CHAPTER 9

DOUBLE ENTRY BOOK KEEPING

9.0 LEARNING OBJECTIVES

By the end of this chapter, students will be able to record the entries in books of accounts using the double entry book-keeping.

9.1 THE DOUBLE ENTRY SYSTEM FOR ASSETS, LIABILITIES AND CAPITAL

Double entry book keeping is the system of accounting which reflects the fact that: x Every financial transaction affects the entity in two ways and gives rise to two accounting entries, one a debit entry and the other a credit entry. x The total value of the debit entries is therefore always equal at any time to the total value of credit entries.

9.2       THE ACCOUNTS FOR DOUBLE ENTRY

Each account should be shown on a separate page in the accounting books. The double entry system divides each page into two halves. The left side of each page is called the debit side while the right hand side of the page is called the credit side. The title of each account is written a cross the top of the account at the centre.

i.e.

Title of the account

Left hand side DEBIT side

Right hand side CREDIT side

These are commonly called T – accounts.

As observed in the previous chapter, transactions increase or decrease assets, liabilities or capital. Thus in terms assets, liabilities and capital: x To increase an asset we make a debit entry. x To decrease an asset we make a credit entry. x To increase a liability/capital account we make a credit entry. x To decrease a liability/capital account we make a debit entry.

Worked examples

Enter the following transactions using the double entry book keeping system

1)         The owner starts the business with K10, 000 in cash on 1 August 2013.

Effect of the transaction                                        action

Increases the asset cash                             debit the cash account

Increases the capital                                   credit the capital account

 THE ASSET OF INVENTORY

Inventory movements x Increase in inventory

Increases in inventory may be due to the following causes:

• The purchase of additional goods
• The return into the business of goods previously sold.

To distinguish the two aspects of the increase of inventory of goods, two accounts are opened:

• A purchase account in which purchases of goods are recorded
• A returns inwards account in which goods being returned into the business are recorded (this is also called a sales return account)

So for increases in inventory, we need to choose which of these accounts to use to record the debit entry of the transaction x Decrease in inventory

Decreases in inventory can be due to the following causes

• The sale of goods
• Goods previously bought by the business now being returned to the supplier

In order to distinguish the two aspects of the decreases in inventory, two accounts are opened:

• A sales account to record the value of goods sold
• A return outwards account in which goods returned to suppliers are recorded. (This is also called a purchase returns account).

So for decreases in inventory, we need to choose which of these two accounts to use to record the credit side of the transaction.

DOUBLE ENTRY FOR EXPENSES AND REVENUE

Example

1. Rent of K20 is paid in cash.

Here the dual effect is as follows:

200. The total of the expenses of rent is increased. Expenses entries are shown as debits; therefore the action is to debit the rent account with K200.
201. The asset of cash is decreased. This means the cash must be credited with K200 to show the decrease of the asset.

Summary:       Debit Rent account with K200.

Credit Cash account with K200.

1. Motor expenses of K355 are paid by cheque.

The dual effect is as follows:

355. The total for motor expenses paid is increased, hence the action required is to debit the motor expenses account with K355.
356. The asset cash in the bank is decreased. This means that the bank account must be credited with K355 to show the decrease of the asset.

Summary:      Debit Motor expenses account.         Credit Bank account.

1. K60 cash is received for commission earned by the business.

The dual effect is as follows:

1. The asset cash is increased; hence a debit entry of K60 is made on the cash account to increase the asset.
2. The revenue account, commission received is increased. Revenue is shown by a credit entry; hence the commission received account is credited with K60.

Summary:       Debit Cash account with K60.

Credit Commission received with K60.

9.5        DRAWINGS

x Sometimes the owners take cash out of the business for their private use. This is known as drawings.

x Any money taken out of a business will educe capital. Drawings should be treated as expenses of a business. x An increase in drawings is a debit entry in the drawings account with the corresponding credit being an asset account such as cash or bank.

NB: In theory, the debit entry should be made in the capital account since drawings decrease capital, However to prevent the capital account becoming full of small transactions, drawings are not entered in the capital account, instead a drawings account is opened.

Example:

On 25^th August the owner takes K50 cash out of the business for his own use. The dual effect of the transaction is as follows:

1) Capital is decreased; hence the drawings account is debited. 2) Cash is decreased and the cash account is credited.

i.e.                        Drawings                                  Cash

Cash     K 50                                                                    Drawings K 50

Exercise1

Prepare the T accounts for the following transactions for the month of June

July    1      started in business with K5000 in the bank and K1000 cash

• bought stationery by cheque K75
• bought goods on credit from smart K2100
• sold goods for cash K340
• paid insurance by cash K290
• bought a computer on credit from M Jere K700
• paid expenses by cheque k32
• sold goods on credit to Mr. Mbewe K630
• returned goods to smart K550

14        paid wages by cash K210

17        paid rent by cheque K225

• received a cheque for K400 form Mr Mbewe.
• paid Mr. Jere by cheque K700
• bought stationery on credit form stationery Ltd K125
• paid stationery Ltd by cheque K120

9.6     BALANCING OFF ACCOUNTS AND PREPARING A TRIAL BALANCE

At the end of the accounting period, all the accounts of the business must be balanced off and the balances from the accounts should be picked up and a trial balance should be prepared.

Balancing off accounts

When balancing the accounts, the following steps should be followed:

• Add up both sides of the accounts to find out their totals
• Deduct the smaller total from the larger total to find the balance

(iii)Enter the balance on the side with the smallest total to balance off the two sides of the account. This is called a balance carried down.

(iv)Enter the totals on both sides of the accounts which should be equal to balance off the accounts.

(v) Enter the balancing figure which is on the smallest total below the totals on the opposite side. This is called a balance brought down

 PREPARING A TRIAL BALANCE

A trial balance is a list of balances extracted from the accounts. All the debit balances are shown on one column and credit balances on the other column. If the double entry for the transactions has been done properly, the total of all the debit balances must be equal to the total of all the credit balances .where this is not the

case then it means that errors may have been made when recording the transactions.

(a) Total debit entries = Total credit entries.

Under the double entry bookkeeping:

x For each debit entry there is a corresponding credit entry. x For each credit entry there is a corresponding debit entry.

Therefore all the items recorded in all the accounts on the debit side should equal, in total, to all the items recorded on the credit side of the accounts.

In order to check that for each debit entry there is a credit entry, a trial balance is prepared. This is a list of account balances arranged according to whether they are debit balances or credit balances.

The trial balance always has the date of the last day of the accounting period to which it relates.

It is normal to prepare a trial balance at the end of an accounting period before preparing an income statement and statement of financial position (balance sheet). An income statement shows what profit has been earned in a period.  A statement of financial position (balance sheet) shows what assets and liabilities of a business are at the end of the period.

• Trial balances and errors

The fact that the trial balance ‘balances’, does not necessarily mean that all the entries in accounts are correct.  There are certain types of error that will not affect the balancing of a trial balance.

Errors that would be revealed by a trial balance are; addition errors, using one figure for a debit entry and another for the credit entry, and entering only one side of a transaction.

• Closing inventory

Inventory at the end of a period is not usually found in an account in the ledger.  It is found  from stock records and physical stocktaking.  Sinceit is not generally found in the ledger, it does not generally appear in a trial balance.  However, opening inventory is often recorded in a  ledger account, so that the inventory balance at   the start of a period, would be included in the trial balance prepared at the end of that period.

SUMMARY OF THE CHAPTER

This chapter tackled aspects of double entry of bookkeeping. Accounting treatment of various elements (including inventory, expenses and revenue) were illustrated. The mechanics of preparing trial balance through this system were also dealt with.

END OF CHAPTER QUESTION

Q1 Double entry system for financial transactions

It is known that for the purpose of the accounting equation approach, all the accounts are classified into the following five types: assets, liabilities, income/revenues, expenses, or capital gains/losses.

Required:

Explain how the double entry rules operate through these types of accounts.