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In Accountancy , the double-entry bookkeeping (or '''double-entry accounting''') system is the basis of the standard system used by businesses and other organizations to record financial transactions. It was first described by the Italian Mathematician Luca Pacioli , in his ''Summa de arithmetica, geometrica, proportioni et proportionalita'' ( Venice , 1494 ). Its premise is that a business's (or other organization's) financial condition and results of operations are best recorded in '''accounts'''. Each account maintains a "history" of changes in monetary values about a particular aspect of the business. This system is called double-entry because each transaction is recorded in at least two accounts. Each transaction results in at least one account being debited and at least one account being credited, with the total debits of the transaction equal to the total credits. This requirement has a benefit to the bookkeeper, but also introduces confusion to the layman. The benefit is that the accuracy of the accounts can be checked quickly - for, when all the accounts that have debit balance are summed, they should equal the sum of all the accounts which have a credit balance. Without this requirement, there would be no quick means to check accuracy. The confusion arises because a healthy business with money in the bank will have a debit balance in the account called "Bank". This is contrary to the layman's experience that, when the layman's bank balance is healthy, his bank statement shows a credit balance. To understand why the double-entry account called "Bank" is normally in debit, consider the recording of the transaction where the owner of a business contributes cash to the business. The two accounts affected by this transaction are "Bank" and "Capital". Given that the reader can easily accept that the "Capital" account is credited, then applying the double-entry rule that at least one account must be debited, it is clear that the account called "Bank" has to be debited. Note that the terms "debit" and "credit" do not mean that one term is somehow good and the other is somehow bad, or that one is positive and the other is negative. In bookkeeping, debits and credits are simply a way of making an account change. If a business's assets increase, then the relevant asset account is debited. Therefore, if a business receives money, its assets have increased, and so the account called "Bank" is debited. If the money received was because the business had taken out a loan, the account that would be credited is the liability account called "Loan". This latter point demonstrates that when liabilities are increased, the affected liability account is credited. (This also helps explain why the layman's healthy bank statement shows a credit balance, because from the viewpoint of the bank, the layman's account is a liability account. For, each time the layman deposits money to a healthy bank account, the bank's liabilities are increased because the bank now owes the layman more money.) Consider also these two examples, if Business A sells an item for cash to Business B, the bookkeeper of the Business A would credit the account called "Sales" and debit the account called "Bank". Conversely, the bookkeeper of Business B, would debit the account called "Purchases" and credit the account called "Bank". Historically, debit entries have been recorded on the left hand side and credit values on the right hand side of a General Ledger account. The ledger accounts are set up as T Account s so called because they resemble the letter T when the account is empty. HISTORY The origins of a primitive double-entry system have been traced as far back as the 12th century. Some sources suggest that used this system widely. Luca Pacioli , a monk and collaborator of Leonardo Da Vinci , first codified the system in a 1494 mathematics textbook [http://acct.tamu.edu/smith/ethics/pacioli.htm]. Pacioli is often called the "father of accounting" because he was the first to publish a detailed description of the double-entry system, which enabled others to study and use it.[http://home.hetnet.nl/~annejvanderhelm/paper.html] THE BOOKKEEPING AND ACCOUNTING PROCESS In the normal course of business, a document is produced each time a transaction occurs. Sales and purchases usually have Invoices or Receipts . Deposit slips are produced when lodgements (deposits) are made to a Bank Account . Cheques are written to pay money out of the account. Bookkeeping involves recording the details of all of these source documents into multi-column '''journals''' (also known as a '''books of first entry''' or '''daybooks'''). For example, all credit sales are recorded in the Sales Journal, all Cash Payments are recorded in the Cash Payments Journal. Columns in the journal, normally correspond to an account. In the Single Entry System , each transaction is recorded only once. Most individuals who balance their cheque-book each month are using such a system, and most personal finance software follows this approach. After a certain period, typically a month, the columns in each journal are each totalled to give a summary for the period. Using the rules of double entry, these journal summaries are then transferred to their respective accounts in the Ledger , or book of accounts. The process of transferring summaries or individual transactions to the ledger is called '''Posting'''. Once the posting process is complete, accounts kept using the "T" format undergo '''balancing''' which is simply a process to arrive at the balance of the account. To quickly check that the posting process was done correctly, a working document called an unadjusted trial balance is created. In its simplest form, this is a three column list. The first column contains the names of those accounts in the Ledger which have a non-zero balance. If an account has a debit balance, the balance amount is copied into column two (the debit column). If an account has a credit balance, the amount is copied into column three (the credit column). The debit column is then totalled and then the credit column is totalled. The two totals must agree - this agreement is not by chance - it happens because under the double-entry rules, whenever there is a posting, the debits of the posting equal the credits of the posting. If the two totals do not agree therefore, an error has been made in either the journals or made during the posting process. The error(s) must be located and rectified and the totals of debit column and credit column re-calculated to check for agreement before any further processing can take place. Once there are no errors, the accountant produces a number of adjustments and changes the balance amounts of some of the accounts. For example, the "Inventory" account and "Office Supplies" asset accounts are changed to bring them into line with the actual numbers counted during a stocktake. At the same time, the expense accounts associated with usage of inventory and with the usage of office supplies are adjusted. Other refinements necessary to ensure that accounting principles are complied with are also done at this time. This results in a listing called, not surprisingly, the '''adjusted trial balance'''. It is the accounts in this list and their corresponding debit or credit balances that are used to prepare the financial statements. Finally Financial Statements are drawn from the trial balance, which may include:
AN EXPLANATION OF DEBITS AND CREDITS Double-entry bookkeeping is governed by the Accounting Equation . At any point in time, the following (basic) equation must be true: :assets = liabilities + equity This can be further expanded and the (extended) equation becomes: :assets = liabilities + equity + (revenue − expenses) or :assets = liabilities + (capital − drawings) + (revenue − expenses) :A = L + C − D + R − E Finally, the equation may be rearranged Algebra ically as follows: :A + E + D = L + R + C This equation must be true, for any time period. If it is, then the accounts are said to be in balance. If the accounts are not in balance, an error has occurred. For the accounts to remain in balance, a change in one account must be matched with a change in another account. These changes are made by Debits And Credits to the accounts. Note that the usage of these terms in accounting is not identical to their everyday usage. Whether one uses a debit or credit to increase or decrease an account depends on the Normal Balance of the account. Assets, Expenses, and Drawings accounts (on the left side of the equation) have a normal balance of ''debit''. Liability, Revenue, and Capital accounts (on the right side of the equation) have a normal balance of ''credit''. On a General Ledger , debits are recorded on the left side and credits on the right side for each account. Since the accounts must always balance, for each transaction there will be a debit made to one or several accounts and a credit made to one or several accounts. The sum of all debits made in any transaction must equal the sum of all credits made. After a series of transactions, therefore, the sum of all the accounts with a debit balance will equal the sum of all the accounts with a credit balance. Debits and credits are then defined as follows:
The following accounts have a normal balance of debit:
The following accounts have a normal balance of credit:
Examples of debits and credits: Purchase of a Computer Debit = Computer A/c (Fixed '' Asset '' A/c) Credit = Creditors A/c ('' Liability '' A/c) Paying supplier for the computer Debit: Creditors A/c ('' Liability '' A/c) You are reducing a Liability A/c Credit: Bank A/c ('' Asset '' A/c) Money going Out, you are reducing an asset account Credit and debit items are summarised at the end of a recording period in a trial balance which is a list of all the debit and credit balances. The trial balance acts as a self checking mechanism for the correctness of entries in the individual accounts and also as a starting point for the preparation of the Final Account which is made up of the balance sheet and the trading, profit and loss account. The following table summarizes the basic accounts. A "+" indicates an increase; a "−" indicates a decrease. As a mnemonic device for students: Note that only Assets and Expenses show an Increase for Debits and Decrease for Credits. All other accounts are the reverse. First memorize the acronyms AID (Assets Increase Decrease) & EID (Expenses Increase Decrease)and then keep in mind that the table reads Debits on the left and Credits on the right. AN EXPLANATION OF A T ACCOUNT A T account is called such because it looks like the letter "T" when drawn like so: Debit entries are made on the left side of the vertical line and credit entries are made on on the right side of the vertical line. DOUBLE-ENTRY WORKING EXAMPLES Example 1 In this example the following will be used: Books of first entry (a.k.a. Books of prime entry)
Ledger Cards
General Ledger (Nominal Ledger) Bank Account Ledger Trade Creditors Ledger Trade Debtors Ledger From the above we will create:
Purchases/creditors =Purchase invoice daybook Each individual line is posted as follows: The amount value is posted as a credit to the individual supplier's ledger a/c The analysis amount is posted a debit to the relevant general ledger a/c From example above: Line 1 - ''Amount'' value 1000 is posted as a credit to the ''Supplier's'' ledger a/c ELE01-Electricity Company Line 1 - ''Electricity'' value 1000 is posted as a debit to the ''Electricity'' general ledger a/c code Double-entry has been observed Dr = 1000 Cr = 1000 Line 2 - ''Amount'' value 1600 is posted as a credit to the ''Supplier's'' ledger a/c WID01-Widget Company Line 2 - ''Widget'' value 1600 is posted as a debit to the ''Widget'' general ledger a/c code Double-entry has been observed Dr = 1600 Cr = 1600 The totals of each column are posted as follows: ''Amount'' total value 2600 posted as a credit to the ''Trade creditors control a/c'' ''Electricity'' total value 1000 posted as a debit to the ''Profit & loss control a/c'' ''Widget'' total value 1600 posted as a debit to the ''Profit & loss control a/c'' Double-entry has been observed Dr = 2600 Cr = 2600 =Bank payments daybook ''Keys: PI = Purchase Invoice, BP = Bank Payment'' Each indivdual line is posted as follows: The amount value is posted as a debit to the individual supplier's ledger a/c The analysis amount is posted as a credit to the relevant general ledger a/c From example above: Line 1 - ''Amount'' value 1000 is posted as a debit to the ''Supplier's'' ledger a/c ELE01-Electricity Company Line 1 - ''Trade creditors'' value 1000 is posted as a credit to the ''Bank'' general ledger a/c code Double-entry has been observed Dr = 1000 Cr = 1000 Line 2 - ''Amount'' value 900 is posted as a debit to the ''Supplier's'' ledger a/c WID01-Widget Company Line 2 - ''Trade creditors'' value 900 is posted as a credit to the ''Bank'' general ledger a/c code Double-entry has been observed Dr = 900 Cr = 900 Line 3 - ''Amount'' value 400 is posted as a debit to the ''Wages'' general ledger a/c code Line 3 - ''Others'' value 400 is posted as a credit to the ''Bank'' general ledger a/c code Double-entry has been observed Dr = 400 Cr = 400 The totals of each column are posted as follows: ''Amount'' total value 2300 posted as a credit to the ''Profit & loss control a/c'' ''Trade Creditors'' total value 1900 posted as a debit to the ''Trade creditors control a/c'' ''Other'' total value 400 posted as a debit to the ''Wages control a/c'' Double-entry has been observed Dr = 2300 Cr = 2300 The daybooks are the key documents (books) to the double entry system. From these daybooks we create the ledger accounts. Each transaction will be recorded in at least two ledger accounts. =Supplier ledger cards Sales/customers =Sales daybook Each individual line is posted as follows: The amount value is posted as a debit to the individual customer's ledger a/c The analysis amount is posted as a credit to the relevant general ledger a/c From example above: Line 1 - ''Amount'' value 2500 is posted as a debit to the ''Customer's'' ledger a/c JJM01-JJ Manufacturing Line 1 - ''Parts'' value 2500 is posted as a credit to the ''Sales-parts'' general ledger a/c code Double-entry has been observed Dr = 2500 Cr = 2500 Line 2 - ''Amount'' value 3200 is posted as a debit to the ''Customer's'' ledger a/c JJM01-JJ Manufacturing Line 2 - ''Service'' value 3200 is posted as a credit to the ''Sales-service'' general ledger a/c code Double-entry has been observed Dr = 3200 Cr = 3200 The totals of each column are posted as follows: ''Amount'' total value 5700 posted as a debit to the ''Trade debtors control a/c'' ''Sales-parts'' total value 2500 posted as a credit to the ''Profit & loss control a/c'' ''Sales-service'' total value 3200 posted as a credit to the ''Profit & loss control a/c'' Double-entry has been observed Dr = 5700 Cr = 5700 =Bank receipts daybook ''Keys: SI = Sales Invoice, BR = Bank Receipt'' Each indivdual line is posted as follows: The amount value is posted as a credit to the individual customer's ledger a/c The analysis amount is posted as a debit to the relevantgeneral ledger a/c From example above: Line 1 - ''Amount'' value 2500 is posted as a credit to the ''Customer's'' ledger a/c JJM01 - JJ Manufacturing Line 1 - ''Customers'' value 2500 is posted as a debit to the ''Bank'' general ledger a/c code Double-entry has been observed Dr = 2500 Cr = 2500 The totals of each column are posted as follows: ''Amount'' total value 2500 posted as a credit to the ''Trade debtors control a/c'' ''Customers'' total value 2500 posted as a debit to the ''Profit & loss control a/c'' Double-entry has been observed Dr = 2500 Cr = 2500 The daybooks are the key documents (books) to the double entry system. From these daybooks we create the ledger accounts. Each transaction will be recorded in at least two ledger accounts. =Customer ledger cards The customers ledger cards shows the breakdown of how the trade debtors control a/c is made up. The trade debtors control a/c is the total of outstanding debtors and the customer ledger cards shows the amount due for each individual customer. The total of each individual customer account added together should equal the total in the trade debtors control a/c. The supplier ledger cards shows the breakdown of how the trade creditors control a/c is made up. The trade creditors control a/c is the total of outstanding creditors and the suppliers ledger cards shows the amount due for each individual supplier. The total of each individual supplier account added together should equal the total in the trade creditors control a/c. Each Bank a/c shows all the money in and out through a bank. If you have more than one bank account for your company you will have to maintain separate bank account ledger in order to complete bank reconciliation statements and be able to see how much is left in each account. The Bank control a/c keeps the total for all bank accounts. The balance of each individual bank account, when added together, must equal the balance in the bank control a/c. = Bank account = Unadjusted trial balance The individual customer accounts are not to be listed in the trial balance, as the Trade debtors control a/c is the summary of each individual customer a/c. The individual supplier accounts are not to be listed in the trial balance, as the Trade creditors control a/c is the summary of each individual supplier a/c. The individual bank accounts are not to be listed in the trial balance, as the Bank control account is the summary of each individual bank a/c. see note 2 below The profit & loss control account is not to be listed in the trial balance, as the profit & loss control account is a summary of the trial balance. Important notes: 1. This example is designed to show double entry. There are methods of creating a trial balance that significantly reduce the time it takes to record entries in the general ledger and trial balance. 2. In practice it is the norm to list each bank account in the trial balance. This allows you to distinguish between bank accounts which are overdrawn or not and which bank accounts are loans or savings accounts. CLASSIFICATION OF ACCOUNTS A. According to ''Modern approach'', Accounts are classified into five groups: B. According to ''Traditional approach'', Accounts are classified into three groups:
JOURNAL Journal is the book where we record the transaction's entry for first time. for e.g. a)business started with cash. Cash A/C ...Dr To Capital A/C =Adjusted trial balance =Profit-and-loss statement and balance sheet ==Classic format (debits and credits) ==Modern format (list method) Example 2 Transactions XYZ Company is closing its books for the end of the month. Each of the daily journals has been summarized and the amounts are ready to be transferred to the general ledger. The amounts to be transferred are:
To close the books for the month, we will adjust expenses and revenue to be zero by appropriately crediting and debiting the income summary and then closing the income summary to Retained Earnings (part of equity). These items are entered in the ledger below; each matching credit and debit have been numbered to make finding them in the ledger easier. Ledgers The amount in equity (in the form of retained earnings) has changed with a net credit of $500,000. Since equity has a normal balance of credit, this means there is now $500,000 ''more'' in equity than at the beginning of the month. ABBREVIATIONS USED IN BOOKKEEPING A/c or a/c - account c/d - carried down b/d - brought down c/f - carried forward b/f - brought forward Dr - debit Cr - credit P&L - Profit & Loss SEE ALSO EXTERNAL LINKS
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