2.1 The Double Entry System of Book-keeping

The double-entry system is the fundamental principle of accounting. It ensures that every financial transaction affects at least two accounts. This system maintains the accounting equation (Assets = Liabilities + Equity) in balance. It provides a more accurate and reliable record of a business's financial position than single-entry bookkeeping.

Key Concepts

• Debits and Credits: The foundation of the double-entry system. Every transaction has equal debits and credits.
• T-Account: A visual representation of an account, showing debits on one side and credits on the other.
• Ledger Accounts: Detailed records of individual accounts, showing all transactions affecting them.
• Balances: The difference between the total debits and total credits in an account. Accounts typically have either a debit balance or a credit balance.

Debits and Credits: The Rules

Understanding the rules for debits and credits is crucial. Here's a summary:

• Assets: Debits increase assets, Credits decrease assets.
• Liabilities: Debits decrease liabilities, Credits increase liabilities.
• Equity: Debits decrease equity, Credits increase equity.
• Revenue: Debits increase revenue, Credits decrease revenue.
• Expenses: Debits increase expenses, Credits decrease expenses.

The acronym "DEAD COLR" can help remember these rules: Debits increase **E**xpenses, **A**ssets, and **D**ividends; **C**redits increase **O**wners' Equity, **L**iabilities, and **R**evenue.

T-Accounts

A T-account is a simple way to visualize how debits and credits affect an account. Here's an example of a T-account for 'Cash':

Debit	Credit
$	$

Transactions are recorded in the appropriate side of the T-account, maintaining the equality of debits and credits.

Ledger Accounts

Ledger accounts are detailed records of individual accounts. They typically include:

• Account Title
• Date
• Description of the transaction
• Folio (reference to the source document)
• Debit Amount
• Credit Amount
• Balance

Here's an example of a ledger account:

Date	Description	Folio	Debit	Credit	Balance
2023-10-26	Initial Capital	1000		1000	1000
2023-10-27	Cash received from owner	1001	1000	1000	2000
2023-10-28	Rent Expense	1010	50		1950

Interpreting Ledger Account Balances

The balance of a ledger account indicates the net effect of all transactions affecting that account. There are two main types of balances:

• Debit Balance: Occurs when the total debits in an account exceed the total credits. This is common for expenses and some liabilities.
• Credit Balance: Occurs when the total credits in an account exceed the total debits. This is common for equity, revenue, and some assets.

To calculate the balance, you subtract the total credits from the total debits (or vice versa, depending on whether it's a debit or credit balance).

Example:

Consider a ledger account for 'Salaries'. The following transactions have occurred:

• Initial balance: $0
• Debits: $2000
• Credits: $1000

The balance of the 'Salaries' account would be: $2000 - $1000 = $1000 (Debit Balance)

Understanding ledger account balances is essential for analyzing a business's financial performance and position. It allows you to see whether the business is profitable (credit balance for equity) or has a healthy level of debt (credit balance for liabilities).