will be debited and cash has gone out (asset decrease), it will be credited.

The answer will be         

                                                Debit Furniture                 Rs.25000

                                                Credit C                ash                         Rs.25000

3.       They open a current with city bank by depositing Rs.1,00,000/-

Here, the two effects are: first, cash in hand has gone out (asset decrease) and second, the business cash at bank has increased (asset increase). Cash is real account Bank is a personal account.

The answer will be

                                                                Debit City Bank                 Rs.1,00,000

                                                                Credit Cash                         Rs.1,00,000

4.       They pay office rent of Rs.15,000 for the month by cheque drawn on their City Bank to M/s Realtors properties.

Here, two aspects are: first, since the payment is made by cheque, bank balance will reduce (asset decrease), and second, rent being an item of expense rent expense will increase.

City bank A/c being a personal A/c, rule for personal account will apply.  City bank A/c will be credited.

Rent A/c being a nominal account, rule for nominal account will apply.  Since, rent is paid, it is an expense.  Hence, Rent a/c will be debited

The answer will be

                                                                Debit rent                           Rs.15,000

                                                                Credit City Bank                Rs.15,000

5.       They buy a motor car worth Rs.4,50,000 from Milennium Motors by making a down payment of Rs.50,000 by cheque drawn on city bank and balance by taking a loan from HDFC Bank

Here the effects will be: first, Motor Car (Which is an asset) has come into the business (increase in asset).  Second, Bank balance (which is an asset) has reduced (decrease in asset).  Thirdly, there is an obligation created towards HDFC Bank from whom loan of Rs.4,00,000 is taken (increase in liability)

City bank is personal account, so rule for personal account will apply.  Motor car has come in, so Motor Car A/c will be debited.

HDFC Bank is provider of loan to whom money is payable by the business in future.  HDFC Bank account being a personal account, rule for personal account will apply.  HDFC Bank being the giver, it will be credited.  (Note: In different opinions, we can consider City Bank A/c as Real account.  The reason behind that is the balance at City bank a/c belongs to the business, so it is an asset.  However in any circumstances HDFC Bank, who has paid Millennium Motors on behalf of the business, cannot be considered as Real Account.  It is a Personal Account as it does not hold any business cash.)

The answer will be

                                                Debit Motor Car                               Rs.4,50,000

                                                Credit City Bank                                                Rs.50,000

                                                Credit Loan from HDFC Bank       Rs.4,00,000

6.       Vikas and Vaibhavi carried out a consulting assignment for Avon Pharmaceuticals and raise a bill for Rs.10,00,000 as consultancy fees.  Avon Pharmaceuticals have immediately settled Rs.250000 by way of cheque and the balance will be paid after 30 days.  The cheque received is deposited into City Bank.

Here the effect will be: first, the work done by Vikas and Vaibhavi has resulted in the revenue for the business.  What should be the amount of revenue considered? Is it Rs.10 lac for which work is done or only Rs.2.5 lacs which is received? The revenue of entire Rs.10 lac will be considered as by doing the work the business has acquired legal claim against Avon Pharmaceutical.  Second effect will be cash that is received by way of cheque(asset increase).  The third effect will be the amount of Rs.7.5 lacs, which Avon Pharmaceuticals owes to the business.

Consultancy fees received (revenue earned) being income, rule for nominal account will apply and this account will be credited.  Cheque received and deposited into City bank will decrease the balance at the bank.  City Bank being a personal account will be debited.  The amount receivable from Avon is an asset, but it’s due from Avon at a future date.  To be able to recover it from them, their personal account will have to be created in books of accounts.  Avon Pharmaceuticals is personal account and they are receiver of consultancy, it will be debited.

The answer will be

                                                Debit City Bank                                                 Rs.2,50,000

                                                Debit Avon Pharmaceuticals       Rs.7,50,000

                                                Credit Consultancy Fees                               Rs.10,00,000

7.       They have employed a receptionist on a salary of Rs.5000 per month and one officer at a salary Rs.10000 per month.  The salary for the current month is payable to them.

Is this a transaction to be recorded in the books? Remember accrual concept? Accordingly the expense of salary for the current month must be recognized as the expense for the current month even if it’s not paid for.  In fact, the business owes the salary to its employees and this obligation (which is a liability) must be shown in the books.

The effects will be: first, salary being an item of expense, is a nominal account and rule for nominal account will be applied.  So, Salary A/c will be debited.  Secondly, the obligation to pay salary is towards both employees, the convention is not to create separate employee accounts, but to use a representative personal account named as Salary payable account.  Since, this is personal account; rule of personal account will apply.  Employees being givers of service, it will be credited.

The answer will be:

                                Debit Salary                                        Rs.15000

                                Credit Salary Payable                      Rs.15000

Please look at the way we have approached each transaction and decided about accounting treatment, if you follow these logical steps, you will certainly be able to grasp the basics thoroughly.

Under Double entry system, the accounting of a business transaction involves the following steps:

a.       Consider whether an event qualifies to be entered in books of accounts in money terms

b.      If the answer to the above is ‘yes’, then assess the two aspects of the transaction

c.       Determine what type of ‘account’ is affected by each of the aspects

d.      Apply the golden Rule of ‘Debit’ and ‘Credit’

e.      Prepare the basic document such as invoice, voucher, debit note or credit note

f.        Prepare the transaction in the primary books of subsidiary books

g.       Carry out the posting into the ledger

h.      Prepare the list of all ledger balances and ensure it tallies

i.         Rectify the errors, if any

j.        Pass adjustment entries

k.       Prepared adjusted Trial Balance

l.         Prepare the financial statements – the Income statement and Balance Sheet.

ACCOUNTING EQUATION:-

               

The whole financial accounting depends on Accounting Equation which is also known as Balance sheet equation.  The basic Accounting Equation is

Assets = Liabilities + Owner’s equity

Or           A             =             L+P

Or           P             =             A-L

Or           L              =             A-P

Where A= Assets, L=Liabilities, P= Capital