DOUBLE-ENTRY BOOK-KEEPING

In accountancy, the double-entry bookkeeping (or double-entry accounting) system is the basis of the standard system used by businesses and other organizations to record financial transactions. Its premise is that a business's (or other organization's) financial condition and results of operations are best represented by several variables, called accounts, each of which reflects a particular aspect of the business as a monetary value.

Every transaction is recorded by entries in at least two accounts. The total of the debit values must equal the total value of the credit values. The premise for this is that any monetary transaction must logically affect two aspects of a company. For example, if an item is purchased, it must be paid (Debit Inventory, Credit Bank Account). Alternatively, if an item is sold, the company must be paid (Debit Bank Account, Credit Inventory). Most transactions consist of two entries, but can have three or more entries e.g. Supplier Invoice Total = Net value + taxes. This system is called double entry because all transactions must "balance" - the debit and credit sides must equal the same amount.

Historically, debit entries have been recorded on the left hand side and credit values on the right hand side of a general ledger account. The ledger accounts are set up as T accounts so called because they resemble the letter T when the account is empty.

History

The origins of double-entry bookkeeping have been traced as far back as the 12th century. By the end of the 15th century, the merchant venturers of Venice used this system widely. Luca Pacioli, a monk and collaborator of Leonardo da Vinci, first codified the system in a 1494 mathematics textbook [1]. Pacioli is often called the "father of accounting" because he was the first to publish a detailed description of the double-entry system, which enabled others to study and use it. Bookkeeping instructions from the mid-fifteenth century

The bookkeeping and accounting process

When a transaction occurs, a document is produced. This document is referred to as a source document. Some examples of source documents are:

• The sales invoice, sales receipt, purchase invoice.
• The deposit slips and checks that affect credits (additions) to and debits (subtractions) from a checking account.

(Non US equivalents: check = cheque, checking account = bank current a/c, deposit = lodgement)

These source documents are then recorded in a journal. This is also known as a book of first entry or daybook. The journal records both sides of the transaction recorded by the source document. These write-ups are known as journal entries.

These Journal entries are then transferred to a ledger. A ledger is also known as a book of accounts. The purpose of a ledger is to bring all of the amounts recorded for that account from the journal together. This process of transferring the values is known as posting.

Once the entries have all been posted, the ledger accounts are added up in a process called balancing. A particular working document called an unadjusted trial balance is created. This lists all the balances from all the accounts in the ledger. Notice that the values are not posted to the trial balance, they are merely copied.

At this point accounting happens. The accountant produces a number of adjustments which make sure that the values comply with accounting principles. These values are then passed through the accounting system resulting in an adjusted trial balance. This process continues until the accountant is satisfied that the resulting figures are correct and can be used to produce financial statements.

Finally financial statements are drawn from the trial balance, which may include:

• the income statement, also known as a statement of financial results, profit and loss statement, or simply P&L
• the balance sheet
• the cash flow statement

Short Examples

Buying an asset (such as a new machine):

1. The amount of fixed assets in the business increases.
2. The amount of cash (a current asset) is reduced.

Selling merchandise on credit:

1. The amount of trade receivables (an asset) for the business increases.
2. The sales revenue for the business increases (eventually this will become part of equity).

Upon payment, the trade receivables account decreases while the cash account increases.

Should the receivable be "written off" as uncollectible debt, the receivable account decreases and the bad debt is added to expenses (which also becomes part of equity when netted against income and cost of goods sold). In larger firms, a portion of the receivable account is written off beforehand as expected to be uncollectible.

Paying a trade creditor:

1. The amount of trade payables (a liability) for the business decreases.
2. The amount of cash in the business is reduced.

An explanation of Debits and Credits

Double-entry bookkeeping is governed by the accounting equation. At any point in time, the following equation must be true:

assets = liabilities + equity

For a particular time period, the equation becomes:

assets = liabilities + equity + (revenue − expenses)

Finally, this equation may be rearranged algebraically as follows:

assets + expenses = liabilities + equity + revenue

This equation must be true, for any time period. If it is, then the accounts are said to be in balance. If the accounts are not in balance, an error has occurred.

For the accounts to remain in balance, a change in one account must be matched with a change in another account. These changes are known as debits and credits. Note that the usage of these terms in accounting is not identical to their everyday usage. Whether one uses a debit or credit to increase or decrease an account depends on the normal balance of the account. Asset and expense accounts (on the left side of the equation) have a normal balance of debit. Liability, equity, and revenue accounts (on the right side of the equation) have a normal balance of credit. On a general ledger, debits are recorded on the left side and credits on the right side for each account. Since the accounts must always balance, for each transaction there will be a debit and a matching credit, and the sum of all debits for all accounts must equal the sum of all credits.

Debits and credits are then defined as follows:

• debit: an increase in one of the accounts with a normal balance of debit or a decrease in one of the accounts with a normal balance of credit. A debit is recorded on the left hand side of a 'T' account
• credit: an increase in one of the accounts with a normal balance of credit or a decrease in one of the accounts with a normal balance of debit. A credit balance is recorded on the right hand side of a 'T' account

• Debit accounts = Asset and Expenses (also debit money received into bank accounts)
  
• Credit accounts = Gains and Liabilities (also credit money paid out of bank accounts)

The following accounts have a normal balance of debit:

• Assets
• Accounts receivable: debts promised by other entities but not yet paid
• Drawings by the owners on equity
• Expenses
• Losses (that is, when expenses exceed revenue)

The following accounts have a normal balance of credit:

• Liabilities
• Accounts payable and taxes, notes or loans payable: debts promised to outsiders but not yet paid
• Revenue
• Profit (that is, when revenue exceeds expenses)

Examples of debits and credits:
Purchase of a Computer
Debit = Computer A/c (Fixed Asset A/c)
Credit = Creditors A/c (Liability A/c)

Paying supplier for the computer
Debit: Creditors A/c (Liability A/c) You are reducing a Liability A/c
Credit: Bank A/c (Asset A/c) Money going Out, you are reducing an asset account

Credit and debit items are summarised at the end of a recording period in a trial balance which is a list of all the debit and credit balances. The trial balance acts as a self checking mechanism for the correctness of entries in the individual accounts and also as a starting point for the preparation of the balance sheet and a profit and loss account.

The following table summarizes the basic accounts. A "+" indicates an increase; a "−" indicates a decrease.

An explanation of a T account

A T account is called such because it looks like the letter "T" when drawn like so;

____________________
 Debits  | Credits
         |
         |
         |
         |
         |
         |

Debit entries are made on the left side of the middle line and credit entries are made on on the right side of the middle line.

Double-entry working examples

Example 1

In this example the following will be used: Books of first entry (a.k.a. Books of prime entry)

• Sales Invoice Daybook (records customer Invoice Daybook)
• Bank Receipts Daybook (records customer & non customer receipts)
• Purchase Invoice Daybook (records supplier Invoice Daybook)
• Bank Payments Daybook (records supplier & non supplier payments)

Ledger Cards

• Customer Ledger Cards
• Supplier Ledger Cards

General Ledger (Nominal Ledger)
Bank Account Ledger
Trade Creditors Ledger
Trade Debtors Ledger

From the above we will create:

• Trial Balance
• Profit and Loss Statement (Dr & Cr Formating, classic format)
• Profit and Loss Statement (List Format, Modern version used today)
• Balance Sheet (Dr & Cr Formatting, classic format)
• Balance Sheet (List Format, Modern version used today)

Purchases/Creditors

Purchase Invoice Daybook

Each indivdual line is posted as follows:
The amount value is posted as a credit to the individual supplier's ledger a/c
The analysis amount is posted a debit to the relevant general ledger a/c
From example above:

   Line 1 - Amount value 1000 is posted as a credit to the Supplier's ledger a/c ELE01-Electricy Company

   Line 1 - Electricty value 1000 is posted as a debit to the Electricity general ledger a/c code

Double-entry has been observed Dr = 1000 Cr = 1000

   Line 2 - Amount value 1600 is posted as a credit to the Supplier's ledger a/c WID01-Widget Company

   Line 2 - Widget value 1600 is posted as a debit to the Widget general ledger a/c code

Double-entry has been observed Dr = 1600 Cr = 1600

The totals' of each column are posted as follows:

   Amount total value 2600 posted as a credit to the Trade creditors control a/c

   Electricity total value 1000 posted as a debit to the Profit & loss control a/c

   Widget total value 1600 posted as a debit to the Profit & loss control a/c

Double-entry has been observed Dr = 2600 Cr = 2600

Bank Payments Daybook

Keys: PI = Purchase Invoice, BP = Bank Payment

Each indivdual line is posted as follows: The amount value is posted as a debit to the individual supplier's ledger a/c
The analysis amount is posted as a credit to the relevantgeneral ledger a/c
From example above:

   Line 1 - Amount value 1000 is posted as a debit to the Supplier's ledger a/c ELE01-Electricity Company

   Line 1 - Trade creditors value 1000 is posted as a credit to the Bank general ledger a/c code

Double-entry has been observed Dr = 1000 Cr = 1000

   Line 2 - Amount value 900 is posted as a debit to the Supplier's ledger a/c WID01-Widget Company

   Line 2 - Trade creditors value 900 is posted as a credit to the Bank general ledger a/c code

Double-entry has been observed Dr = 900 Cr = 900

   Line 3 - Amount value 400 is posted as a debit to the Wages general ledger a/c code

   Line 3 - Trade creditors value 400 is posted as a credit to the Bank general ledger a/c code

Double-entry has been observed Dr = 400 Cr = 400

The totals' of each column are posted as follows:

   Amount total value 2300 posted as a debit to the Trade creditors control a/c

   Electricity total value 1900 posted as a credit to the Profit & loss control a/c

   Widget total value 400 posted as a credit to the Profit & loss control a/c

Double-entry has been observed Dr = 2300 Cr = 2300

The daybooks are the key documents (books) to the double entry system. From these daybooks we create the ledger accounts. Each transaction will be recorded in at least two ledger accounts.

Supplier Ledger Cards

Sales/Customers

Sales daybook

Each indivdual line is posted as follows:
The amount value is posted as a debit to the individual customer's ledger a/c
The analysis amount is posted a credit to the relevant general ledger a/c
From example above:

   Line 1 - Amount value 2500 is posted as a debit to the Customer's ledger a/c JJM01-JJ Manufacturing

   Line 1 - Electricty value 2500 is posted as a credit to the Sales-parts general ledger a/c code

Double-entry has been observed Dr = 2500 Cr = 2500

   Line 2 - Amount value 3200 is posted as a credit to the Customer's ledger a/c JJM01-JJ Manufacturing

   Line 2 - Electricty value 3200 is posted as a debit to the Sales-service general ledger a/c code

Double-entry has been observed Dr = 3200 Cr = 3200

The totals' of each column are posted as follows:

   Amount total value 5700 posted as a debit to the Trade debtors control a/c

   Sales-parts total value 2500 posted as a credit to the Profit & loss control a/c

   Sales-service total value 3200 posted as a credit to the Profit & loss control a/c

Double-entry has been observed Dr = 5700 Cr = 5700

Bank Receipts daybook

Keys: SI = Sales Invoice, BR = Bank Receipt

Each indivdual line is posted as follows: The amount value is posted as a credit to the individual customer's ledger a/c
The analysis amount is posted as a debit to the relevantgeneral ledger a/c
From example above:

   Line 1 - Amount value 2500 is posted as a credit to the Customer's ledger a/c JJM01 - JJ Manufacturing

   Line 1 - Customers value 2500 is posted as a credit to the Bank general ledger a/c code

Double-entry has been observed Dr = 2500 Cr = 2500

The totals' of each column are posted as follows:

   Amount total value 2500 posted as a credit to the Trade debtors control a/c

   Customers total value 2500 posted as a debit to the Profit & loss control a/c

Double-entry has been observed Dr = 2500 Cr = 2500

The daybooks are the key documents (books) to the double entry system. From these daybooks we create the ledger accounts. Each transaction

will be recorded in at least two ledger accounts.

Customer Ledger Cards

General Ledger

General Ledger

GENERAL LEDGER

The customers ledger cards shows the breakdown of how the trade debtors control a/c is made up. The trade debtors control a/c is the total of outstanding debtors and the customer ledger cards shows the amount due for each individual customer. The total of each individual customer account added together should equal the total in the trade debtors control a/c.

The supplier ledger cards shows the breakdown of how the trade creditors control a/c is made up. The trade creditors control a/c is the total of outstanding creditors and the suppliers ledger cards shows the amount due for each individual supplier. The total of each individual supplier account added together should equal the total in the trade creditors control a/c.

Each Bank a/c shows all the money in and out through a bank. If you have more than one bank account for your company you will have to maintain separate bank account ledger in order to complete bank reconcilliation statements and be able to see how much is left in each account.

The Bank control a/c keeps the total for all bank accounts. The balance of each individual bank acount, when added together, must equal the balance in the bank control a/c.

Bank account

Unadjusted Trial balance

The individual customer accounts are not to be listed in the trial balance, as the Trade debtors control a/c is the summary of each individual customer a/c.

The individual supplier accounts are not to be listed in the trial balance, as the Trade creditors control a/c is the summary of each individual supplier a/c.

The individual bank accounts are not to be listed in the trial balance, as the Bank control account is the summary of each individual bank a/c. _{see note 2 below}

The profit & loss control account is not to be listed in the trial balance, as thr profit & loss control account is a summary of the trial balance.

Important notes:
1. This example is designed to show double entry. There are methods of creating a trial balance that significantly reduce the time it takes to record entries in the general ledger and trial balance.
2. In practice it is the norm to list each bank account in the trial balance. This allows you to distinguish between bank accounts which are overdrawn or not and which bank accounts are loans or savings accounts.

Journal Entries

Depreciation Wages Stock Accurals Prepayments

adjusted Trial balance

Profit & Loss Statement and Balance Sheet

Classic Format (Debits & Credits)

Modern Format (List method)

Example 2

Transcactions

XYZ Company is closing its books for the end of the month. Each of the daily journals has been summarized and the amounts are ready to be transferred to the general ledger. The amounts to be transferred are:

• Purchase raw materials by using line of credit: $500,000
• Pay workers from cash in bank to make goods: $1,500,000
• Pay sales force from cash in bank to sell goods: $1,000,000
• Sell goods for cash: $3,500,000

To close the books for the month, we will adjust expenses and revenue to be zero by appropriately crediting and debiting the income summary and then closing the income summary to retained earnings (part of equity).

These items are entered in the ledger below; each matching credit and debit have been numbered to make finding them in the ledger easier.

Ledgers

The amount in equity (in the form of retained earnings) has changed with a net credit of $500,000. Since equity has a normal balance of credit, this means there is now $500,000 more in equity than at the beginning of the month.

See also

• Single-entry accounting system

External links

Wikibooks has more about this subject:

Accounting

• Institute of Certified Bookkeepers
• A double entry GnuCash How-to
• More accounting theory
• An accounting tutorial
• GnuCash data entry concepts
• Bean Counter's bookkeeping tutorial
• Free Bookkeeping Course
• Bookkeeping Terms
• Computer database modeling