(6) DUAL IMPACT OF BUSINESS TRANSACTIONS

 

Dual impact of business transactions

Many transactions occur daily in a business. As a result of these transactions, the values of assets, liabilities, equity, income and expenses are changed. In accounting, these changes are identified as a dual impact of a transaction. As explained earlier, each transaction causes change to two items of the accounting equation. This is termed as the dual impact of a transaction. 

Examples :- 

Investing Capital           Asset (cash) increases                Equity increases 

Purchase of furniture     Asset (furniture ) increases        Asset (cash) decrease 

Payment of Salary         Asset (cash) decreases               Equity decreases 

Because of this dual impact of each transaction, the value of each transaction should be written in two places. This means there should be two entries for each transaction. However, when the business expands, a large number of transactions could take place. In such a case, recording those transactions in an accounting equation may not be practical. Even though we could record those transactions in the accounting equation, it is very difficult to obtain information clearly whenever necessary. Therefore, the dual impact of transactions are usually recorded in accounts according to the double entry system. 

Double entry system 

As mentioned above, there is a dual impact of each transaction to the accounting equation and this dual impact should be recorded in accounts. When recording the dual impact of a transaction, the same amount has to be recorded in two separate accounts. Each account has a debit and a credit side. If a value of a transaction is debited to a particular account, that value also should be credited to another account. The accounting system, which records the same amount in debit and credit sides of accounts is called as the double entry system. 

Account 

An account is a commonly accepted structure that is used to record the change (increase or decrease) of an asset, an equity, a liability, an income or an expense for a time period. An account can be prepared as follows. 

Types of accounts 

We already discussed that assets, equity, liabilities, income and expenses arise due to business transactions. Accounts are used to record the changes of assets, equity, liabilities, income and expenses due to transactions. All these accounts can be classified into five types. 

• Asset accounts 

Examples :- Building account, Debtors account, Cash account 

• Liability accounts 

Examples :- Bank loan account, Creditors account, Electricity expense payable account 

• Equity accounts 

Examples :- Capital account, Drawings account 

• Income accounts 

Examples :- Sales account, Sales commission income account, Interest income account 

• Expenses accounts 

Examples :- Salary expense account, Insurance charges account, Electricity expense account 

When recording business transactions in accounts, the value of a transaction should be either recorded in the debit side or the credit side of the relevant account. Let us consider how to record such transactions in accounts.

Recording transactions in accounts 

Accounts are debited or credited to show the increase or decrease of assets, equity, liabilities, income or expenses due to transactions. However, debiting an account does not always mean an increase. To show an increase, some accounts are debited and also to show a decrease some accounts are debited. This is same with crediting an account. This creates a problem. The problem is to decide what is debited or what is credited to show this changes. There are some generally accepted principles in accounting which address this problem. These principles are called as the principles of Double Entry. There are five principles for the five types of accounts. They are shown in the following table.

Example :- 

Purchased a machine on 03. 01. 20xx at Rs. 500 000 

Double entry 

Machinery account (Asset increases) Dr. Rs. 500 000 

Cash book (Asset decreases) Cr. Rs. 500 000

Example :- 

Obtained a bank loan of Rs. 200 000 on 04.01.20xx 

Double entry 

Cash book (Asset increases) Dr. Rs. 200 000 

Bank loan account (Liability increases) Cr. Rs. 200 000

Example :- 

The owner invested Rs. 300 000 as the capital on 5.01.20xx 

Double entry 

Cash book (Asset increases) Dr. Rs. 300 000 

Capital account (Equity increases) Cr. Rs. 300 000

Example :- 

Received an interest income of Rs. 20 000 on 05.01.20xx 

Double entry 

Cash account (Asset increases) Dr. Rs. 20 000 

Interest income account (Income increases) Cr. Rs. 20 000

The Ledger 

A separate account has to be maintained for each type of asset. Accordingly, there can be many asset accounts in a business such as motor vehicle account, furniture account, cash account, etc. Similarly, there can be many accounts for each type of equity, liability, income and expenses in a business. A collection of all accounts is called as the ledger. Therefore, recording business transactions in accounts is also named as recording business transactions in the ledger.

THE END OF THE DUAL IMPACT OF BUSINESS TRANSACTIONS

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