Chapter:-2 Double entry book keeping system

• Double entry, a fundamental concept underlying present-day bookkeeping and

accounting, states that every financial transaction has equal and opposite effects in at
least two different accounts.

• It is used to satisfy the equation Assets = Liabilities + Equity.

• The double entry has two equal and corresponding sides known as debit and credit. The
left-hand side is debit and right-hand side is credit. For instance, recording a sale of $100
might require two entries: a debit of $100 to an account named "Cash" and a credit of
$100 to an account named "Revenue."[

• The accounting equation

– Assets= Equity + Liabilities

• is an error detection tool; if at any point the sum of debits for all accounts does not
equal the corresponding sum of credits for all accounts, an error has occurred. However,
satisfying the equation does not guarantee that there are no errors; the ledger may still
"balance" even if the wrong ledger accounts have been debited or credited.

The following are the definitions of double entry system of book-keeping:

• "The specific technique which reflects the concept of duality is known as double entry
book- keeping." -Lewis and Gillespie

• "Double entry system is the system under which each transaction is regarded to have
two-fold aspects and both the aspects are recorded to obtain the complete record of
dealings."- Juneja, Chawla, and Saksena

• From the above definition, it is obvious that double entry system is regarded as the
most systematic and scientific system under which every financial transaction is
recorded into two separate accounts with the equal amount to determine the true
profit or loss and financial position of the business.

What is double entry system?

 The accounting equation is the very heart of a double entry accounting system

Assets – liabilities = equity + (income – expenses)

  For every change in value of one account in the accounting equation , there must be a
balancing change in another.

 This concept is known as the principle of balance

 You will always be concerned with at least 2 accounts , necessary to keep the accounting
equation balanced

Advantages of double entry

 It is possible to keep a full record of dual aspect of each transaction.

 Transactions are recorded in a scientific and systematic manner and thus the books of
accounts provide the most reliable information for controlling the organization
efficiently and effectively.

 Since the total debit under this system be equal to total credit , arithmetical accuracy of
the books can be tested by means of trial balance.

 An income and expenditure accounts can be prepared to know the excess income /
expenditure during a particular period and to know how such excess income /
expenditure has arisen

 The financial position of the organization can be readily ascertained by preparing a

balance sheet.

 Fraud are prevented, because alteration in accounts becomes difficult abd discovery of
irregularities is facilitated.

Features
• 1. Two Aspects

The double-entry book-keeping recognizes that every transaction has two aspects. It is based
on the fact that a transaction is an exchange and every exchange involves either two things, or
two persons, or a thing and a person. Furthermore, if business makes a transaction, the
business will be either the benefit receiver or benefit giver.

2. Debit and Credit

The double-entry book-keeping system provides the two aspects of the transaction with the
names 'debit' and 'credit' respectively. For example, the benefit receiver is given the name
'debit' and the benefit giver is given 'credit'. Thus, for each transaction, one aspect is debited
and another aspect is credited.

3. Two Fold/Double Effect

The double-entry book-keeping system records two-fold or double effect of every transaction.
This implies that the two aspects of a transaction are recorded on two opposite sides of two
separate accounts.

For example, if cash of $1000 is received by a business from Tom, one aspect of the transaction
is recorded on the debit side of the cash account and other aspect is recorded on the credit side
of Tom's account in the book of the business.

4. Equal Effect
The double-entry book-keeping system shows an equal effect of the two aspects of a
transaction. This implies that the amount of one aspect of a transaction is always equal to the
amount of other aspect. It, therefore, follows that for every debit amount there is an equal
credit amount which means ' for every debit there is a corresponding credit or vice versa'.

Classification of accounts
Personal account:-

When a transaction involved with a person known as personal account such as Mr. Krishna &
sons, ABC ltd co. Mr. Rama’s a/c etc.

Nominal account:-

All recurring expenses /income are known as nominal account, such as salary , rent , interest
etc.

Real account:-

Other than above two accounts all fall under this category, such as machinery, furniture etc

Rules of double entry system

In case o personal account
 - Debit all expenses and losses and credit all income and liabilities .

In the case of nominal account –

- Debit all expenses and losses and credit all income and liabilities.

In case of real accounts –

- Debit what comes in and credit what goes out.

Features contd.
5. Scientific and systematic

6. Complete

Debit / credit (left side / right side )

 Balancing changes ( or transfers of money ) among accounts is done by debiting one

account and simultaneously crediting another

 accounting debits and credits do not mean “decrease” and “increase”

 Debits and credits

Each increase certain types o accounts and decrease and others

 In asset and expense accounts,

Debits increase the balance and credits decrease the balance

 In liability , equity and income accounts ,

Debits decrease the balance and credits increase the balance

 Debits are always on the “left side “, credits are always on the “right” side

Advantages DEBS
• Scientific
the double entry system is a scientific system of book keeping. It has its own principles
and rules. The two aspects of every financial transaction are recorded under certain
rules and principles.

• Systematic
a systematic technique is followed in recording financial transactions in book-keeping. It
 records financial transactions in systematic and chronological order with a suitable
narration of the financial transactions.

• Complete
It is a complete system of book-keeping. It records not only each and every financial
transaction but also each aspect of the transaction.

• Accuracy
this system is based on the double-entry principle which means 'for every debit amount
there is corresponding credit amount or vice-versa'. Such a method of debit and credit
can help to ensure the arithmetical accuracy of the recordings of financial transactions.

• Profit or loss
this system helps to ascertain the true profit or loss of a business by preparing the profit
and loss account for a given period of time.

• Financial position
this system also helps to reveal information about the financial position of the business
by preparing a statement called balance sheet.

• Control
this system also helps to reveal information about the financial transactions. Therefore,
the recording of financial transactions in books provides necessary information for the
purpose of control costs.

• Comparison
this system facilitates the comparison of financial results of different years. The reasons
for the change in the operational results and the business's financial position in a year
can be ascertained easily.

• Decision making
this system communicates financial information that is necessary for taking decisions by
a business. It also provides necessary information to different users such as owners,
managers, and creditors for the purposes of making decisions.

• Frauds and errors

this system helps to ensure the arithmetical accuracy of the recordings of the financial
transactions in the books. It also provides full details of information of all kinds of assets
and liabilities of a business. Therefore, there is a smaller chance of frauds and errors
occurring in the books of accounts.
 Accounting Equation

Assets (A) Liability (L) Owner’s equity (E)

Items of value owned Monetary value of a Owner investment in

by the company company’s current and the company
future obligations

• Cash • Contractual • Common

• Investment ( reserves stocks
stocks, bonds • Commissions outstanding
• premium due payable • Preferred
and receivable • Accrued stock
• accrued expense outstanding
income • Additional
• equipment paid-in capital
• Real estate etc • Retained
earnings
• Identifying the financial transactions
A business may perform several
transactions. Of which, financial transactions are recorded in accounts. In the first step
of the accounting process, therefore, financial transactions are identified.
 • Recording of financial transactions
All the financial transactions of the business are
systematically recorded in the journal and subsidiary books in the second step of the
accounting process.

• Classifying the financial transactions

The financial transactions are classified mainly into
the transactions related to persons that include enterprises, persons, assets, and
income-expenses.

• Summarizing financial transactions

All financial transactions are summarized by
preparing a trial balance. The preparation of trial balance helps to prepare final
accounts. The final accounts disclose the profit or loss and financial position of a
particular of a business enterprise.

• Communicating the results of the business operations and financial position

Finally, the results of the
business operations such as profits or losses and the company's financial positions are
communicated to the users.

Basic terminologies
1. Capital

2. Liabilities

i. Long term

ii. Short-term

3. Assets

i. Fixed assets

a. Tangible

b. Intangible- Ips

ii. Current assets

4. Purchase

5. Sales
 6. Debtors

7. Creditors

8. Stocks/Inventory

9. Revenue

10. Expenses

Capital
• In its simplest form, capital means the funds brought in to start a business by the
owner(s) of a company.

• It is an investment by the proprietor(s) or partner(s) in the business. Bringing in equity

can mean money or assets as well.

• It is business’ liability towards the owner(s) also referred to as one of the internal
liabilities of the business. It is also called Net Worth or Owner’s Equity.

– It can increase with fresh investments or profits earned by the business.

– It can decrease with drawings made by the owner(s) or losses incurred by the
business.

Liabilities
• Liabilities are economic obligations or payables of the business.

• Company assets come from 2 major sources – borrowings from lenders or creditors, and
contributions by the owners. The first refers to liabilities; the second to capital.

• Liabilities represent claims by other parties aside from the owners against the assets of
a company.

• Like assets, liabilities may be classified as either current or non-current.

• A. Current liabilities – A liability is considered current if it is due within 12 months.

– If the company's normal operating cycle is longer than 12 months, a liability is

considered current if it is due within the operating cycle.

– Current liabilities include:

 • Trade and other payables – such as Accounts Payable, Notes Payable,
Interest Payable, Rent Payable, Accrued Expenses, etc.

• Current provisions – estimated short-term liabilities that are probable

and can be measured reliably

• Short-term borrowings – financing arrangements, credit arrangements or loans that are

short-term in nature

B. Non-current liabilities –

Liabilities are considered non-current if they are not currently payable, i.e. they are not due
within the next 12 months

– In other words, non-current liabilities are those that do not meet the criteria to
be considered current.

– Long-term notes, bonds, and mortgage payables;

– Deferred tax liabilities; and

– Other long-term obligations

Assets
• Assets refer to resources owned and controlled by the entity as a result of past
transactions and events, from which future economic benefits are expected to flow to
the entity. In simple terms, assets are properties or rights owned by the business. They
may be classified as current or non-current.

• A. Current assets –

• Assets are considered current if they are held for the purpose of being traded, expected
to be realized or consumed within twelve months after the end of the period or its
normal operating cycle (whichever is longer), or if it is cash. Examples of current asset
accounts are:

– Cash and Cash Equivalents – bills, coins, funds for current purposes, checks, cash
in bank, etc.

– Receivables – Accounts Receivable (receivable from customers), Notes

Receivable (receivables supported by promissory notes), Rent Receivable,
Interest Receivable, Due from Employees (or Advances to Employees), and other
claims.
 – Inventories – assets held for sale in the ordinary course of business

– Prepaid expenses – expenses paid in advance, such as, Prepaid Rent, Prepaid
Insurance, Prepaid Advertising, and Office Supplies

• B. Non-current assets – Assets that do not meet the criteria to be classified as current.
Hence, they are long-term in nature – useful for a period longer that 12 months or the
company's normal operating cycle. Examples of non-current asset accounts include:

– Long-term investments – investments for long-term purposes such as investment

in stocks, bonds, and properties; and funds set up for long-term purposes

– Land – land area owned for business operations (not for sale)

– Building – such as office building, factory, warehouse, or store

– Equipment – Machinery, Furniture and Fixtures (shelves, tables, chairs, etc.),

Office Equipment, Computer Equipment, Delivery Equipment, and others

– Intangibles – long-term assets with no physical substance, such as goodwill,

patent, copyright, trademark, etc.

– Other long-term assets