1 ACCOUNTANCY AN UNDERSTANDING OF DOUBLE ENTRY SYSTEM By: Jean Paul Ndindamahina In accounting especially in book keeping, there are three main financial function on which accountant must be competent at and that is recording, analyzing and summarizing financial transactions. Double entry book system is widely used in book keeping and the double entry system is the main part of accounting. Double entry system has two sides: left side and right side. Left side is called Debit which is short written as DR and right side called Credit which is short written as CR. It is indeed that accountant main role is to be able to identify what financial transaction is DR and Cr. Making the right judgment about Dr and CR will enable true transparent in preparation of financial statement such as Balance Sheet (BS) which is referred sometimes as Statement of Financial Position (SOFP) or Statement of Profit and Income (SOPI) in another words Income statement. Financial transaction has to be recorded in the prime entry documents (account ledgers) before analyzing and summarizing them. Recording financial transaction is what involves the double entry book keeping where double entry system skills come to work. Double entry system can look like magic if you are not familiar with the principles and techniques used to record certain transactions. For example if I tell you that as a business owner I bought 3 computers in cash for 2000 and I recorded this transaction as follows: Dr Computers as Noncurrent Asset 2000 Cr Cash as current asset 2000
2 For any person who does not understand the principles, concept and techniques of double entry system will be seeing the above financial record as true magic or a guess from nowhere. The good thing about accounting is that as an accountant, you never guess, you have to be sure of what you are doing in order to avoid errors. Making errors in recording financial transaction can lead to mismanagement of cash flow, fraud and inadequate management decision as management decision is based on financial information provided by the accountant hence profitability of an organization can be affected as well by the way the way the financial transactions are recorded. It is therefore very important for an accountant to be able to identify accounting transaction and be able to record them accurately. Financial transaction will be identified through books of prime entry which are the main source that accountant will need to refer to in seeking evidence or proof of the occurrence of financial transaction or event. The proof of fiancé occurrence can be receipt, invoice, debit note and remittance advice. After identifying that financial transaction has taken place, then it will be the time to record this financial transaction in question. Double entry system concept Accounting is an amazing language which is very important to business. Accounting is a business language which has rules to follow and these rules need knowledge in hand.in accounting, it is normal that every debit has its corresponding credit. Many people wonder how it is possible that every Credit has its corresponding debit. But, what is surprising, it is that in everyday life, everyone uses this concept. Dr and Cr concept is a concept which is used in everyday life not only in business but also in our everyday life. For example, say that you live in a rented flat, your landlord told you that you owe him one month rent equivalent to 500
3 which you need to pay in cash. The first time you see this chasing letter telling you when and how you need to pay, you think two things: Your money whether in a bank account and the money you owe your landlord. You also think what will happen if you pay the debt. You think how your cash balance in your pocket or in bank account is going to decrease because of you paying the landlord. You may think also how it would be good for you to clear the debt. You can now see that you have two things in mind: Cash and Debt. It can be emphasized that either Cash or debt none is increasing. The transaction event to pay the land lord will see both debt and cash decreasing. You can now draw the logic behind this scenario of landlord asking payment. You will have to pay the landlord which you consider as expense but the money you spend on that expenses will have to come from your income. You now have two concept: Dr(income) and Credit (expenses). The simple way to understand the concept is every transaction has its main source. For example if you buy computers where come from the money to pay for the computers? That double thinking is what we identify in accounting as Debit and credit. For example, a carpenter buys computer for business use and he pays in cash. Computer is noncurrent asset for the business but we recognize also the cash spent in purchasing that computer. This kind of thinking is what will lead you identifies what transaction is on debit side and what transaction is credit side. The good thing is, for to be able to achieve a successful financial recording in double entry system, there are principles for you to follow all the way. Double Entry System Principles
4 In Business, there are five financial statements. That is Cash flow statement, Income statement (IS)sometimes called Statement of profit and income (SOPI), Balance Sheet(BS) sometimes referred as Statement of Financial position (SOFP), Equity statement and Director s notes. In this instance, we will ignore cash flow statement, Directors notes as this statement are irrelevant to double book keeping entry system. However, without competence of double entry system, Cash flow can not reflect the truth as Cash flow depends on accuracy of how financial transactions are recorded. Therefore let us see how double entry system is performed on BS and IS. Balance sheet Balance sheet is a snap shot of financial position in an organization. Balance sheet has two elements: Asset and liability which both have two types: current asset and noncurrent asset, current liability and noncurrent liability. Those elements of balance sheet are used in double entry system. Let us look on each of them. Current Asset: current assets are what company owns and they are no current asset when there are intended to be used for more than twelve months. Noncurrent assets are anything which is used to aid the ongoing business operation for more than 12 months when the asset is for trading purpose and is intended to be sold within 12 months period then it is said to be current asset. There is a rule which states that when you purchase a noncurrent asset you debit the asset when you sell the noncurrent asset you credit. This rule applies to current asset as well. In simple way when there is an increase in noncurrent asset you debit and when the noncurrent asset decreases you credit.
5 For example: If a company purchase 2 delivery vans and pay 22,000 the transaction will be recorded as follow: Dr 2 delivery vans 22,000 and Cr Cash 22,000 2 delivery vans have been debited because it is an increase in asset and cash (Current asset) is an asset which we used to pay for the delivery vans which resulted in this current asset decreasing therefore we need to credit the cash because it is a decreasing in an asset. Liability: Liability is everything that a company owes or anything that the company has to pay back. Liabilities which are to be paid in long term over one year are said to be noncurrent liability and those in short term less than one year are said to be current liability. In accounting, there is a rule which states that when liability decreases you debit and when liability increases you credit. In simple way, a decrease in liability result in recording transaction in debit side and increase in liability results in recording the transaction in Credit side. An accountant must know that when the liability decreases then it is Dr and when liability increases it is a Cr. For example: The company has borrowed 100,000 from the creditors to buy machinery and this loan has to be paid in 5 years time. This transaction will be recorded as follow: Dr Machinery (noncurrent asset) 10,000 and CR Payable to creditors (non current liability) 100,000 Another example; let us say that a company purchases 5 computers on credit for 3000 then this transaction will be recorded as follows DR 5 Computers (noncurrent asset) 3000 and Cr payable to creditors (current liability) 3000
6 Then you may wonder what will happen when the company pays creditor. For example let us say that 3000 is paid then the transaction will be recorded as follow: DR payable to Creditor (Current liability) 3000 and CR Trade debtors (current asset) 3,000 Income Statement Income statement is the financial statement which shows the profitability of the company. If expenses are greater than income then it is a loss but if income is greater than expenses it is profit. Therefore, Income statement has two components which are Income and expenses. Income is any gain by an organization within a specified time frame. In accounting world this time is called accounting period which varies from company to another. Expenses are an out flow of money from an organization in purposes to pay for goods and services. Both income and expenses are expressed in monetary terms. In double entry system income and expenses are used to determine Dr and Cr transactions. There is one rule which says that when income decreases it is a Dr and when income increases it is a Cr but when expenses decreases it is Cr and when expenses increases it is Dr. For example: the company pays rent of 4000 in cash Dr Cash Payable (Current liability) 4000 and CR Rent (expenses) 4,000 In above example we credited rent as an expense because expenses have been reduced by paying an owed amount of rent and we debit cash payable because liability has been reduced.
7 You can see that knowing the impact of one transaction is very important in double entry system. For example: the company which sells cars has sold 40 cars on credit for 400,000. This transaction will be recorded in the following way: Dr Receivable (Current asset) 400,000 and Cr Income 400,000 Based on principles of Income statement and balance sheet, you can record any transaction come on your way using double entry system. All you have to remember is that when asset increases it is Dr When asset decreases it is Cr and increase in liability is Cr and decrease in Liability is Dr. You must remember and be able to differentiates what is current asset and noncurrent asset, current liability and noncurrent liability from the balance sheet in order for you to make a correct narration of the recorded transaction. You also have to be comfortable with income statement in order to know what can be classified as an income and what can be classified as an expense. You also need to remember that when there is a decrease in income it is Dr and when there is increase in income it is Cr but when expenses decrease it is Cr and when expenses increase it is Dr. If the principle is easy for you to remember that means that double entry system will be easy for you to perform and from this principles above you can do trial balance using Dr and Cr, Journals and T accounts easily. TECHNIQUES Double entry for the balance sheet can be memorized using the following techniques
8 And the double entry for the income statement can be memorized using the following techniques For the trial balance under DR and Cr, it will be a must to remember the equation of accounting which states that Asset= Liability +equity We know that asset can be current and noncurrent asset and liability can be current or noncurrent liability. In this way when preparing Trial balance we DR asset and we credit liability and equity. Remember that in every circumstance, Dr must be equal to Cr
9 DR = CR CURRENT ASSET + NO CURRENT ASSET = CURRENT LIABILITY +NO CURRENT LIABILITY+EQUITY CASH + NONCURRENT ASSET + RECEIVABLE = CAPITAL + PAYABLES + REVENUES (EXPENSES) Example: ND Ltd is a company which makes a plastic basket. The company started with a capital of 115,440.It made a purchase of law material equivalent to 96,250 and sold 300 plastic baskets for 146,390. However 30 plastic baskets were damaged and credit note were issued worth 8,500. The company paid 10,240 and employees salary was 28,980. The bill for the telephone was 3,020. The company incurred interest charge for its bank loan of 2,350. There was also travel expense 1,045 and the company made overdraft of 1050. The company bought new premises for 125,000 and borrowed from creditors 12495 and loan from the bank was 20,000. The company s debt was 10, 390. There was 150 in cash and the company made drawings of 9,450. If you are asked to record these transactions under double entry system then you will need to use the above techniques. By using the accounting equation to record financial transaction, you will see that every transaction is recorded twice. Hence the solution to the above example will be as follow:
10 DR CR Accounts Revenue Cash Asset Receivable Payables Capital (Expenses) 150 150 96,250 96,250 146,390 146,390-28,980-28,980-10,240-10,240-3,020-3,020-2,350-2,350-1,045-1,045 1,050 1,050 12,495 12,495 20,000 20,000-8,500 125,000 125,000-8,500-10,390-10,390 115,440 115,440-9,450-9,450 221,550 221250 222055 135,590 85155 442,800 Total 442,800
11 However there are other techniques you can use to balance DR and Cr without the need to use double entry book keeping therefore the recorded transactions in previous example will look like this: DR CR Description Description Materials 96250 Sales 146,390 Sale return 8500 Bank overdraft 1050 Wages 28,980 Creditors 12495 Admin. expenses 10,240 Loan 20,000 Interest paid 2,350 Capital 115,440 Travel expense 1,045 Telephone 3,020 Premises 125,000 Debtors 10,390 Cash 150 Drawings 9450 Total 295,375 Total 295,375 That is the only hint how Double entry system can be performed. If you have any suggestion then writes to me on Info@ndindamahina-finance.co.uk