Double Entry Bookkeeping Accounting I Double Entry Bookkeeping

Dr. Clive Vlieland-Boddy FCA FCCA MBA Barcelona 2009

Qualification & Objectives You do not need to become accountants, nor can I achieve that today. You need to have a basic understanding to how financial accounts are created. So we need to appreciate the issue of Double Entry Bookkeeping..

History & Reasons Invented over 500 years ago. It was created to ensure that all entries are correctly and accurately recorded.

Objective 1 What is Double Entry Bookkeeping 1 1

What is “Double Entry” By recording the same entry twice, it enables a higher degree of confidence of the accuracy and completeness of the accounting.

Double Entry System Record dual effects of each transaction Each transaction affects at least two accounts Each transaction is recorded with at least One debit One credit Total debits must equal total credits 7

Debits and Credits Books of accounts and ledgers are divided in half. On the left is the so called “DEBIT” side. And on the right is the so called “CREDIT” side.

Objective 2 The “T” Account 1 1

T-Account Simple tool for analysing and determining the balance in a given account Account Name (Left Side) Debit (Right Side) Credit 10

Which account is debited? Which account is credited? The “T” Accounts Which account is debited? Which account is credited? For what amount? For what amount? Accounts Payable will be debited for $476 and Purchase Returns and Allowances will be credited for $476. 11

Debits Assets Bank Receipts Expenditures Losses

Credits Liabilities Bank Payments Shareholders Funds Incomes (Sales)‏ Profits

YES they WILL Debits & Credits If we post the same amount to both the Debit and the Credit side, then when we add up all the debits and the credits…. They will total the same. YES they WILL

Assets vs Liabilities In Session 2 we talked about assets and liabilities. For every asset there will be a corresponding and equal liability EG. If you buy a new car for £10,000 you will owe the garage that sum.

Asset Accounts ______________________________________ Debits: Increase I Credits : Reduce Assets I Assets

Liability Accounts ______________________________________ Debits: Reduce I Credits : Increase Liabilities I Liabilities

Equity Accounts ______________________________________ Debits: Reduce I Credits : Increase Equity I Equity

Equity (Shareholders) Account This represents the funds invested into the company by the owners. It also is the profits that have been generated to date but have not been paid out as dividends. This is really shareholders money that the company retains for future growth.

Income Accounts _____________________________________ Debits: Reduce I Credits : Increase Incomes I Incomes

Expense Accounts _____________________________________ Debits: Increases I Credits: Decrease Expenditure I Expenditure

Rules of Debit and Credit Liabilities Equity = + Debit Credit - + Debit Credit Assets + - 22

= + Normal Balances Liabilities Equity Assets + - - + - + Normal Debit Credit + - Debit Credit - + Debit Credit - + Normal Balance Normal Balance Normal Balance 23

_ = Normal Balances Profits & Losses - + + - - + Revenues Expenses Profits or Losses Debit Credit Debit Credit Debit Credit - + + - - + Normal Balance Normal Balance Normal Balance 24

But who owns theses profits The Shareholders.

The Shareholders As the shareholders own the profits that are generated, they are shown in the Shareholders Equity. Thus the net balances of the Incomes and Expenses are shown in Shareholders Equity.

Expanding the Rules of Debit and Credit Shareholders Equity _ Profits = Shareholders Capital Expenses = Revenues Debit Credit Debit Credit Debit Credit + - - + - + 27

Profits and Losses ( Incomes & Expenses)‏ Previously we talked about Incomes & Expenses. These result in either a profit or a loss depending on whether the income is greater or less than the expenditures. Therefore the net Profit or loss being owned by the shareholders is shown in the Equity account.

How debits and credits affect the different elements of the accounts. Debit/credit ▲ ▼ Revenue Shareholder Equity Liabilities Expenses Assets Credit Debit Account

Objective 3 Work an actual example 1 1

Lets work Basic Example 1 ( See page 23)‏ The owners invest €100,000 in cash into the business. So what are the double entries?

The Double Entries are: We have to show that the owners (Shareholders) have invested €100,000 into the business. And.. We have to show that the bank account has received €100,000

Assets Increases This represents a Debit entry to an Asset account. So the bank balance has increased by €100,000. Therefore we increase the bank balance by €100,000. So Debit (DR) Bank Account with €100,000

Equity Increases This represents an increase in the Equity account which is a Credit entry. So as the investors have injected €100,000 into the business, we need to increase the Equity account by that sum. So Credit (CR) the Equity account by €100,000.

Bank Account Equity Account Investors 100,000 100,000 Shares

Analysis of Example 1 transaction: Accounts Bank is increasing Equity is increasing CREDIT DEBIT REF DESCRIPTION DATE The Double Entry Jun x Bank Account 100,000 Equity Account 100,000 36

Do the books Balance? YES they DO

Basic Example 2 The company buys a car costing €20,000. It finances this purchase by way of a Bank Loan.

Assets Increases This represents a Debit entry to an Asset account. The company has acquired a car costing €20,000. Therefore we increase the Asset account for Cars by €20,000. So Debit (DR) Cars (Vehicles) Account with €20,000

Liability Increases This represents an increase in the liability account which is a Credit entry. So as the Bank has lent €20,000 to the business, we need to increase the liability account by that sum. So Credit (CR) the Liability (Bank Loan Account) by €20,000.

Vehicle Account Bank Loan Car 20,000 20,000 New Loan

Analysis of Example 2 transaction: Vehicles Account is increasing Bank Loan is increasing CREDIT DEBIT REF DESCRIPTION DATE The Double Entry Jun x Vehicles Account 20,000 Bank Loan 20,000 42

Do the books Balance? YES they DO

Basic Example 3 The company repays €5,000 to the bank to reduce the loan of €20,000 it took out to buy the car.

Assets Decreases This represents a Credit entry to an Asset account. The company has reduce the bank by €5,000. Therefore we decrease the Bank Account by €5,000. So Credit (CR) Bank Account with €5,000

Liability Decreases This represents an decrease in the liability account which is a Debit entry. So as the Bank Loan has been reduced by €5,000, we need to decrease the liability account by that sum. So Debit (DR) the Liability (Bank Loan Account) by €5,000.

Bank Loan Bank Account Repay Loan 5,000 5,000 Repay Loan

Analysis of Example 3 transaction: Accounts Loan is reducing Bank Account is reducing CREDIT DEBIT REF DESCRIPTION DATE The Double Entry Jun x Bank Loan 5,000 Bank Account 5,000 48

Do the books Balance? YES they DO

Basic Example 4 The company buys 20 widgets costing €3,000 each that it will resell (inventories or stocks) with a total value of €60,000 but still owes the supplier for them.

Assets Increases This represents a Debit entry to an Asset account. The company has acquired inventories of goods it will sell costing €60,000. Therefore we increase the Asset account for Inventories by €60,000. So Debit (DR) Inventories Account with €60,000

Liability Increases This represents an increase in the liability account which is a Credit entry. So as the company owes the supplier €60,000, we need to increase the liability account by that sum. So Credit (CR) the Liability (Accounts Payable Account) by €60,000.

Inventories Accounts Payable Widgets 60,000 60,000 Supplier of Widgets

Analysis of Example 4 transaction: Inventories are increasing Accounts Payable is increasing CREDIT DEBIT REF DESCRIPTION DATE The Double Entry Jun x Inventories 60,000 Accounts Payable 60,000 54

Do the books Balance? YES they DO

Basic Example 5 The company sells 6 of the widgets it has to customers for €25,000 allowing 90 days for them to pay for the goods.

Accounts Receivable Sales of Widgets Customer x 25,000 25,000 Sales

Analysis of Example 5 transaction: Accounts Receivable is increasing Sales is increasing CREDIT DEBIT REF DESCRIPTION DATE The Double Entry Jun x Accounts Receivable 25,000 Sales of Widgets 25,000 58

But we need to match income with expenditure….. We have shown the total sales of 6 units but as yet no cost has been matched against this revenue. We need to transfer from inventories the cost of the 6 widgets sold.

Asset Reduces Inventories will be reduced by 6 units at €3,000 = €18,000 So Credit Inventories by $18,000

Inventories We bought 20 widgets We have now sold 6 widgets How many do we have left in inventories? Yes 16. And what is therefore the value of the inventories. Yes 16 * £3000 = £48,000

Expense This is an expense, it will represent a movement in the profit or loss which belongs to the shareholders. As it is an expense, it will be a debit to the Cost of Sales Account. So Debit Cost of Sales Account with €18,000

Cost of Goods Sold Inventories Cost of 6 Widgets 18,000 18,000 Widgets Sold

Further Analysis of Example 5 transaction: Cost of Sales is increasing Inventories are reducing CREDIT DEBIT REF DESCRIPTION DATE The Double Entry Jun x Cost of Goods Sold 18,000 Inventories of Widgets 18,000 64

Do the books Balance? YES they DO

Finally – Basic Example 6 The company receives the telephone bill for the last 3 months for €1,000. It has received…. Not actually paid it!

This is an Expense This represents a Debit entry to the expense account. The company has incurred telephone expense of €1,000. This reduces the profits that the shareholders get. So Debit (DR) Telephone Account with €1,000

Liability Increases This represents an increase in the liability accounts as the telephone company is owed €1,000. So Credit (CR) the Liability (Accounts Payable Account) by €1,000.

Telephone Accounts Payable Phone Bill 1,000 1,000 Phone Co

Analysis of Example 6 transaction: Expense Account – Telephone is increasing Accounts Payable is increasing CREDIT DEBIT REF DESCRIPTION DATE The Double Entry Jun x Telephone Expense 1,000 Accounts Payable 1,000 70

Do the books Balance? YES they DO

Exercise 5.1.4

Share Capital 100,000 Bal 100,000 Bank Account Accounts Payable Car 100,000 5,000 60,000 20,000 1,000 Bal 95,000 Bal 20,000 Bal 61,000 Loan For Car Share Capital Share Capital Inventories 100,000 20,000 60,000 5,000 Bal 100,000 18,000 Bal 42,000 Bal 15,000 Sales of Widgets Cost of Sales Phone Expense 25,000 18,000 1,000 Bal 25,000 Bal 18,000 Bal 1,000 73

Prepare and use a trial balance Objective 5 Prepare and use a trial balance 1 1

Trial Balance List of all accounts with their balances 75

See Page 26

Incomes & Expenditures We have stated that as profits and losses are the property of the shareholders. Then in the Balance Sheet, Incomes & Expenditures are shown in the Equity Account. So the total of all the Income and Expenditure accounts are shown in the Balance Sheet as Equity.

Revenue = Equity Account This represents an increase in the Equity account which is a Credit entry, as this creates profits which belongs to the shareholders. So as the company has generated incomes of €25,000, we need to increase the Equity account by that sum. So Credit (CR) the Equity by €25,000.

Locating Trial Balance Errors What if it doesn’t balance? Is the addition correct? Are all accounts listed? Are the balances listed correctly? 79

Locating Trial Balance Errors Divide the difference by two Is there a debit/credit balance for this amount posted in the wrong column? Divide the difference by 9. If evenly divisible, the error may be a slide or transposition error 80

The bank reconciliation . . . A critical control activity for cash. 81

Study Pack 1

The End… to be continued…..