Double entry book-keeping – A

Introduction

A business would find it impossible to prepare a statement of financial position after every single transaction. The day-to-day transactions are recorded in the books of a business using the double-entry system of bookkeeping. The term double entry is used because the two effects of a transaction (a giving and a receiving) are both recorded in the ledger. A business maintains a separate ledger account for each type of asset, expense, liability and income and also for each individual debtor and creditor. Every transaction is recorded in the ledger account relating to that particular item or person. A ledger is traditionally a bound book where each account appears on a separate page. Over the years, the ledger has developed into a looseleaf folder with separate sheets, each containing a ledger account. Recent developments have seen the introduction of a computer file divided into separate ledger accounts.

Ledger accounts are divided into two sections, which can be shown by a central vertical line, in this textbook the central vertical line is not shown. The left-hand side is known as the debit side and the right-hand side is known as the credit side. The term debit is usually abbreviated to ‘dr’ and the term credit is usually abbreviated to ‘cr’. On either side of the account, there are columns to record the date, details and amount of each transaction. A folio number column is used for reference purposes. The use of folio numbers is not required when answering questions. However, folio numbers have been included in examples present up to Chapter 7 so that you can appreciate their use and purpose. In order to record the two aspects of every transaction, every transaction is entered twice – on the debit side of one account and on the credit side of another account. The account which is receiving or gaining the value is debited and the account which is giving the value is credited

Double entry bookkeeping — the process of making a debit entry and a credit entry for each transaction.

Double-entry records for assets and liabilities

A ledger account is opened for each type of asset and liability. Applying the double entry principle, every transaction is entered twice. The account which is receiving the money is debited and the account which is giving the money is credited.

Double-entry records for expenses and income

A ledger account is opened for each type of expense and income. The same double entry principles applied to assets and liabilities are applied to expenses and income. The account which is receiving the money is debited and the account which is giving the money is credited.

Double-entry records for drawings

Whenever the owner of a business takes value from the business for his/her own use this is known as drawings. This value may be in the form of money, non-current assets or goods from the inventory held by the business. It is usual to open a drawings account to record these values so that the capital account does not have a large number of entries. Any drawings are debited in the drawings account to show the value going into that account. The credit entry will be in the account giving the value. When money is withdrawn, either the cash or bank account will be credited. When a non-current asset is withdrawn, the appropriate non-current asset account will be credited. When goods are withdrawn, the purchases account will be credited. This is because these goods were originally purchased for resale and the amount of goods available for resale is reduced when goods are taken by the owner. At the end of the financial year, the total of the drawings account is transferred to the capital account. This reduces the amount owed by the business to the owner of the business.

Drawings — represent any value taken from the business by the owner of that business

Balance — on a ledger account is the difference between the debit side and the credit side.

Balancing ledger accounts

At the end of each month, it is usual to balance any account of assets and liabilities which contain more than one entry. The balance is the difference between the two sides of the account and represents the amount which is left in that account. The steps necessary to balance a ledger account are summarized as follows:

• On a calculator or a separate sheet of paper, add up each side of the account and find the difference between the two sides.

• Enter this difference on the next available line on the side which is the smaller in money. Enter the date (usually the last day of the month) in the date column and the word ‘balance’ in the details column. It is usual to insert ‘c/d’ in the folio column. This is the abbreviation for ‘carried down’ and indicates where the double entry for this item will be made.

• Total each side of the account. This is done by drawing total lines and inserting the figure between these lines. It is usual to show a single line above the total and either a single or a double line below the total. The totals of an account must be on the same level and must be the same figure.

• Make the double entry for the balance carried down. On the line below the totals, write the amount of the balance on the opposite side to where the words ‘Balance c/d’ were written. Enter the date (usually the first day of the next month) in the date column and the word ‘balance’ in the details column. It is usual to insert ‘b/d’ in the folio column. This is the abbreviation for ‘brought down’ and indicates where the double entry for this item was made.

Double-entry records for sales, purchases and returns

It is necessary to open an account to record goods which are purchased for resale and also an account to record goods which are sold by the business. Whilst these are actually the same goods coming into the business and going out of the business, it is necessary to record them in separate accounts as the purchases will be at the cost price and the sales at the selling price. A purchases account and a sales account are used rather than a goods account. An inventory account is only used to record the goods left at the end of the financial year and not for day-to-day transactions. The same double-entry principles applied to assets and liabilities are applied to purchases, sales and returns.

Purchases

a. Goods purchased for cash or cheque

Whenever goods are purchased, the purchases account will be debited as the goods are coming into the business and the purchases account is receiving that value. The double entry will be a credit in either the cash account or the bank account depending on whether the amount was paid in cash or by cheque.

b. Goods purchased on credit

It is common for businesses to buy on credit and pay for the goods at a later date rather than at the time of purchase. The purchase account will be debited in the usual way.

The credit entry will be made in the account of the supplier of the goods to show the value coming from that person. The supplier of goods is known as a trade creditor. When payment is made to the supplier, the bank or cash account will be credited (to show value going out of that account) and the account of the supplier will be debited (to show value going into that account).

Sales

a. Goods sold for cash or cheque

Whenever goods are sold, the sales account will be credited as the goods are going out of the business and the sales account is giving out that value. The double entry will be a debit in either the cash account or the bank account depending on whether the amount was received in cash or by cheque.

b. Goods sold on credit

Just as a business may purchase goods and pay for them at a later date, it may also sell goods on credit. The sales account will be credited in the usual way. The debit entry will be made in the account of the customer to whom the goods were sold to show the value going to that person. The customer who bought the goods on credit is known as a trade debtor. When payment is received from the debtor, the bank or cash account will be debited (to show value coming into that account) and the account of the debtor will be credited (to show value going out of that account)

Returns

Sometimes goods which have been purchased have to be returned to the supplier. They may be faulty, damaged or not what was ordered. These goods are known as purchases returns or returns outward. A special account known as a purchases returns account (or returns outward account) is opened and any returns are credited to this account to show the value going out. The debit entry will be made in the account of the supplier to whom the goods are being returned (to show the value going to that person). Similarly, a customer may return goods to the business. These goods are known as sales returns or returns inwards. An account known as the sales returns account (or returns inwards account) is opened and any returns are debited to this account to show the value coming in. The credit entry will be made in the account of the customer who returned the goods (to show the value coming from that person).

Double entry records for carriage inwards and carriage outwards

The term carriage refers to the cost of carrying or transporting goods. Carriage inwards is part of the cost of purchasing goods as it occurs when a business has to pay for goods it has purchased to be delivered to its premises. Carriage outwards is a selling expense as it occurs when a business pays for goods to be delivered to the customer’s premises. It is important that these two expenses are treated separately in the accounts. Applying the double entry principle to carriage inwards, the carriage inwards account is debited as this is the account receiving the money and the cash account (or the bank account if the money is paid by cheque) is credited as the money is coming from this account. Similarly, if the payment relates to carriage outwards, the cash account or bank account is credited and the carriage outwards account is debited. If the carriage is not actually paid for at the time, the account of the supplier of the carriage service will be credited instead of the cash account or bank account.

Carriage — is the cost of transporting goods.

Carriage inwards — is the cost of bringing the goods to the business

Carriage outwards — is the cost of delivering the goods to the customer.

Three-column running balance accounts

The ledger accounts presented so far have been in the traditional form. This form is also known as the ‘T’ account format. There is another method of presenting ledger accounts which is commonly used on computer-generated accounts which is known as the three column running balance format. This form of presentation uses only one column each for the date, details and folio and has three money columns side-by-side – one for debit, one for credit and one for balance after each transaction. The layout of a ledger account using this format is as follows:

The advantage of this method is that it shows the balance of the account after every transaction. When the accounts are prepared manually, it involves extra calculations which may lead to errors

Interpreting ledger accounts and their balances

It is necessary to be able to understand the entries made in a ledger account and to be able to explain those entries

Summary

■ Every transaction must be entered twice – on the debit side of one account and on the credit side of another account.

■ The debit entry is made in the account which is receiving the value and the credit entry is made in the account which is giving the value.

■ Each type of asset, liability, expense and income has its own ledger account.

■ Any value taken from the business by the owner of the business is known as drawings.

■ At the end of the period, the accounts of assets and liabilities which contain more than one entry should be balanced.

■ The entries for purchases and sales, and purchases returns and sales returns, are recorded in separate accounts.

■ Carriage is the cost of transporting goods