Financial management: Introduction to basic accounting principles

By GR Thengdi

Accounting is based on this simple principle. When we deposit money in our bank account, we have debited our bank account. But for bank, it is a credit transaction

The system of book keeping by double entry is the most beautiful and scientific system of keeping financial records. Debit and credit are the only two terms used in accounting. For any financial transaction, value of debit and credit must be same. There are two parties to a financial transaction. One party has money and he wants to purchase particular goods using his money. The other party has ‘those’ goods which he wants to sell or exchange for money.

They agree to the price. Now the accounting transactions for the two parties will be as follows:

The first party

  • Debit purchase (or consumption) a/c
  • Credit cash a/c       

The second party

  • Debit cash a/c
  • Credit sales a/c

First party has received the goods and second party has received cash and hence both have debits for what they have received. The first party has parted with cash, while the second party has parted with goods hence both have credits for what they have given.

Transactions on credit

Financial transaction takes place when either money is received or paid, however, there can be some transactions where goods are actually exchanged but money is paid at a later date. Till the money is paid, the receiver owes the money to the supplier and the supplier is his creditor.

For the supplier, the buyer is his debtor till he receives the money from the buyer. Thus, the buyer will credit supplier’s a/c (or creditor’s a/c) instead of cash a/c—when he receives the goods—and the supplier will debit buyer’s a/c (or debtor’s a/c) when he parts with the goods. When cash is exchanged, the transaction will be complete. Purchase by using credit card is an example of purchases on credit.

The buyer gets the goods and services by swiping his card with the dealer, and the dealer gets his dues from the credit card company. The credit card company will send a consolidated statement of transactions during the billing cycle to the card member and when the card member pays the amount the cycle gets completed.

In short, what one receives or owns is debit transaction and what one gives or owes is a credit transaction. Expenditure heads are debit accounts and cash spent is credit head. Income heads are credit accounts and cash received is debit account. Accounting is based on this simple principle. When we deposit money in our bank account, we have debited our bank account. For bank, it is a credit transaction. When we draw money from bank, we credit bank account and the bank will debit account. We will have debit balance in our bank account and bank will have credit balance. For us, balance in bank account is asset, for bank, balance in our account is liability.

The author has worked in the field of financial management over 50 years.

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