Fundamental Principles of Accounting

1. Introduction

A business house must necessarily keep a systematic record of what happens from day to day so that it can know where it stands and so that it can satisfy the ever increasing curiosity of the income tax officer, if nothing else. Most of the business, these days is run by joint stock companies and these are required by law to prepare annually statements in proper form showing the state of financial affairs. A systematic record of the daily and hourly events of a business leading to a presentation of a complete financial picture is known as accounting or, in its elementary stages, as book-keeping.

A firm constantly enters into transactions with outsiders. A transaction may be defined as the actions and reactions of one person or firm in relation to another person or firm or groups of persons or firms. The transaction may be as stunning as the ordering of a huge plant or as small as utilizing the services of a coolie for an hour. Transactions may be entered into with outsiders’ employees as outsiders technically, one still will have to record, let us say, the effect of a spontaneous fire or the effect of a fall in prices for which no employee or no outsider may be responsible.

There are two systems for recording transactions - single entry system and double entry system. Single entry system sounds economical but is really closely because it is rather a lack of system. It will be discussed later. The only real system is the double entry system. This system recognizes the fundamental fact that a transaction is a double sided affair. If one receives something, then either (a) some other person has given it, (b) something's stock must have been diminished, or (c) some service must have been rendered. If one loses something in the sense that either cash or its equivalent has to be given up or is irretrievably lost then a corresponding benefit must have been received unless it is just bad luck. For good and accurate results a transaction should be recorded in both the aspects. This is what is done in the double entry system.

2. Rules

Benefits received are denoted by debits and benefits given are denoted by credits. If A and B go to see a cricket match and A buys the ticket for B also, one says that B has been placed under an obligation or a debt and that A has done a creditable thing and, therefore, entitled to a credit. In the accountant's language, B will be debited and A will be credited. At the next match, B might repay the debt and buy tickets both for himself and for A. Repaying a debt is also creditable and the accountant will be making another entry, this time debiting A and crediting B. One must treat each transaction separately. From this one develops the rule: Debit the receiver and credit the giver. This holds good in case of all transactions with persons.

Now suppose the business receives cash, it will certainly appoint a person to receive and pay cash. Following the rule of debit the receiver and credit the giver, one should debit Mr. cashier whenever he receive cash and credit the person who gives it and credit him whenever he pays out the cash and debit the person who receives it . It is convenient to name Mr. Cashier's account as just cash account. In case of receipt of goods, one could debit Mr. Godown Keeper and in case of issue of goods on sale otherwise, one could credit him. Bu this will raise difficulties. Mr. Godown Keeper is merely a worker who looks after stores and godowns as best as he can. He is responsible for the goods only in a general way and not in a very strict sense which is applicable to the cashier. It is, therefore, convenient to name Mr. Godown Keeper's account as simply goods or stock account. Similar reasoning applies to all other things that the business acquires or deposes of. The rules are Debit what comes in and credit what goes out. If cash has come in, debit cash, if goods have come in debit goods. If furniture has been bought, debit furniture; if furniture has been sold, credit furniture and so on.

Another broad category of transactions remains to be dealt with. Suppose at the end of the month salary is paid to a clerk. Following the two rules, above mentioned, one should debit Mr. Clerk because he has received cash and credit cash account because cash has gone out. But debiting Mr. Clerk is useless since he is not going to pay the money back, he has already rendered service for a month and that is all. If one debits Mr. Clerk the debits will go on mounting and all sum standing to his debit will be a loss. It is far better to recognize from the very beginning that the money paid to the clerk is an expense and realistically, one should debit “salaries” account. If one pays rent one should debit rent account and not the landlord personally.

Thinking of income which the business gets one can easily establish the rule that instead of crediting the person from whom such incomes are received, one should credit the income account such as “commission received account” or interest account. The three basic rules about recording transactions are:

1. Debit the receiver and credit the giver.

2. Debit what comes in and credit what goes out.

3. Debit all expenses and losses and credit all incomes and gains.

The students should clearly understand the nature of debit and credit.

A debit denotes:

a) In case of a person, that he has received some benefit against which he has already rendered some service or will render service in future. When a person becomes liable to do something in favor of the firm, the fact is recorded by debiting that person’s account.

b) In case of goods or properties, that the stock and value of such goods or properties or has lost money.

c) In case of other account like salary or rent, that the firm has enjoyed some benefit or has lost money.

A credit denotes:

a) In case of a person, that some benefit has been received from him, entitling him to claim from the firm a return benefit in the form of cash or goods or services. When a person becomes entitled to money’s worth for any reason, the fact is recorded by crediting him.

b) In case of goods or properties, that the stock and value of such goods or properties has diminished.

c) In case of other account, for example commission account, that a firm has made a gain.

A debit shows that

a) Money is owing to the firm:
b) The firm owns some property ( cash, goods , furniture , etc) or
c) The firm has lost money or has incurred some expenses.

A credit shows that:

a) Money is owing to some person:

b) The firm has given up so much property or

c) The firm has earned an income.


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Accounting Education: Fundamental Principles of Accounting
Fundamental Principles of Accounting
Accounting Education
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