TYPES OF ACCOUNTS,

ACCOUNTING RULES AND

EQUATION
 TYPES OF ACCOUNTS

1. Personal
Accounts

Personal accounts relate to individuals, organizations,

firms, and other legal entities. These accounts help
track transactions involving people or entities with
whom the business interacts financially.

Examples:
• Natural Persons: Accounts for individuals (e.g., Mr. X's Account).
• Artificial Persons: Corporate entities like companies or institutions (e.g., ABC Ltd.’s Account).
• Representative Accounts: Accounts representing a group or an obligation (e.g., Outstanding
Wages, Prepaid Rent).
GOLDEN RULE FOR PERSONAL ACCOUNTS:

"Debit the Receiver, Credit the Giver".

This means when a person or entity receives something, the account is

debited. When a person or entity gives something, the account is
credited.

Example: If cash is paid to Mr. X, Mr. X’s account will be debited, and Cash
will be credited.
 2. Real
Accounts

Real accounts pertain to all assets, both tangible and intangible, that are owned
by the business. These are permanent accounts that reflect the actual resources
the business owns and carries over from one accounting period to another.

Examples:
• Tangible Assets: Physical assets like Cash, Buildings, Equipment, Vehicles.
• Intangible Assets: Non-physical assets like Patents, Trademarks, Goodwill.
 GOLDEN RULE FOR REAL ACCOUNTS:

"Debit What Comes In, Credit What Goes Out".

When an asset enters the business, it is debited, and when

an asset leaves the business, it is credited.

Example: When equipment is purchased for cash,

Equipment (asset) is debited, and Cash (asset) is credited.
 3.
Nominal
Accounts

Nominal accounts represent all expenses, losses, incomes, and

gains. These accounts are temporary, meaning they are closed at the
end of each accounting period to determine the net profit or loss.

Examples:
• Expenses and Losses: Rent, Salaries, Electricity, Interest Paid.
• Incomes and Gains: Sales, Commission Received, Interest Earned.
 GOLDEN RULE FOR NOMINAL ACCOUNTS:

"Debit All Expenses and Losses, Credit All Incomes and Gains".

This implies expenses and losses are debited to show a reduction in

capital, while incomes and gains are credited to reflect an increase in
capital.

Example: If rent is paid, Rent Expense is debited, and Cash is credited.

 THE ACCOUNTING EQUATION
The accounting equation is the foundation of accounting. It shows the relationship between a
company's assets, liabilities, and owner’s equity and demonstrates that all financial transactions
affect both sides of this equation.

Assets = Liabilities + Owner’s Equity

1 Assets: Resources owned by the business that have economic value, such as cash, equipment,
and inventory.

2 Liabilities: Obligations or debts that the business owes to external entities, like loans and
accounts payable.

3 Owner’s Equity: The owner's claim on the business assets after liabilities are subtracted (e.g.,
capital contributed, retained earnings).
 IMPACT OF TRANSACTIONS ON THE
ACCOUNTING EQUATION
• The accounting equation must stay balanced with every
transaction, meaning every transaction affects at least two
accounts:
• Example 1: If a business owner invests $10,000 in cash, the
equation will show an increase in assets (cash) and an increase in
owner’s equity (capital).
• Assets (Cash) = Liabilities + Owner’s Equity (Capital).
• Journal Entry: Debit Cash, Credit Capital.
• Example 2: If the business buys equipment for $5,000 in cash, there’s
no effect on liabilities or owner’s equity but a shift within assets.
• The asset Cash decreases by $5,000, while the asset Equipment
increases by $5,000.
• Journal Entry: Debit Equipment, Credit Cash.
 1. INTRODUCTION TO JOURNAL ENTRIES

A journal entry is the first step in the accounting

process where business transactions are recorded
systematically.

It follows the double-entry system where every

transaction affects two or more accounts and
ensures that total debits equal total credits.
 2. PURPOSE OF JOURNAL ENTRIES

To maintain a chronological record of all business

transactions.

To ensure the accounting equation (Assets = Liabilities

+ Equity) is balanced.

To serve as the base for preparing ledgers, trial balance,

and financial statements.
 PREPARATION OF JOURNAL ENTRIES

Journal entries are the initial records of financial transactions in the accounting
system. They provide detailed documentation, which is essential for the
integrity and reliability of financial records.

Components of a Journal Entry

• Date: The date when the transaction occurs.

• Account Titles and Descriptions: Proper account names involved in the transaction.
• Debit and Credit: Each entry must include at least one debit and one credit, following the golden
rules.
• Narration: A brief description explaining the nature of the transaction.
FORMAT OF A JOURNAL ENTRY
 3. CATEGORIES OF TYPES OF ACCOUNTS

Assets: Resources owned by the business (e.g., Cash, Inventory, Equipment).

Liabilities: Obligations or debts owed by the business (e.g., Loans, Creditors).

Equity: The owner’s residual interest in the business (e.g., Capital, Retained
Earnings).

Income/Revenue: Earnings generated from operations (e.g., Sales, Rent Income).

Expenses: Costs incurred during operations (e.g., Purchases, Rent, Salaries).

 4. RULES OF DEBIT AND CREDIT

• The golden rules help determine whether to debit or credit an account:

 7. THE DOUBLE-ENTRY SYSTEM

• Principle: Every transaction affects at least two accounts.

• Debits and Credits:
• Debit: Left-hand side of an account; represents increases in assets and expenses or
decreases in liabilities and income.
• Credit: Right-hand side of an account; represents increases in liabilities and income or
decreases in assets and expenses.
 8. CUE TO REMEMBER DEBIT AND CREDIT

• Use DEALER:
• Debit:
• Expenses
• Assets
• Losses
• Credit:
• Liabilities
• Equity
• Revenue
 2. OPENING A LEDGER ACCOUNT

• Each account from the journal entry is posted in a separate ledger account. Ledger
accounts are typically formatted in a "T" shape, with two columns: Debit (Dr.) on the
left and Credit (Cr.) on the right.
• For our example, we’ll create two ledger accounts:

• Machinery Account
• Cash Account
 3. POSTING TO THE LEDGER

• For each transaction:

• Debit Posting: In the debit account (Machinery in this example), record the
transaction date, details of the account credited (Cash), and the debit amount (Rs.
1,20,000).
• Credit Posting: In the credit account (Cash in this example), record the transaction
date, details of the account debited (Machinery), and the credit amount (Rs.
1,20,000).
 KEY POINTS IN LEDGER POSTING

1.Separate Ledger for Each Account: Each account, such as Cash, Capital, Machinery,
etc., has its own ledger where all transactions affecting that account are recorded.
2.T Format: The ledger typically has a T format with debit on the left and credit on the
right.
3.Date and Particulars: Each entry includes the transaction date and the opposite
account (under "Particulars") to show the nature of the transaction.
4.L.F (Ledger Folio): The L.F. column in ledgers is used to note the page number of the
journal from which the entry was transferred. This is useful for referencing.
5. Balancing the Ledger: At the end of the accounting period, each ledger is balanced
to reflect the closing balance, which is then carried forward or reported in financial
statements.
6. Real, Personal, and Nominal Accounts:
1. Real Accounts (like Cash, Furniture, Machinery) generally carry a closing balance.
2. Personal Accounts (like MNO Traders) represent balances with specific entities and may
also carry balances.
3. Nominal Accounts (like Rent, Salary, Sales, Purchases) are closed at the end of the
period by transferring their balances to the Profit and Loss Account.
 FORMAT OF LEDGER

• Machinery Account
• Explanation: The debit side of the Machinery Account is entered with Rs. 1,20,000,
and the "Particulars" column notes Cash A/c to indicate that cash was used to
purchase the machinery.

Date Particulars L.F Debit Credit

June 5, 2021 Cash A/c 1,20,000

 FORMAT OD LEDGER

• Cash Account
• Explanation: The credit side of the Cash Account is entered with Rs. 1,20,000, and
the "Particulars" column notes Machinery A/c to show that the cash was used to buy
machinery.

Date Particulars L.F Debit Credit

June 5, 2021 Machinery A/c 1,20,000

 WHAT IS A TRIAL BALANCE?

A trial balance is a financial statement that

lists all the ledger accounts and their
balances (debit or credit) at a specific point
in time. It is used to ensure that the total
debits equal the total credits in the
accounting system.
 PURPOSE OF A TRIAL BALANCE

Error Detection: To check for mathematical accuracy in the ledger accounts. If

the total of debit balances equals the total of credit balances, it indicates the
books are arithmetically correct.

Preparation of Financial Statements: Forms the basis for creating the profit
and loss account and the balance sheet.

Summarization: Summarizes all account balances in one place for easy

review.
 TRIAL BALANCE

Account Name Debit Credit

Capital 0 50000

Cash 46000 0

Purchases 32000 0

Rita 0 2000

Rohit 9000

Sales 0 35000

Total 87000 87000

 INTRODUCTION TO FINAL ACCOUNTS

Final accounts are a complete set of financial statements prepared at the end of an
accounting period (monthly, quarterly, or annually) to ascertain:
1.Financial Performance: Achieved through the Trading Account and Profit & Loss
Account.
2.Financial Position: Revealed through the Balance Sheet.
 OBJECTIVES OF PREPARING FINAL ACCOUNTS

Compliance with
Assess Financial
Determine Gross Determine Net Profit Legal and Regulatory
Position: Via the
Profit or Loss: Through or Loss: Through the Requirements: For
Balance Sheet, showing
the Trading Account. Profit & Loss Account. taxation and statutory
assets and liabilities.
reporting.
COMPONENTS OF FINAL ACCOUNTS

Trading Profit and Balance

Account Loss Account Sheet
 1. TRADING ACCOUNT

• The Trading Account measures gross profit or loss, focusing on direct business
activities like manufacturing or purchasing goods and selling them.
• Purpose: Evaluate the efficiency of core business operations.
 FORMAT:

Debit Side:
• Opening Stock: Unsold inventory at the start of the period.
• Purchases: Goods bought for resale.
• Direct Expenses: Expenses directly linked to goods (e.g., wages,
carriage inwards, freight).
Credit Side:
• Sales: Revenue from sold goods (cash + credit).
• Closing Stock: Unsold inventory at the end of the period.
 EXAMPLE

Opening Stock: Unsold inventory at the start of the period (₹50,000).

Purchases: Goods purchased for resale (₹2,00,000).

Direct Expenses: Wages incurred for production/sale activities (₹20,000).

Sales: Revenue from selling goods (₹3,50,000).

Closing Stock: Unsold inventory at the end of the period (₹40,000).

Gross Profit: Calculated to balance both sides (₹1,20,000).

 FORMULA:

Gross Profit/Loss = Sales + Closing Stock

−(Opening Stock +Purchases + Direct Expenses)
 2. PROFIT AND LOSS ACCOUNT

• The Profit and Loss Account identifies the net profit or loss by considering all
indirect expenses and additional incomes.
• Purpose: Reflect operational efficiency beyond core activities.
 FORMAT

Debit Side: Indirect Expenses (e.g., salaries,

rent, depreciation, advertising, office expenses).

Credit Side: Incomes (e.g., discount received,

commission earned, rent income).
 FORMULA

Net Profit/Loss = Gross Profit + Other Incomes

− Indirect Expenses
Gross Profit (brought down): Derived from the Trading Account (₹1,20,000).

Salaries: Indirect expense paid to staff (₹15,000).

Rent: Expense for business premises (₹5,000).

Advertising: Indirect expense for marketing (₹10,000).

Depreciation on Furniture: Loss of value for assets like furniture (₹2,000).

Net Profit: Balancing figure to equate both sides (₹98,000).

 3. BALANCE SHEET

The Balance Sheet provides a snapshot of financial position by listing:

1.Assets: Resources owned by the business.

2.Liabilities: Obligations owed to outsiders.
3.Equity: Owner’s capital and retained earnings.

Purpose: Assess financial stability and solvency.

 STRUCTURE

Assets:
• Fixed Assets: Long-term assets like buildings, machinery.
• Current Assets: Short-term assets like cash, inventory, debtors.
Liabilities:
• Long-term Liabilities: Loans payable after a year.
• Current Liabilities: Obligations due within a year (e.g., creditors, bills
payable).
Equity:
• Owner’s Capital: Initial investment and additional capital.
• Reserves and Surplus: Retained earnings and profits reinvested in the
business.
 FORMULA

Assets= Liabilities + Equity

PREPARE A TRADING ACCOUNT, PROFIT & LOSS ACCOUNT, AND BALANCE SHEET
FROM THE FOLLOWING INFORMATION FOR THE YEAR ENDING 31ST MARCH 2024
FROM DETAILS OF THESE TRANSACTIONS:

1.Opening Stock: ₹50,000 8. Depreciation on

Furniture: ₹2,000
2.Purchases: ₹2,00,000
9. Rent Received: ₹5,000
3.Sales: ₹3,50,000 10. Furniture (Book Value):
4.Closing Stock: ₹40,000 ₹60,000
11. Debtors: ₹80,000
5.Wages: ₹20,000
12. Creditors: ₹40,000
6.Salaries: ₹15,000
13. Cash: ₹30,000
7.Advertising Expenses:
14. Capital: ₹2,00,000
₹10,000
 QUICK RULES FOR DEBIT AND CREDIT
1. Trading Account
• Debit: All direct expenses related to the cost of production or purchases.
• Credit: All revenue generated through sales or closing stock.
2. Profit & Loss Account
• Debit: All indirect expenses (office, administrative, selling, and distribution
expenses).
• Credit: All indirect incomes (commission, rent, interest, etc.).
3. Balance Sheet
• Assets:
• Items the business owns or is owed (e.g., buildings, machinery, cash, inventory,
debtors).
• Liabilities:
• Items the business owes (e.g., loans, creditors, outstanding expenses).
CASH FLOW STATEMENT

A cash flow statement is a

financial report that shows the
flow of cash into and out of a
business during a specific
period. It helps understand
how a company generates and
uses cash, which is critical for
assessing its financial health.
 THE CASH FLOW STATEMENT IS DIVIDED INTO THREE
MAIN SECTIONS:

1. Operating Activities

• Definition: Operating activities show the cash generated or spent

during the normal business operations, like producing and selling
goods or providing services.

• Purpose: Indicates whether the company can generate enough cash

from its core activities to sustain operations and pay expenses.
 EXAMPLES:

Cash Inflows:
• Cash received from customers.
• Refunds from suppliers.
Cash Outflows:
• Payments to suppliers for inventory.
• Salaries and wages to employees.
• Rent, utilities, and taxes.
2. Investing Activities

• Definition: Investing activities relate to buying or

selling long-term assets or investments.

• Purpose: Shows the cash spent on future growth and

investments.
 EXAMPLES:

Cash Inflows:
• Selling property, equipment, or machinery.
• Selling investments like stocks or bonds.
Cash Outflows:
• Buying new machinery or equipment.
• Purchasing land or buildings.
• Investing in other companies.
3. Financing Activities

• Definition: Financing activities show cash movements related to

funding the business, such as borrowing or repaying loans and
equity transactions.

• Purpose: Indicates how the company is funded and how it manages

its financial obligations.
 EXAMPLES:

Cash Inflows:
• Taking a loan.
• Issuing shares to investors.
Cash Outflows:
• Repaying loans.
• Paying dividends to shareholders.
Operating = Day-to-Day

Investing = Buying/Selling Assets

Financing = Borrowing/Repaying Money

 WHAT DOES THE CASH FLOW STATEMENT RESULT IN?

The cash flow statement gives the net cash flow,

which can be:

• Positive: If inflows exceed outflows, the company has more

cash to expand or save for the future.
• Negative: If outflows exceed inflows, the company may need
additional funding to cover operations or investments.
 FORMAT OF CALCULATING CASH FLOW STATEMENT BY DIRECT
METHOD
Particulars Amount (₹)
Cash Flows from Operating Activities:
Cash received from customers 18000
Cash paid to suppliers (5000)
Cash paid for operating expenses (3000)
Net Cash Flow from Operating Activities (A) 10000
Cash Flows from Investing Activities:
Sale of assets 9000
Purchase of assets (4000)
Net Cash Flow from Investing Activities (B) 5000
Cash Flows from Financing Activities:
Proceeds from issuing shares 16000
Loan repayments (24000)
Net Cash Flow from Financing Activities (C) (8000)
Net Increase/Decrease in Cash (A + B +C) 7000
Add: Opening Cash Balance XXX (GIVEN)
Closing Cash Balance (SOLUTION) XXX (ANSWER)
 QUESTION
ABC Enterprises had the following cash transactions during December:
1. Received ₹50,000 from customers.
2. Paid ₹20,000 to suppliers.
3. Paid ₹8,000 for rent and utilities.
4. Bought new machinery for ₹12,000.
5. Took a loan of ₹15,000 from the bank.
6. Paid ₹5,000 to repay part of the loan.
7. The opening cash balance on December 1 was ₹10,000.
Prepare a Cash Flow Statement for December using the direct method.
 CATEGORIZATION

Operating Activities:
• Cash received from customers: ₹50,000.
• Cash paid to suppliers: ₹(20,000).
• Rent and utilities paid: ₹(8,000).
Investing Activities:
• Purchase of new machinery: ₹(12,000).

Financing Activities:
• Loan taken: ₹15,000.
• Loan repayment: ₹(5,000).
CASH FLOW STATEMENT FOR ABC ENTERPRISES (DIRECT METHOD)
Particulars Amount (₹)
Cash Flows from Operating Activities:
Cash received from customers 50,000
Cash paid to suppliers (20,000)
Rent and utilities paid (8,000)
Net Cash Flow from Operating Activities (A) 22,000
Cash Flows from Investing Activities:
Purchase of new machinery (12,000)
Net Cash Flow from Investing Activities (B) (12,000)
Cash Flows from Financing Activities:
Loan taken 15,000
Loan repayment (5,000)
Net Cash Flow from Financing Activities (C) 10,000
Net Increase in Cash (A + B + C) 20,000
Add: Opening Cash Balance (Dec 1) 10,000
Closing Cash Balance (Dec 31) 30,000
 LIST OF ACTIVITIES UNDER EACH CATEGORY (EASY TO
REMEMBER)

Operating Activities (Day-to-day business operations)

• Cash Inflows:
• Cash received from customers.
• Refunds from suppliers.
• Other operational receipts like rent from subleasing.
• Cash Outflows:
• Payments to suppliers for goods or services.
• Salaries and wages to employees.
• Rent paid for office or store space.
• Utilities (electricity, water, internet).
• Taxes paid to the government.
• Insurance expenses.
Investing Activities (Buying or selling long-term assets)
• Cash Inflows:
• Sale of old equipment or machinery.
• Sale of property or buildings.
• Sale of investments (stocks, bonds, etc.).
• Cash Outflows:
• Purchase of new equipment or machinery.
• Buying land or buildings.
• Investments made in shares or other businesses.
Financing Activities (Raising or repaying funds)
• Cash Inflows:
• Loans taken from banks or financial institutions.
• Proceeds from issuing shares or bonds.
• Cash Outflows:
• Repayment of loans.
• Payment of dividends to shareholders.
• Interest paid on loans.