Why is accounting important to every business? Accounting plays an important role in running a business because it helps in tracking revenue and expenses, it ensures statutory compliance and provides quantitative financial information to investors, management and the government, which can be used in making better financial decisions.
What is accounting?
It is an art of recording, summarizing, and classifying the transactions in a significant way along with storing, sorting, and retrieving information which results in various reports and analyses.
Important terms of accounting
Debit and credit: these are the two main pillars of accounting. Every transaction is recorded in a T shaped accounting system, the debit lists are recorded on the left side of the statements, and credits are recorded on the right-hand side.
Double-entry system: every transaction in the accounting system affects at least two accounts, out of which one will be debited and the other one will be credited.
Approaches to accounting
In accounting, there are two approaches through which a business can record its transaction.
- Traditional Approach;
The traditional approach of accounting classifies the accounts in three different ways. The traditional approach is also known as a universal approach. There are three golden rules to record transactions for three respective types of accounts.
What are the three types of accounts?
- Personal accounts are the accounts related to the person. These are individual accounts, firm accounts, and company accounts. Personal accounts are classified into
- Natural accounts
- Artificial accounts
- Representative accounts
- Real accounts; include the assets, liabilities, and equity accounts of the organization. these accounts are further classified into
- Tangible accounts
- Intangible accounts
- Nominal accounts; are the accounts relating to the income, losses, expenses, and gains. These accounts are future classified into
- Incomes
- Expenses
- Gains
- losses
Golden rules of accounting
- Real account rules;
Debit what comes into the business account
Credit what goes out of the business
- Personal account rules;
Debit the receiver
Credit the giver
- Nominal account rules;
Debit all expenses and losses
Credit all incomes and gains
Example;
The company paid Rs. 20000 as salary to the employee
Type of account is, Company is a nominal account and the employee is a personal account. And the rules accordingly.
- Modern Approach
The modern approach uses the accounting equation to record the transactions. Accounts classified under the modern approach are assets, liabilities, capital, revenue, and expenses.
| Type of accounts | Accounts to be debited | Accounts to credit |
| Asset accounts | Increase | decrease |
| Liabilities account | decrease | Increase |
| Capital account | decrease | Increase |
| Revenue account | decrease | Increase |
| Expenses account | increase | decrease |
Example
Deposited Rs 20000 in HDFC bank
Under the traditional approach
Rule- real account rules debit what comes in credit what goes out
Thus, the bank will be debited and cash will be credited.
Under the modern approach
Rule- asset account
The amount of account increasing will be debited and the amount of account decreasing will be credited.
