Thursday, July 29, 2010

Understanding Accounting Transactions

Accounting transactions follow a double entry system. The double entry system is based on the principle that there are two sides to any transaction.If one person gives money, there is another who receives the money. If there is a decrease  in one account, there should be an increase in another. If you pay cash for wages, the cash decreases and the wages expense increases, both by the same amount. Thus every accounting transaction entails two entries. One is called the debit and the other credit. This system offers the advantage of easy verification and detection of errors. Since each debit entry has a corresponding credit entry for the same amount, at any point of time, the sum of the debits should be equal to the sum of the credits. In accounting terminology, this is called balancing. Balancing of accounts is the basic requisite of a reliable accounting system. We can imagine how valuable the system of double entry accounting would have been in the days when we did not even have mechanical adding devices and all additions (not to speak of more complicated operations like multiplication and division) had to be made manually!

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