2.1 The double entry system of book-keeping
You do not need to explain or use folio columns.
Outline of the Double Entry System of Book-keeping
The double entry system is a fundamental accounting principle that ensures accurate recording of financial transactions. It involves recording each transaction in at least two different accounts: a debit entry and a corresponding credit entry. This system helps maintain the balance between assets, liabilities, and equity.
Example:
Consider a business that purchases inventory on credit (pay later):
|
Debit (Dr) |
Credit (Cr) |
|
Inventory (increases
asset) |
Trade Payable (increases
liability) |
|
|
Process
Accounting Data using The Double
Entry System
|
Identify Transactions: Record each financial transaction with its date and description.
Analyze Transactions: Determine which accounts are affected and how (asset, liability, equity, revenue, expense).
Record Entries: Make entries in the respective accounts—debit one account and credit another.
Example: On January 1, ABC Ltd. receives cash for services rendered:
|
Debit (Dr) |
Credit (Cr) |
|
Cash (increases asset) |
Service Revenue
(increases revenue) |
Prepare Ledger Accounts
Ledger accounts are individual records that summarize transactions related to a specific account. They provide detailed information about changes to each account over time.
Example:
Cash Account Ledger:
| Date | Description | Debit | Credit | Balance |
|---|---|---|---|---|
| 2023-01-01 | To balance b/d | 2000 | 2000 | |
| 2023-01-05 | Sales | 500 | 1500 |
Post Transactions to Ledger Accounts
Posting involves transferring the information from the journal to the respective ledger accounts. Each entry in the journal has corresponding entries in the respective debit and credit columns of the ledger accounts.
Example:
From the journal:
- Cash A/C Dr 2000
- Sales A/C Cr 500
Post to Cash Account:
- Debit Cash: 2000
- Credit Sales: 500
Balance Ledger Accounts and Transfer to Financial Statements
Balancing ledger accounts involves calculating the net balance (debit or credit) for each account. These balances are then transferred to financial statements like the statement of profit or loss and statement of financial position.
Example:
Balance Sheet
| Accounts | Debit (DR) | Credit (CR) |
|---|---|---|
| Cash | 1500 | |
| Sales | 500 |
Interpret Ledger Accounts and Their Balances
Interpreting ledger accounts helps understand the financial position of a business. Each account’s balance indicates whether it has a debit or credit balance, impacting financial statements and decision-making.
Example:
A credit balance in the sales account indicates total sales revenue earned during the accounting period.
Division of the Ledger into Sales Ledger, Purchases Ledger, and Nominal Ledger
Ledgers are often divided into specialized categories:
- Sales Ledger: Accounts receivable from credit sales.
- Purchases Ledger: Accounts payable for credit purchases.
- Nominal (General) Ledger: All other accounts (revenue, expense, equity, etc.).
Example:
Separating these ledgers helps in efficient management and reporting of specific types of transactions.
Past Paper Questions with Answers
Question: Explain the double entry system of book-keeping and provide an example.
Answer: The double entry system requires every business transaction to be recorded with at least two entries: a debit and a credit. For instance, when a business receives cash from sales, cash (an asset) increases (debit), and sales revenue (equity) also increases (credit).
