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Introduction to Double Entry System

"Every business transaction affects at least two accounts."

The Double Entry System is the backbone of modern accounting. It was documented by Luca Pacioli, an Italian mathematician, in 1494. This system ensures that the accounting equation (Assets = Liabilities + Capital) always remains balanced.

What is Double Entry System?

Definition: A system where every transaction is recorded in at least two accounts - one account is debited, and another is credited with equal amounts.

Core Principle: Dual Aspect Concept - Every transaction has two effects.

Example:

  • You buy furniture for ₹50,000 cash.
  • Effect 1: Furniture (Asset) increases by ₹50,000 → Debit Furniture
  • Effect 2: Cash (Asset) decreases by ₹50,000 → Credit Cash

The Accounting Equation

ASSETS = LIABILITIES + CAPITAL

This equation must always be in balance after every transaction.

Example:

  • Started business with ₹1,00,000 cash.
  • Assets (Cash) = ₹1,00,000
  • Capital = ₹1,00,000
  • Liabilities = ₹0
  • Balanced: ₹1,00,000 = ₹0 + ₹1,00,000 ✓

Types of Accounts

All accounts are classified into 3 main categories:

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1. Personal Accounts

Accounts representing persons or entities.

Types:

  • Natural Persons: Individuals (Ramesh, Suresh)
  • Artificial Persons: Companies, Banks, Firms (Tata Motors Ltd., State Bank of India)
  • Representative Personal Accounts: Represent a group (Outstanding Salary A/c, Prepaid Insurance A/c)

Golden Rule:

Debit the Receiver
Credit the Giver

Example: Paid cash to Ramesh ₹5,000.

  • Ramesh receives → Debit Ramesh
  • Cash gives → Credit Cash

2. Real Accounts

Accounts representing assets and properties that have a physical existence or value.

Types:

  • Tangible Real Accounts: Physical assets (Cash, Furniture, Machinery, Building)
  • Intangible Real Accounts: Non-physical assets (Goodwill, Patents, Trademarks)

Golden Rule:

Debit what comes in
Credit what goes out

Example: Purchased machinery for ₹2,00,000 cash.

  • Machinery comes in → Debit Machinery
  • Cash goes out → Credit Cash

3. Nominal Accounts

Accounts representing expenses, incomes, losses, and gains.

Characteristics:

  • These accounts are temporary (closed at year-end).
  • Balances transferred to Profit & Loss Account.

Golden Rule:

Debit all Expenses and Losses
Credit all Incomes and Gains

Examples:

  • Paid salaries ₹30,000 → Debit Salary (expense)
  • Received commission ₹5,000 → Credit Commission Received (income)

The Golden Rules Summary

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Modern Approach: Debit and Credit Rules

In modern accounting, we classify based on the accounting equation:

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Step-by-Step: How to Record a Transaction

Transaction: Purchased goods for ₹10,000 from Mohan on credit.

Step 1: Identify the accounts involved

  • Purchases A/c (Nominal - Expense)
  • Mohan A/c (Personal - Creditor)

Step 2: Classify the accounts

  • Purchases = Nominal Account
  • Mohan = Personal Account

Step 3: Apply the golden rules

  • Purchases (Expense) → Debit
  • Mohan (Giver) → Credit

Journal Entry:

Purchases A/c                Dr.    ₹10,000
    To Mohan A/c                       ₹10,000
(Being goods purchased on credit)

Advantages of Double Entry System

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Real-World Example

Reliance Industries - Everyday Transactions

  1. Paid electricity bill ₹50,000 cash:

    • Electricity (Nominal - Expense) → Debit
    • Cash (Real - Asset) → Credit

  2. Received cash from customer Walmart ₹10 Lakhs:

    • Cash (Real - Asset) → Debit
    • Walmart (Personal - Debtor) → Credit

  3. Owner withdrew ₹2 Lakhs for personal use:

    • Drawings (Personal - Reduces Capital) → Debit
    • Cash (Real - Asset) → Credit

Quiz: Double Entry System

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