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 provides a more accurate and reliable record of a business's financial position than single-entry bookkeeping.

Understanding the Core Principle

The core principle of double-entry bookkeeping is that for every debit entry, there must be an equal and corresponding credit entry. This maintains the accounting equation: Assets = Liabilities + Equity.

This system ensures that the accounting equation always remains in balance.

Debits and Credits

Debit (Dr)

Debits are typically recorded on the left-hand side of an account.

The effect of a debit depends on the type of account:

• Assets: Debits increase assets (e.g., cash, inventory, equipment).
• Liabilities: Debits decrease liabilities (e.g., loans, accounts payable).
• Equity: Debits decrease equity (e.g., retained earnings, capital).
• Revenue: Debits have no effect on revenue accounts.
• Expenses: Debits increase expenses (e.g., rent, salaries, utilities).

Credit (Cr)

Credits are typically recorded on the right-hand side of an account.

The effect of a credit depends on the type of account:

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

The Accounting Equation and Double Entry

The double-entry system always ensures that the total debits equal the total credits for each transaction.

Consider a simple transaction: A business receives £1,000 cash from a customer for goods sold.

This transaction will involve a debit to the cash account (an increase in assets) and a credit to the sales revenue account (an increase in revenue). The total debits (£1,000) will equal the total credits (£1,000), maintaining the accounting equation.

Chart of Accounts

A chart of accounts is a list of all the accounts used by a business to record its financial transactions. It provides a structured framework for organizing financial data.

Account Name	Account Type
Cash at Bank	Asset
Inventory	Asset
Accounts Receivable	Asset
Equipment	Asset
Accounts Payable	Liability
Loan from Bank	Liability
Capital	Equity
Sales Revenue	Revenue
Rent Expense	Expense
Salaries Expense	Expense

Journal Entries

A journal is the book of original entry. It's where all financial transactions are initially recorded in chronological order, using the double-entry system. Each entry shows the date, the accounts affected, and the debit and credit amounts.

A typical journal entry includes:

• Date of the transaction
• Name of the accounts to be debited
• Amount to be debited
• Name of the accounts to be credited
• Amount to be credited
• A brief description of the transaction

Example Journal Entry:

Date: 2024-01-26

Account: Cash at Bank

Dr £1,000

Account: Sales Revenue

Cr £1,000

Description: Received cash from customer for goods sold.

Trial Balance

A trial balance is a list of all the accounts and their balances at a specific point in time. It's prepared to check whether the total debits equal the total credits in the ledger. If they don't, it indicates an error in the bookkeeping.

The trial balance is typically prepared at the end of an accounting period.

Advantages of the Double-Entry System

• Accuracy: Reduces the risk of errors as every transaction is recorded in two accounts.
• Reliability: Provides a more reliable basis for financial reporting.
• Completeness: Ensures that all transactions are recorded.
• Error Detection: Makes it easier to detect errors.
• Financial Reporting: Provides the necessary information for preparing accurate financial statements (e.g., income statement, balance sheet).