1. Classification of Accounts 2. Liabilities Account 3. Capital Account 4. Revenue and Profit Account 5. Expenses and Losses Account
Every business organization possesses some assets. These assets differ in nature of the business and its purposes. As per the use of these assets, the company earns profit and increase the value of assets. Although its value decreases in other aspects, the main motive is to earn profit and increase the revenue.
Generally, any firm own assets in various possible ways like cash in hand, cash at banks, plant machinery furniture, stocks of goods, vehicles, buildings and debtors. So the increase or decrease in the value of returns is recorded systematically to establish concrete financial position in the particular business.
Whatever the theme of the business is, the investment on the representative project by the proprietors should be reimbursed and repay back. This is because the proprietors are then liable for the expenditure and thus, the capital will be reduced. Here, the increase in assets is debited and decrease in assets means credited. In this context, it can be represented as-
Debit Increase (+) Assets Credit Decrease (–)
Recording of the financial transactions needs to identify whether it relates to assets or capitals or liabilities or expenses or losses or revenues or profit.
For example, if the transaction is related to the assets whether increase or decrease, the increase amount will be debited and the amount will be credited. It can be represented as-
Debit increase in assets
Credit decrease in assets
This rule is accepted for all the transaction values whether it increases or decreases. In this same manner, if the organization purchases furniture or any other material, then it will be debited in the furniture account as it gets increased in its volume.
Thus, it can be said that in the commencement of any project the cash account is debited to highlight the increase in its volume.
As the furniture has now brought, the company has to pay its value either in cash or in any other medium. In this context, if the organization pays cash, then the amount of cash decreases and will be represented as credited.
Suppose the company sells some of its machinery. This will surely increase the amount of cash. This is the reason it is represented as debited. In depreciation of fixed assets, the volume of assets gets reduced and it is represented as credited.
After checking all the financial transactions, it is identified that the value those are increased are debited with the amount of increase and the assets those value decreases are debited with its amount of decrease.
An increase in the liability will definitely increase the proprietors’ claim. This is because the amount has been borrowed on behalf of proprietors. Thus, the increase in the liability will be credited and decrease in liability will be debited. It can be represented as-
Debit Decrease (–) Liabilities Credit Increase (+)
For example, Rs. 7,000 has been borrowed from Mhabemo Company. This amount will be credited in Mhabemo’s account. When the payment will be made to the company, the liability will get reduced and it will be shown as debited. It can be represented as-
Debit decrease in liability
Credit increase in liability
The capital will represent the amount of money that is in proprietor’s account. When this amount is presented by any of the proprietor, the capital account represents an increase in proprietors’ equity. This amount is then credited.
Similarly, when the proprietor reduced the capital amount, it will be represented as debited. It can be represented as follows-
Debit Decrease (–) Capital Credit Increase (+)
In this case, proprietor introduces the capital. It depend on him whether he is willing to introduce more capital or not. It also depends on him how he is going to represent either with interest or not. Here, his capital balance will be increased as the investment and other additional funds get increased. So, this value will be credited.
Due to certain reasons, if the company incurs losses, then the proprietors’ capital will reduce and this amount will be debited. Its rule can be represented as-
Debit decrease in capital
Credit increase in capital
Revenue and Profit:
If the value of the revenue amount gets increased, it will be credited to the revenue account. Similarly, if proprietors’ equity amount gets reduced, it will be debited to the revenue account. Suppose the proprietor has opted for interest than receiving the interest means gain. This amount increases the proprietors’ equity and this amount will be credited.
After completing all the transactions related to the firm, the interest account data is transferred to the Profit and Loss Account to close it. Now, the interest account is represented as debited. Either there is an increase in expense or decrease in revenue, both represent the same. If any proprietor equity comes under the same criteria, then its value is debited. This can be represented as-
Debit Decrease (–) Revenue and Profit Credit Increase (+)
Whether it is revenue received or profit earned, both are the liability of business. Here, the profit will be credited to proprietors’ account as it is the amount of reward for risks taken. Its rule can be represented as-
Debit decrease in revenue and profit
Credit increase in revenue and profit
Expenses and Losses
The increase in the expense and loss of the company will reduce the proprietors’ claim whereas a decrease in the expense and loss will increase the proprietors’ share. The amount of proprietors’ claim will be represented as debited and the amount of proprietors’ share will be represented as credited. It can be represented as-
Debit Decrease(+) Expenses and Losses Credit Increase (–)
For example, the payment of salaries to the employees increase the expense and it is debited. After this, the data is transferred to Profit and Loss Account to close it and is represented as credited. It is summarized as-
Debit increase in expenses and losses
Credit decrease in expenses and losses
Regarding the business financial transactions, all these are classified as assets, capital, liability, expense and revenue either it gets increase or decrease. The above basic rules of different items are represented below-
Modern Approach- Summary of Rules of Debit and Credit
Decrease in capital Increase in capital
Increase in assets Decrease in assets
Decrease in liability Increase in liability
Increase in expense or loss Decrease in expense or loss
Decrease in revenue and profit Increase in revenue or profit
The above rules are developed after certain scientific studies and analysis. Everything has been tested and verified accordingly to reach the conclusion. This approach is termed as the modern scientific approach to accounting. It is also termed as American Approach.
Considering the fact of earlier conventional or traditional approach, the rules mentioned above of ‘Debit and Credit’ are different.
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