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Double Entry Bookkeeping
Accounting I Double Entry Bookkeeping
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Dr. Clive Vlieland-Boddy FCA FCCA MBA Barcelona 2009
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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..
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History & Reasons Invented over 500 years ago.
It was created to ensure that all entries are correctly and accurately recorded.
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Objective 1 What is Double Entry Bookkeeping 1 1
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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.
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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
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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.
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Objective 2 The “T” Account 1 1
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T-Account Simple tool for analysing and determining the balance in a given account Account Name (Left Side) Debit (Right Side) Credit 10
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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
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Debits Assets Bank Receipts Expenditures Losses
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Credits Liabilities Bank Payments Shareholders Funds Incomes (Sales)
Profits
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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
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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.
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Asset Accounts ______________________________________
Debits: Increase I Credits : Reduce Assets I Assets
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Liability Accounts ______________________________________
Debits: Reduce I Credits : Increase Liabilities I Liabilities
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Equity Accounts ______________________________________
Debits: Reduce I Credits : Increase Equity I Equity
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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.
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Income Accounts _____________________________________
Debits: Reduce I Credits : Increase Incomes I Incomes
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Expense Accounts _____________________________________
Debits: Increases I Credits: Decrease Expenditure I Expenditure
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Rules of Debit and Credit
Liabilities Equity = + Debit Credit Debit Credit Assets 22
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= + Normal Balances Liabilities Equity Assets + - - + - + Normal
Debit Credit Debit Credit Debit Credit Normal Balance Normal Balance Normal Balance 23
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_ = Normal Balances Profits & Losses - + + - - + Revenues Expenses
Profits or Losses Debit Credit Debit Credit Debit Credit Normal Balance Normal Balance Normal Balance 24
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But who owns theses profits
The Shareholders.
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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.
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Expanding the Rules of Debit and Credit
Shareholders Equity _ Profits = Shareholders Capital Expenses = Revenues Debit Credit Debit Credit Debit Credit 27
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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.
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How debits and credits affect the different elements of the accounts.
Debit/credit ▲ ▼ Revenue Shareholder Equity Liabilities Expenses Assets Credit Debit Account
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Objective 3 Work an actual example 1 1
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Lets work Basic Example 1 ( See page 23)
The owners invest €100,000 in cash into the business. So what are the double entries?
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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
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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
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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.
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Bank Account Equity Account Investors 100,000 100,000 Shares
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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
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Do the books Balance? YES they DO
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Basic Example 2 The company buys a car costing €20,000.
It finances this purchase by way of a Bank Loan.
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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
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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.
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Vehicle Account Bank Loan Car ,000 20,000 New Loan
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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
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Do the books Balance? YES they DO
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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.
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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
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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.
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Bank Loan Bank Account Repay Loan 5,000 5,000 Repay Loan
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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
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Do the books Balance? YES they DO
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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.
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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
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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.
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Inventories Accounts Payable Widgets ,000 60,000 Supplier of Widgets
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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
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Do the books Balance? YES they DO
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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.
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Accounts Receivable Sales of Widgets Customer x 25,000 25,000 Sales
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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
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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.
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Asset Reduces Inventories will be reduced by 6 units at €3,000 = €18,000 So Credit Inventories by $18,000
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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
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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
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Cost of Goods Sold Inventories Cost of 6 Widgets 18,000
18,000 Widgets Sold
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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
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Do the books Balance? YES they DO
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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!
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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
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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.
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Telephone Accounts Payable Phone Bill ,000 1,000 Phone Co
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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 ,000 Accounts Payable 1,000 70
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Do the books Balance? YES they DO
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Exercise 5.1.4
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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
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Prepare and use a trial balance
Objective 5 Prepare and use a trial balance 1 1
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Trial Balance List of all accounts with their balances 75
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See Page 26
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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.
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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.
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Locating Trial Balance Errors
What if it doesn’t balance? Is the addition correct? Are all accounts listed? Are the balances listed correctly? 79
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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
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The bank reconciliation . . .
A critical control activity for cash. 81
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Study Pack 1
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The End… to be continued…..
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