Question

In 200 words or more, Explain how accounts, debits, and credits are used to record business transactions.

Answer 1

Accounts:   Account is a record in the general ledger that is used to collect and store debit and credit amounts. For example, a company will have a Cash account in which every transaction involving cash is recorded. If the company sells merchandise for cash, the Cash account will be debited and the Sales account will be credited. All the transactions of business are recorded in accounts

There are mainly three types of accounts in accounting: Real, Personal and Nominal accounts, personal accounts are classified into three subcategories: Artificial, Natural, and Representative.

If you fail to identify an account correctly as either a real, personal or nominal account, in most cases, you will get end up recording incorrect journal entries.

1. Real Accounts: All assets of a firm, which are tangible or intangible, fall under the category “Real Accounts“.

Tangible real accounts are related to things that can be touched and felt physically. Few examples of tangible real accounts are building, machinery, stock, land, etc.

Intangible real accounts are related to things that can’t be touched and felt physically. Few examples of such real accounts are goodwill, patents, trademarks, etc.

2. Personal Accounts: These accounts are related to individuals, firms, companies, etc. A few examples of personal accounts include debtors, creditors, banks, outstanding/prepaid accounts, accounts of credit customers, accounts of goods suppliers, capital, drawings, etc.

Natural personal accounts: This type of personal accounts is the simplest to understand out of all and includes all of God’s creations who have the ability to deal, who, in most cases, are people. E.g. Kumar’s A/C, Adam’s A/C, etc.

Artificial personal accounts: Personal accounts which are created artificially by law, such as corporate bodies and institutions, are called Artificial personal accounts. E.g. Pvt Ltd companies, LLCs, LLPs, clubs, schools, etc.

Representative personal accounts: Accounts which represent a certain person or a group directly or indirectly. E.g. Let’s say that wages are paid in advance to an employee – a wageprepaid account will be opened in the books of accounts. This wages prepaid account is a representative personal account indirectly linked to the person.

3. Nominal Accounts

Accounts which are related to expenses, losses, incomes or gains are called Nominal accounts. The dictionary meaning of the word “nominal” is “existing in name only” and the meaning remains absolutely true in accounting sense too, because nominal accounts do not really exist in physical form, but behind every nominal account money is involved. E.g. Purchase A/C, Salary A/C, Sales A/C, Commission received A/C, etc.

The final result of all nominal accounts is either profit or loss which is then transferred to the capital account.

DEBIT

A debit is an accounting entry that either increases an asset or expense account, or decreases a liability or equity account. It is positioned to the left in an accounting entry.

CREDIT

A credit is an accounting entry that either increases a liability or equity account, or decreases an asset or expense account. It is positioned to the right in an accounting entry.