Traditional Vs Modern Accounting Systems

Explore key differences between traditional vs modern accounting systems. Learn benefits, efficiency, & automation for better financial management.

Traditional Vs Modern Accounting Systems

Upon completing this module, students will gain an understanding of the definition of accounting and the different types of accounting systems. Specifically, they will explore the traditional and modern accounting systems in detail and be able to perform a comparative evaluation of the two.

Introduction

Business transactions are the daily events in which a company interacts with the external world. These interactions generate monetary and non-monetary effects. Which must accurately recorded for future reference. The initial process of noting these transactions in the books called Book Keeping.

Information is only useful if it communicated to management and other interested users. Accounting is the process of recording, summarizing, analyzing, and interpreting this meaningful information. Its main function is to provide quantitative, financial, and understandable data to management to aid in crucial economic decision-making.

Meaning of Accounting

Accounting is essentially the business language that communicates a company’s performance in quantitative or monetary terms to interested parties. It involves identifying, recording, summarizing, analyzing, interpreting, and communicating the necessary information to the organization’s users.

A.I.C.P.A. defines accounting 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

To ensure accounting information is effective—meaning reliable, accurate, and comparable—accountants adhere to a specific set of principles, conventions, and predetermined rules for debit and credit. This structured approach governs how transactions entered into the books of accounts in HR.

Accounting is an ancient concept, practiced as early as 4000 B.C. in Babylonia and Egypt, where transactions like tax and wage payments were recorded on clay tablets. Over time, the accounting system has evolved significantly. Currently, there are two primary approaches for recording transactions:

1. Traditional Accounting System (English Approach)
2. Modern Accounting System (American Approach)

Traditional Accounting System (English Approach)

This method divides accounts into various categories, and specific debit and credit rules are applied based on the account type. The categories are:

A) Impersonal Accounts

These accounts are not associated with any specific person. They are further classified into:

1. Real Account: Accounts related to the business’s financial transactions in terms of property or assets.
   • (a) Tangible Account: Pertains to assets that can be touched, seen, and felt (e.g., machinery, building).
   • (b) Intangible Account: Pertains to assets that cannot be seen or touched (e.g., goodwill, patent, copyright).
2. Nominal Account: Accounts for all transactions related to the business’s expenses, incomes, gains, or losses (e.g., rent account, interest account).

B) Personal Accounts

These refer to the accounts of all persons or individuals with whom the business transacts. They are classified into three types:

1. Natural: Accounts of individual human beings (e.g., Rowan’s Account).
2. Artificial: Accounts of legal bodies created by law (e.g., firm’s account, bank account).
3. Representative: Accounts that represent a person or group of persons (e.g., Outstanding Expenses Account, Accrued Income Account).

Traditional Rules of Debit and Credit

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

Examples:

1. TRANSACTION: Sale of building for Rs 300,000.
   • Analysis: Cash A/C (Real) and Building A/C (Real) are involved.
   • Rule Application: Cash is debited (What Comes In); Building is credited (What Goes Out).
2. TRANSACTION: Dividend received in cash Rs 50,000.
   • Analysis: Cash A/C (Real) and Dividend A/C (Nominal) are involved.
   • Rule Application: Cash is debited (What Comes In); Dividend is credited (All Incomes and Gains).
3. TRANSACTION: Received cash from Rajesh Rs 30,000.
   • Analysis: Cash A/C (Real) and Rajesh A/C (Personal) are involved.
   • Rule Application: Cash is debited (What Comes In); Rajesh is credited (Credit the Giver).
4. TRANSACTION: Salaries of Rs 60,000 paid through Cheque.
   • Analysis: Salaries A/C (Nominal) and Bank A/C (Personal) are involved.
   • Rule Application: Salaries is debited (All Expenses and Losses); Bank is credited (Credit the Giver).

Modern Accounting System (American Approach)

With global business expansion, the traditional approach has become complex for large organizations. The modern system is increasingly adopted, focusing on the Accounting Equation to maintain a balance between the two sides of the equation:

$$Assets = Liabilities + Capital$$

• Assets: What the company owns (e.g., cash, building, land).
• Liabilities: What the company owes to outsiders (e.g., salaries payable, loans).
• Capital: The owner’s equity or investment in the company.

Under the modern approach, accounts are classified into five categories, which form the basis for the debit and credit rules:

Modern Rules of Debit and Credit (Accounting Equation Approach)

ACCOUNT TYPE	INCREASE	DECREASE
Asset	Debit	Credit
Liability	Credit	Debit
Capital	Credit	Debit
Expenses/Losses	Debit	Credit
Revenue/Gain	Credit	Debit

Examples:

1. TRANSACTION: Deposited cash Rs 400,000 into the bank.
   • Analysis: Bank A/C (Asset) and Cash A/C (Asset) are involved.
   • Rule Application: Bank is debited (Increase in Asset); Cash is credited (Decrease in Asset).
2. TRANSACTION: Purchased furniture from Sham law & Sons, for Rs 60,000. Rs 30,000 paid in advance in cash.
   • Analysis: Furniture A/C (Asset), Cash A/C (Asset), and Sham law & Sons A/C (Liability) are involved.
   • Rule Application: Furniture is debited (Increase in Asset); Cash is credited (Decrease in Asset); Sham law & Sons is credited (Increase in Liability).
3. TRANSACTION: Cash withdrawn by owner of Rs 30,000, from the business.
   • Analysis: Cash A/C (Asset) and Capital A/C are involved.
   • Rule Application: Capital is debited (Decrease in Capital); Cash is credited (Decrease in Asset).

Traditional vs Modern Accounting Systems

Accounting is an evolving field, with concepts and conventions constantly modified to meet changes in the social, economic, political, and legal environments. This evolution has led to advancements in recording transactions, giving accountants the freedom to choose either the traditional (English) or modern (American) approach.

Key takeaway: Regardless of whether the traditional or modern system is followed, the effect on the transaction and the final end result will be the same. Both systems merely provide a different framework and set of rules for classifying accounts and applying debits and credits.

Summary of Key Differences in Rules

Feature	Traditional Accounting System	Modern Accounting System
Classification	Personal, Real, Nominal	Asset, Liability, Capital, Expense, Revenue
Basis	Focuses on classifying accounts by nature	Based on the Accounting Equation ($A=L+C$)
Rule for Asset Increase	Debit (under Real A/C: “What Comes In”)	Debit
Rule for Liability Increase	Credit (under Personal A/C: “The Giver”)	Credit
Rule for Expense Increase	Debit (under Nominal A/C: “All Expenses & Losses”)	Debit

In conclusion, the evolution of accounting has provided businesses with advanced and flexible methods for book-keeping and record maintenance, aiding both management and external users in making informed decisions.