2.1 The Double Entry System of Book-keeping

The double-entry system is the fundamental principle underlying modern accounting. It ensures that every financial transaction affects at least two accounts. This system maintains the accounting equation (Assets = Liabilities + Equity) in balance.

Core Principles

The core principle of double-entry bookkeeping is that for every debit entry, there must be an equal and corresponding credit entry.

This ensures that the accounting equation remains in balance. The total debits will always equal the total credits.

Key Terms

• Debit (Dr): An entry on the left-hand side of an account. Debits increase the balances of assets, expenses, and drawings, and decrease the balances of liabilities, equity, and revenue.
• Credit (Cr): An entry on the right-hand side of an account. Credits increase the balances of liabilities, equity, and revenue, and decrease the balances of assets, expenses, and drawings.
• T-account: A visual representation of an account, with debits on the left and credits on the right.

The Accounting Equation

The double-entry system is directly linked to the accounting equation:

$$Assets = Liabilities + Equity$$

Every transaction affects at least two accounts, ensuring the equation remains balanced.

How it Works: A Simple Example

Consider a transaction where a business receives £100 cash for goods sold.

1. Increase in Cash (Asset): Cash is an asset, and assets increase with a debit. Therefore, Cash is debited by £100.
2. Increase in Revenue: Revenue increases equity. Therefore, Revenue is credited by £100.

This transaction is recorded in a journal entry, showing the debit and credit amounts.

Table Summarizing Debits and Credits

Account	Debit	Credit
Assets (e.g., Cash, Inventory)	Increase	Decrease
Liabilities (e.g., Accounts Payable)	Decrease	Increase
Equity (e.g., Capital)	Decrease	Increase
Revenue (e.g., Sales)	Decrease	Increase
Expenses (e.g., Rent, Salaries)	Increase	Decrease
Drawings	Increase	Decrease

Journal Entries

Transactions are initially recorded in a journal. A journal entry shows the date, the accounts affected, and the debit and credit amounts.

Example Journal Entry:

Ledger Accounts

After posting from the journal, the information is transferred to ledger accounts. Ledger accounts are individual accounts for each asset, liability, equity, revenue, and expense. They provide a summary of all transactions affecting a particular account.

Advantages of the Double-Entry System

• Accuracy: Ensures that financial records are accurate and balanced.
• Error Detection: Helps to identify errors in bookkeeping.
• Comprehensive Financial Information: Provides a complete picture of the business's financial position.
• Audit Trail: Creates a clear audit trail for financial transactions.