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Accounting Effects

Basic Accounting Equation :


Assets = Liabilities + Owners’ Equity


double-entry-accountingImage

Assets, liabilities and owners’ equity are the three components of accounting equation that make up a company’s balance sheet.


(Owner’s equity in simple form is the value of all the assets after deducting the value of assets needed to pay liabilities.)


Debits and Credits :


Debits and Credits are at the heart of double-entry accounting principles, and are also the cause of much confusion and anguish to people who are new to accounting. The confusion is understandable for a number of reasons:


  • Debits and credits mean different things depending on whether you're looking at them from a business's perspective or from a bank's perspective;

  • A debit to one account will increase the balance, whereas in another account it will decrease the balance;

  • A 'debt' may sound like a kind of debit, but it's not really;

  • An Account can be said to be in 'credit' but that is a different thing to a 'credit entry' in the Account;

  • Banks issue 'debit cards' and 'credit cards', but these have little to do with debits and credits posted to the Accounts.


Transactions vs. Entries


A balanced set of debit and credit 'entries' are linked together as a single 'transaction'. The transaction is saved (posted) to the General Ledger as a whole. If any entry fails to save, then the whole transaction is aborted.


Every transaction must consist of an equal and opposite set of debit and credit entries.


A DEBIT to Accounts in the five primary sections has the following effect on the account balances:


  • Assets (INCREASE)

  • Liabilities (DECREASE)

  • Equity (DECREASE)

  • Income (DECREASE)

  • Expenses (INCREASE)


A CREDIT to accounts in the five primary sections has the following effect on the account balances:


  • Assets (DECREASE)

  • Liabilities (INCREASE)

  • Equity (INCREASE)

  • Income (INCREASE)

  • Expenses (DECREASE)



Example


Ascertain the debit and credit from the following particulars under Modern Approach.


1. Started business with capital.


2. Bought goods for cash


3. Sold goods for cash.


4. Paid salary.


5. Received Interest on Investment.


6. Bought goods on credit from Mr. Y


7. Paid Rent out of Personal cash


Solutions

  Effect of Transaction Account To be debited/Credited
1 Increase in Cash

Increase in Capital
Cash A/c

Capital A/c
Debit

Credit
2 Increase in stock

Decrease in Cash
Purchase A/c

Cash A/c
Debit

Credit
3 Increase in Cash

Decrease in Stock
Cash A/c

Sale A/c
Debit

Credit
4 Increase in Expense

Decrease in Cash
Salary A/c

Cash A/c
Debit

Credit
5 Increase in Cash

Decrease in Income
Cash A/c

Interest A/c
Debit

Credit
6 Increase in Stock

Decrease in Liability
Purchase A/c

Y A/c
Debit

Credit
7 Increase in Expense

Decrease in Capital
Rent A/c

Capital A/c
Debit

Credit
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