Accounts Their Construction

How accounts are made? What are sources of these accounts to initiate the accounting process so that the required statements are generated subsequently?What is the format of accounts and what purpose do they serve? Before we answer all these questions it is worthwhile to understand some of the frequently used terms in accounting.

i.Account

An Account is a systematic record of the financial transactions pertaining to a particular asset, a particular liability, an owner’s equity item, a revenue item or an expense item. Transactions of similar nature are brought together at one place in an account, which are opened in a book called Ledger.

ii. Ledger

A ledger is a set of accounts of an enterprise. It may be kept in bound or Loose Leaf form. All these accounts, each on a separate page or card are the source of information for preparation of the various financial statements.

iii. Journal

A journal is a chronological record of transactions. The Journal is the original book in which the transactions are recorded in the order in which they happen.

iv. Assets

Assets are items of value owned by a enterprise. It includes tangible and intangible items or rights. Tangible items may be in the form of money, buildings, machinery etc. Intangible items include claims on tangible assets, claims on services and also items such as goodwill, patents, copyrights and franchises. Assets can further be classified into current assets and long term assets.

v. Equities

These are claims against the enterprise. Claims are of two types

i) Liabilities: amount due to outsiders. Liabilities are debts or obligations of the enterprise to pay money or other assets at some future date. Liabilities can be further classified into current liabilities and long term liabilities

ii) Capital: Claims of owners or proprietors.

The sum of the claims of outsiders (creditors) and that of the owners is always equal to the total value of all assets owned by the enterprise. It is known as the Fundamental Accounting Equation.

 

Having known the basic terminology let us understand how an account is constructed. We know that accounting is concerned with the recording of financial transactions of a business entity. The source of account is a document (calledSource Document) which becomes the basis for recording a transaction in the books of accounts. Source documents are the original sources of information that provide documentation (proof) that a transaction has occurred. Sales invoices,invoices from suppliers, contracts, cheques written and cheques received, promissory notes, and various other types of business documents are source documents.These documents provide us with the information needed to record our financial transactions in our bookkeeping records.There is a variety of forms for accounts but the most common is the ‘T’ account because each account form resembles a capital letter ‘T’.The title is placed above and in the centre of each account At the centre of the horizontal line a perpendicular is drawn downward to separate the account into two distinct parts. The left part of the T account is called debit side and the right one is called the credit side as shown below:



To enter an amount on the left side of an account to known as debiting 

To enter an amount in the right side of an account is known as crediting the account.

The Rules of Debits and Credits and the Account How to determine whether an entry is to be made in debit or credit side of any account and what are the rules that guide us so that the proper entries are made in the book of accounts? The following shall help us in this process.

(1) Determine the type of account (asset, liability, revenue, or expense account) the transactions affect

(2) Determine if the transaction increases or decreases the account’s balance.

(3) Apply the debit and credit rules based on the type of account and whether the balance of the account will increase or decrease after the transaction.

Assets are increased by debits. There is no reason for this other than that it has been conventional approach for several hundred years. If an asset is increased by a debit and if debits must equal credits, then a liability account or stockholders’equity account must be increased by a credit Conversely assets are reduced by credits and debits would then reduce liability or stockholders’ equity. The following rules of making entries are adopted with respect to assets, liabilities and capital and the nominal accounts.

Regarding Assets: Increases in assets are debits and decreases in assets are credits.

Regarding Liabilities: Increases in liabilities are credits and decreases in liabilities are debits.
Regarding Capital: Increases in capital are credits and decreases are debits.

Regarding Expense: Increases in expenses are debits and decreases are credits Regarding Income or Profits: Increases in income or profit are credits, decreases are debits

Regarding Stocks: Debit what comes in and credit, what goes out.

Regarding Receiver/ Giver: Debit the receiver and credit the giver

The purpose of accounts is to supply the recorded data for the preparation of accounting statements.