Paper: 02, Accounting & Financial Analysis

Module: 7, Double Entry System

Prof. S P Bansal
Principal Investigator Vice Chancellor
Maharaja Agrasen University, Baddi

Prof YoginderVerma
Co-Principal Investigator Pro–Vice Chancellor
Central University of Himachal Pradesh. Kangra. H.P.

Dr. O.P Verma

Paper Coordinator Department of Commerce
Himachal Pradesh University shimla

Prof S.S Narta

Content Writer Director UCBS Himachal Pradesh
University Shimla
 Items Description of Module
Subject Name Management
Paper Name Accounting & Financial Analysis
Module Title Double Entry System
Module Id Module No- 7
Pre- Requisites Debit and Credit Rules
Objectives To understand the meaning, features and
history of double entry
Keywords Double Entry, Dual Effect

QUADRANT I

1. Module-7: Double Entry System

2. Learning Objectives
3. Introduction
4. Methods of Accounting
5. Meaning of Double Entry System
6. Features Double Entry System
7. History Double Entry System
8. Debit and Credit Rules
9. Maintaining accounts under Double Entry System
10. Advantages of Double Entry System
11. Summary

LEARNING OBJECTIVES:

After studying the module, students may be able to understand the meaning of double entry system,
its features and history. The understanding on the debit credit rules might be deepened, along with the
procedure in record maintenance and some of the advantages of double entry book keeping.

INTRODUCTION:

Every incorporated business is involved in the continuous business of sale and purchase of goods and
services, and works for the purpose of earning the profits, attracting the customers and thereby
satisfying them. They deal with the monetary transactions (those which are capable of being measured
in terms of money) throughout the accounting year. This dealing with the transactions, affects the
business in two ways: something is increased and something is deducted from the business.
This two way effect needs to be recorded carefully in order to get a complete and a clear image of the
financial position of the enterprise at the end of the year. The recording of the transactions is done in a
systematic and chronological order in the books of accounts, be it the journal, ledger, or trial balance.
The entire process of recording the transactions in the books of accounts is termed as Book Keeping.
It is clear that this recorded data is of no use, unless and until it is communicated to the interested
users within time. The process of analysing the data and communicating/ presenting it in the form of
organised information to the management, is termed as Accounting. The data is presented in the form
of final accounts, which include the summary of the entire working of the enterprise in quantitative
terms. The aim of final accounts is to give a complete image of the enterprise, and this complete
picture is possible only if the two way effect of each transaction is highlighted in the accounts, i.e. the
debit effect and the credit effect. By this way the final accounts will be considered correct as well as
complete.

METHODS OF ACCOUNTING:

Accounting deals with the recording, analysing and interpreting the accounting information to the
interested users (both insiders and outsiders). Business transactions can be recorded in the books, in
two ways:

1) Single Entry System: Business organisations if follow this system, prepare only cash book
and personal accounts of debtors/ creditors. Therefore complete record maintenance is not
possible and trial balance cannot be prepared.
2) Double Entry System: it maintains a two-fold effect of benefit giving and receiving aspects.
It means that the record of equal debit and equal credit is maintained. In India, business
transactions are recorded by the way of double entry system, hence depicting the debit and
credit of every transaction.

MEANING OF DOUBLE ENTRY SYSTEM:

As the name suggests, double entry system means a double effect of a transaction on the business. It
means that every debit have a corresponding credit, with an equal amount. This further means that
two accounting entries need to be passed in the books of accounts, to record each financial
transaction. It is a modern and a new revised scientific method of recording the transactions in the
books of accounts. In simple terms it means that every transaction have equal and opposite effects in
two separate accounts. This system is based on the accounting equation of “Assets= Liabilities+
Equity”. The transactions are always recorded in terms of Debit and Credit. Since both the debits and
credits are recorded with the same amount, therefore at the end of accounting year all debits should be
equal to all credits, which will also help in detecting the errors and accurately preparing the final
accounts.

FEATURES OF DOUBLE ENTRY SYSTEM:

1) Dual Effect: this means that when following a double entry system, each and every transaction
will have a two way effect on the business, and both the effects will be recorded on the opposite
sides of the account.
2) Affected by same amount: as per the golden rule of double entry system, every debit has an equal
and corresponding credit. Equal means, with the same amount. It means that if there is a debit
with Rs 3000, the Credit will also be by Rs 3000.
3) Accurate recording: by following the system of double entry, the chance of any fault in recording
reduces. As the amount is recorded on both the debit as well as credit side, of two separate books,
at the end the debit side total always equals the credit side total. It maintains accuracy in the
accounts.
4) Involvement of two parties: a transaction is said to take place when two parties are involved, one
being the receiver of benefit and the other, the giver of benefit. Each party is affected by the equal
amount, one being debit and the other being credit.

HISTORY OF DOUBLE ENTRY SYSTEM:

Accounting enjoys a remarkable history. Accounting is believed to be started in Babylonia and Egypt
around 4000 B.C., where the transactions were recorded on the clay tablets. As far as the history of
double entry book keeping is concerned, the first ever mention of it was done in a book named
“Summa de Arithmetica, Geometria, Proportion at Proportionality”, written by “Luca Pacioli’s”, in
the year 1494. In his book along with the explanation to business and book keeping, the use of the
accounting terms Debit and Credit was also done. Pacioli mentioned that all entries have to be double
entry; it means that if one creditor is made, it becomes important to make one debtor as well.

DEBIT: is derived from an Italian word Debito, further derived from Latin word debita and debeo,
which means owned to the proprietor.

CREDIT: is derived from Italian word Credito, further derived from a Latin word Credo which means
trust/ belief on the owner.

QUICK REVISION:
▪ Business transactions can be recorded in the books of accounts in two ways: single entry system and
double entry system.
▪ Double entry system means a double effect of a transaction on the business. It means that every
debit have a corresponding credit, with an equal amount.
▪ Double entry system is used only in nominal ledger accounts.
▪ The first ever mention of double entry system was done in a book named “Summa de Arithmetica,
Geometria, Proportion at Proportionality”, written by “Luca Pacioli’s”, in the year 1494.

DEBIT AND CREDIT RULES:

In order to maintain a record of the transactions in the books of accounts, an accountant uses various
rules in order to show the two way effect of the transaction. The rules of debit and credit can be
classified into two heads under the double entry system: Traditional Approach and Modern Approach.
The double effect of the transaction on the books of accounts remains the same, irrespective of which
type of approach is being used by the accountant.

TRADITIONAL APPROACH – As per the traditional approach, the accounts are divided into real,
personal and nominal.

1. Real Account: refers to the accounts relating to the assets and liabilities.
2. Personal Account: refers to the accounts of persons or organisations, with whom the business
deals with. Example: accounts of debtors and creditors.
3. Nominal Account: means the accounts dealing with revenue, expenses, losses and gains.

If an accountant uses the traditional approach to record the transactions in the books of accounts, then
the following Golden Rules must be followed, in case of different accounts:

ACCOUNT DEBIT CREDIT

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

For Example:

The following transaction, are classified as different accounts, and also either an increase or decrease
are shown respectively:

TRANSACTIONS ACCOUNTS TYPE OF DEBIT/CREDIT RULES

ACCOUNT
1. Salaries Paid Salary Account Nominal Debit all expenses/ losses
Cash Account Real Credit what goes out
2. Dividend Dividend Account Nominal Credit all Incomes and Gains
Received Cash Account Real Debit what comes in

3. Machine Purchase Machine Account Real Debit what comes in

Cash Account Real Credit what goes out

MODERN/ ACCOUNTING EQUATION APPROACH- In order to follow this approach, the

transaction is recorded keeping in mind the accounting equation i.e. (Assets= Liabilities+ Capital).
For this purpose, the accounts are divided into five heads: Asset, Liability, Capital, Expenses/Losses
and Income/Gains.

An increase in assets, losses and decrease in capital, gains, liability means Debit. On the other hand, a
decrease in assets, losses and an increase in capital, gains, liability leads to a Credit. The following
rules are summarised below:

ASSETS LIABILITIES CAPITAL INCOME/GAIN EXPENSE/LOSS

INCREASE Debit Credit Credit Credit Debit
DECREASE Credit Debit Debit Debit Credit

For Example:

1. Mohan started a business, with a cash balance of Rs 10,00,000

In the above statement, the effect of the transaction would be a cash increase, as well as capital
increase. An increase in cash (an asset) would lead to a debit, whereas, an increase in capital,
 results into a credit. Therefore the transaction would be recorded in the journal, with Rs 10,00,000
as follows:
Cash A/C ……Dr. 1000000
To Mohan’s Capital Account 1000000
(Being cash brought in the business)

2. Purchased Machinery for Rs 6,00,000 and paid the amount in the form of a cheque
According to the above statement, no cash is involved. The effect of transaction would be,
increase in machinery (an asset) by Rs 6,00,000 and a simultaneous decrease in bank balance
(an asset) by equal amount. An increase in asset means Debit, whereas a decrease in asset means
Credit. The journal entry for the same would be:
Furniture A/C…..Dr 600000
To Bank A/C 600000
(Being furniture purchased and paid in cheque)

QUICK REVISION:
▪ The rules of debit and credit can be classified into two heads under the double entry system:
Traditional Approach and Modern Approach.
▪ The double effect of the transaction on the books of accounts remains the same, irrespective of
which type of approach is being used by the accountant.
▪ As per the traditional approach, the accounts are divided into real, personal and nominal.
▪ Under the accounting equation approach the accounts are divided into five heads: Asset, Liability,
Capital, Expenses/Losses and Income/Gains.

MAINTAINING ACCOUNTS UNDER DOUBLE ENTRY SYSTEM:

It is clear that the every transaction carried out by the business, have a dual effect on the business,
debit and credit, with the same amount. This debit and credit of the account are presented in the form
of a “T Account”. T Account is an individual account depicting the increase or decrease in that
particular account only. It is prepared horizontally. With Debit on the left side, whereas Credit on the
right side. The difference between the two sides is known as the Account Balance.

Account Title

Left Side (Debit) Right Side (Credit)

The preparation of T Account is just a one single step, from a sequence of steps involved in preparing
a full- fledged financial statement. However, it provides a simple way of record keeping to the
accountant. There is a proper procedure to be followed in order to record the transactions and show
the dual effect of the transaction. The steps involved in recording are:

1) Analysing the source documents: the first step is to analyse the documents with respect to each
transaction. Before recording the transactions, it is the responsibility of the person recording the
 transactions, to check for the evidence/proof for that transaction, either in the form of invoice or
bank statement. Thereby, fulfilling the objective evidence concept.
2) Recording in Journal: the next step is the preparation of journal. Also known as book of original
entry, maintains a chronological record of all the monetary transactions, which took place in an
accounting year.
3) Posting from Journal to Ledger: after preparing the journal, a ledger account is maintained
where the information about all the accounts is kept. A ledger account shows the two sided effect
of each transaction. For example: all the information regarding the increase and decrease in cash
is recorded under the ledger to update the cash accounts.
4) Preparation of Trial Balance: a trial balance shows a list of all the accounts with their respective
balances. All the ledger accounts are listed in the trial balance with their amounts, and are totalled
up so that the sum total of debit equals the sum total of credit. Such information helps in the
preparation of the final accounts.
5) Preparation of Financial Statements: after the preparation of the trial balance, and cross
checking that the debit and credit totals are equal, the final step includes the preparation of the
final accounts, which helps in predicting the financial position, solvency and effective working of
any enterprise.

In order to deepen the knowledge about the double entry system, a hypothetical example is given
below, and preparation of journal, ledger and trial balance is done:

Example:

From the following transactions of M/s Malice & Brothers, prepare a journal, post the entries in
ledger accounts.

DATE (2014) DETAILS AMOUNT

Aug 5 Business started with cash 500000
Aug 8 Opening of bank account with PNB 100000
Aug 10 Goods bought on credit by XYZ Ltd 80000
Aug 15 Purchased furniture, and payment done by cheque 90000
Aug 20 Cash sales 20000
Aug 22 Rent paid by cheque 28000
Aug 25 Goods sold on credit to ABC Ltd 50000
Aug 27 Cash paid to XYZ Ltd 80000
Aug 29 Cheque received by ABC Ltd 50000
Aug 31 Salary Paid in cash 30000

Solution:

1) Recording the transactions in a journal

 Journal

DATE PARTICULARS L.F. DEBIT (Rs) CREDIT

(Rs)
Aug 5 Cash A/C 500000
Dr. 500000
To Capital
(business started with cash)
Aug 8 Bank A/C 100000
Dr. 100000
To Cash A/C
(opening a bank account)
Aug 10 Purchases A/C 80000
Dr. 80000
To XYZ Ltd
(goods brought on credit)
Aug 15 Office furniture A/C 90000
Dr. 90000
To bank
(office furniture purchased)
Aug 20 Cash A/C 20000
Dr. 20000
To Sales A/C
(goods sold on cash)
Aug 22 Rent A/C 28000
Dr. 28000
To Bank A/C
(rent paid by cheque)
Aug 25 ABC Ltd A/C 50000
Dr. 50000
To Sales A/C
(goods sold on credit)

Aug 27 XYZ Ltd 80000

Dr. 80000
To Cash A/C
(cash paid to XYZ Ltd)
Aug 29 Bank A/C 50000
Dr. 50000
To ABC Ltd
(payment received by ABC Ltd)
Aug 31 Salary A/C 30000
Dr. 30000
To Cash A/C
(salaries paid )
TOTAL 10,28,000 10,28,000
2) Posting the transactions in the Ledger Book

Cash A/C

Dr
Cr

Date Particulars Amount Date Particulars Amount

Aug 5 Capital 500000 Aug 8 Bank 100000
Aug 20 Sales 20000 Aug 27 XYZ Ltd 80000
Aug 31 Salary 30000

Capital A/C

Dr
Cr

Date Particulars Amount Date Particulars Amount

Aug 5 Cash 500000

Bank A/C

Dr
Cr

Date Particulars Amount Date Particulars Amount

Aug 8 Cash 100000 Aug 15 Office furniture 90000
Aug 22 Rent 28000

Purchases A/C

Dr
Cr

Date Particulars Amount Date Particulars Amount

Aug 10 XYZ Ltd 80000

XYZ Ltd A/C

Dr
Cr

Date Particulars Amount Date Particulars Amount

Aug 27 Cash 80000 Aug 10 XYZ Ltd 80000

Office Furniture A/C

Dr
Cr

Date Particulars Amount Date Particulars Amount

Aug 15 Bank 90000

Rent A/C

Dr
Cr

Date Particulars Amount Date Particulars Amount

Aug 22 Bank 28000

ABC Ltd A/C

Dr
Cr

Date Particulars Amount Date Particulars Amount

Aug 25 Sales 50000 Aug 29 Bank 50000

Sales A/C

Dr
Cr

Date Particulars Amount Date Particulars Amount

Aug 20 Cash 20000
Aug 25 ABC Ltd 50000

Salary A/C

Dr
Cr

Date Particulars Amount Date Particulars Amount

Aug 31 Cash 30000
3) Maintenance of Trial Balance
After the preparation of journal, ledger accounts, a summary of all the accounts is made in the
form of a Trial Balance. It helps in maintaining accuracy of the ledger accounts, and helps in
locating the errors in the ledger account. It further helps in the preparation of financial statements.

ADVANTAGES OF DOUBLE ENTRY SYSTEM:

Following are some of the advantages of double entry system:

1) Scientific in nature: the double entry system, records the transactions, keeping in mind the own
set of framed rules and principles, hence it can be said that double entry system is scientific in
nature.
2) Systematic: it can be termed to be systematic, as the transactions are recorded in a chronological
order, i.e. as and when they occur.
3) Accurate: the accounts prepared on the basis of double entry, are accurate as for every debit there
is an equal credit with the same amount, hence maintains a mathematical accuracy.
4) Helps in ascertaining profit/ loss: with the help of profit and loss account, a true picture of the
profits and loss can be ascertained.

SUMMARY:

Business houses deal with the transactions, throughout the year, which affects the business in two
ways. This two way effect needs to be recorded carefully in order to get a complete and a clear image
of the financial position of the enterprise at the end of the year. Two ways means a dual effect of the
transaction, debit and the credit effect. The double entry system means a double effect of a transaction
on the business. It means that every debit have a corresponding credit, with an equal amount. As far as
the history of double entry book keeping is concerned, the first ever mention of it was done in a book
named “Summa de Arithmetica, Geometria, Proportion at Proportionality”, written by “Luca
Pacioli’s”, in the year 1494.

In order to keep the record of transactions, certain rules of debit and credit need to be followed. The
rules of debit and credit can be classified into two heads under the double entry system: Traditional
Approach and Modern Approach. The double effect of the transaction on the books of accounts
remains the same, irrespective of which type of approach is being used by the accountant. As per the
traditional approach, the accounts are divided into real, personal and nominal. And under the
accounting equation approach the accounts are divided into five heads: Asset, Liability, Capital,
Expenses/Losses and Income/Gains. In order to keep a record of financial transactions showing dual
effect, a proper procedure needs to be followed, i.e. preparing a ledger account, posting the balances
to the ledger account and then preparing a trial balance, hence depicting the accuracy of the ledger
accounts. The double entry system is systematic in nature, scientific, accurate and helps in
ascertaining the true profit and loss balances of an enterprise.