Double entry accounting
Get to grips with accounting terminology
Units 4 and 5 introduced the accounting and profit equations and the dual aspect of book-keeping; each time there is a business transaction there are two effects on the accounting equation.
This is known as DOUBLE ENTRY e.g as we saw, an investment of £10,000 as capital means that the asset of cash will go up by £10,000.
Each element of the transaction is stored in the financial records in an ACCOUNT.
So in the example the investment is stored in the Capital Account, the cash is stored in the Bank (or Cash) account.
A group of accounts in the financial records is known as a LEDGER.
So for example, if a business has a number of customers each with amounts owed to the business, each customer will have its own account in the financial records showing the amount owed and the group of customer accounts is known as the Sales Ledger or sometimes the Accounts Receivable Ledger.
Two additional terms that are commonly used in conjunction with double entry are DEBIT and CREDIT
So that the principle of double-entry book-keeping is that for every business financial transaction:
- one account is debited and
- one account is credited
A debit entry to the account which gains value or records an asset or expense
A credit entry to the account which gives value or records a liability or income
Some examples may help:
Owners (Shareholders) decide to invest £2000 in a new enterprise.
The account which gains value is the bank account so debit the bank with £2,000. The other entry is made to the account which gives value, in this case the capital account, so credit that with £2,000.
The business buys a computer for the office for £1,500 paid for with a cheque.
The computer represents an asset to the business, so debit a computer asset account with £1,500. The other entry is to the bank account where the cheque will reduce the balance (i.e. has given value to the computer asset account) so credit the bank with £1,500.
The business has paid the office rent of £300 by standing order.
As the payment of the rent is an expense, debit the office rent account with £300. In a sense the rent account gains in value , as the business can continue to enjoy the use of the office. The bank account is credited with £300, again the account has given value.
The bank account mentioned above is of course the business bank account used for recording cash impacts of financial transactions inside the business.
There is usually also the bank account held at a Bank in which the cash is actually held.
Clearly the flows through the two accounts will be the same, but not necessarily recorded at exactly at the same time
(Hence one of the needs for regular bank reconciliation).
You will remember that when there are funds held at the Bank the account it is said to be in credit; whereas when the business bank account has positive funds it is said to be an asset and therefore is a debit, we also debit the account when we increase the balance and credit it when we reduce the balance (see examples above). The reason for this discrepancy is simply a point of view. From the Bank’s point of view the money in your account is yours; owed to you, so it is a liability from their perspective. A liability is a credit, hence the Banks use the term in credit, but it remains your asset, a debit from your perspective.
A summary of common bookkeeping and accounting terms with their meanings can be down loaded from the link
Common Book-keeping and Accounting Terms – PDF file.
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