Double Entry Book Keeping

What is Double Entry Book Keeping? There is a clue to what double entry is in its title double Double can mean two or two parts and here is our first point that will help us understand what double entry book keeping is. EVERY complete financial transaction has TWO parts. In financial terms there is a cause and effect for every transaction that takes place in a business. A rookie error when it comes to double entry is to think we can cheat the system and only carry out one part of the transaction. In finance terms if we do we will create ourselves a problem as we have only recorded half of the entry. The two parts have names - one is called a Debit the other a Credit. For our financial transaction to be complete we must record both a Debit and a Credit. What are Debits and Credits? To help us understand Debits and Credits let us look at figure 1 below:

Figure 1 The first thing to notice is the shape of the diagram, the shape is in a T shape. This T shaped diagram is aptly named a T account and will help us understand some of the basic principles not only of double entry but of accounting principles in general. There are two related points to note next: 1. The Debit is on the left hand side of the T account 2. The word Debit has been abbreviated to Dr

The next two related points to note are: 1. The Credit is on the right hand side of the T account 2. The word Credit has been abbreviated to Cr Debits can be described as positive entries or payments made into an account and credits can be described as negative entries or payments made out of an account. Debit entries increase the amount or balance in the account. Credit entries reduce the amount or balance in the account. If we were to add up the total amount of the debit entries and were to add up the total amount of credit entries they will always be equal. The Three Main Ledgers The debits and credits are recorded as ledger entries. Originally in the early days of accounting actual books were used to record the various transactions that a business did, these were called ledgers. In modern times with the arrival of computers these actions are recorded electronically but the names of the ledgers remain. There are three main ledgers in accounting terms that record specific types of business transactions. They are; The Sales Ledger As it sounds the sales ledger is used to record the sales or the income a business receives from the sale of its products or services. The Purchase Ledger As it sounds the purchase ledger records the purchases of stock the business makes. There is one important thing to note - the transactions recorded in the purchase ledger are the purchases the business uses to produce what it sells. So if a manufacturer sells curtains the purchase ledger would be used to record the purchase of the material it uses to make the curtains. It would not record the electricity it purchases to run the sewing machines, that is recorded somewhere else. The Nominal Ledger The nominal ledger (sometimes called the general ledger) forms the backbone of the accounting system and contains most of the sub-ledgers. It includes the expenses a business incurs such as the electricity, insurance, fuel for vehicles and postage. The Accounting Equation

The accounting equation is: Assets = Liabilities + Capital (or investment to start the business) Assets are the things such as vans or stock or cash in the bank owned by the business Liabilities are things that are owed by the business; they can be loans or overdrafts at the bank or capital used to start the business. To illustrate this we are going to look at how a business starts and the very first transaction that takes place in a business. When any business starts it needs money to start this money is called capital. The capital is usually lent to the business by a friends family or the person starting may put their savings into the business to start it. We know that the rules of double entry say there will be two parts to this initial transaction one a debit and one a credit. Let us look at figure 2 and see what the transactions are.

Figure 2

Recording Financial Transactions We have seen a glimpse of the workings of double entry book keeping with the Capital Account and Bank Account of the business we are now going to explore this concept a little further let us look at figure 3.

Figure 3 We can see that in figure 3 the business owner decides to buy a van for the business. They pay 400.00 for the van to the person selling the van. This transaction as with all our transactions has two parts - a debit and credit. The first entry is the credit entry. In this entry the business owner takes 400 pound out of the business bank account. This is shown on the right hand-side of the bank. In exchange for the 400 the business has acquired an asset, something of value being added

to the business. The second part of our transaction must therefore be shown as a debit. To record this transaction the business opens an account in their accounts to record the addition of the asset called the motor vehicle account where the 400.00 is entered. Using Credit to Buy Goods (1) So far we have looked at cash transactions, however many businesses use credit to buy goods. Credit is when one company trusts a company to pay for goods at a later date usually the end of the month. Let us look at figure 4 to see how this works.

Figure 4 We can see that our business owner has approached a company and bought 300 pounds worth of product he needs for his business. The company he approaches agrees to let him pay

for the goods at a later date. Our business owner records the transaction by entering a credit of 300 onto an account in his business he has opened for creditors. To complete the transaction he must enter a corresponding debit entry which he does in the purchases account (which is in the purchase ledger). At this point no transaction touches the bank account because the transaction is done on credit and will be paid for at a later date. We can observe that on the creditors account there is a balance on the account of the creditor. Indicating the business owner owes 300 to the creditor. Using Credit to Buy Goods (2) We can see below the double entry when the business owner pays for the goods he purchased on credit illustrated in figure 5

Figure 5 We can see that the business owner is now paying for his goods by crediting cash out of the bank and debiting the creditors account. You will observe that the balance on both side of the creditors account is the same. This indicates there is nothing to pay to the creditor and the account is clear. Using Credit to Buy Goods (2) We can see below the double entry when the business owner pays for the goods he purchased on credit illustrated in figure 5

Figure 5 We can see that the business owner is now paying for his goods by crediting cash out of the bank and debiting the creditors account. You will observe that the balance on both side of the creditors account is the same. This indicates there is nothing to pay to the creditor and the account is clear. Selling Goods for Cash Our business owner now sells some product to a customer for cash and the way we record the financial transactions using double entry is shown below in figure 6

Figure 6 We can see that the sale of goods to our business owners customer is recorded as a credit to the sales account (which is in the sales ledger) and the money the business receives is debited to the bank account.

Recording Financial Transactions We have seen a glimpse of the workings of double entry book keeping with the Capital Account and Bank Account of the business we are now going to explore this concept a little further let us look at figure 3.

Figure 3 We can see that in figure 3 the business owner decides to buy a van for the business. They pay 400.00 for the van to the person selling the van. This transaction as with all our transactions has two parts - a debit and credit. The first entry is the credit entry. In this entry the business owner takes 400 pound out of the business bank account. This is shown on the right hand-side of the bank.

In exchange for the 400 the business has acquired an asset, something of value being added to the business. The second part of our transaction must therefore be shown as a debit. To record this transaction the business opens an account in their accounts to record the addition of the asset called the motor vehicle account where the 400.00 is entered. Using Credit to Buy Goods (1) So far we have looked at cash transactions, however many businesses use credit to buy goods. Credit is when one company trusts a company to pay for goods at a later date usually the end of the month. Let us look at figure 4 to see how this works.

Figure 4 We can see that our business owner has approached a company and bought 300 pounds worth of product he needs for his business. The company he approaches agrees to let him pay

for the goods at a later date. Our business owner records the transaction by entering a credit of 300 onto an account in his business he has opened for creditors. To complete the transaction he must enter a corresponding debit entry which he does in the purchases account (which is in the purchase ledger). At this point no transaction touches the bank account because the transaction is done on credit and will be paid for at a later date. We can observe that on the creditors account there is a balance on the account of the creditor. Indicating the business owner owes 300 to the creditor. Using Credit to Buy Goods (2) We can see below the double entry when the business owner pays for the goods he purchased on credit illustrated in figure 5

Figure 5 We can see that the business owner is now paying for his goods by crediting cash out of the bank and debiting the creditors account. You will observe that the balance on both side of the creditors account is the same. This indicates there is nothing to pay to the creditor and the account is clear. Selling Goods for Cash Our business owner now sells some product to a customer for cash and the way we record the financial transactions using double entry is shown below in figure 6

Figure 6 We can see that the sale of goods to our business owners customer is recorded as a credit to the sales account (which is in the sales ledger) and the money the business receives is debited to the bank account.

Ledger Balances Carry Forward (1) We have seen how the various financial transactions are entered into the ledgers and now we are going to learn how to find out what the balances are on each of the ledgers. Let us look at our first account, the capital account in figure 7.

Figure 7

We can see if we add up the total number of debits and add up the total number of credits we have an uneven number one side the credit adds up to 1000 the other is zero. To balance the account we have to find the number that is currently represented by the question marks. We call this figure the carried forward figure. We can see this in figure 8 below.

Figure 8

Now we can see to make both sides add up we have to add 1000 to the debit side. When we do add 1000 to the debit side of the T account it equals 1000 and the credit side of the account equals 1000. Whenever you see the term carried forward this means the balance is going to be carried forward into the next period. You will see that the carried forward figure becomes the brought forward number. This now tells us the balance on the account. Look at figure 7 again you will see that both figure 7 and figure 8 have a credit balance of 1000.

Ledger Balances Carry Forward (2) Let us look at each of the accounts in the same way and apply the same principle figure 9 show us the Motor Vehicle account.

Figure 9 Here we can see the same principle applied and see that the debits add up to 400 and the credits add up to zero. We need to work out what the figure we carry forward is.

Figure 10 We can keep applying the principle to every account to find out what the balance is.

Figure 11 Figure 11 show us the creditors account and in our example this shows us something different. You will remember our business owner paid the creditor 300 before the end of the month. If we add up both the debits side of the T account and the credit side of the T account we can see that the figures are the same. There is 300 of debits and 300 of credits. That tells us that the account has no value to carry forward. Our business owner owes no money to the supplier. Ledger Balances - Purchases Account We carry on applying the same principle to every account including our purchases account. The purchases account has a balance of 300 showing us the total value of purchases for our period of time was 300.

Figure 12

Figure 13 Ledger Balances - Sales Account We do the same for our sales account.

Figure 14

Figure 15

We can see once we have carried out the exercise the balance brought forward is 300 this shows us that the business sold 300 of product in the period of time. Ledger Balances - The Bank Account The last account for us to balance is the bank account we can see this in figure 16

Figure 16

Figure 17 Once we have carried out our exercise of adding up the debits and credits we can see that the balance in our bank account is 600.