FINANCIAL ACCOUNTING (Lecture-05) Learning Objective •
This lecture will cover o Classification of accounts into Assets, Liabilities, Income and Expenses, and o Rules of Debit and Credit for these classes.
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.
Classification of Accounts •
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We have studied following classification of accounts: o Assets, o Liabilities, o Income, o Expenses o Expenses can be further divided into capital and revenue expenses. We have already studied about these classifications in different lectures but to refresh your memory we will gather them at one place.
Assets & Liabilities ASSETS • •
Assets are the properties and possessions of the business. Properties and possessions can be of two types, one that have physical existence (called tangible) and the other that have no physical existence (called intangible).
LIABILITIES • •
Liabilities are the debts and obligations of the business. Liability is the obligation of the business to provide a benefit or asset on a future date. Asset is a right to receive and liability is an obligation to pay, therefore, these are opposite to each other.
FINANCIAL ACCOUNTING (Lecture-05) Income & Expenses INCOME • •
Income / Revenue is the value of goods or services that a business charges from its customers. or The reward / return received from the resources committed in the business.
EXPENSES • •
Expenses are the costs incurred to earn the revenue. The resources spent and the efforts made to earn the income, when translated in money terms are the expenses of the business
Rules of Debit and Credit •
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From our discussion up to this point, we have established following rules for Debit and Credit: Any account that obtains a benefit is Debit. OR Anything that will provide benefit to the business is Debit. Both these statements may look different but in fact if we consider that whenever an account benefits as a result of a transaction, it will have to return that benefit to the business then both the statements will look like different sides of the same picture. For credit Any account that provides a benefit is Credit. OR Anything to which the business has a responsibility to return a benefit in future is Credit. As explained in the case of Debit, whenever an account provides benefit to the business the business will have a responsibility to return that benefit at some time in future and so it is Credit.
FINANCIAL ACCOUNTING (Lecture-05) Rules of Debit and Credit for Assets • •
Similarly we have established that whenever a business transfers a value / benefit to an account and as a result creates some thing that will provide future benefit; the ‘thing’ is termed as Asset. By combining both these rules we can devise following rules of Debit and Credit for Assets: o When an asset is created or purchased, value / benefit is transferred to that account, so it is Debited i. Increase in Asset is Debit o Reversing the above situation if the asset is sold, which is termed as disposing off, for say cash, the asset account provides benefit to the cash account. Therefore, the asset account is Credited ii. Decrease in Asset is Credit
Rules of Debit and Credit for Liabilities •
Anything that transfers value to the business, and in turn creates a responsibility on part of the business to return a benefit, is a Liability. Therefore, liabilities are the exact opposite of the assets. o When a liability is created the benefit is provided to business by that account so it is Credited iii. Increase in Liability is Credit o When the business returns the benefit or repays the liability, the liability account benefits from the business. So it is Debited iv. Decrease in Liability is Debit
Rules of Debit and Credit for Expenses • • •
Just like assets, we have to pay for expenses. From assets, we draw benefit for a long time whereas the benefit from expenses is for a short run. Therefore, Expenditure is just like Asset but for a short run. Using our rule for Debit and Credit, when we pay cash for any expense that expense account benefits from cash, therefore, it is Debited. o Now we can lay down our rule for Expenditure: i. Increase in Expenditure is Debit o Reversing the above situation, if we return any item that we had purchased, we will receive cash in return. Cash account will receive benefit from that Expenditure account. Therefore, Expenditure account will be credited ii. Decrease in Expenditure is Credit
FINANCIAL ACCOUNTING (Lecture-05) Rules of Debit and Credit for Income • •
Income accounts are exactly opposite to expense accounts just as liabilities are opposite to that of assets. Therefore, using the same principle we can draw our rules of Debit and Credit for Income iii. Increase in Income is Credit iv. Decrease in Income is Debit