Financial Accounting

Prepared by: Asma Saddique

What is debit and credit

Understanding what are debits and credits

Finance terms are based on accounting and when we see double entry book system, every debit must have a corresponding credit
entry. This is how total assets always equal total liabilities.

There are three simple rules of accounting.

These rules are set for three categories of accounts—Personal, Real and Nominal account.

Types of accounts:

There are three main types of accounts:

1. Personal accounts
2. Real accounts
3. Nominal accounts
1. Personal accounts:

These accounts are related to individuals, firms, companies etc.

Rule: Debit the receiver, credit the giver.

Liability accounts:

Normal balance: Credit

Rule: An increase is recorded on the credit side and a decrease is recorded on the debit side of all liability accounts.
 2. Real accounts:

All assets of a company which are tangible (building, machinery, stock, land etc.) or intangible (goodwill, patents, trademarks etc.) fall
under the category of real accounts.

Rule: Debit what comes in, credit what goes out

Asset accounts:

Normal balance: Debit

Rule: An increase is recorded on the debit side and a decrease is recorded on the credit side of all asset accounts.

3. Nominal accounts:

Accounts which are related to expenses, losses, incomes or gains are called nominal accounts.

Rule: Debit all expenses and losses, Credit all incomes and revenues

Revenue/Income accounts:

Normal balance: Credit

Rule: An increase is recorded on the credit side and a decrease is recorded on the debit side of all revenue accounts.

Expense accounts:

Normal balance: Debit

Rule: An increase is recorded on the debit side and a decrease is recorded on the credit side of all expense accounts.
Examples:

a. Cash Sale
b. Cash Purchase
c. Repayment of loan

Solution:

1. Sale for cash

Cash A/c – Dr.

To Sale A/c

2. Purchase of inventory from the supplier for cash

Inventory A/c – Dr.

To Cash A/c

3. Repaying a loan
Loan payable A/c – Dr.

To cash A/c

Example:

The following transactions are related to Small Traders:

1. Started business with cash $95,000.

2. Purchased furniture for cash $8,000.
3. Purchased goods for cash $40,000.
4. Purchased goods on credit from Big Traders $57,000.
5. Sold goods for cash $5,000.
6. Purchased equipment for business $4,000.
7. Sold goods on credit to John Retailers $15,000.
8. Paid salary to employees $1,200

Required: Identify the accounts involved in above transactions and state the nature of each account. Also mention how increases
or decreases in accounts resulting from above transactions should be recorded.

Solution:
Problem 1:

Creative Advertising, owned by Miss Abida Masood, provides advertising consulting services. During January 2011, the following
events occurred:

Jan. 2 Owner contributed Rs. 50,000 to start her business.

Jan. 4 Office supplies were purchased on account for Rs. 4,000.

Jan. 10 Creative Advertising obtained 5-year loan of Rs. 20,000 from the bank.

Jan. 12 Creative Advertising paid the utility bills for Rs. 2,750.

Jan. 15 Paid the Rs. 3,000 in Accounts Payable from the purchase of office supplies on Jan. 4.

Jan. 24 Advertising services completed in January were billed to clients Annies’ Flowers at Rs. 18,300.

Jan. 27 Creative Advertising received Rs. 5,500 from Annies’ Flowers, a client, as payment on account.

Jan. 30 Miss Abida Masood withdrew Rs. 6,000 of cash for personal use.

Requirement: You are required to pass Journal Entry, post to appropriate general ledger account and make a trial balance?

Solution: General Journal

Date Account title and explanation Ref Debit Credit

Jan 2nd 2011 Cash 50000

Owner’s Equity 50000

(started business with cash)

Jan 4th 2011 Office supplies 4000

Account payable 4000

(office supplies purchased on credit)

Jan 10, 2011 Cash 12000

Bank loan 12000

(loan obtained)
Jan 12th, 2011 Utility bills 2750

Cash 2750

(utility bills paid)

th
Jan 15 , 2011 Account payable 3000

Cash 3000

(Paid partial account payable)

Jan 24th, 2011 Account receivable 18300

Client services 18300

(bill to customer for services earned)

th
Jan 27 , 2011 Cash 5500

Account receivable 5500

(partial payment received from A/C

payable)
Jan 30th, 2011 Drawing 6000
 Cash 6000

(cash withdrawn for personal use)

General Ledger

Cash Account

Date Description Ref Amount Date Description Ref Amount

Jan 2 Owner’s equity 50,000 Utility bills 2750
Jan 10 Bank loan 20,000 Account payable 3000
Jan 27 Account 5500 Drawings 6000
receivable
Bal c/d 63,750
Total 75,500 75,500

Owner’s Equity Account

Date Description Ref Amount Date Description Ref Amount

Jan 2 Cash 50000
Bal c/d 50,000
Total 50000 50000

Office supplies account

Date Description Ref Amount Date Description Ref Amount

Jan 4 Account payable 4000
Bal c/d 4000
Total 4000 4000

Accounts payable account

Date Description Ref Amount Date Description Ref Amount
Jan 15 Cash 3000 Jan 4 Office supplies 4000
Bal c/d 1000
Total 4000 4000

Bank loan account

Date Description Ref Amount Date Description Ref Amount

Jan 10 Cash 20000
Bal c/d 20,000
Total 20000 20000

Utility Bills account

Date Description Ref Amount Date Description Ref Amount

Cash 2750
Bal c/d 2750
Total 2750 2750

Account Receivable account

Date Description Ref Amount Date Description Ref Amount

Jan 24 Advertising 18300 Jan 27 Cash 5500
services
Bal c/d 12800
Total 18300 18300

Advertising services account

Date Description Ref Amount Date Description Ref Amount

Jan 24 A/C receivable 18300
Bal c/d 18300
 Total 18300 18300

Drawing Account

Date Description Ref Amount Date Description Ref Amount

Jan 30 Cash 6000
Bal c/d 6000
Total 6000 6000

Trial Balance

Sr. No. Heads of account Ref Amount

Debit Credit
1 Cash 63,750
2 Owner’s Equity 50000
3 Office supplies 4000
4 Account payable 1000
5 Advertising services 18300
6 Bank loan 20,000
7 Utility services 2750
8 Account receivable 12800
9 Drawing 6000
Total 89,300 89,300
Assignment:

Pass journal entries for these transactions, post them to ledger account and make trial balance for ABC Ltd as on June 30th, 2008:

1. Owner investment in Cash Rs. 10,000

2. Borrowing Rs. 1,000 from a local bank on a Note due in three months
3. Purchase Equipment of Rs. 500, paid Rs. 100 Cash and promising the rest on a Note Payable
4. Paid Rs. 150 for Stationery
5. Lent Rs. 200 to an employee who signed a Note promising to repay within 60 days
6. Paid Insurance for three year at start of this accounting period Rs. 1,800
7. Insurances expired recorded as Insurance Expense of Rs. 600
8. Personal withdrawal of owner of Rs. 700