BOOK-KEEPING
The double entry system requires two separate entries to be made for each accounting transaction, and that these entries are equal and opposite (plus and minus amounts). This means that the system is constantly self-balancing.
When double-entry accounts are presented, by convention, the left-hand side is the debit side and the right-hand side is the credit side. eg:
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| | | DEBIT | | CREDIT |
|
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| CASH ACCOUNT | | | | |
| (A) Cash from bank | | 35.00 | | |
| (B) Stationery purchase | | | | 35.00 |
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| BANK ACCOUNT | | | | |
| (A) Cheque drawn for cash | | | | 35.00 |
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| STATIONERY ACCOUNT | | | | |
| (B) Paper purchased by cash | | 35.00 | | |
Transaction (A) = cash drawn from bank account.
Transaction (B) = cash purchase of paper, using the cash drawn.
As many ledger accounts as thought necessary can be opened to record the two sides of every transaction.
The cash account is made the root of double-entry accounting, then transactions are recorded as follows:
For every cash receipt (ie. every debit in the cash account), there is a corresponding debit in some other ledger account.
If the cash account is the root of the double entry system, what of transactions that do not involve a cash receipt or payment? This presents no problem because, having established the principle of double entry recording for cash transactions, there is a logical follow-on for non-cash transactions. Because cash receipts are debits, corresponding credits will comprise:
capital, eg, cash introduced
liabilities, eg, loan received
income, eg, cash sales.
Because cash payments are also credits, corresponding debits will comprise:
assets, eg, stock or machinery purchased
expenses, eg, salaries paid.
Having firmly established the principles of double-entry book keeping by using the cash transactions as the basis, the system can be extended to non-cash transaction by saying that:
Debits are: assets, losses, purchase and expenses
Credits are: capital, liabilities, profits, sales and income.
The double entry for a non-cash transaction, in this example, stocks for resale on credit at a cost of 475, would be as follows:
| | | | | | |
| | | DEBIT | | | | CREDIT |
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| PURCHASES | | | | | | |
| Creditors | | 475 | | | | |
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| CREDITORS | | | | | | |
| | | | | Purchases | | 475 |
and when the creditors are paid, the double-entry (shown above) will be:
| | | | | | |
| | | DEBIT | | | | CREDIT |
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| CREDITORS (same account) | | | | | | |
| Cash | | 475 | | | | |
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| CASH | | | | | | |
| | | | | Creditors | | 475 |
At the end of an accounting period, it is customary to rule-off (balance the ledger accounts).
Prior to computerised accounting, it was usual to balance the cash account fairly frequently (probably at the end of each month), but to balance for profit and loss and balance sheet purposes only at the end of the financial year. With the advent of computerised accounting, production of full accounts was no longer a chore, and it is now quite usual for a business to produce full accounts at each month-end, thereby increasing control on the firm's finances.
For balance sheet (asset, capital and liabilities) accounts, the balance necessary to close the old accounts is carried down to become the opening balance for the new account in the following accounting period. Carrying the balance down from the old to the new account is effectively a double-entry, because to carry down the balance on the cash account, the old account is credited, and the new account is debited. In the case of income and expense accounts, balance is achieved by transferring the amount that is necessary to close off each account to the trading and profit and loss account, eg:
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| PURCHASES | | | | | | |
|
| | | DEBIT | | | | CREDIT |
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| Date | | | | Date | | |
| 01-Jan-xx Cash | | 185 | | 31-Dec-xx Transfer to trading a/c | | 310 |
| 31-Dec-xx Creditor | | 125 | | (If no stock left on this date) | | |
| | | | | | |
| | | 310 | | | | 310 |
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| | | | | | |
Having cleared all the income and expense accounts to one account, a figure that represents an excess (or deficit) of income over expenditure is produced. This figure is the profit (or loss) for the period.
Finally, at the end of the financial period, the balance of profit or loss is transferred from the trading and profit and loss account to the capital account in order to clear the former account.
The opening ledger account balances at the start of a financial year will be assets, capital, and liability accounts only. This must be in agreement with the balance sheet at the end of the immediately preceding period.
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