Learn Double Entry Book Keeping from ACCA Subject Specialist Thomas Henry John Clendon

Learn Double Entry Book Keeping from ACCA Subject Specialist Thomas Henry John Clendon

Double-entry bookkeeping by Tom Clendon

No topic is more essential to passing Paper F3 than double-entry bookkeeping. Having an understanding of double entry can only assist your studies. I think part of the trouble is that most double-entry book keeping systems are computerised so there are fewer and fewer people who actually write up the books of account. However, the nature of professional accounting exams is that students are expected to be familiar with the principles of double-entry book keeping even if it is not something they have to do on a daily basis at work.

Computerisation

The double-entry bookkeeping system is well suited to computerisation because the initial capturing of volumes of repetitive data and the day-to-day recording of transactions involves the application of a set of rules; the subjective exercise of judgement in the determination of profit comes later. The computer system is able to post and balance all the accounts and produce a trial balance, i.e. a listing of all the balances in the accounts in the ledger. Accounting becomes more interesting when the statement of profit or loss and the statement of financial position have to be prepared. At this stage decisions have to be made regarding the selection of accounting policies and an understanding is required as to how these affect the measurement of profit and reporting of assets and liabilities. If double-entry booking can be computerised then it must be capable of being reduced down to a set of rules to follow.

Books of prime entry

Repetitive transactions may initially be captured in day books (also known as books of prime entry), e.g. all the sales invoices may be listed in the sales day book (also known as the sales journal). These day books are not part of the double-entry system but enable the number of double-entries to be reduced by ascertaining an aggregate. The total of the day book, or the single transaction, is recorded in the double-entry system by being posted to the accounts.

The T accounts

Each account (or T account) has two sides, the left hand side of which is called the debit side (DR) and the right hand side of which is called the credit side (CR). A T account looks like this

    Title of the account    
             
Date Narrative $   Date Narrative $
             
  Debit side (DR)       Credit side (CR)  
             
             

The date refers to the date the transaction is recorded. The narrative states where the double entry is posted. Transactions can only be recorded if they have a reliable measurement.

There is no limit to the number of accounts that can be opened or any restriction on their names. Accounts are normally opened for each asset and each liability (or class thereof), and one for each type of expense and income. In addition there will equity accounts, which in the context of a sole trader is known as the capital account. Capital (equity) represents the proprietary interest in the net assets of the business. It is created when the owner introduces resources into the business entity and increases when the business generates a profit. The business is recorded as a distinct entity from its owners (the entity concept). Of course, only transactions capable of being measured objectively in monetary terms can be recorded (this is known as the money measurement concept).

The double-entry rules

To record entries in a double-entry system there are two rules to learn. They require little understanding but by practice can become automatically applied without thinking.

Rule 1. The duality rule.

Every transaction has two effects, one of which will be recorded as a debit in one account and the other which will be recorded as a credit in another account. If this rule is broken, the trial balance will not agree. For example the two effect of charging depreciation are to record an expense and to record the reduction in an asset. The two effects of a trade receivable settling their account is to increase the asset of cash and to reduce the asset of trade receivable.

Rule 2. The when to Debit and when to Credit rule.

The rules as to when to debit a T account and when to credit a T account can be summarised in the following table.

  Increase Decrease
     

Asset

Expenses

Debit (Dr) Credit (Cr)
     

Liability

Income

Capital

Credit (Cr) Debit (Dr)
     
     

The DR/CR table is logical in its construction once you accept that when the effect of a transaction is to increase an asset the entry to be posted to the asset account is a debit (e.g. when asset is recorded e.g. a trade receivable is debited on the sale of goods where the customer will pay later).  On that basis then any decrease in an asset account is a credit to the asset account.

Further as a liability is the opposite of an asset so it is appropriate that it behaves in the opposite way, i.e. that to record an increase in a liability, the entry to be posted to the liability account is a credit.

As income is the opposite of expenses so it is appropriate that it behaves in the opposite way to expenses i.e. that to record income (e.g. revenue) is to record a credit in the income account.

Expenses behave in the same way as asset accounts. This is because both will be recorded when they are paid for or a liability incurred.

Capital behaves in the same way as a liability as it represents the owner’s interest and can be thought of as a liability that the business entity has to its owners.

Application of the double entry rules

So when it comes to recording the debit and credit of a transaction it is first necessary to identify the two impacts that each transaction has and whether each impact is causing an increase or a decrease.

Example 1 - Land is bought for cash, $80,000.

The two effects of this transaction are to increase the asset of land account and to decrease the asset of cash account.

When applying the DR/CR rules, to reflect the increase in the asset of land by recording a debit in the land account and to reflect the decrease in the asset of cash by a credit in the cash account.

Dr Land account $80,000  
Cr Cash account   $80,000

Example 2 – Plant suffers an impairment loss, $20,000.

The two effects are to increase the expense of impairment loss and to decrease the asset of Plant.

When applying the DR/CR rules, to reflect the increase in the expense of impairment loss by recording a debit in the impairment loss account and to reflect the decrease in the asset of plant by recording a credit in the plant account.

Dr Impairment loss account $20,000  
Cr Plant account   $20,000

Example 3 – A trade payable is paid in cash, $10,000.

The two effects are to decrease the liability of trade payable and to decrease the asset of cash.

When applying the DR/CR rules, to reflect the decrease in the liability of trade payable by recording a debit in the trade payable account and to reflect the decrease in the asset of cash by recording a credit in the cash account.

Dr Trade payable account $10,000  
Cr Cash account   $10,000

Conclusion

To gain a proficiency in double-entry bookkeeping requires a lot of practice but is very useful both in your studies and in the work place as all accounting issues (however complex) can be explained and boiled down to the debit and the credit.

Tom Clendon FCCA is a senior lecturer at FTMS, is based in Singapore and teaches across SE Asia. He is the author of “a student’s guide to group accounts” published by Kaplan which is now in its second edition. His articles are regularly published in professional journals. He runs a popular Facebook page for students called Tom Clendon Lecturer.

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