Double-Entry Book-Keeping

The Accounting Process

Purchases are transactions that involve buying raw materials or goods intended
for re-sale. Sales are transactions that involve selling goods or services to
customers. Wages are payments to employees. Other examples of categories
that could be used are rent, heating and lighting, bank charges, advertising,
transport and so on. When transactions are summarised in this way it is usual
to summarise them. This might involve adding up the totals every week. Business transactions are
summarised so that large numbers of transactions can be handled more easily.

At the end of an accounting period, the overall totals in each category are calculated. For example,
a business will add up total sales and total purchases. The business can then generate useful
financial information, such as the amount of Profit or Loss that the business has made. If sales
revenue is greater than costs then a business will have made a profit, if the costs are greater than
revenue then a loss has been made.

The main reason why people set up businesses is to make profits. Of course, if they are not
successful they may well incur a loss. The calculation of such profits and losses is probably the
most important objective of the accounting function.

Introduction to Double-Entry Book-Keeping

The method of bookkeeping known as double-entry bookkeeping is practised worldwide and has a
long history.

The essence of this method is the entering of the details of transactions in separate accounts. Each
account is, in effect, a story about some relevant subject, i.e. an asset such as cash, or a liability
such as a bank loan, or an expense such as wages.

Duality: is the very foundation of double entry book keeping system and it comes from the
fact that every transaction has a double (or dual) effect on the position of a business as recorded in
the accounts. For example, when an asset is bought, another asset cash (or bank) is also and
simultaneously decreased OR a liability such as creditors is also and simultaneously increased.

In fact every single business transaction will have two effects on the position of the business in the
accounts. More on this later!!

T Accounts (called T accounts due to their appearance)

Accounts have two sides, the left-hand side known as the DEBIT (DR) and the right hand side the
CREDIT (CR). Each transaction is recorded by entering the details on the debit side of one
account, and the credit side of another account – hence the name double entry bookkeeping.

Although manual bookkeeping has now been largely overtaken by the Computer Age, the computer
has not changed the fundamentals of double-entry bookkeeping.
DR SALES CR

Mr Saunders – AS Accountancy – Module 1

The Accounting Equation

One of the most important concepts in accounting is the relationship between the
value of a business’s assets, its capital and liabilities. The relationship is called
the ACCOUNTING EQUATION. For any business:

Assets = Capital + Liabilities

The accounting equation states that the value of all the resources owned by a business, i.e. the
assets, must equal the value of all the money introduced into or owed by the business. The two
sides of the equation will always equal each other. This is because any money introduced in the
business or owed by the business, shown in the right hand side of the equation, must have the same
value as the resources bought with that money, shown on the left.

Any change in the value of assets will be matched by a change in the total value of capital and
liabilities and vice versa.

However, we must also take into account revenue, expenses and drawings.

The Full Accounting Equation

Assets + Expenses + Drawings = Capital + Liabilities + Revenue

How the Double-Entry system works

It is basically a plus and minus system, as each transaction will result in an increase or decrease in
the value of items.

A simple rule must be memorised to ensure that the entries are recorded on the correct side of each
account.

Note: This is perhaps the most important thing you will learn this year. Everything else we do
will require the instant knowledge of these rules and the accounting equation.

INCREASES IN:

DEBIT CREDIT

[A] Assets Capital [C]

[E] Expenses Liabilities [L]
[D] Drawings Revenue [R]

[C] Capital Assets [A]

[L] Liabilities Expenses [E]
[R] Revenue Drawings [D]

DECREASES IN

Mr Saunders – AS Accountancy – Module 1

Procedure

1.) Identify the two items in the transaction.

2.) Ensure there is an account for each (within reason).
3.) Taking each item independently:
a.) Ascertain which category in the above chart it falls into.
b.) Decide whether the transaction increases or decreases the item.
c.) Enter on the correct side of the account for that item.
4.) Repeat process in 3 above with the other item involved in the transaction.
5.) Check that one account has been debited and the other has been credited.

EXAMPLE:

September 1st. Tom starts a business with £100 cash.

September 2nd. Tom bought a handcart for business use with £100 of the cash.

ANSWER:
TOM’S BUSINESS LEDGER

Tom’s Capital Account

£ £
Sept. 1 Cash Account 100

Cash Account
£ £
Sept. 1 Tom’s Capital A/c 100 Sept.2 Fixed Asset A/c 100

Fixed Asset Account (Handcart)

£ £
Sept.2 Cash Account 100

Copy from the board to complete the layout of these ‘T’ accounts.

Activity: See question sheet for bookkeeping Exercises.

Confusion can arise when talking about the debit and credit side of accounts. They just mean
debit is the left-hand side and credit is the right hand side. Students can become confused when
comparing these rules to what happens with their own bank accounts. For example a ‘credit’ on a
bank statement means that the amount in a customers account has increased. We might mistakenly
think that according to double entry bookkeeping, this should be a debit, because the money in the
account, which is an asset, has increased. NOT TRUE!!

The explanation is that the bank statement is written from the bank's point of view. From their
perspective, and if you where to deposit money in your bank account, the bank would owe you
money, which would be a liability (and therefore a CREDIT). When you take the money out,
the bank obviously no longer owes you money, so the liability has reduced and (therefore a
debit).

Mr Saunders – AS Accountancy – Module 1

Information Generation Process

EG: Invoices
SOURCE DOCUMENTS

Recorded in:

BOOKS OF PRIME ENTRY EG: Journal

Cash book

Posted to:
EG: Debtors (sales) Ledger
LEDGERS
Creditors (purchases) Ledger
General (nominal) Ledger

Checked by:
Bank reconciliation
Control Accounts
Trial Balance

EG: Accruals / Pre-payments

YEAR END ADJUSTMENTS Depreciation of fixed assets

EG: Profit and Loss Account, Balance Sheet

FINAL ACCOUNTS

Classifying and summarising transactions

At the end of each day, week or month, batches of transactions are totalled and POSTED, i.e.
transferred, from the books of prime entry to LEDGERS using the double-entry system. By
using the books or prime entry to summarise the information from source documents, fewer
details need to be posted to the ledger accounts.

Each ledger has several different accounts within it as seen previously. These could include capital
accounts, cash accounts, bank accounts, fixed asset account etc. They hold
details of transactions that are similar in type. The three main ledger accounts
include:

 Sales (Debtors) ledger – this contains all of the customer accounts

(debtors), and show details of credit sales and how much is owed by
customers.

Mr Saunders – AS Accountancy – Module 1

 Purchases (Creditors) ledger – This contains all the supplier accounts (creditors), and shows
how much a business has purchased on credit and what is owed to each supplier.

 Nominal (General) ledger – contains impersonal accounts such as wages, rent, purchases,
sales, bank charges, machinery and buildings.

Another source of confusion is the use of the term ‘bank account’ in double entry bookkeeping. A
bank account is simply one of the ledger accounts that a business will use to record transactions.
It is not the same as a bank account that a bank provides and which is used by individuals and
businesses for writing cheques and receiving payments.

More information:

Cash sales

If a business sold goods worth £100 for cash, then we would credit the sales account in the
nominal ledger, because revenue has increased. We would then post the second part of this
double entry transaction into a cash account in the nominal ledger as a debit, as the assets of cash
have increased.

Credit sales

If goods where sold for £100 on credit, then we would debit the customers own private account in
the sales ledger, as this money owing is seen as an asset. However, we would then need to credit
the sales account in the nominal ledger. This is a credit because it is seen as an increase in
revenue. This sales account will contain details of sales to all of our customers so it is not personal
to any one customer. NOTE: The Cash Book is not used as the sales are on credit.

Cash Purchases

If the purchases are revenue expenditure (buying up the stocks of finished goods that the business
is planning to sell) and paid for in cash, we would credit the cash account (decrease in assets),
and debit the purchases account (increase in expenses) in the nominal ledger.

Credit Purchases

If the purchases of stocks had been bought on credit then we would credit the suppliers own
private account in the purchases ledger (as this is a liability), and debit the purchases account
in the nominal ledger.

Cash Purchase of fixed assets, i.e. computers

This is an example of Capital Expenditure and must be kept separate from purchases. Therefore
We DO NOT use the purchases account. Every fixed asset will have its own account, so we
Would debit the computer account (increase in assets) in the nominal ledger, and credit the
cashbook (decrease in assets).

Credit Purchase of fixed assets, i.e. computers

This is an example of Capital Expenditure and must be kept separate from purchases. Therefore
We DO NOT use the purchases account. Every fixed asset will have its own account, so we
Would debit the computer account (increase in assets) in the nominal ledger, and credit the
suppliers account (increase in liabilities) in the purchase ledger.
Mr Saunders – AS Accountancy – Module 1
Transaction Account to Why? Which Account to Why? Which ledger?
be debited ledger? the credited
Sale of stock for
cash
Sale of stock on
credit
Payment
received (one
week later) for
credit sales
Purchases of
stock for cash
Purchases of
stock on credit
Payment made
(one week later)
for credit
purchases
Sale of fixed
asset for cash
Sale of fixed
asset on credit
Payment
received (one
week later) for
credit sale of
fixed asset
Purchase of
fixed asset for
cash
Purchase of
fixed asset on
credit
Payment made
(one week later)
for the purchase
of fixed asset on
credit

Complete unit assessment 1 on page 10 of Jones.

Mr Saunders – AS Accountancy – Module 1