What are the Rules of Accounting?

Learn about the Rules of Accounting with Shah Rukh Khan

Case breakdown: Movie Raees:

The scene that you saw shows Raees (played by Shah Rukh Khan) talking to an older gentleman. He mentions about a building that needs to be constructed on a land for which he has given his word. Raees goes on to say, accounting (hisaab) has its own rule but here my rule exists.

In this blog, Learning Perspectives, will explore the meaning of rules of accounting.

What are the Rules of Accounting?

External transactions have the affect of increase or decrease in the account balances. In accountancy words increase and decrease are replaced with debit and credit. Now a student needs to understand how to increase and decrease account balances.

Debit comes from a Latin word ‘debere‘ which implies ‘to owe’ in English while Credit according to English dictionary means to give praise, approval, honor or something positive. In accountancy they are quite close to their English meanings. As with learning any language there are some rules that one needs to remember and apply, same goes for accountancy.

Rule 1:

Assets= Liabilities+ Stockholder’s Equity.

This is the accounting equation. This equation always balances out as this equation means assets or resources of a business is equal to claim of the creditors and owners of the business.

Rule 2 :

One of the rule of accountancy is that every debit has a credit, hence it is also called a double entry book-keeping. This also means that two accounts will be affected in every transaction. e.g. Let’s say you received Rs. 5000 in your account, your account balance increases (credits) by Rs. 5,000 but someone else’s account decreases (debit) by Rs. 5,000. Hence, just like every increase has a decrease every debit has a credit.

 

Rule 3:

Whenever an assets increases we debit the account and when it decreases we credit the account. This situation reverses for liabilities and stockholders’ equity.

If this rule is presented graphically, it will look like this:

Follow this rule to make journal Entries

Let’s understand this through some examples:

  1. If you borrow money from bank, what will be the journal entry in the business:

The first thing to understand is when I borrow from bank Rs. 1,00,000 and sign a note for it, I get Rs. one lakh that means Cash (Asset) comes in my business. This increases assets of the business.

As there are no free lunches, Rs. one Lakh is not free as well, bank gives me this as a loan (burden/liability), so it’s my obligation to pay back Rs. one Lakhs with interest to the bank. This increases the liability of my business by Rs. 1,00,000.

Now, according to the rule 3, whenever asset (cash) increases we debit it, so cash is debited and if liabilities increase we credit it (See rule 3 above). Also the equation would always be balanced. Hence, the journal entry becomes:

 

Being Rs. 1,00,000 borrowed from bank

  1. If you purchase equipment for your business for Rs. 25,000

Let’s say I run a restaurant business, I would purchase a food processor or a bulk Roti maker etc. to run my business. This would be an asset for my business. When I purchase it, this food processor would come in the business but another asset would go out and that would be cash.

So, if you see the rule an increase in asset, would be debited while a decrease in asset would be credited.

Written by: Ms. Gitika Chandra

3 Comments

Leave a Reply