What is the concept of Double Entry System?

Concept of Double Entry. pdf. download for more

Every transaction has two effects. For example, if someone transacts a purchase of a drink from a local store, he pays cash to the shopkeeper and in return, he gets a bottle of dink. This simple transaction has two effects from the perspective of both, the buyer as well as the seller. The buyer's cash balance would decrease by the amount of the cost of purchase while on the other hand he will acquire a bottle of drink. Conversely, the seller will be one drink short though his cash balance would increase by the price of the drink.

Accounting attempts to record both effects of a transaction or event on the entity's financial statements. This is the application of double entry concept. Without applying double entry concept, accounting records would only reflect a partial view of the company's affairs. Imagine if an entity purchased a machine during a year, but the accounting records do not show whether the machine was purchased for cash or on credit. Perhaps the machine was bought in exchange of another machine. Such information can only be gained from accounting records if both effects of a transaction are accounted for.

Traditionally, the two effects of an accounting entry are known as Debit (Dr) and Credit (Cr). Accounting system is based on the principal that for every Debit entry, there will always be an equal Credit entry. This is known as the Duality Principal.

Ledger Accounts. pdf. download for more

Accounting Entries are recorded in ledger accounts. Debit entries are made on the left side of the ledger account whereas Credit entries are made to the right side. Ledger accounts are maintained in respect of every component of the financial statements. Ledger accounts may be divided into two main types: balance sheet ledger accounts and income statement ledger accounts.

Accounting Equation. pdf. download for more

Business transactions are financial in nature and so every transaction affects the financial position of the business. These transactions increase or decrease the assets, liabilities or capital. Every business has certain assets.

 These assets are purchased with the funds supplied to the business by its proprietors or creditors. Proprietors’ and creditors’ funds, in whatever form they are, create assets. For example, if the business receives Rs. 1, 00,000 as capital from the proprietor and retains that in the firm, it will create an asset i.e. cash in hand. If Rs. 80,000 are deposited in to bank, the total capital will be represented by two assets i.e. cash in hand Rs. 20,000 and cash at bank Rs. 80,000.

 It machines, worth Rs. 20,000 are purchased and payment is made out of bank deposit, the assets will now consist of cash in hand Rs. 20,000, cash at bank Rs. 60,000 ( due to purchase of furniture, bank balance has reduced by Rs. 20,000 ) and furniture Rs. 20,000. As such accounting equation is a statement of equality between debits and credits.

Double entry is recorded in a manner that the accounting equation is always in balance:

Assets = Liabilities + Equity

Assets of an entity may be financed either by external borrowing (i.e. Liabilities) or from internal sources of finance such as share capital and retained profits (i.e. Equity). Therefore, assets of an entity will always equal to the sum of its liabilities and equity.

The accounting equation may be re-arranged as follows:

Assets - Liabilities = Equity

We may test the Accounting Equation by incorporating the effects of several transactions to see whether it still balances as theorized in the accountancy literature. For the purpose of this test, we may classify accounting transaction into the following generic types:

1.     Transactions that only affect Assets of the entity

2.     Transactions that affect Assets and Liabilities of the entity

3.     Transactions that affect Assets and Equity of the entity

4.     Transactions that affect Liabilities and Equity of the entity

Note:

For all the examples on the next pages, it will be assumed that before any transaction, Assets of ABC LTD are $10,000 while its Liabilities and Equity are $5,000 each.

Accounting Equations Example. pdf. download for more