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ACCOUNTING PROCESS

BY
S C MALHOTRA
ASSOCIATE PROFESSOR
SHRI RAM COLLEGE OF COMMERCE
UNIVE$ITY OF DELHI, DELHI-110007

Accounting Process
Various Steps in Accounting Process:
1.
2.

Identify transactions and events.


Analyze transactions and events in terms of the basic accounting
equation.

3.
4.
5.

Translate the transaction analysis into debits and credits.


Pass journal entries and post them to the general ledger.
Prepare trial balance

6.
7.
8.

Pass adjustment entries and post them to the general ledger.


Prepare adjusted trial balance
Pass closing entries and post them to the ledger.

9. Prepare profit and loss account


10. Prepare the balance sheet.

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Analysis of transactions and events


The analysis of transactions and events under double
entry system of book-keeping may be explained in any
of the following two ways:

1. Accounting Equation approach


2. Traditional approach

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Accounting Equation Approach


The financial position of a business concern at
any given point of time may be expressed in
the form of following accounting equation:
Liabilities

Owners equity =
Or

Assets

Liabilities + (Capital + Retained Earnings) = Assets


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Illustration 1
Show how each of the following transactions of Rama Stores for the month of July, 2010 will be
analyzed under accounting equation approach:
1.
Mr. Ram invested $ 50,000 in cash to commence the business as owner of Rama Stores.
2.

Machine is purchased for $25,000 cash.

3.

Purchased furniture for $8,000 on credit from Rahul.

4.

Paid salary to the manager, Gaurav $10,000.

5.

Purchased merchandise $20,000 on credit from the supplier Preetam.

6.

Sold merchandise costing $ 15,000 for $35,000 cash.

7.

Machine is depreciated by $2,000.

8.
9.
10.

Furniture is depreciated by $500.


Paid $9,000 to Preetam, supplier of goods.
Proprietor Mr. Ram withdrew $7,000 for meeting personal expenses.

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Record through accounting equation


Transaction Capital
No.

Retained
Earnings

Liabili
-ties

= Cash
+50,000

+50,000

2
New Bal

-25,000
+50,000

+50,000

+8,000

+8,000

= +25,000

-10,000
+50,000

-10,000

5
New Bal

+25,000

+8,000

4
New Bal

+25000

= +25,000

3
New Bal

Goods

Assets
Machine Furni

-10,000
+8,000

= +15,000

+20,000
+50,000

-10,000

+25,000 +8,000

+28,000

+25,000 +8,000
+20,000

= +15,000

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+20,000

+25,000

+8,000

Transaction Capital
No.

Retained
Earnings

Liabili
-ties

= Cash

Goods

Assets
Machine Furni

New Bal

-10,000

+28,000

= +15,000

+20,000

+25,000

+8,000

+35,000

-15,000

= +50,000

+5,000

+25,000

+8.000

+50,000

6
New Bal

+20,000
+50,000

New Bal

+28,000

-2,000

+50,000

8
New Bal

+10,000

+8,000

-2,000

+28,000

= +50,000

+5,000

+23,000

-500
+50,000

+7,500

-500
+28,000

= +50,000

-9,000

New Bal

+50,000

10

-7,000

New Bal

43,000

+7,500

+8,000

+19,000

+5,000

+23,000

+7,500

+5,000

23,000

+7,500

5,000

23,000

7,500

-9,000

= +41,000
-7,000

7,500

19,000

= 34,000

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Solution 1
Analysis of transactions:
Sl. Capital
No
1
2
3
4
5
6
7
8
9
10

Retained
Earnings

Liabilities

+50,000

Cash

Goods

+50,000
-25,000

Assets
Machin
e
+25,000

+8,000

+8,000

-10,000

-10,000
+20,000

+20,000
-2,000
-500

+35,000

-500
-9,000
-7,000

-7,000

7,500

+20,000
-15,000
-2,000

-9,000

43,000

Furni

19,000

34,000

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5,000

23,000

7,500

Balance Sheet of Rama Stores


as at 31st July, 2010
Liabilities
Rams Capital
Retained Earnings
Creditors

Assets

43,000 Machine
7,500 Furniture
19,000 Stock
Cash
--------69,500
---------

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$
23,000
7,500
5,000
34,000
--------69,500
---------

The procedure just discussed appears to be quite suitable. But it is not so when it
comes to the record of large number of transactions that occur in actual business
operations.
Where the number of items under different heads is many, the record of transaction
through accounting equation becomes unmanageable. To overcome this problem, an
improvement is made to the above procedure on the following lines:
1.

Each element of accounting equation has plus and minus items. To have
convenience in finding the balance of an element, it is suggested that all plus
items of an element be shown on one side and all minus items on the other.

2.

Instead of showing all the elements of an equation on one page, show them on
different pages.

In accounting, the device developed for this purpose is called an account.

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ACCOUNT
An account is a record of the transactions that affect a particular
type of asset, liability, or an element of owners equity.
The two sides of an account, usually, take the following form. As
this form resembles the English letter T, it is known as T
form account:
Title of the item
Dr.___________________________________________Cr.
Left side
(Debit)

Right side
(Credit)

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One basic characteristic of account form is that entries recording increases (plus items)
and decreases (minus items) are separated. Conventionally, for showing increases
and decreases the following procedure is followed:

Liabilities + Owners equity


________________________________
(Debit)
(Credit)
-

Symbols:

Assets
________________
(Debit)
(Credit)

Debit means the left hand side


Credit means the right hand side
+ indicates side for recording increases
- indicates side for recording decreases
* indicates side for normal balance

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Liabilities + *Owners Capital + Net Profit]

= Assets

Liabilities + [Capital + (Revenues - Expenses)] = Assets


Liabilities + Capital + Revenues

Liabilities + Capital + Revenues


(Debit)
-

(Credit)
+
*

Assets + Expenses

Assets + Expenses
(Debit)
+
*

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(Credit)
-

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RULES OF RECORDING TRANSACTIONS


The above system of recording transactions may be explained as follows in the form of
rules of double entry system of book-keeping:
Liabilities. When a particular liability increases, credit that liability account and when a
particular liability decreases, debit that liability account.
Owners capital. When owners capital increases, credit owners capital account and
when owners capital decreases, debit owners capital account.
Revenues. When a particular item of revenue increases, credit that revenue account
and when a particular item of revenue decreases, debit that revenue account.
Since increases in liabilities, owners equity and revenues are credited to these
relevant accounts, they usually have credit balances.
In the case of assets and expenses, the rules are just the reverse.
Assets. When a particular asset increases, debit the relevant asset account and when
a particular asset decreases, credit the relevant asset account.
Expenses. When a particular expense increases, debit the relevant expense account
and when a particular expense decreases, credit the relevant expense account.
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The above procedure of recording the transactions in the ledger accounts


appears to be satisfactory. It is definitely superior to recording the
transactions in different elements of financial statements in the form of
accounting equation. But it has serious limitations when it comes to recording
large number of transactions. These limitations are as follows:

1.

Difficulty in recording.

2.

Identity of individual transaction is lost.

3.

Difficulty in understanding the entries.

In view of the above limitations, it is considered necessary to keep record of


all the transactions, initially at one place in a chronological order. It is
done in such a way that the impact of each transaction on different
accounts is determined and shown at one place with relevant
explanation of that transaction. A book containing such type of records is
called the Journal.

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Format of journal
Date
Particulars
January

L.F.

Dr.
Amount

Cash Account
Dr.
To Rams Capital
(Being a cash of $ 5,85,000 brought
in by Ram as his capital)
___________________________
Alternatively,
Debit Cash
Credit Rams Capital

5,85,000

Machine Account
Dr.
To Cash
(Being purchase of a machine of $
3,40,000 for Solid Machines for
cash vide .)
____________________________
Alternatively,
Debit Machine
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Credit Cash

3,40,000

Cr.
Amount
5,85,000

5,85,000
5,85,000

3,40,000

3,40,000

3,40,000

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An Illustration Of Accounting Procedures


Assume that Dharma Engineers began operations in January 2010 and
engaged in a number of transactions. His transactions are used here
to demonstrate the accounting procedures just discussed.
Transaction 1: Dharma contributed $50,000 as capital.
Analysis: Increase cash; increase Dharmas capital.
Debits and credits: Increase cash (an asset) by a debit; increase
Dharmas capital (an equity account) by a credit.

Journal entry: January 1


Cash Account
Dr
To Dharmas Capital Account
[Capital contributed by Dharma
In cash $ 50,000]

$50,000
$50,000

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Transaction 2: Dharma Engineers borrowed $20,000


from a bank as loan.
Analysis: Increase cash; increase bank loan.
Debits and credits: Increase cash by a debit; increase
bank loan by a credit.

Journal entry: January 1


Cash Account
Dr.
To Bank Loan Account
[Borrowed $ 20,000 from
A bank as loan]
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$20,000

$20,000

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Transaction 3: Dharma Engineers paid in advance one years


rent of $12,000.

Analysis: Increase prepaid rent; decrease cash.


Debits and credits: Increase prepaid rent by a debit; decrease
cash by a credit.
Journal entry: January 1
Prepaid Rent Account
To Cash Account
[To record prepayment of
one years rent]

Dr.

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$12,000

$12,000

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Transaction 4: Purchased inventory on account from Z, $30,000.


Analysis: Increase inventory; increase amount payable to Z, a creditor.
Debits and credits: Increase inventory by a debit; increase accounts
payable by a credit.

Journal entry: January 1


Purchases Account
To Z (Accounts Payable)
[To record the purchase
of inventory on account]

Dr.

$30,000

Alternatively,
Inventory Account
Dr.
To Z (Accounts payable) Account

$ 30,000

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$30,000

$ 30,000

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Transaction 5: Purchased equipment for $25,000.


Analysis: Increase equipment; decrease cash.

Debits and credits: Increase equipment by a debit;


decrease cash by a credit.
Journal entry: January 2
Equipment Account
Dr.
To Cash Account
[Purchase of Equipment
of $ 25,000 for cash]

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$25,000

$25,000

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Transaction 6: Rendered services to customer Rahim for $600;


received cash of $ 200 plus a promised future payment of $400.

Analysis: Increase cash; increase accounts receivable; increase service


revenue.
Debits and credits: Debit cash by $200; debit accounts receivable by
$400; credit service revenue by $600.
Journal Entry: January 3
Cash Account
Rahims A/c (Accounts Receivable)
To Service Revenue Account
[Service revenue of $ 600 earned;
Received $ 200 in cash and a
Promise to pay $ 400 in future]

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Dr.
Dr.

$200
$400

$600

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Transaction 7: Received $100 from a customer for


services to be performed at a later date.
Analysis: Increase cash; increase unearned revenue
[remember that unearned revenue is a liability].

Debits and credits: Debit cash; credit unearned revenue.


Journal entry: January 8
Cash Account
Dr.
To Unearned revenue Account
[Received unearned revenue
Of $ 100 from a customer in
In advance]

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$100

$100

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Transaction 8: Paid salaries to employees of $700.


Analysis: Increase salary expense; decrease cash.
Debits and credits: Debit salary expense; credit cash
Journal entry: January 15

Salary Expense Account


To Cash Account

Dr.

$700
$700

[Salary of $ 700 paid]

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Transaction 9: Received a utility bill of $ 120 for services


already used. Payment was not immediately made.
Analysis: Utilities expense increases; utilities payable
increases.
Debits and Credits: Debit utilities expense; credit utilities
payable.
Journal entry: January 18
Utilities Expense Account Dr.
To Utilities Payable Account

$120

$ 120

[ Utility bill for services used


Still payable]
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Transaction 10: Sold inventory costing $ 2,200 to Khalifa on credit for


$4,000.
Analysis: Amount receivable from Khalifa (Accounts receivable) increases;
sales (an income) increases.
Debits and credits: Debit Khalifa (accounts receivable) Account; credit sales
an income account
Journal entry: January 20
Khalifas Account (accounts receivable) A/c
To Sales Account
[Sold goods on credit to Khalifa for $ 4,000]

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Dr.

$ 4,000
$ 4,000

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Alternatively (when purchase of goods is treated as asset),


(a)
Khalifas Account (Accounts Receivable) Dr.$4,000
To Sales Account
$4,000
[Sold goods on credit to
Khalifa for $ 4,000]
(b)
Analysis: Expense cost of goods sold increases; asset inventory
decreases.
Debits and credits: Debit cost of goods sold; credit inventory.
Cost Of Goods Sold Account
To Inventory
[Sold goods to Khalifa
costing $ 2,200]

Dr.

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$2,200

$2,200

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Transaction 11: Interest expense of $150 incurred but did not


pay.

Analysis: Increase interest expense; increase interest payable


a liability.
Debits and credits: Debit interest expense; credit interest
payable.
Journal entry: January 31
Interest Expense Account
To Interest Payable Account
[Interest expense of $ 150
Is outstanding]

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Dr.

$150

$150

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Transaction 12: Used $1,000 of prepaid rent.

Analysis: Increase rent expense; decrease prepaid


rent, an asset.
Debits and credits: Debit rent expense; credit
prepaid rent.
Journal entry: January 31
Rent Expense Account
Dr. $1,000
To Prepaid Rent Account
[Rent expense for the
month of January recorded]

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$1,000

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Transaction 13: Depreciation on equipment amounted to $210.

Analysis: Increase depreciation expense; decrease equipment or


increase the balance in the contra-asset account, accumulated
depreciation.
Debits and credits: Debit depreciation expense; credit equipment or
accumulated depreciation.
Journal entry: January 31
Depreciation Expense Account Dr.
To Equipment Account
or
To Accumulated Depreciation Account
[Depreciation expense on equipment
amounted to $ 210]

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$210
$210

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Transaction 14: Earned $ 50 of the $100 advance


payment previously made by customer.
Analysis: Decrease unearned revenue (a liability);
increase service revenue (an income).
Debits and credits: Debit unearned revenue; credit
service revenue.
Journal entry: January 31
Unearned Revenue Account
To Service Revenue
[Service revenue earned $ 50
out of unearned revenue]

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Dr.

$50

$50

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Transaction 15: Paid for taxes $100.


Analysis: Tax expense increases; cash decreases.
Debits and credits: Debit tax expense; credit
cash.
Journal entry: January 31
Taxes Expense Account
Dr.
To Cash

$100
$100

[Taxes of $ 100 paid]


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Format of General Journal


Date

Particulars

L.F.

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Dr.
Amount

Cr.
Amount

33

Date
Jan.

Particulars

L.F.

Cash Account
Dr.
To Dharmas Capital Account
[Capital contributed by Dharma
In cash $ 50,000]
______________________________
Cash Account
Dr.
To Bank Loan
[Borrowed $ 20,000 from a bank as loan]
______________________________
Prepaid Rent Account
Dr.
To Cash Account
[To record prepayment of one years rent]
______________________________
Purchases Account
Dr.
To Z (Accounts Payable)
[To record the purchase of inventory on
account]

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Dr.
Amount

Cr.
Amount

$50,000
$50, 000

$20,000
$20,000

$12,000
$12,000

$30,000
$30,000

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Date
Jan.

Particulars

Equipment Account
To Cash Account

L.F.
Dr.

Dr.
Amount

Cr.
Amount

$25,000
$25,000

[Purchase of Equipment of $ 25,000 for cash]


_____________________________________

Cash Account
Dr.
Rahims A/c (Accounts Receivable)
Dr.
To Service Revenue
[Service revenue of $ 600 earned; received
$ 200 in cash and a promise to pay $ 400
in future]
_________________________________
Cash Account
Dr.
To Unearned revenue
or
To Revenue received in advance
[Received unearned revenue of $ 100 from
a customer in advance]

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$200
$400

$600

$100
$100

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Date
Jan.

Particulars

15

Salary Expense Account


To Cash Account

L.F.
Dr.

Dr.
Amount

Cr.
Amount

$700
$700

[Salary of $ 700 paid]


________________________________________

18

Utilities Expense Account


To Utilities Payable Account

Dr.

$120
$ 120

[ Utility bill for services used still payable]


________________________________________

20

25

Khalifas (accounts receivable) Account Dr.


To Sales Account
[Sold goods on credit to Khalifa for $ 4,000]
____________________________________
Interest Expense Account
Dr.
To Interest Payable
[Interest expense of $ 150
Is outstanding]

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$ 4,000
$ 4,000

$150
$150

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Date
Jan.

Particulars

31

Rent Expense Account


To Prepaid Rent

L.F.
Dr.

Dr.
Amount

Cr.
Amount

$1,000

$1,000

[Rent expense for the month of January recorded]


__________________________________________

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31

Depreciation Expense Account


Dr.
To Equipment Account
or
To Accumulated Depreciation Account
[Depreciation expense on equipment
amounted to $ 210]
_____________________________________
Unearned Revenue Account Dr.
To Service Revenue

$210
$210

$50
$50

[Service revenue earned $ 50 out of unearned


revenue]
__________________________________________

31

Taxes Expense Account


To Cash

Dr.

$100
$100

[ Taxes of $ 100 paid]


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1.Post journal entries to ledger


accounts

2.Find the balancing amount of each of


the ledger account
3.Prepare trial balance

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Format of an Account
Dr.
Date

Cr.
Particulars

JF

Amount

Date

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Particulars

JF

Amount

39

Trial Balance as at 31st January, 2010

Debit balances
Cash
Prepaid rent
Equipment
Debtors:
Rahim
Khalifa
Purchases
Salary expense
Utility expense
Interest
Rent
Depreciation
Tax

Amount

Credit Balances

32,500 Dharamas Capital


11,000 Bank loan
24,790 Creditors
Z
400 Unearned revenue
4,000 Utility expense payable
30,000 Interest payable
700 Service revenue
120 Sales
150
1,000
210
100
_________
1,04,970
_________
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Amount
50,000
20,000
30,000
50
120
150
650
4,000

__________
1,04,970
__________
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Select the correct option in each of the following cases:


1. On purchase of equipment for cash, owners equity would:
a.
b.
c.

2.

Purchase of government securities for cash would:


a.
b.
c.

3.

Reduce assets
Increase assets, or
Keep assets unchanged.

The accounting equation is satisfied by:


a.
b.
c.

4.

Increase ,
Decrease, or
Remain unchanged

Capital = Assets + Liabilities


Liabilities = Capital Assets
Capital = Net assets

On sale of old machine at profit, owners equity would:


a.
b.
c.

Increase
Decrease
Remain unchanged

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5. Withdrawals by the proprietor would:


a. Reduce both assets and owners equity
b. Reduce assets and increase liabilities
c. Reduce owners equity and increase liabiliities
6. Both assets and owners equity would be increased by:
a. Proprietors withdrawals
b. Purchasing a building on credit
c. Selling goods on credit
7. Payment of salary is recorded by:
a. Debiting salary account and crediting cash account
b. Debiting employee account and crediting cash account
c. Debiting cash account and crediting employee account
8. Purchase of goods on credit from Rohan is recorded as:
a. Debit Purchases account and credit Cash account
b. Debit Rohan account and credit Purchases account
c. Debit Purchases account and credit Rohan account

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2. Traditional Approach
Under this approach, the above accounts are first classified as
a) personal accounts,
b) real accounts and
c) nominal accounts,
and then rules of recording transactions therein are enumerated.
Rules of recording transactions:
a) Personal accounts: Debit the receiver and credit the giver
b) Real accounts: Debit what comes in and credit what goes
out
c) Nominal accounts: Debit all expenses and losses and credit
all incomes and gains
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