Accounting is a complex business and goes far beyond mere bookkeeping . The crux of the matter comes down to, unequivocally, two important aspects of accounting: debit and credit. A transaction cannot be meaningfully recorded without a clear understanding of what account should be debited or credited.
When a financial transaction takes place, it affects two accounts and, in the dual entry system of accounting, we have two columns for entering our transaction: the debit side and the credit side. How we record the figures in those columns now depends very much on the type of account/s we are dealing with. There are three categories of accounting in the golden rules:
Real account: These are the tangible aspects of the business, such as equipment, cash, furniture, and so on. If an item on this account is coming into a business, it’s recorded on the debit side of the ledger and if it’s going out of the business it’s written on the credit side.
Nominal account: These represent all the expenses, losses, income, and gains incurred while doing business, such as electricity bills, interest earned, running expenses, and so on. Under this category, all expenses and losses are recorded on the debit side of the ledger, and all incomes and gains are recorded on the credit side of the ledger.
Personal account: These represent general ledger accounts connected to legal entities, i.e., individuals or registered organisations. An employee’s salary account, vendor accounts, and creditor accounts are some types of personal accounts. Under this category, transactions where money is received from the business are recorded on the debit side of the ledger and transactions where money is paid into the business are recorded on the credit side of the ledger.
In a nutshell, then, when it comes to accounting, the golden rules are as tabulated as below:
|Ledger Column||Real Accounts||Nominal Accounts||Personal Accounts|
|Debit||What comes in||Expenses & losses||The receiver|
|Credit||What goes out||Income & profits||The giver|
A solid accounting system in place allows an organisation to plan an effective budget and budgeting policy while controlling expenditure to boost income; monitor the performance of the business more accurately; manage cash flow; possess more complete data snapshots of the company’s performance; and, ensure the legal and regulatory compliance of the company.
The system of debits and credits is at the very basis of this double-entry system of bookkeeping. While it is the best system we have, it does tend to be difficult to implement. Understanding the system of debits and credits may require a few expensive resources. However, even at the best of times, few companies can afford the price of the vast investment required for effective record keeping. It is generally done by clerical staff and people who work in the stores department; and it is generally done inadequately, leading to all sorts of juggling retroactively, and frequently leading to losses.
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A company’s financial health is always the major concern of its creditors and investors. Financial statements serve as an effective methodology to gauge the profitability and safety of their investment, as well as providing critical insights into a company’s financial position and provide an overview of assets and liabilities and stockholders’ equity. It also helps comprehend the company’s revenues and expenditure, how the company pays its debts, and how it services its operational expenses.
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