8 Traditional and Modern Accounting System

S.S Narta

epgp books

 

 

LEARNING OBJECTIVES:

 

After studying the module, students will be able to get an idea about the meaning of accounting and the different types of accounting systems. Further a detail idea can be gathered about the traditional as well as modern accounting system and a comparative evaluation of both the systems.

 

INTRODUCTION:

 

Transactions refer to the events in which the business is engaged in day to day business, and conduct business by dealing with the outside world. This interaction with the outsiders leads to the creation of certain monetary as well as non monetary effects, which need to be noted down in proper order, for the purpose of future reference. The recording of transactions in the books of accounts is termed as Book Keeping.

 

It is clear that an information is useless, unless and until it is communicated to the management and the interested users. The process of recording, summarising, analysing and interpreting the useful and meaningful information is termed as Accounting. Accounting is a process whose main function is to provide quantitative, financial and understandable information to the management, so as to help in making certain important economic decisions.

 

MEANING OF ACCOUNTING:

 

Accounting is the business language, which communicates the working of business, in quantitative/ monetary terms to those interested in the business. It is the process of identifying, recording, summarising, analysing, interpreting, as well as communicating the required information to the interested users of the organisation.

 

According to A.I.C.P.A., “Accounting may be defined as the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events, which are in part, at least of financial character, and interpreting the results thereof.”

 

DIFFERENT ACCOUNTING SYSTEMS:

 

In order to make accounting more effective, i.e. in order to improve the effectiveness of accounting information, it is important that the information so presented, is reliable, accurate and comparable. For this purpose, accountants follow a certain set of accounting principles and conventions, along with some pre determined rules of debit and credit. This means that for entering the transactions in the books of accounts, certain rules are to be followed by the accountants.

 

Accounting is an old concept, it was even practiced in around 4000 B.C., in Babylonia and Egypt, where the transactions such as payment of tax and wages, was recorded on clay tablets. But with the passage of time, accounting system faced many changes and advancements, and the system of recording the transactions changed from time to time. There are two approaches for recording the transactions in the books of accounts:

 

  • 1) Traditional Accounting System
  • 2) Modern Accounting System

 

TRADITIONAL ACCOUNTING SYSTEM:

 

Also known as English Approach, is the method of accounting where the accounts are divided into various categories. And on the basis of which, the rules for debit and credit are applied on different accounts respectively.

  1. A) IMPERSONAL ACCOUNTS: are the accounts which are not associated to any person, directly or indirectly. It is further divided into real and nominal accounts.
  • 1) REAL ACCOUNT: the account which is related to the recording of financial transactions of the business, in terms of property or assets. The real account is divided into tangible and intangible accounts.
  • (a) TANGIBLE ACCOUNT: is the account related to the assets of the business, whichcan be touched, seen and felt. Example: machinery, table, building etc.
  • (b) INTANGIBLE ACCOUNT: is the account which is concerned with the concerned with those assets, which cannot be seen, felt, touched etc. example: goodwill, patent, copyright.
  • 2) NOMINAL ACCOUNT: all the transactions connected with the expenses, incomes, gain or loss of the business, are grouped under the nominal account. For example: rent account, interest account etc.
  1. B) PERSONAL ACCOUNTS: it refers to the accounts of all the persons/ individuals with whom the business transacts in the entire course of the business. It is further classified into three types:
  • 1) NATURAL: all individual persons with whom the business transacts in its entire life, are grouped under one head, natural person’s account. Example: Rowan’s Account.
  • 2) ARTIFICIAL: this is an account including the financial dealings of the business with the artificial personal (bodies created by law). Example: firm’s account, bank account.
  • 3) REPRESENTATIVE: representative person’s account includes the accounts that act as a representative for a person or individual. Outstanding expenses or accrued income accounts form a part of this category. Example: accrued rent is a personal account representing rent received by the business.

After discussing the types of accounts in detail, the general rules of debit and credit, concerned with the traditional approach are discussed below:

 

1) Personal Account: in case of personal account, “Debit the Receiver, Credit the Giver” rule is applicable.

2) Real Account: here the rule “Debit what comes in, Credit what goes out” rule is followed.

3) Nominal Account: the rule applied in case of nominal accounts is “Debit all expenses and losses, Credit all incomes and gains.”

 

The rules mentioned above are tabulated below:

ACCOUNT DEBIT CREDIT
Real What Comes In What Goes Out
Personal The Receiver The Giver
Nominal All Expenses & Losses All Incomes & Gains

EXAMPLES:

 

1)      TRANSACTION: Sale of building for Rs 300000.

 

ANALYSIS: On starting with the analysis, the first step is to find the number of accounts involved. Here, cash account and building account are involved. Further, the nature of building account being the real account, and that of cash account also real account.

 

On applying the rule to the real account, “Debit what comes in, Credit what goes out”, we conclude that cash will be debited as it is coming in, whereas building will be credited as it is

 

moving out of the business.

 

To Building A/C 300000

 

 

2)      TRANSACTION: Dividend received in cash Rs 50000.

 

ANALYSIS: On starting with the analysis of the transaction, it is clear that the accounts involved are dividend account and the cash account. The cash account being the real account, whereas dividend account being the nominal account.

 

On applying the rule to the real account (cash in this case), “Debit what comes in”, we conclude that cash account will be debited. Further on applying the rule to the nominal account (dividend in this case), “Credit all Incomes and Gains”, we conclude that dividend account will be credited.

 

ENTRY: Cash A/C…….Dr. 50000
To Dividend A/C 50000
  • 3) TRANSACTION: Received cash from Rajesh Rs 30000.

 

ANALYSIS: it is clear that the two accounts involved are the cash account and the Rajesh account. The nature of cash account is real, whereas the nature of bank account is personal account.

 

Real account rule, “Debit what comes in” is applied on the cash account, thereby debiting the cash account by Rs 30000. On the other hand, Rajesh being a personal account is credited, as the rule

for personal account say, “Credit the Giver.”

 

ENTRY: Cash A/C…..Dr. 30000
To Rajesh A/C 30000

 

  • 4) TRANSACTION: Salaries of Rs 60000 paid through Cheque.

ANALYSIS: the transaction depicts that the business has paid all the salaries through cheque, i.e. cash is not involved in the transaction. As a result the two accounts involved are Salaries Account and Bank Account (because payment made though cheque). Salaries account is classified as nominal account and on applying the rule “Debit all expenses and losses”, we debit the salaries account with Rs 60000. On the other hand, as bank is a personal account and as the rule says “Credit the giver”, bank account will be credited with Rs 60000.

 

ENTRY: Salaries A/C…..Dr.   60000
To Bank A/C 60000

 

MODERN ACCOUNTING SYSYTEM:

 

With the ever increasing and growing economy, the business houses are dealing with a large number of customers and trying to expand their business globally. In such a case it becomes difficult to follow and practice the traditional approach therefore the modern approach is being followed by most of the organisations. According to the modern approach, the transactions are recorded keeping in mind the accounting equation, and efforts are made to maintain a balance between both sides of the equation. Before, moving ahead it is important to understand what an accounting equation is:

 

Assets= Liabilities+ Capital

 

Assets: means everything a company owes to itself. It includes cash, building, suppliers, land, account receivables etc.

 

Liabilities: it means what a company owes to the outsiders, in the form of short term or long term debt. Means everything which a company is liable to pay back is a liability. Example: salaries, rent, loan repayment etc.

 

Capital: it refers to the owner’s equity. It belongs to the business as a whole. It is the amount the owner has invested in the company. The accounting equation is a statement which depicts the equality between the debits and credits. The rules are different for debit and credit on the basis of the nature of the account. Therefore, the accounts are classified into five categories under the accounting equation approach/ modern approach

The fundamental rules of debit and credit are as follows:

 

ASSET ACCOUNT: Increase in asset is debited, Decrease in asset is credited.

 

LIABILITY ACCOUNT: Increase in liability is credited, Decrease in liability is debited.

 

CAPITAL ACCOUNT: Increase in capital is credited, Decrease in capital is debited.

 

EXPENSES/ LOSSES: Increase in expenses is debited, Decrease in expenses is credited.

 

REVENUE/ GAIN: Increase in revenue is credited, Decrease in revenue is debited.

ANALYSIS: The two accounts involved are the cash account and the bank account, both being Asset in nature. And as the rule highlights, an increase in asset is debited, therefore bank account is debited. As there is a decrease in cash, cash being an asset will be credited because decrease in asset is credited.

 

ENTRY: Bank A/C……Dr. 400000
To Cash A/C 400000

 

  • 3) TRANSACTION: Purchased furniture from Sham law & Sons, for Rs 60000. Rs 30000 paid in advance in cash.

ANALYSIS: Purchase of furniture means increase in asset of the firm by Rs 60000, therefore debited. Further only a part of money (Rs 30000) is paid to the supplier, therefore cash will be reduced by Rs 30000 only as a result cash account will be credited, as decrease in asset is credited.

 

And the liability to Sham law & Sons increases by Rs 30000 (60000 – 30000), the unpaid amount by the business. An increase in liability will be credited, i.e. Sham law & Sons account will be credited.

ENTRY: Furniture A/C…..Dr. 60000
To Cash A/C 30000
To Sham law & Sons 30000

 

  • 4) TRANSACTION: Cash withdrawn by owner of Rs 30000, from the business.

 

ANALYSIS: The two accounts involved are cash (asset) and capital. The cash is taken out of the business therefore decreasing the cash account by Rs 30000, decrease in asset is credited therefore cash account will be credited. By doing so the capital of the business will be affected, it will decrease by Rs 30000 and therefore will be debited.

 

ENTRY: Capital A/C….Dr.   30000

 

To Cash A/C 30000

 

TRADITIONAL V/S MODERN ACCOUNTING SYSTEMS:

 

Accounting is at its evolving stage, where with the changes in the social, economic, political and legal environment, the accounting concepts and conventions are modified to meet up the required changes. This modification has led to the advancements and changes in the methods of recording the transactions in the books of accounts. Now, with the passage of time the accountants are free to follow any of the accounting styles or any of the accounting methods for recording purposes. It is up to the accountant, to either choose the cash basis of accounting or the accrual basis of accounting. After making such a decision, the next step is to decide upon which system to apply while recording the transactions. As discussed above, there are two systems of accounting, traditional (also known as English approach) and modern system (also known as American approach).

 

The debit and credit rules are different according to the type of system followed. It should be noted that there is a same effect on the transaction, whether traditional approach is followed or the modern approach. The end result will be the same irrespective of the type of accounting system followed. To enumerate this certain examples are comparatively evaluated by using both the systems.

From the above examples it is clear that there is no effect in the entry to be passed, irrespective of the accounting system followed by the accountant, and irrespective of what rules for debit and credit are used.

 

 

SUMMARY:

 

Accounting is as old as the currency, and has been used since 4500 B.C., in Egypt and Babylonia, where the transactions were recorded on clay tablets. This process of recording the transactions in the books of accounts is termed as Book Keeping. As it is known that the recorded data is of no use unless and until it is presented in a form of understandable, comparable, reliable and relevant piece of information. The recorded data is analysed and presented in front of the management so that they can take certain economic decisions relating to the business. This process is termed as accounting.

 

Accounting is an evolving process, which means that the system of recording the transactions in the books should be changed and modified with time, so as to meet up the change in the environment and maintain flexibility. Keeping this in mind, the accounting concepts and conventions are modified from time to time along with the change in the system of book keeping. The accountants now have an option of either choosing the traditional accounting system for maintaining the records or go with the modern system of accounting. It is worth mentioning that there will be no change in the transaction to be recorded in the books, irrespective of the accounting system followed.

 

For different accounting systems, different set of debit and credit rules are framed. Under the traditional approach, the accounts are classified as real, personal and nominal. The rule for Personal Account says: Debit the receiver, Credit the giver. Real account’s rule is defined as: Debit what comes in, Credit what goes out, whereas rule for Nominal Account: Debit all expenses and losses, Credit all incomes and gains. Under the modern system of accounting the accounts are divided into five categories of: asset, liability, capital, expenses, and income. Modern system of accounting is based on the accounting equation.

 

The rules under the modern approach are different for different accounts. For Asset Account, an Increase is debited and decrease is credited. For Liability Account, an Increase is credited and decrease is debited. For Capital Account, Increase is credited and decrease is debited. For Income/ Gain, Increase is credited and decrease is debited and for Expense/ Loss an Increase is debited and decrease is credited.

 

It can be concluded that with the evolution in the business environment, accounting as well faced many evolutions for the ease of recording the transactions in the books of accounts. And this evolution added to the new advanced methods of book keeping and accounting, which acted as a helping hand for the management as well as the outsiders.

 

you can view video on Traditional and Modern Accounting System

SUGGESTED READINGS:

 

  • TULSIAN . P.C (2014) “FINANCIAL ACCOUNTING” PEARSON EDUCATION INDIA.
  • LAL, JAWAHAR AND SEEMA SRIVASTAVA (2004) “FINANCIAL ACCOUNTING” S.CHAND (G/L) & COMPANY LTD.
  • GOYAL, V.K. AND RUCHI GOYAL (2012) “FINANCIAL ACCOUNTING” PHI.
  • MAHESHWARI, S.N., SUNEEL K MAHESHWARI AND SHARAD KMAHESHWARI(2012) “FINANCIAL ACCOUNTING” VIKAS PUBLISHING HOUSE PVT LTD
  • RAIYANI JAGADISH R INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) & INDIAN ACCOUNTING PRACTICES” NEW CENTURY PUBLICATIONS.
  • PATEL, CHINTAN N. AND BHUPENDRA MANTRI (2015) “INDIAN ACCOUNTING STANDARDS (IND AS)” TAXMANN.
  • MONGA, J.R. “AVANCED FINANCIAL ACCOUNTING” MAYOOR PAPERBACKS.

 

POINTS TO PONDER

 

  1. Accounting is an evolving process, which means that the system of recording the transactions in the books should be changed and modified with time, so as to meet up the change in the environment and maintain flexibility.
  2. Keeping this in mind, the accounting concepts and conventions are modified from time to time along with the change in the system of book keeping.
  3. The accountants now have an option of either choosing the traditional accounting system for maintaining the records or go with the modern system of accounting.
  4. There will be no change in the transaction to be recorded in the books, irrespective of the accounting system followed.
  5. For different accounting systems, different set of debit and credit rules are framed. Under the traditional approach, the accounts are classified as real, personal and nominal.
  6. Under the modern system of accounting the accounts are divided into five categories of: asset, liability, capital, expenses, and income. Modern system of accounting is based on the accounting equation.
  7. It can be concluded that with the evolution in the business environment, accounting as well faced many evolutions for the ease of recording the transactions in the books of accounts.
  8. And this evolution added to the new advanced methods of book keeping and accounting, which acted as a helping hand for the management as well as the outsiders.