In this page, I will discuss some modern concept of accounting worldwide. Although accounting basic to types isn’t purely different but some technical changes should every student must go through. Before learning Rues of accounting, makes sure you clear concept of Types of accounts in accounting.
Accounting Divide into 2 Types
Accounting is generally divided into 2 categories. The UK style of accounting, also known as the traditional style of accounting is one.
Golden Rules of Accounting
Whereas the other is the American or the modern style of accounting. Both these kinds of accounting techniques are not indigenous to the places as the names suggest. These are just terminologies associated with them. The traditional accounting rules are also known as the Golden Rules of Accounting.
Modern Rules of Accounting
Whereas, the rules of the American styles are known as the Modern Rules of accounting.
The traditional accounting is largely based on three different kinds of accounts, namely Real, Nominal and Personal.
Modern rules of accounting, however, are based on 6 different kinds of accounts. Namely, Assets, Liabilities, Capital, Revenue, Expense, and Drawing.
- One way of memorizing it is CRADLE, an acronym for all the names of the accounts involved in modern accounting.
C for Capital, R for revenue, A for assets and so on. Modern accounting has very prominent and powerful rules for credit and debits against each type of account.
Credit and Debit
One method of understanding how these rules work against credit and debt is that if one goes down, the other goes up and if the other goes down, the first goes up.
- Keeping this inverse relationship in mind, the following trend should make sense.
According to the table, one can easily deduce a visible relationship that seems pretty simple. Here’s how the background of the relationship works.
Asset accounts are those accounts that represent the funds (money) available to the company. These can include profits, inventory, property that the company owns or anything material owned by the company having a market value.
In order to make sense of how the rules are applied to asset accounts, we can assume the following example.
- Suppose a company wants to invest in new vehicles. If a total of $500,000 is invested, then two types of accounts will be affected.
- The assets account is debited with new cars worth $500,000 and hence the total value of the assets account goes up because an equivalent of $500,000 has been added to it.
On the other hand, a total of $500,000 in cash is credited to the assets and is used to buy cars. Therefore, this account goes down.
The balance sheet shows a proportional increase and decreases when assets are debited and credited.
Another example is that a company takes a loan from a bank for new inventory. Let’s say that the loan is worth $100,000.
- When the company receives the loan, its assets go up by $100,000. Makes sense till here, but the assets have been debited by $100,000, how is this amount balanced?
- The company is liable to pay the bank an amount equivalent to the loan received, and hence, the credit account of liabilities goes up.
In this way, the modern rules of accounting are a perfect inverse of the credit and debit accounts and can be used for efficiently balancing payments and earnings.